**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-QSB**

** **
| x                                    |   | **QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE** |
|--------------------------------------|--------|----------------------------------------------------------------------------|
|                                 |   | **ACT OF 1934**                                                            |
|                                 |   |                                                                       |
| ** **                           |   | **For the  quarterly period ended June 30, 2006**                          |
| ** **                           |   | ** **                                                                 |
| o                                    |   | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF  THE EXCHANGE ACT**       |
|                                 |   |                                                                       |
| **Commission  file number: 0-31152** |
|                                 |

** **

**CRDENTIA CORP.**

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

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

** **

**5001 LBJFreeway, Suite 850, Dallas, Texas 75244**(Address of principal executive offices)

**(972)850-0780**(Issuer’s telephone number)

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x  No o

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

State the numberof shares outstanding of each of the issuer’s classes of common equity, as ofthe latest practicable date.  AtAugust  9, 2006, 14,329,960 shares of common stock, $.0001 par value, wereoutstanding.

Transitional SmallBusiness Disclosure Format (check one): Yes o  No x

 

 

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**CRDENTIA CORP.**

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

**Table of Contents**

 
|                                          | ** ** | ** **                                                                                                           | ** ** | **Page**   |
|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                               | ** ** | ** **                                                                                                           | ** ** | ** ** |
| **PART  I — FINANCIAL INFORMATION** |       | 3                                                                                                                    |
| ** **                               | ** ** | ** **                                                                                                           | ** ** | ** ** |
| Item 1.                                  |       | Financial Statements                                                                                                 |       | 3          |
|                                     |       |                                                                                                                 |       |       |
|                                     |       | Unaudited Condensed Consolidated Balance Sheets at  June 30, 2006 and December 31, 2005                              |       | 3          |
|                                     |       |                                                                                                                 |       |       |
|                                     |       | Unaudited Condensed Consolidated Statements of  Operations for the Three and Six Months Ended June 30, 2006 and 2005 |       | 4          |
|                                     |       |                                                                                                                 |       |       |
|                                     |       | Unaudited Condensed Consolidated Statements of Cash  Flows for the Six Months Ended June 30, 2006 and 2005           |       | 5          |
|                                     |       |                                                                                                                 |       |       |
|                                     |       | Notes to Unaudited Condensed Consolidated Financial  Statements                                                      |       | 6          |
|                                     |       |                                                                                                                 |       |       |
| Item 2.                                  |       | Management’s Discussion and Analysis or Plan of  Operation                                                      |       | 17         |
|                                     |       |                                                                                                                 |       |       |
| Item 3.                                  |       | Controls and Procedures                                                                                              |       | 33         |
|                                     |       |                                                                                                                 |       |       |
| **PART  II — OTHER INFORMATION**    |       | 34                                                                                                                   |
| ** **                               | ** ** | ** **                                                                                                           | ** ** | ** ** |
| Item  1.                                 |       | Legal  Proceedings                                                                                                   |       | 34         |
|                                     |       |                                                                                                                 |       |       |
| Item 2.                                  |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                         |       | 34         |
|                                     |       |                                                                                                                 |       |       |
| Item 3.                                  |       | Defaults Upon Senior Securities                                                                                      |       | 34         |
|                                     |       |                                                                                                                 |       |       |
| Item 4.                                  |       | Submission of Matters to a Vote of Security Holders                                                                  |       | 34         |
|                                     |       |                                                                                                                 |       |       |
| Item  5.                                 |       | Other  Information                                                                                                   |       | 34         |
|                                     |       |                                                                                                                 |       |       |
| Item 6.                                  |       | Exhibits                                                                                                             |       | 34         |
|                                     |       |                                                                                                                 |       |       |
| **SIGNATURES**                           |       | 37                                                                                                                   |

 

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**PART 1. FINANCIAL INFORMATION**

**Item 1. UnauditedCondensed Consolidated Financial Statements**

**CRDENTIA CORP.Unaudited Condensed Consolidated Balance Sheets**
| ** **                                                                                                                                                                                                                                 | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Current assets:                                                                                                                                                                                                                            |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                  |       | $                       | 111,526    |                        | $          | 434,921 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $207,771 at June 30, 2006 and $275,000 at December 31, 2005                                                                                                           |       | 5,630,000               |       | 4,566,975                   |       |
| Unbilled receivables                                                                                                                                                                                                                       |       | 740,743                 |       | 625,899                     |       |
| Other current assets                                                                                                                                                                                                                       |       | 641,302                 |       | 464,865                     |       |
| Total current assets                                                                                                                                                                                                                       |       | 7,123,571               |       | 6,092,660                   |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Property and  equipment, net                                                                                                                                                                                                               |       | 460,165                 |       | 418,837                     |       |
| Goodwill                                                                                                                                                                                                                                   |       | 24,532,476              |       | 22,977,377                  |       |
| Intangible  assets, net                                                                                                                                                                                                                    |       | 1,972,732               |       | 1,985,585                   |       |
| Other assets                                                                                                                                                                                                                               |       | 867,939                 |       | 518,001                     |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total assets                                                                                                                                                                                                                               |       | $                       | 34,956,883 |                        | $          | 31,992,460 |   |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Revolving lines of credit                                                                                                                                                                                                                  |       | $                       | 5,131,323  |                        | $          | 4,672,096 |   |
| Accounts payable and accrued expenses                                                                                                                                                                                                      |       | 1,945,818               |       | 1,447,905                   |       |
| Accrued dividends on convertible preferred stock                                                                                                                                                                                           |       | —                  |       | 800,748                     |       |
| Accrued employee compensation and benefits                                                                                                                                                                                                 |       | 1,059,189               |       | 980,005                     |       |
| Debentures, net of discount of $1,450,003                                                                                                                                                                                                  |       | 289,997                 |       | —                      |       |
| Notes payable                                                                                                                                                                                                                              |       | 1,410,000               |       | 3,215,490                   |       |
| Current portion of notes payable to lender, net of  discount of $140,150 at June 30, 2006 and $200,168 at December 31, 2005                                                                                                           |       | 907,651                 |       | 1,147,634                   |       |
| Other current liabilities                                                                                                                                                                                                                  |       | 190,723                 |       | 321,963                     |       |
| Total current  liabilities                                                                                                                                                                                                                 |       | 10,934,701              |       | 12,585,841                  |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Note payable to  lender, less current portion, net of discount of $200,167                                                                                                                                                                 |       | —                  |       | 1,149,833                   |       |
| Long term bonus  payable                                                                                                                                                                                                                   |       | 850,996                 |       | 801,084                     |       |
| Other long-term  liabilities                                                                                                                                                                                                               |       | 7,032                   |       | 7,032                       |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total  liabilities                                                                                                                                                                                                                         |       | 11,792,729              |       | 14,543,790                  |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Commitments and  contingencies                                                                                                                                                                                                             |       |                    |       |                        |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Convertible preferred  stock, 10,000,000 shares authorized:                                                                                                                                                                                |       |                    |       |                        |       |
| Series C convertible preferred stock $0.0001  par value, 183,028 shares issued and outstanding at December 31, 2005 (liquidation  preference of $54,908,400 at December 31, 2005)                                           |       | —                  |       | 10,020,048                  |       |
| Series C preferred stock warrants                                                                                                                                                                                                     |       | —                  |       | 839,555                     |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                                 |       |                    |       |                        |       |
| Common stock, par value $0.0001, 150,000,000 shares  authorized, 14,437,601 shares issued and 14,329,966 shares outstanding at  June 30, 2006 and 3,515,766 shares issued and 3,408,125 shares  outstanding at December 31, 2005 |       | 1,444                   |       | 352                         |       |
| Additional paid in capital                                                                                                                                                                                                                 |       | 126,286,828             |       | 109,802,174                 |       |
| Treasury stock, 107,641 shares at cost                                                                                                                                                                                                     |       | —                  |       | —                      |       |
| Accumulated deficit                                                                                                                                                                                                                        |       | (103,124,118            | )          | (103,213,459                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                           |       | 23,164,154              |       | 6,589,067                   |       |
|                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                           |       | $                       | 34,956,883 |                        | $          | 31,992,460 |   |

 

The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.

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**CRDENTIA CORP.Unaudited Condensed Consolidated Statements of Operations**
| ** **                                                                   | ** ** | **Three Months Ended June 30,** | ** **  | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|-------------|---------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                            | ** **  | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Revenue from  services                                                       |       | $                                                   | 11,312,679  |                                              | $          | 9,207,508 |   | $ | 20,297,502 |   | $ | 14,329,821 |   |
| Direct operating  expenses                                                   |       | 8,964,495                                           |        | 7,110,117                                         |       | 16,200,014 |   | 11,158,937 |   |
| Gross profit                                                                 |       | 2,348,184                                           |        | 2,097,391                                         |       | 4,097,488 |   | 3,170,884 |   |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Operating expenses:                                                          |       |                                                |        |                                              |       |   |   |   |   |
| Selling, general, and administrative expenses                                |       | 3,090,962                                           |        | 2,175,271                                         |       | 5,691,747 |   | 3,891,151 |   |
| Loss on impairment of intangibles                                            |       | 123,000                                             |        | —                                            |       | 123,000 |   | — |   |
| Gain from settlement of acquisition claim                                    |       | —                                              |        | —                                            |       | (1,064,693 | ) | — |   |
| Gain from extinguishment of debt                                             |       | (3,215,490                                          | )           | —                                            |       | (3,215,490 | ) | — |   |
| Non-cash stock based compensation                                            |       | 451,369                                             |        | 191,488                                           |       | 829,629 |   | 270,334 |   |
| Total operating  expenses                                                    |       | 449,841                                             |        | 2,366,759                                         |       | 2,364,193 |   | 4,161,485 |   |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Income (loss)  from operations                                               |       | 1,898,343                                           |        | (269,368                                          | )          | 1,733,295 |   | (990,601 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Interest  expense, net                                                       |       | (450,415                                            | )           | (474,884                                          | )          | (1,643,954 | ) | (998,918 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Income (loss) before  income taxes                                           |       | 1,447,928                                           |        | (744,252                                          | )          | 89,341 |   | (1,989,519 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Income tax  expense                                                          |       | —                                              |        | —                                            |       | — |   | — |   |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Net income  (loss)                                                           |       | $                                                   | 1,447,928   |                                              | $          | (744,252 | ) | $ | 89,341 |   | $ | (1,989,519 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Deemed dividend  on preferred stock                                          |       | (45,554,618                                         | )           | —                                            |       | (45,554,618 | ) | — |   |
| Non-cash  preferred stock dividends                                          |       | —                                              |        | (200,792                                          | )          | — |   | (2,362,979 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Net loss  attributable to common stockholders                                |       | $                                                   | (44,106,690 | )                                                 | $          | (945,044 | ) | $ | (45,465,277 | ) | $ | (4,352,498 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Basic and  diluted loss per common share attributable to common stockholders |       | $                                                   | (3.26       | )                                                 | $          | (0.35 | ) | $ | (5.41 | ) | $ | (2.15 | ) |
|                                                                         |       |                                                |        |                                              |       |   |   |   |   |
| Weighted average number  of common shares outstanding—basic and diluted |       | 13,520,008                                          |        | 2,671,462                                         |       | 8,396,203 |   | 2,021,089 |   |

 

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

 

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**CRDENTIA CORP.Unaudited Condensed Consolidated Statements of Cash Flows**

 
| ** **                                                                            | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| **Operating activities**                                                              | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                    |       | $                                                 | 89,341     |   | $ | (1,989,519 | ) |
| Adjustments to  reconcile net income (loss) to net cash used in operating activities: |       |                                              |       |   |   |
| Amortization of long-term bonus payable                                               |       | 49,912                                            |       | 45,181 |   |
| Non-cash interest expense                                                             |       | 1,157,612                                         |       | 435,171 |   |
| Depreciation and amortization                                                         |       | 523,633                                           |       | 382,882 |   |
| Loss on impairment of intangibles                                                     |       | 123,000                                           |       | — |   |
| Gain on disposal of fixed assets                                                      |       | (500                                              | )          | — |   |
| Gain on settlement of acquisition claim                                               |       | (1,064,693                                        | )          | — |   |
| Gain on extinguishment of debt                                                        |       | (3,215,490                                        | )          | — |   |
| Non-cash stock based compensation                                                     |       | 829,629                                           |       | 270,334 |   |
| Changes in  operating assets and liabilities, net of effects of acquisitions          |       |                                              |       |   |   |
| Accounts receivable                                                                   |       | (1,063,025                                        | )          | (330,206 | ) |
| Unbilled receivables                                                                  |       | (114,844                                          | )          | (357,763 | ) |
| Other assets and liabilities                                                          |       | (333,224                                          | )          | 166,281 |   |
| Accounts payable and accrued expenses                                                 |       | 162,876                                           |       | (1,489,439 | ) |
| Accrued employee compensation and benefits                                            |       | 79,184                                            |       | 375,900 |   |
| Net cash used in  operating activities                                                |       | (2,776,589                                        | )          | (2,491,178 | ) |
|                                                                                  |       |                                              |       |   |   |
| **Investing activities**                                                              | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Purchases of  property and equipment                                                  |       | (88,608                                           | )          | (25,907 | ) |
| Cash paid for  acquisition of subsidiaries, net of cash received                      |       | —                                            |       | (4,939,180 | ) |
| Other                                                                                 |       | —                                            |       | 9,505 |   |
| Net cash used in  investing activities                                                |       | (88,608                                           | )          | (4,955,582 | ) |
|                                                                                  |       |                                              |       |   |   |
| **Financing activities**                                                              | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Issuance of  common stock for cash                                                    |       | 1,500,000                                         |       | — |   |
| Exercise of  warrants for Series C preferred stock, net of expenses                   |       | —                                            |       | 7,713,083 |   |
| Net increase in  revolving lines of credit                                            |       | 459,227                                           |       | 414,836 |   |
| Repayment of  subordinated convertible note                                           |       | (12,500                                           | )          | (12,500 | ) |
| Proceeds from  notes payable to majority stockholder                                  |       | —                                            |       | 1,050,000 |   |
| Repayment of  notes payable to majority stockholder                                   |       | —                                            |       | (1,450,000 | ) |
| Proceeds from  debentures and warrants                                                |       | 2,000,000                                         |       | — |   |
| Repayment of  note payable to lender                                                  |       | (1,650,000                                        | )          | — |   |
| Proceeds from  note payable                                                           |       | 245,075                                           |       | — |   |
| Repayment of  notes payable to sellers                                                |       | —                                            |       | (138,156 | ) |
| Debt issuance  costs                                                                  |       | —                                            |       | (21,639 | ) |
| Net cash  provided by financing activities                                            |       | 2,541,802                                         |       | 7,555,624 |   |
|                                                                                  |       |                                              |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                 |       | (323,395                                          | )          | 108,864 |   |
| Cash and cash  equivalents at beginning of period                                     |       | 434,921                                           |       | 362,472 |   |
| Cash and cash  equivalents at end of period                                           |       | $                                                 | 111,526    |   | $ | 471,336 |   |

 

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

5

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

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

Organization

Crdentia Corp (the“Company”), a Delaware corporation, is a provider of healthcare staffingservices in the United States.  Suchservices include travel nursing, per diem staffing, contractual clinicalservices and private duty home health care. The Company considers these services to be one segment.  Each of these services relate solely toproviding healthcare staffing to customers and the Company utilizes commonsystems, databases, procedures, processes and similar methods of identifyingand serving these customers.

At the beginningof 2003, the Company was a development stage company with no commercialoperations.  During that year, theCompany pursued its operational plan of acquiring companies in the healthcarestaffing field and completed the acquisition of four operating companies.  The companies acquired in 2003 were BakerAnderson Christie, Inc., New Age Nurses, Inc., Nurses Network, Inc., PSR NurseRecruiting, Inc. and PSR Nurses Holdings Corp., which holds the limited partnerand general partner interests in PSR Nurses, Ltd.  During 2004, the Company completed theacquisitions of Arizona Home Health Care/Private Duty, Inc. and Care ProsStaffing, Inc.  During 2005, the Companyacquired TravMed USA, Inc. and Health Industry Professionals, LLC, Prime Staff,LP and Mint Medical Staffing Odessa. During 2006, the Company purchased Staff Search Ltd.

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

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

Basis ofPresentation

The accompanyingunaudited financial data as of June 30, 2006 and for the three months and sixmonths ended June 30, 2006 and 2005 have been prepared by the Company pursuantto the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to such rules and regulations.  These unaudited condensed consolidatedfinancial statements should be read in conjunction with the audited financialstatements and the notes thereto included in the Company’s annual report onForm 10-KSB for the year ended December 31, 2005.

In the opinion ofmanagement, all adjustments (which include only normal recurring adjustments)necessary to present fairly the financial position, results of operations, andcash flows as of June 30, 2006 and for the three months and six months endedJune 30, 2006 and 2005 have been made. The results of operations for the three months and six months ended June30, 2006 are not necessarily indicative of the expected operating results forthe full year.

Going Concern

The Company used cash in operations of $2,776,589 during the first sixmonths of operations in 2006.   Althoughthe Company ended the second quarter of 2006 with a significant working capitaldeficit of $3,811,130, it was able to secure additional funding during thisperiod to finance its operations as it continued to execute its business planto acquire and grow companies involved in healthcare staffing.  The Company will need to raise additionalfunds during the next twelve months for working capital needs and for debtrefinancing.  There is no assurance thatthe Company will be able to raise the amount of debt or equity capital requiredto meet its objectives.  The Company’schallenging financial circumstances may make the terms, conditions and cost ofany available capital relatively unfavorable. If additional debt or equity capital is not readily available, theCompany will be forced to scale back its acquisition activities and itsoperations.  This would result in anoverall slowdown of the Company’s development. The Company’s short-term need for capital may 

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force it toconsider and potentially pursue other strategic options sooner than it mightotherwise have desired.  These conditionsraise substantial doubt about the Company’s ability to continue as a goingconcern.  The accompanying financialstatements do not include any adjustments to reflect the possible futureeffects on the recoverability and classification of assets, or the amounts andclassification of liabilities that may result from the outcome of thisuncertainty.  

Management hastaken a number of steps to address the Company’s financial performance and toimprove cash flow during 2006.  TheCompany replaced a portion of its debt with new debt that has a lower interestrate, restructured the operating management team, and implemented programs toobtain expense savings.  Management is devoting constant attentiontoward achieving growth both organically and through acquisitions so that theCompany can spread its corporate overhead over a larger base of business andachieve economies of scale.  In aneffort to become much larger and achieve economies of scale, on July 31, 2006,the Company announced that it had entered into a non-binding letter of intentto merge with Caregiver Services, Inc. (“CSI”), a leading provider of in-homeassisted living and supplemental staffing services throughout Florida.  Under terms of the letter, CSI will mergeinto a wholly owned subsidiary of the Company and CSI shareholders will receivethe Company’s common stock.  CSI will beprovided representation on the Company’s Board of Directors and CSI’s ChiefExecutive Officer, Alan Soderquist, will also join the executive managementteam. Upon closing of the transaction, it is contemplated that shareholders ofCSI will own approximately 60% of the Company’s outstanding common stock,subject to an adjustment of up to 5% up or down based upon an agreed uponformula.  The completion of the proposedtransaction is subject to the execution of a definitive agreement and approvalof the Board of Directors of both Crdentia and CSI, along with approval by theshareholders of CSI.  The parties havealso agreed to enter into an exclusivity agreement regarding the proposedtransaction for a period of 30 days. There can be no assurance that this mergerwill close.

While there can beno assurances that the Company will be successful, management has taken somesignificant steps in 2006 to achieve critical mass and to emerge as aprofitable, competitive company.  TheCompany’s liquidity outlook will be affected significantly by developments withCSI during the third quarter of 2006.

On a stand-alonebasis, the Company will need $1 million to $2 million of debt or equity in thenext twelve months to fund regular working capital shortfalls. The Company iscurrently negotiating with debenture holders to raise additional capital. Thereis no assurance that the Company will be successful, and if not successful inraising capital in the very short-term, the Company could be harmed and couldbe unable to meet payroll costs. The Company will also need over $6 million inthe third quarter of 2006 to repay its present revolving credit facility andterm loan if it is are unable to renegotiate the terms of its existing debt.

Stock-BasedCompensation

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

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

Stock-based compensation expense recognized during theperiod is based on the value of the portion of stock-based payment awards thatis ultimately expected to vest. Stock-based compensation expense recognized in the condensedconsolidated statement of operations for the three and six months ended June30, 2006 included compensation expense for stock-based payment awards grantedprior to, but not yet vested, as of December 31, 2005 based on the grant datefair 

7

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value estimated in accordance with the pro formaprovision of SFAS 148 and compensation expense for the stock-based paymentawards granted subsequent to December 31, 2005, based on the grant date fairvalue estimated in accordance with SFAS 123R. As stock-based compensation expense recognized in the condensedconsolidated statement of operations for the three and six months ended June30, 2006 is based on awards ultimately expected to vest, it has been reducedfor estimated forfeitures.  SFAS 123Rrequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.  In the pro forma informationrequired under SFAS 148 for the periods prior to January 1, 2006, forfeitureswere accounted for as they occurred.

The table belowshows net loss per share attributable to common stockholders for the three andsix months ended June 30, 2005 as if the Company had elected the fair valuemethod of accounting for stock options effective January 1, 2005.
| ** **                                                           | ** ** | **Three months ended  June 30, 2005**                                                         | ** ** | **Six months ended  June 30, 2005** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                                 |       |                                                                                                              |       |                                                    |       |
| Net loss  attributable to common stockholders, as reported           |       | $                                                                                                                 | (945,044   | )                                                       | $          | (4,352,498 | ) |
| Add:                                                                 |       | stock-based  employee compensation in reported net loss, net of related tax effects                               |       | 191,488                                                 |       | 270,334 |   |
| Deduct:                                                              |       | stock-based  employee compensation determined under fair value method for all awards, net  of related tax effects |       | (232,789                                                | )          | (325,023 | ) |
| Pro forma net  loss attributable to common stockholders, as adjusted |       | $                                                                                                                 | (986,345   | )                                                       | $          | (4,407,187 | ) |
|                                                                 |       |                                                                                                              |       |                                                    |       |
|                                                                 |       |                                                                                                              |       |                                                    |       |
| Loss per share  attributable to common stockholders:                 |       |                                                                                                              |       |                                                    |       |
| Basic and diluted, as reported                                       |       | $                                                                                                                 | (.35       | )                                                       | $          | (2.15 | ) |
| Basic and  diluted, as adjusted                                      |       | $                                                                                                                 | (.37       | )                                                       | $          | (2.18 | ) |

 

Earnings Per Share

Basic per sharedata has been computed on the loss attributable to common stockholders for eachperiod divided by the weighted average number of shares of common stockoutstanding for each period (excluding restricted common stock issued tocertain officers of the Company). Diluted earnings per common share include both the weighted averagenumber of common shares and any dilutive common share equivalents such asconvertible securities, options or warrants in the calculation.  As the Company recorded net losses for thethree and six months ended June 30, 2005, and 2006, common share equivalentsoutstanding would be anti-dilutive, and as such, have not been included indiluted weighted average shares outstanding. Common share equivalents that were excluded in the three and six monthsended June 30, 2006 were 1,357,195 and 1,400,528, respectively, and in both thethree and six months ended June 30, 2005 were 4,161,602.

**Note 2    Acquisitions**

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

8

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

 

The acquisitionwas accounted for using the purchase method of accounting. Customer relatedintangible assets will be amortized over their estimated useful life of fiveyears.  The purchase price allocated tocustomer relationships was determined by management’s estimate based on aconsistent model for all acquisitions and was initially developed by aprofessional valuation group.  Goodwillrepresents the excess of merger consideration over the fair value of assetsacquired. The Company will be required to pay additional cash and issueadditional shares of its common stock to the former stockholders of StaffSearch Ltd. should its results of operations exceed performance standardsestablished in the merger agreement.  Ifresults of operations for Staff Search Ltd. fall below performance standardsestablished in the merger agreement, the former stockholders of Staff SearchLtd. are required to return certain amounts of the Company’s common stock thatwere issued in connection with the acquisition. The goodwill acquired may be amortized for federal income tax purposes.

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

Unaudited ProForma Summary Information

The followingunaudited pro forma summary approximates the consolidated results of operationsas if all acquisitions had occurred as of January 1, 2005, after giving effectto certain adjustments, including amortization of specifically identifiableintangibles and interest expense.  Thepro forma financial information does not purport to be indicative of theresults of operations that would have occurred had the transactions taken placeat the beginning of the period presented or of future results of operations.
| ** **                                                                       | ** ** | **Three Months  Ended  June 30,  2006** | ** **  | **Three Months  Ended  June 30,  2005** | ** ** | **Six Months  Ended  June 30,  2006** | ** ** | **Six Months  Ended  June 30,  2005** | ** **  |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------|-------------|---------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|-------------|
|                                                                             | ** ** | ** **                                        | ** **  | ** **                                        | ** ** | ** **                                      | ** ** | ** **                                      | ** **  |
| Revenue from  services                                                           |       | $                                                 | 11,312,679  |                                              | $          | 13,028,571                                      |       | $                                               | 23,547,502  |   | $ | 26,984,700 |   |
| Net loss  attributable to common stockholders                                    |       | $                                                 | (44,106,690 | )                                                 | $          | (845,054                                        | )          | $                                               | (45,381,027 | ) | $ | (1,429,189 | ) |
| Basic and  diluted net loss per common share attributable to common stockholders |       | $                                                 | (3.26       | )                                                 | $          | (0.29                                           | )          | $                                               | (5.32       | ) | $ | (0.62 | ) |
| Weighted-average shares  of common stock outstanding (basic and diluted)         |       | 13,545,187                                        |        | 2,906,757                                         |       | 8,522,793                                       |       | 2,323,226                                       |        |

 

**Note 3    Settlement of Acquisition Claim**

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

9

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**Note 4    Accounts Payable and Accrued Expenses**

Accounts payableand accrued expenses consist of the following:

|                  | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------|------------|-------------------------|------------|-----------------------------|------------|
|             |       |                    |       |                        |       |
| Accounts payable |       | $                       | 1,086,403  |                        | $          | 825,986 |   |
| Accrued expenses |       | 859,415                 |       | 621,919                     |       |
|             |       |                    |       |                        |       |
|             |       | $                       | 1,945,818  |                        | $          | 1,447,905 |   |

 

**Note 5    Revolving Line of Credit**

On June 16, 2004, the Company entered into a Loan andSecurity Agreement with Bridge Healthcare Finance, LLC (“Bridge Healthcare”),pursuant to which the Company obtained a revolving credit facility that allowedfor maximum borrowings of up to $15,000,000 (the “Loan”).  During the first quarter of 2005, the maximumborrowings under the Loan were reduced to $10,000,000 permitting the Company tolower its effective interest rate through lower unused line fees.  The Loan had an original term of three yearsand bears interest at a rate equal to the greater of three percent (3.0%) perannum over the prime rate or nine and one-half percent (9.5%) per annum (11.0%at June 30, 2006) with interest payable monthly.  Accounts receivable serves as security forthe Loan and the Loan is subject to certain financial and reportingcovenants.  Customer payments are used torepay the advances on the Loan after deducting charges for interest expense,unused line and account management fees. Except in certain limited circumstances, the Loan cannot be prepaid infull without 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 Companyrenegotiated covenants related to the Loan; however, at December 31, 2005 andeach quarter thereafter, the Company is not in compliance with the revisedcovenants.  Bridge Healthcare waivedcompliance with the covenants for 2005. However, in subsequent quarters, the Company had not obtained a waiverfor non-compliance.  Management iscurrently considering various alternatives to rectify covenant non-compliance,including renegotiating the covenants with Bridge Healthcare or negotiating anew facility with a new lender.  TheCompany was charged fees by Bridge Healthcare for various compliance violationsand related waivers granted during 2005 and 2006.

During the third quarter of 2005, Bridge Healthcaremade a $600,000 credit line available to the Company in the form of anover-advance on the Company’s Loan.  Theline of credit was used as necessary to pay certain remaining amounts due onacquisitions completed in March 2005 and for working capital purposes.  During the first quarter of 2006, the Companyused proceeds from a private offering (as discussed in Note 8) to repay the $600,000over-advance.  During the second quarterof 2006, Bridge Healthcare made $650,000 available to the Company in the formof an over-advance on the Loan.  Theover-advance was used for working capital purposes and is to be repaid on orbefore September 15, 2006.  The $650,000over-advance is partially secured by a guaranty from MedCap Partners L.P. (“MedCap”),the Company’s majority stockholder, with the remainder secured by a personalguaranty from C. Fred Toney, a member of the Company’s board of directors, andthe managing member of MedCap Management & Research LLC, the generalpartner of MedCap.  Bridge Healthcarecharges monthly fees in excess of normal Loan interest charges for allover-advances.

The Loan includes events of default (with graceperiods as applicable) and provides that, upon the occurrence of certain eventsof default, payment of all amounts payable under the Loan, including theprincipal amount of, and accrued interest on, the Loan may be accelerated.  There are also cross default provisionsbetween the Loan and the Term Loan discussed in Note 6.  The outstanding balance on the Loan is$5,131,323 at June 30, 2006, which represents the total availability under theline relative to the amount of receivables outstanding at that date plusover-advances discussed above.  Thematurity date of the Loan was extended for an additional year through June2008.  The prepayment penalty discussedabove is applicable for the one-year extension period except the amount isreduced in the event of a change in control of the Company.

10

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**Note 6    Notes Payable to Lender**

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

The Term Loanprovides that the Company shall issue warrants to purchase shares of commonstock to the lender up to 12% of the Company’s overall capitalization on thedate of borrowing.  On August 31, 2004,the Company issued warrants to purchase 90,578 shares of common stock at aprice of $31.50 per share in connection with the first borrowing under thecredit facility.  As a result, the TermLoan has been recorded net of a discount of $810,000 which represents theestimated fair market value related to the warrants at the date ofissuance.  The discount is beingamortized to interest expense over the life of the Term Loan.  During the first quarter of 2006, the Companyused proceeds from a private offering (as discussed in Note 8) to repay$1,350,000 of the Term Loan.  As a resultof this repayment, the Company recorded $200,168 of additional interestrelating to the proportionate amount of unamortized discount associated withthe repayment.  Amortization of the remainingdiscount totaled $60,017 during the first six months of 2006.  During the second quarter of 2006, BridgeHealthcare demanded further repayments of the term loan amounting to $300,000and future monthly principal payments of $45,742 until the Term Loan is paid infull.  The outstanding balance of theTerm Loan is $1,047,801 at June 30, 2006, which is before an unamortizeddiscount of $140,150.

Except in certainlimited circumstances, based on terms of the agreement, the Term Loan cannot beprepaid in full without the Company incurring a significant prepaymentpenalty.  Bridge Healthcare has indicatedan intent to waive the prepayment penalty if the Company repays the Term Loanduring 2006.  The Company is currentlyseeking to refinance the Term Loan.  TheTerm Loan also contains certain financial covenants, including the maintenanceof minimum tangible net worth, minimum debt service coverage ratios, minimumEBITDA, maximum capital expenditure limits and maximum operating leaseobligations.  At March 31, 2005, theCompany was out of compliance with certain financial covenants of the TermLoan, for which a waiver was received from the lender.  In May 2005 the Company renegotiatedcovenants related to the term loan; however, at December 31, 2005 and in subsequentquarters, the Company is not in compliance with the revised covenants.  Bridge Healthcare waived compliance with thecovenants for 2005.  However, during2006, the Company has not obtained waivers for non-compliance.  Accordingly, the Term Loan has beenclassified as a current liability on the accompanying balance sheet as of June30, 2006.  The Company was charged feesby Bridge for various compliance violations and related waivers granted during2005 and 2006.  Management is currentlyconsidering various alternatives to rectify this covenant non-compliance,including renegotiating the covenants with Bridge Healthcare or negotiating anew facility with a new lender.  The TermLoan includes events of default (with grace periods as applicable) and providesthat, upon the occurrence of certain events of default, payment of all amountspayable under the Term Loan, including the principal amount of, and accruedinterest on, the Term Loan may be accelerated. There are also cross default provisions between the Term Loan and theLoan.

**Note 7    Notes Payable to Sellers**

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

11

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

**Note 8    Debentures**

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

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

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

The debentureshave cross-default provisions with the Company’s revolving line of credit andnotes payable to lender.  Since theCompany is in default on its revolving line of credit and notes payable tolender, it is also in default on the debentures.  Accordingly, the amount of the debentures($1,740,000 face value outstanding and $289,997 after a discount of $1,450,003)has been classified as a current obligation on the accompanying balance sheetas of June 30, 2006.  Amortizationof the remaining discount on debentures totaled $346,873 for the six monthsended June 30, 2006.

The Company has registeredthe shares (including the shares issuable upon conversion of the debentures andexercise of the warrants) for resale on a registration statement.  The Company has used the proceeds from theprivate placement for working capital and the retirement of 50% of itsoutstanding $2.7 million Term Loan (discussed in Note 6) as well asretirement of the initial $600,000 over-advance facility (discussed inNote 5).

12

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**Note 9    Convertible Preferred Stock**

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

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

 

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

**Note 10  Common Stock and Stock Options**

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

On April 4, 2006,the Company implemented a one-for-ten reverse split of its outstanding sharesof common stock.  At the Company’s AnnualMeeting of Stockholders held on November 8, 2005, its stockholders approved aproposal to amend its Amended and Restated Certificate of Incorporation to effecta reverse stock split of all of its outstanding shares of common stock at anexchange ratio ranging from one-to-two to one-to-ten, with the final ratio tobe determined by the Board of Directors following stockholder approval.  Pursuant to a resolution of the Board ofDirectors effective March 1, 2006, the directors approved a reverse stock splitat an exchange ratio of one-to-ten.  Nofractional shares were issued in connection with the reverse stock split.  In lieu of fractional shares, stockholdersreceived a cash payment based on the market price, after adjustment for theeffect of the stock split, of the Company’s common stock on the effective dateof the stock split.  The cash payment forfractional shares was nominal.  Thereverse stock split also affected options, warrants and other securitiesconvertible into or exchangeable for shares of the Company’s common stock thatwere issued and outstanding immediately prior to the effective time of thestock split.  All common and per shareinformation included in these financial statements and notes have beenretroactively adjusted to reflect the reverse stock split.

Employee StockOptions and Restricted Stock Grants

The Companyentered into a Restricted Stock Bonus Agreement with James D. Durham, its ChiefExecutive Officer dated effective March 24, 2006.  Pursuant to the agreement, the Company issuedMr. Durham 150,000 shares of its common stock with an aggregate fair marketvalue of $675,000.  The shares ofrestricted stock vest in accordance with the following schedule: 1/4 of thetotal shares vest on March 24, 2007 and 1/48 of the total shares vest monthlythereafter.  In addition to the timevesting requirement, these shares are also subject to minimum stock tradingvolume levels.  In the event of a “CorporateTransaction” (as defined in the agreement), the shares shall immediately becomefully vested if, within five years after the Corporate Transaction, Mr. Durham’sservice is terminated by the successor company, the Company or a related entitywithout “Cause” or voluntarily by Mr. Durham with “Good Reason.”  The Company is expensing the fair marketvalue of these restricted shares over the four year vesting period.  The Company recorded $42,187 in expense inthe second quarter of 2006 associated with this restricted stock grant.

13

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

On May 2, 2006,the Board of Directors granted 177,318 options to purchase the Company’s commonstock to employees of the Company at a per share exercise price of $4.00 pershare.

Impact of theAdoption of SFAS 123R

The Company adopted SFAS 123R using the modifiedprospective transition method beginning January 1, 2006.  The Company’s consolidated interim financialstatements for the three and six months ended June 30, 2006 reflect theimpact of adopting SFAS 123R. The impact on the Company’s results ofoperations of recording stock-based compensation for the three and six monthsended June 30, 2006 was approximately $235,182 and $445,442, respectively,and was recorded in selling, general, and administrative expenses.

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

ValuationAssumptions

The Companycalculated the fair value of each option award on the date of grant using theBlack-Scholes option pricing model.  Thefollowing assumptions were used for six months ended June 30, 2006.

|                            | ** ** | **Six Months Ended  June 30, 2006** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| Risk-free  interest rate   |       | 4.66% - 4.98                                            | %          |
| Expected lives  (in years) |       | 4                                                       |       |
| Dividend Yield             |       | 0.00                                                    | %          |
| Expected volatility        |       | 103.36% - 113.12                                        | %          |

 

Stock optionactivity is summarized as follows:

|                         | ** ** | **Six Months Ended  June 30, 2006** | ** ** |
|-------------------------|------------|---------------------------------------------------------|------------|
| Outstanding,  January 1 |       | 500,667                                                 |       |
| Granted                 |       | 327,318                                                 |       |
| Exercised               |       | 0                                                       |       |
| Forfeited               |       | (20,740                                                 | )          |
| Outstanding, June 30    |       | 807,245                                                 |       |

 

14

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|                                                         | ** ** | **Six Months Ended  June 30, 2006** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                    |       |                                                    |       |
| Exercisable at  June 30                            |       | 372,023                                                 |       |
| Non-vested,  January 1                             |       | 349,517                                                 |       |
| Non-vested,  June 30                               |       | 435,222                                                 |       |
| Granted                                                 |       | 327,318                                                 |       |
| Forfeited                                               |       | 20,740                                                  |       |
| Vested, net of  forfeitures                             |       | 70,779                                                  |       |
|                                                    |       |                                                    |       |
| Average exercise price  per share:                      |       |                                                    |       |
|                                                    |       |                                                    |       |
| Outstanding,  January 1                            |       | $                                                       | 10.21      |   |
| Granted                                                 |       | 4.23                                                    |       |
| Exercised                                               |       | —                                                  |       |
| Forfeited                                               |       | 21.35                                                   |       |
| Outstanding,  June 30                              |       | 9.50                                                    |       |
| Exercisable                                             |       | 7.85                                                    |       |
| Non-vested,  January 1                             |       | 9.50                                                    |       |
| Non-vested, June 30                                |       | 8.41                                                    |       |
|                                                    |       |                                                    |       |
| Weighted-average  remaining term of outstanding options |       | 8.59                                                    |       |
| Weighted-average  remaining term of exercisable options |       | 7.63                                                    |       |
|                                                    |       |                                                    |       |
| Weighted-average  grant date fair value                 |       | $                                                       | 3.16       |   |
| Total future  cost of unvested options                  |       | $                                                       | 5,847,689  |   |
| Weighted-average period  of unvested options            |       | 3.41 years                                              |       |

 

**Note 11  Supplemental Disclosure to the Statements ofCash Flows**

|                                                                                                            | ** ** | **June 30,  2006** | ** ** | **June 30,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| Supplemental cash flow  disclosures:                                                                       |       |                    |       |                    |       |
| Cash paid for  interest                                                                                    |       | $                       | 469,307    |                    | $          | 438,706 |   |
| Cash paid for  income taxes                                                                                |       | —                  |       | —                  |       |
| Non-cash investing and  financing activities:                                                              |       |                    |       |                    |       |
| Conversion of  preferred stock into common stock                                                           |       | —                  |       | 30,873,400              |       |
| Conversion of  debentures into common stock                                                                |       | 260,000                 |       | —                  |       |
| Issuance of the  following in connection with acquisitions:                                                |       |                    |       |                    |       |
| Common stock  issued                                                                                       |       | 976,084                 |       | 2,888,864               |       |
| Revolving credit  line assumed                                                                             |       | —                  |       | 941,390                 |       |
| Notes payable  issued for acquisition                                                                      |       | 1,410,000               |       | 3,215,490               |       |
| Common stock  issued as payment of preferred stock dividends                                               |       | 800,748                 |       | 3,390,233               |       |
| Common stock  issued associated with working capital loans from majority stockholder                       |       |                    |       | 162,500                 |       |
| Common stock  issued for interest on debentures                                                            |       | 69,600                  |       | —                  |       |
| Common stock issued in  exchange for Series C preferred stock, Series B-1 warrants and  Series C |       |                    |       |                    |       |
| warrants                                                                                                   |       | 10,859,603              |       | —                  |       |
| Placement fees  payable related to sale of common stock                                                    |       | 65,000                  |       | —                  |       |
| Value of  debentures allocated to attached common stock warrants and beneficial  conversion feature        |       | 2,000,000               |       | —                  |       |
| Cost associated  with registration statement                                                               |       | 100,037                 |       | —                  |       |
| Fair value of warrants  issued as placement fee related to debentures                                      |       | 419,722                 |       | —                  |       |
|                                                                                                            |            |                         |            |                         |            |  |  |

 

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**Note 12  Legal Proceedings**

On January 27,2006, the Company filed suit against the sellers of TravMed USA, Inc. assertingclaims for breach of non-competition/solicitation agreements, breach offiduciary duty, tortious interference with existing and prospective contractsand business relations, and declaratory relief arising out of the acquisitionagreement.  The Company is seekingdamages related to the above claim.  OnMay 5, 2006, the sellers of TravMed USA, Inc. filed a counterclaim and applicationfor temporary restraining order and injunctive relief claiming breach ofcontract.  Management believes thiscounterclaim is without merit and the Company intends to vigorously defend thecounterclaim.

On January 31,2006, the Company filed suit against the sellers of Arizona Home Health/PrivateDuty, Inc. asserting claims for fraud, indemnity, and declaratory reliefarising out of the acquisition agreement. On February 23, 2006, the sellers filed a counterclaim. Managementbelieves this counterclaim is without merit and the Company intends tovigorously defend the counterclaim.

From time to time,the Company may become involved in various lawsuits and legal proceedings whicharise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverseresult in these or other matters may arise from time to time that may harm theCompany’s business.  The Company is notcurrently aware of any such legal proceedings or claims that are expected tohave, individually or in the aggregate, a material adverse affect on theCompany’s business, financial condition or operating results.

**Note 13  Subsequent Events**

On July 31, 2006,the Company announced that it had entered into a non-binding letter of intentto merge with Caregiver Services, Inc. (“CSI”), a leading provider of in-homeassisted living and supplemental staffing services throughout Florida.  Under terms of the letter, CSI will mergeinto a wholly owned subsidiary of Crdentia and CSI shareholders will receiveCrdentia common stock. CSI will be provided representation on Crdentia’s Boardof Directors and CSI’s Chief Executive Officer, Alan Soderquist, will also joinCrdentia’s executive management team. Upon closing of the transaction, theparties contemplate that shareholders of CSI will own approximately 60% ofCrdentia’s outstanding common stock, subject to an adjustment of up to 5% up ordown based on an agreed upon formula. The completion of the proposedtransaction is subject to the execution of a definitive agreement and approvalof the Board of Directors of both Crdentia and CSI, along with approval by theshareholders of CSI. The parties have also agreed to enter into an exclusivityagreement regarding the proposed transaction for a period of 30 days. There canbe no assurance that this merger will close.

Subsequent toJune 30, 2006, Bridge Healthcare made $475,000 available to the Company inthe form of additional over-advances on the Company’s Loan.  The over-advances were used for working capitalpurposes, are to be repaid on or before September 15, 2006, and aresecured by a personal guaranty from C. Fred Toney, a member of the Company’sboard of directors, and the managing member of MedCap Management & ResearchLLC, the general partner of MedCap.

 

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

**OVERVIEW**

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

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

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

We are a provider of healthcare staffing services, focusing on theareas of travel nursing, per diem staffing, contractual clinical services,locum tenens, allied services and private duty home care.  Our travel nurses are recruited domesticallyas well as internationally, and placed on temporary assignments at healthcarefacilities across the United States.  Ourper diem nurses are local nurses placed at healthcare facilities on short-termassignments.  Our contractual clinicalservices group provides complete clinical management and staffing for healthcarefacilities.  Our locum tenens physicianscontract with us to perform medical services for healthcare organizations for aspecified length of time.  Our alliedservices primarily consist of diagnostic imaging, respiratory, laboratory,therapies and administrative modalities and our private duty home care groupprovides nursing case management and staffing for skilled and non-skilled carein the home.  We consider the differentservices described above to be one segment as each of these services relate solelyto providing healthcare staffing to customers that are healthcare providers andutilize similar distribution methods, common systems, databases, procedures,processes and similar methods of identifying and serving these customers.

We did not have any revenue in 2003 until we completed our firstacquisition in August 2003.  During 2003,we pursued our operational plan of acquiring companies in the healthcarestaffing field and completed acquisitions of four companies.  In 2004, we purchased two companies, in 2005purchased three additional companies and on April 18, 2006 we purchased onecompany.  We have contracted with morethan 1,500 healthcare facilities across 49 U.S. states and the District ofColumbia.  We anticipate continuing ourplan to acquire specialized companies in the healthcare staffing field for theforeseeable future.

The companies we acquired in 2003 — Baker Anderson Christie, Inc., NewAge Nurses, Inc., Nurses Network, Inc., and PSR Nurse Recruiting, Inc. and PSRNurses Holdings Corp., which hold the limited partner and general partnerinterests in PSR Nurses, Ltd. — provide the foundation for our continuedgrowth.  During 2003 we began operatingthe acquired companies, combining the various back offices and support staffinto a central location and began streamlining the operations.  We continued our acquisition program in 2004and acquired Care Pros Staffing, Inc. and Arizona Home Health Care/PrivateDuty, Inc.  On March 28, 2005, weacquired TravMed USA, Inc. and Health Industry Professionals, LLC.  On May 4, 2005, we acquired PrimeStaff, LPand Mint Medical Staffing Odessa.  OnApril 18, 2006, we acquired Staff Search Ltd.

Some key factors we are focusing on to improve performance are asfollows:

·                  Wecontinue to identify innovative ways to attract and retain nurses.

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·                  Weare vigorously managing professional liability insurance costs, workerscompensation insurance costs, and health care costs to enhance gross margins.

·                  Weare aggressively expanding our locum tenens business, our allied services andour home health business in an effort to improve gross margins through a bettermix of the services provided.

·                  Weare devoting constant attention toward achieving growth both organically andthrough acquisitions so that we can spread our corporate overhead over a largerbase of business and achieve economies of scale.

·                  Duringthe first six months of 2006, we raised approximately $2,000,000 in debenturesand $1,500,000 in equity.  These proceedswere used to repay $1,650,000 on the term loan and the balance was used forworking capital purposes.  We arecurrently working to raise additional debt and equity for working capital needsand for debt refinancing.

·                  Weare seeking to list our common stock on the Nasdaq Market or another national exchange(our common stock is currently quoted on the OTC Bulletin Board).

**LIQUIDITYAND CAPITAL RESOURCES**

During the first six months of 2006, we raised approximately $2,000,000in debentures and $1,500,000 in equity. These proceeds were used to repay $1,650,000 on the term loan and thebalance was used for working capital purposes. We are currently working to raise additional debt and equity for workingcapital needs and for debt refinancing.

On June 16, 2004, we entered into a Loan and SecurityAgreement with Bridge Healthcare Finance, LLC (“Bridge Healthcare”), pursuantto which we obtained a revolving credit facility up to $15,000,000 (the “Loan”).  During the first quarter of 2005, the Loanwas reduced to $10,000,000 permitting us to lower its effective interest ratethrough lower unused line fees.  The Loanhad an original term of three years and bears interest at a rate equal to thegreater of three percent (3.0%) per annum over the prime rate or nine and one-halfpercent (9.5%) per annum (11.0% at June 30, 2006).  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 Loan after deducting charges for interest expense, unused lineand account management fees.  Except incertain limited circumstances, the Loan cannot be prepaid in full without ourincurring a significant prepayment penalty. The financial covenants are for the maintenance of minimum tangible networth, minimum debt service coverage ratios, minimum EBITDA, maximum capitalexpenditure limits and maximum operating lease obligations.* *In May 2005 we renegotiatedcovenants related to the Loan; however, at December 31, 2005 and each quarter thereafter,we are not in compliance with the revised covenants.  Bridge Healthcare waived compliance with thecovenants for 2005.  However, insubsequent quarters, we have not obtained a waiver for non-compliance.  Management is currently considering variousalternatives to rectify covenant non-compliance, including renegotiating thecovenants with Bridge Healthcare or negotiating a new facility with a newlender. We have been charged fees by Bridge Healthcare for various complianceviolations and related waivers in 2005 and 2006.

During the third quarter of 2005, Bridge Healthcaremade a $600,000 credit line available to us in the form of an over-advance onour Loan.  The line of credit was used asnecessary to pay certain remaining amounts due on acquisitions completed inMarch 2005 and for working capital purposes. During the first quarter of 2006, we used proceeds from a privateoffering as discussed below to repay the $600,000 over-advance.  During the second quarter of 2006, BridgeHealthcare made $650,000 available to us in the form of an over-advance on ourLoan.  The over-advance was used forworking capital purposes and is to be repaid on or before September 15,2006.  The $650,000 over-advance ispartially secured by a guaranty from MedCap Partners L.P. (“MedCap”), ourmajority stockholder, with the remainder secured by a personal guaranty from C.Fred Toney, a member of our board of directors, and the managing member ofMedCap Management & Research LLC, the general partner of MedCap.  Bridge Healthcare charges monthly fees inexcess of normal Loan interest charges for all over-advances.

Subsequent to June30, 2006, Bridge Healthcare made $475,000 available to us in the form ofadditional over-advances on our Loan. The over-advances were used for working capital purposes, are to berepaid on or before September 15, 2006, 

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and are secured bya personal guaranty from C. Fred Toney, a member of our board of directors, andthe managing member of MedCap Management & Research LLC, the generalpartner of MedCap.

The Loan includes events of default (with graceperiods as applicable) and provides that, upon the occurrence of certain eventsof default, payment of all amounts payable under the Loan, including theprincipal amount of, and accrued interest on, the Loan may be accelerated.  There are also cross default provisionsbetween the Loan and the Term Loan discussed below.  The outstanding balance on the Loan is$5,131,323 at June 30, 2006, which represents the total availability under theline relative to the amount of receivables outstanding at that date plusover-advances discussed above.  Thematurity date of the Loan was extended for an additional year through June2008.  The prepayment penalty discussedabove is applicable for the one-year extension period except the amount isreduced in the event of a change in control of Crdentia.

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

The Term Loanprovides that we shall issue warrants to purchase shares of common stock to thelender up to 12% of our overall capitalization on the date of borrowing.  On August 31, 2004, we issued warrants topurchase 90,578 shares of common stock at a price of $31.50 per share inconnection with the first borrowing under the credit facility.  As a result, the Term Loan has been recordednet of a discount of $810,000 which represents the estimated fair market valuerelated to the warrants at the date of issuance.  The discount is being amortized to interestexpense over the life of the Term Loan. During the first quarter of 2006, we used proceeds from a privateoffering as discussed below to repay $1,350,000 of the Term Loan.  As a result of this repayment, we recorded$200,168 of additional interest relating to the proportionate amount ofunamortized discount associated with the repayment.  Amortization of the remaining discounttotaled $60,017 during the first six months of 2006.  During the second quarter of 2006, BridgeHealthcare demanded further repayments of the Term Loan amounting to $300,000and future monthly principal payments of $45,742 until the Term Loan is paid infull.  The outstanding balance of the TermLoan is $1,047,801 at June 30, 2006, which is before an unamortized discount of$140,150.

Except in certainlimited circumstances, based on terms of the agreement, the Term Loan cannot beprepaid in full without our incurring a significant prepayment penalty.  Bridge Healthcare has indicated an intent towaive the prepayment penalty if we repay the Term Loan during 2006.  We are currently seeking to refinance theTerm Loan.  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, we were out of compliancewith certain financial covenants of the Term Loan, for which a waiver wasreceived from the lender.  In May 2005 werenegotiated covenants related to the term loan; however, at December 31, 2005and in subsequent quarters, we are not in compliance with the revisedcovenants.  Bridge Healthcare waivedcompliance with the covenants for 2005. However, during 2006, we have not obtained waivers fornon-compliance.  Accordingly, the TermLoan has been classified as a current liability on the accompanying balancesheet as of June 30, 2006.  We were chargedfees by Bridge for various compliance violations and related waivers grantedduring 2005 and 2006.  Management iscurrently considering various alternatives to rectify this covenantnon-compliance, including renegotiating the covenants with Bridge Healthcare ornegotiating a new facility with a new lender. 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.

As partialconsideration for the acquisition of TravMed USA, Inc. (“TravMed”) on March 29,2005, we issued unsecured subordinated notes to the former TravMed stockholdersin the total amount of $3,215,490.  Thenotes were three-year convertible notes bearing interest at 7.75%.  Monthly interest payments were required forthe first six months followed by principal and interest payments the nextthirty months to fully repay the debt. We did not make debt service payments required by terms of these notespayable to sellers since claims were asserted in State District Court inDallas, Texas against the sellers of TravMed for breach ofnon-competition/solicitation agreements, breach of fiduciary duty, 

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tortiousinterference with existing and prospective contracts and business relations,and declaratory relief.  We received anotice of default in early November 2005 and the due date of the notes wasaccelerated such that the entire balance of the notes payable to sellers wasdue.  The default under the notes payableto sellers triggered defaults under the Loan and Term Loan discussed above, aswell as the Debentures discussed below. Also, as a result of this default, Bridge Healthcare has discontinuedmaking revolving credit loans to us on receivables of TravMed.

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

In January 2006,we completed a private placement totaling $4 million.  The first phase was completed on December 30,2005 and consisted of $2 million, or 333,333 shares of common stock and thesecond phase consisted of $2 million of 8% convertible debentures.  The convertible debentures have a term ofthree years and bear interest at a rate of 8% per year, payable semi-annuallyin cash or registered stock at our option. The debentures are convertible into common stock at a price of $6.00 pershare.  The sale of convertibledebentures included common stock warrant coverage allowing debenture holders toexercise warrants to purchase 500,000 common shares.  Warrants to purchase 166,667 common shareshave a five year term and an exercise price of $7.50 per share.  Warrants to purchase 333,333 common shares atan exercise price of $6.00 per share expired on June 14, 2006 with none beingexercised.  We computed the relative fairvalue of the warrants at $1,443,265 and the beneficial conversion featurerelated to the debentures at $556,735, and recorded these amounts as a discountto the debentures which will be amortized over the term of the debentures.

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

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

The debentureshave cross-default provisions with our revolving line of credit and notespayable to lender.  Since we are indefault on our revolving line of credit and notes payable to lender, we arealso in default on the debentures. Accordingly, the amount of the debentures ($1,740,000 face valueoutstanding and $289,997 after a discount of $1,450,003) has been classified asa current obligation on the accompanying balance sheet as of June 30, 2006.

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

In the first sixmonths of 2006 we completed further equity financings with our majoritystockholder for $1,500,000 at per share prices ranging from $6.00 to$8.00.  The proceeds were used forworking capital purposes.  Our capitalcommitments for the next twelve months are minimal as our business does notrequire the purchase of plants, factories, extensive capital equipment orinventory.

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We used cash inoperations of $2,776,589 during the first six months of operations in2006.   Although we ended the secondquarter of 2006 with a significant working capital deficit of $3,811,130, wewere able to secure additional funding during this period to finance ouroperations as we continued to execute our business plan to acquire and growcompanies involved in healthcare staffing. We will need to raise additional funds during the next twelve months forworking capital needs and for debt refinancing. There is no assurance that we will be able to raise the amount of debtor equity capital required to meet our objectives.  Our challenging financial circumstances maymake the terms, conditions and cost of any available capital relativelyunfavorable.  If additional debt orequity capital is not readily available, we will be forced to scale back ouracquisition activities and our operations. This would result in an overall slowdown of our development.  Our short-term need for capital may force usto consider and potentially pursue other strategic options sooner than we mightotherwise have desired.  These conditionsraise substantial doubt about our ability to continue as a going concern.  The accompanying financial statements do notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets, or the amounts and classificationof liabilities that may result from the outcome of this uncertainty.  Management has taken a number of steps toaddress our financial performance and to improve cash flow during 2006.  We replaced a portion of our debt with newdebt that has a lower interest rate, restructured the operating managementteam, and implemented programs to obtain expense savings.  We are devoting constant attention toward achieving growth bothorganically and through acquisitions so that we can spread our corporateoverhead over a larger base of business and achieve economies of scale.  In an effort to become much larger andachieve economies of scale, on July 31, 2006, we announced that we had enteredinto a non-binding letter of intent to merge with Caregiver Services, Inc. (“CSI”),a leading provider of in-home assisted living and supplemental staffingservices throughout Florida.  Under termsof the letter, CSI will merge into a wholly owned subsidiary of ours and CSIshareholders will receive our common stock. CSI will be provided representationon our Board of Directors and CSI’s Chief Executive Officer, Alan Soderquist,will also join our executive management team. Upon closing of the transaction,we contemplate that shareholders of CSI will own approximately 60% of ouroutstanding common stock, subject to an adjustment of up to 5% up or down basedupon an agreed upon formula to be calculated after issuance of the audited 2006year-end financial statements of each entity. The completion of the proposedtransaction is subject to the execution of a definitive agreement and approvalof the Board of Directors of both Crdentia and CSI, along with approval by theshareholders of CSI. The parties have also agreed to enter into an exclusivityagreement regarding the proposed transaction for a period of 30 days. There canbe no assurance that this merger will close.

While there can beno assurances that we will be successful, management has taken some significantsteps in 2006 to achieve critical mass and to emerge as a profitable,competitive company.  Our liquidityoutlook will be affected significantly by developments with CSI during thethird quarter of 2006.

On a stand-alonebasis, we will need $1 million to $2 million of debt or equity in the nexttwelve months to fund regular working capital shortfalls. We are currentlynegotiating with debenture holders to raise additional capital. There is noassurance that we will be successful, and if we are not successful raisingcapital in the very short-term, we could be harmed and could be unable to meetpayroll costs. We will also need over $6 million in the third quarter of 2006to repay our present revolving credit facility and term loan if we are unableto renegotiate the terms of this existing debt.

**CRITICALACCOUNTING POLICIES AND MANAGEMENT JUDGEMENT**

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

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**AccountsReceivable**

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

**PurchaseAccounting, Goodwill and Intangible Assets**

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

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

**Stock-Based Compensation**

On January 1,2006, the Company adopted the modified prospective method of SFAS No. 123(Revised 2004), *Share-Based Payment* (“SFAS No.123R”), which is a revision of SFAS No. 123, *Accountingfor Stock-Based Compensation* (“SFAS No. 123”).  SFAS No. 123R supersedes APB Opinion No. 25,and amends SFAS No. 95, *Statement of Cash Flows*.  SFAS No. 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values.  Pro forma disclosure is no longer analternative.  Under the modifiedprospective application, SFAS No. 123R is applied to new awards and to awardsmodified, repurchased or cancelled after the effective date.  Compensation cost for the portion of awardsfor which requisite service has not been rendered that are outstanding as ofthe effective date is recognized as the service is rendered on or after theeffective date.  The compensation costfor that portion of awards is based on the grant date fair value of thoseawards as calculated for pro forma disclosures under SFAS No. 123.  In accordance with the modified prospectivemethod, the consolidated financial statements for the prior periods have notbeen restated to reflect, and do not include, the impact of SFAS No. 123R.

The adoption ofSFAS No. 123R will require the Company to record substantial non-cashcompensation expenses.  While theadoption of SFAS No. 123R is not expected to have a significant effect on theCompany’s financial condition or cash flows, it is expected to have asignificant effect on the Company’s results of operations.  The future impact of the adoption of SFAS No.123R cannot be predicted at this time because it will depend on the levels ofshare-based payments granted by the Company in the future.  However, had the Company adopted SFAS No.123R in prior periods, the impact of the standard would have approximated the impactof SFAS No. 123 as described in the pro forma net loss attributable to commonshareholders.

Prior to January1, 2006, the Company accounted for stock-based employee compensationarrangements in accordance with provisions of Accounting Principles Board (“APB”)Opinion No. 25, *Accounting for Stock Issued to Employees,*and complied with the disclosure provisions of SFAS No. 123 as amended by SFASNo. 148.  Under APB Opinion No. 25,

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compensationexpense for employees is based on the excess, if any, on the date of grant, ofthe fair value of the Company’s stock over the exercise price and is recognizedon a straight-line basis over the vesting term of the option.

The Companyaccounts for equity instruments issued to non-employees in accordance with theprovisions of SFAS No. 123 and SFAS No. 148 and Emerging Issues Task ForceIssue No. 96-18, *Accounting for Equity Instruments That AreIssued to Other Than Employees for Acquiring, or in Conjunction with Selling,Goods or Services*.  Alltransactions in which goods or services are the consideration received for theissuance of equity instruments are accounted for based on the fair value of theconsideration received or the fair value of the equity instrument issued,whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issuedis the earlier of the date on which the counterparty’s performance is completeor the date on which it is probable that performance will occur.

**RESULTSOF OPERATIONS**

The followingcondensed financial information includes Crdentia Corp. plus the results ofoperations of all companies acquired from their respective dates of acquisition(in thousands).

 
| ** **                                         | ** ** | **For the three months  ended June 30,** | ** ** | **For the six months  ended June 30,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                                          | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Revenue from services                              |       | $                                                                 | 11,313     |                                                            | $          | 9,208 |   | $ | 20,297 |   | $ | 14,330 |   |
| Direct operating  expenses                         |       | 8,965                                                             |       | 7,110                                                           |       | 16,200 |   | 11,159 |   |
| Gross profit                                       |       | 2,348                                                             |       | 2,098                                                           |       | 4,097 |   | 3,171 |   |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Operating expenses:                                |       |                                                              |       |                                                            |       |   |   |   |   |
| Selling, general  and administrative expenses      |       | 3,091                                                             |       | 2,175                                                           |       | 5,692 |   | 3,891 |   |
| Loss on  impairment of intangibles                 |       | 123                                                               |       | —                                                          |       | 123 |   | — |   |
| Gain from  settlement acquisition claim            |       | —                                                            |       | —                                                          |       | (1,065 | ) | — |   |
| Gain from  extinguishment of debt                  |       | (3,215                                                            | )          | —                                                          |       | (3,215 | ) | — |   |
| Non-cash stock based  compensation                 |       | 451                                                               |       | 192                                                             |       | 829 |   | 271 |   |
| Total operating  expenses                          |       | 450                                                               |       | 2,367                                                           |       | 2,364 |   | 4,162 |   |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Income (loss) from  operations                     |       | 1,898                                                             |       | (269                                                            | )          | 1,733 |   | (991 | ) |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Interest expense, net                              |       | (450                                                              | )          | (475                                                            | )          | (1,644 | ) | (999 | ) |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Income (loss) before  income taxes                 |       | 1,448                                                             |       | (744                                                            | )          | 89 |   | (1,990 | ) |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Income tax expense                                 |       | —                                                            |       | —                                                          |       | — |   | — |   |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Net income (loss)                                  |       | 1,448                                                             |       | (744                                                            | )          | 89 |   | (1,990 | ) |
|                                               |       |                                                              |       |                                                            |       |   |   |   |   |
| Deemed dividends on  preferred stock               |       | (45,555                                                           | )          | —                                                          |       | (45,555 | ) | — |   |
| Non-cash preferred  stock dividends           |       | —                                                            |       | (201                                                            | )          | — |   | (2,363 | ) |
| Net loss attributable  to common stockholders |       | $                                                                 | (44,107    | )                                                               | $          | (945 | ) | $ | (45,466 | ) | $ | (4,353 | ) |

 

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***Threemonths ended June 30, 2006 compared to the three months ended June 30, 2005***

Revenues in thesecond quarter of 2006 were $11,313,000 compared to revenues of $9,208,000 inthe second quarter of 2005.  Revenueshave increased in the second quarter of 2006 compared to the second quarter of2005 due principally to our acquisition of Staff Search Ltd. in April 2006.  In the second quarter of 2006 approximately26% (43% in the second quarter of 2005) 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 area of the assignment.  In the second quarter of 2006, we alsoprovided per diem nurses to satisfy the very short-term needs of healthcarefacilities.  Per diem services provided61% of our revenue in the second quarter of 2006 (48% in the second quarter of2005).  The remaining amount of ourrevenue in the second quarter of 2006 came from providing clinical managementand staffing to healthcare facilities and private duty homecare and alliedservices.  In 2005 the remaining revenuecame from providing clinical management and staffing to healthcare facilitiesand private duty homecare. During the second quarter of 2006 and 2005, most ofour customers were acute care hospitals located throughout the continentalUnited States.

Our overall grossprofit in the second quarter of 2006 was $2,348,000 or 20.8% of revenuescompared to $2,098,000 or 22.8% of revenues in the second quarter of 2005. Ourgross profit is the difference between the revenue we realize when we bill ourcustomers for the services of our healthcare professionals and our directoperating costs, which include the cost of the healthcare professionals and therelated housing and travel costs, certain employment related taxes and workerscompensation insurance coverage.  Priceincreases have not kept pace with increases in labor, housing and travelcosts.  The gross profit percentage inthe second quarter of 2006 is less than the percentage in the second quarter of2005 reflecting a need for price increases in 2006.  As new contracts are negotiated withhealthcare facilities in 2006, we are implementing price increases which webelieve is consistent with a trend in the temporary staffing industry in2006.  Since price increases are beingimplemented during 2006, the majority of the benefit of these increases willnot be reflected in higher margin percentages until the last six months of2006.

Our selling,general and administrative costs were $3,091,000******or27.3% of revenues in the second quarter of 2006 compared to $2,175,000 or 23.6%******of revenues in the second quarterof 2005.  Selling, general andadministrative expenses are comprised primarily of personnel costs, legal andaccounting fees related to being a public company and various other office andadministrative expenses.  During the secondquarter of 2006, we incurred over $126,000 in legal fees associated with thesuit filed against the sellers of TravMed. Selling, general and administrative costs as a percentage of revenuehave increased in the second quarter of 2006. Management is currently endeavoring to reduce selling, general andadministrative costs at certain of our locations where cost percentages arehigher relative to cost percentages at other locations (benchmarks).  In addition, price increases should bringselling, general and administrative costs as a percentage of revenue more inline with previous periods.

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

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

Non-cashstock based compensation expense increased from $192,000 in 2005 to $451,000 in2006.  This increase resulted from theCompany’s adoption of SFAS 123R requiring expensing of the fair value ofoptions granted and amortization related to 430,000 shares of restricted stockto officers of the Company.  Of the370,000 shares granted in May 2005, 90,000 were incentive based and forfeitedin December 2005 when targeted operating goals were not achieved.

Interest costsdecreased from $475,000 in the second quarter of 2005 to $451,000 in the secondquarter of 2006.  This decrease ininterest cost is due to lower levels of debt, partially offset by higher rateson our revolving credit line, and greater non-cash interest expense relating todiscounts on our debentures and amortization of additional deferred financingcosts.

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Duringthe second quarter of 2006 a special committee of the Board of Directorsrecommended, the Board of Directors approved and holders of the Preferred Stockand Warrants agreed to the exchange of all outstanding Series C ConvertiblePreferred Stock, Series C warrants and Series B-1 warrants into common stock asfollows.  The exchange as approved by theBoard of Directors varied from existing Preferred Stock conversion ratios andwas based on recommendations from the special committee of the Board ofDirectors after they sought guidance from an outside firm.  The effect of this exchange transferred thecarrying value of the Convertible Preferred Stock and the Series C preferredstock warrants on our balance sheet to stockholders’ equity resulting in anincrease in stockholders’ equity of $10,859,603.  This exchange also resulted in therecognition of a deemed dividend of $45,555,000.  This deemed dividend was calculated byvaluing the 10,257,131 shares of common stock issued in the exchange at theclosing price of the stock on the date of the exchange ($5.50) less therecorded value of the Convertible Preferred Stock and Warrants of $10,859,603.

The non-cashpreferred stock dividends in the second quarter of 2005 are cumulative commonstock dividends declared for December 31, 2004 and March 31, 2005 related tothe warrants exercised on May 2, 2005 for 22,187 shares of Series C convertiblepreferred stock.  The common stockdividends on the warrants were payable once the warrants were exercised.

***Sixmonths ended June 30, 2006  compared tothe six months ended June 30, 2005***

Revenues in thefirst six months of 2006 were $20,297,000 compared to revenues of $14,330,000in the first six months of 2005. Revenues have increased in the first six months of 2006 compared to thefirst six months of 2005 due principally to acquisitions in March and May of2005 and our acquisition of Staff Search Ltd. in April 2006.  In the first six months of 2006 approximately31% (37% in the first six months of 2005) 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 area of the assignment.  In the first six months of 2006, we alsoprovided per diem nurses to satisfy the very short-term needs of healthcarefacilities.  Per diem services provided59% of our revenue in the first six months of 2006 (50% in the first six monthsof 2005).  The remaining amount of ourrevenue in the first six months of 2006 came from providing clinical managementand staffing to healthcare facilities and private duty homecare and alliedservices.  In 2005 the remaining revenuecame from providing clinical management and staffing to healthcare facilitiesand private duty homecare. During the first six months of 2006 and 2005, mostof our customers were acute care hospitals located throughout the continentalUnited States.

Our overall grossprofit in the first six months of 2006 was $4,097,000 or 20.2% of revenuescompared to $3,171,000 or 22.1% of revenues in the first six months of 2005.Our gross profit is the difference between the revenue we realize when we billour customers for the services of our healthcare professionals and our directoperating costs, which include the cost of the healthcare professionals and therelated housing and travel costs, certain employment related taxes and workerscompensation insurance coverage.  Priceincreases have not kept pace with increases in labor, housing and travelcosts.  The gross profit percentage inthe first six months of 2006 is less than the percentage in the first sixmonths of 2005 reflecting a need for price increases in 2006.  As new contracts are negotiated withhealthcare facilities in 2006, we are implementing price increases which webelieve is consistent with a trend in the temporary staffing industry in2006.  Since price increases are beingimplemented during 2006, the majority of the benefit of these increases willnot be reflected in higher margin percentages until the last six months of2006.

Our selling,general and administrative costs were $5,692,000******or28.0% of revenues in the first six months of 2006 compared to $3,891,000 or27.2%******of revenues in the first six monthsof 2005.  Selling, general andadministrative expenses are comprised primarily of personnel costs, legal andaudit fees related to being a public company and various other office andadministrative expenses.  During thesecond quarter of 2006, we incurred $126,000 in legal fees associated with thesuit filed against the sellers of TravMed. Selling, general and administrative costs as a percentage of revenuehave increased in the first six months of 2006. Management is currently endeavoring to reduce selling, general andadministrative costs at certain of our locations where cost percentages arehigher relative to cost percentages at other locations (benchmarks).  In addition, price increases should bringselling, general and administrative costs as a percentage of revenue more inline with previous period.

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

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In2005, we asserted a claim against a seller of one of our 2003acquisitions.  In January 2006, we andthe seller settled with the seller returning 59,150 shares of our stock thathad been issued in connection with the acquisition.  We reported a gain on this settlement of$1,064,693 representing the fair value of the stock returned on the date of thesettlement.

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

Non-cashstock based compensation expense increased from $271,000 in 2005 to $830,000 in2006.  This increase resulted from theCompany’s adoption of SFAS 123R requiring expensing of the fair value ofoptions granted and amortization related to 430,000 shares of restricted stockto officers of the Company.  Of the370,000 shares granted in May 2005, 90,000 were incentive based and forfeitedin December 2005 when targeted operating goals were not achieved.

Interest costsincreased from $999,000 in the first six months of 2005 to $1,644,000 in thefirst six months of 2006.  This increasein interest cost is due to higher rates on our revolving credit line, greaternon-cash interest expense relating to discounts on our debentures, acceleratedwrite-off of discounts on retired term debt and amortization of additionaldeferred financing costs partially offset by lower debt levels.

Duringthe first six months of 2006 a special committee of the Board of Directorsrecommended, the Board of Directors approved and holders of the Preferred Stockand Warrants agreed to the exchange of all outstanding Series C ConvertiblePreferred Stock, Series C warrants and Series B-1 warrants into common stock.  The exchange as approved by the Board ofDirectors varied from existing Preferred Stock conversion ratios and was basedon recommendations from the special committee of the Board of Directors afterthey sought guidance from an outside firm. The effect of this exchange transferred the carrying value of theConvertible Preferred Stock and the Series C preferred stock warrants on ourbalance sheet to stockholders’ equity resulting in an increase in stockholders’equity of $10,859,603.  This exchangealso resulted in the recognition of a deemed dividend of $45,554,618.  This deemed dividend was calculated byvaluing the 10,257,131 shares of common stock issued in the exchange at theclosing price of the stock on the date of the exchange ($5.50) less therecorded value of the Convertible Preferred Stock and Warrants of $10,859,603.

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

**RISKFACTORS**

We were formed inNovember 1997, and commenced operations on August 7, 2003 following ouracquisition of Baker Anderson Christie, Inc. Any investment in our common stock involves a high degree of risk.  You should consider carefully the followinginformation about these risks, together with the other information contained inthis report and our other SEC filings, before you decide to buy our commonstock.  The risks and 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 report.  In such case, the trading price of our commonstock could decline, and you may lose all or part of the money you paid to buyour common stock.

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

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

Wehave limited cash resources and will need to raise additional capital throughpublic or private financings or other arrangements in order to meet currentcommitments 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.

Wehave financed our operations since inception primarily through the privateplacement 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 andrestrictive covenants that limit our operations.

On a stand-alone basis, we will need $1 million to $2 million of debt or equity in the next twelve months to fund regular working capital shortfalls. There is no assurance that we will be successful, and if we are not successful raising capital in the very short-term, we could be harmed and could be unable to meet payroll costs.

There can be no assurance that management’s plans to become cash flow positive during 2006 will be successful.  We have been successful raising capital in the past; however, if we are unsuccessful in raising additional capital, we may need to reduce the level of our operations, resulting in a material adverse effect on our business and operations and charges that could be material to our business and results of operations.

**We mayface difficulties identifying acquisitions and integrating these acquisitionsinto our operations.  These acquisitionsmay be unsuccessful, involve significant cash expenditures or expose us tounforeseen liabilities.**

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

·                     potentialloss of revenues following the acquisition;

·                     difficultiesintegrating acquired personnel and distinct cultures into our business;

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

·                     diversion ofmanagement attention from existing operations; and

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

Theseacquisitions may also involve significant cash expenditures, debt incurrenceand integration expenses that could seriously harm our financial condition andresults of operations.  We may fail toachieve expected efficiencies and synergies. Any acquisition may ultimately have a negative impact on our businessand financial condition.

**There isnot an active public market for our common stock, and the trading price of ourcommon stock is subject to volatility.**

The quotation ofshares of our common stock on the OTC Bulletin Board began on February 24,2003.  There can be no assurances,however, that a market will develop or continue for our common stock.  Our common stock may be thinly

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traded, if tradedat all, even if we achieve full operation and generate significant revenue andis likely to experience significant price fluctuations.  In addition, our stock may be defined as a “pennystock” under Rule 3a51-1 adopted by the Securities and Exchange Commissionunder the Securities Exchange Act of 1934, as amended.  In general, a “penny stock” includessecurities of companies which are not listed on the principal stock exchangesor the National Association of Securities Dealers Automated Quotation System (“Nasdaq”)or National Market System (“Nasdaq NMS”) and have a bid price in the market ofless than $5.00; and companies with net tangible assets of less than $2,000,000($5,000,000 if the issuer has been in continuous operation for less than threeyears), or which have recorded revenues of less than $6,000,000 in the lastthree years.  “Penny stocks” are subjectto Rule 15g-9, which imposes additional sales practice requirements onbroker-dealers that sell such securities to persons other than establishedcustomers and “accredited investors” (generally, individuals with net worth inexcess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 togetherwith their spouses, or individuals who are officers or directors of the issuerof the securities).  For transactionscovered by Rule 15g-9, a broker-dealer must make a special suitabilitydetermination for the purchaser and have received the purchaser’s writtenconsent to the transaction prior to sale. Consequently, this rule may adversely affect the ability of broker-dealersto sell our common stock, and therefore, may adversely affect the ability ofour stockholders to sell common stock in the public market.

The trading priceof our common stock is likely to be subject to wide fluctuations. Factorsaffecting the trading price of our common stock may include:

·                  Variationsin our financial results;

·                  Announcementsof innovations, new solutions, strategic alliances or significant agreements byus or by our competitors;

·                  Recruitmentor departure of key personnel;

·                  Changesin estimates of our financial results or changes in the recommendations of anysecurities analysts that elect to follow our common stock;

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

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

**Our needto raise additional capital in the future could have a dilutive effect on yourinvestment.**

We will need toraise additional capital.  One possibility for raising additional capitalis the public or private sale of our Common Stock or securities convertibleinto or exercisable for our common stock. Such sales could be consummated at a significant discount to the tradingprice of our stock.

If we selladditional shares of our common stock, such sales will further dilute thepercentage of our equity that our existing stockholders own.  In addition, our recent private placementfinancings have involved the issuance of securities at a price per share thatrepresented a discount to the trading prices listed for our Common Stock on theOTC Bulletin Board and it is possible that we will close future privateplacements involving the issuance of securities at a discount to prevailingtrading prices.  Depending upon the priceper share of securities that we sell in the future, a stockholder’s interest inus will be further diluted by any adjustments to the number of shares and theapplicable exercise price required pursuant to the terms of the agreementsunder which we previously issued securities. No assurance can be given that previous or future investors, finders orplacement agents will not claim that they are entitled to additionalanti-dilution adjustments or dispute our calculation of any suchadjustments.  Any such claim or dispute could require us to incur materialcosts and expenses regardless of the resolution and, if resolved unfavorably tous, to affect dilutive securities issuances or adjustments to previously issuedsecurities.  In addition, futurefinancings may include provisions requiring us to make additional payments tothe investors if we fail to obtain or maintain the effectiveness of SEC registrationstatements by specified dates or take other specified action.  Our ability to meet these requirements maydepend on actions by regulators and other third parties, over which we willhave no control.  These provisions mayrequire us to make payments or issue additional dilutive securities, or couldlead to costly and disruptive disputes. In addition, these provisions could require us to record additionalnon-cash expenses.

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

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

The CreditFacility involves significant interest expenses and other fees.  Inaddition, except in certain limited circumstances, the Revolving Facilitycannot be pre-paid in full without us incurring a significant pre-paymentpenalty.

The CreditFacility imposes various restrictions on our activities without the consent ofthe lenders, including a prohibition on fundamental changes to us or our director indirect subsidiaries (including certain consolidations, mergers and salesand transfer of assets, and limitations on our ability or any of our direct orindirect subsidiaries to grant liens upon our property or assets).  Inaddition, under the Credit Facility we must meet certain net worth, earningsand debt service coverage requirements.  The Credit Facility includesevents of default (with grace periods, as applicable) and provides that, upon theoccurrence of certain events of default, payment of all amounts payable underthe Credit Facility, including the principal amount of, and accrued intereston, the Credit Facility may be accelerated.  In addition, upon theoccurrence of certain insolvency or bankruptcy related events of default, allamounts payable under the Credit Facility, including the principal amount of,and accrued interest on, the Credit Facility shall automatically becomeimmediately due and payable.  We arecurrently in default of certain covenants and requirements contained in theCredit Facility.

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

**Theagreements governing the convertible debentures contain covenants andrestrictions that may limit our ability to operate our business.**

The terms of our2006 convertible debentures limit our ability to, among other things: declareor pay dividends or distributions on any equity securities, create or incuradditional indebtedness, create additional liens on our assets and repurchasecommon stock.  These restrictions couldadversely affect our ability to borrow additional funds or raise additionalequity to fund our future operations.  Inaddition, if we fail to comply with any of the covenants contained in theagreements or otherwise default on the convertible debentures, the holders mayaccelerate the indebtedness, and we may not have sufficient funds available tomake the required payments.  We arecurrently in default of certain covenants contained in the convertible debentures.

**MedCapPartners L.P. controls a majority of our outstanding capital stock and this maydelay or prevent change of control of our company or adversely affect our stockprice.**

MedCap PartnersL.P. controls approximately 76% of our outstanding capital stock.  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 aredependent upon the personal efforts of our management team.  The loss of any of our officers or directorscould have a material adverse effect upon our business and future prospects.  We do not presently have key-person lifeinsurance upon the life of any of our officers or directors. Additionally, aswe continue our planned expansion of commercial operations, we will require theservices of additional skilled personnel. There can be no assurance that we can attract persons with the requisiteskills and training to meet our future needs or, even if such persons areavailable, that they can be hired on terms favorable to us.

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**We havehad a short operating history.**

We were formed inNovember 1997 and commenced operations on August 7, 2003 with our acquisitionof Baker Anderson Christie, Inc.  We area “start-up” operation and subject to all the risks inherent in a new businessventure, many of which are beyond our control, including the ability toimplement successful operations, lack of capital to finance acquisitions andfailure to achieve market acceptance.  Inaddition, as a start-up venture we will face significant competition from manycompanies virtually all of which are larger, better financed and havesignificantly greater market recognition than us.

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

With respect toour planned operations, management cannot accurately project or give anyassurance with respect to our ability to control development and operatingcosts and/or expenses in the future. Consequently, as we expand our commercial operations, management may notbe able to control costs and expenses adequately, and such operations maygenerate losses.

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

Although ouroperations are currently not subject to any significant government regulations,it is possible that, in the future, such regulations may be legislated.  Although we cannot predict the extent of anysuch future regulations, a possibility exists that future or unforeseen changesmay have an adverse impact upon our ability to continue or expand ouroperations as presently planned.

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

We relysignificantly on our ability to attract and retain nurses and healthcareprofessionals who possess the skills, experience and licenses necessary to meetthe requirements of our hospital and healthcare facility clients.  We compete for healthcare staffing personnelwith other temporary healthcare staffing companies and with hospitals andhealthcare facilities.  We must continuallyevaluate and expand our temporary healthcare professional network to keep pacewith our hospital and healthcare facility clients’ needs.  Currently, there is a shortage of qualifiednurses in most areas of the United States, competition for nursing personnel isincreasing, and salaries and benefits have risen.  We may be unable to continue to increase thenumber of temporary healthcare professionals that we recruit, decreasing thepotential for growth of our business. Our ability to attract and retain temporary healthcare professionals dependson several factors, including our ability to provide temporary healthcareprofessionals with assignments that they view as attractive and to provide themwith competitive benefits and wages.  Wecannot assure you that we will be successful in any of these areas.  The cost of attracting temporary healthcareprofessionals and providing them with attractive benefit packages may be higherthan we anticipate and, as a result, if we are unable to pass these costs on toour hospital and healthcare facility clients, our losses could increase.  Moreover, if we are unable to attract andretain temporary healthcare professionals, the quality of our services to ourhospital and healthcare facility clients may decline and, as a result, we couldlose clients.

**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 temporarystaffing industry is highly competitive and fragmented, with limited barriersto entry.  We compete in national,regional and local markets with full-service agencies and in regional and localmarkets with specialized temporary staffing agencies.  Some of our competitors include AMNHealthcare Services, Inc., Cross Country, Inc., Medical Staffing NetworkHoldings, Inc. and On Assignment, Inc. All of these companies have significantly greater marketing andfinancial resources than we do.  Ourability to attract and retain clients is based on the value of the service wedeliver, which in turn depends principally on the speed with which we fillassignments and the appropriateness of the match based on clients’ requirementsand the skills and experience of our temporary employees.  Our ability to attract skilled, experiencedtemporary professionals is based on our ability to pay competitive wages, toprovide competitive benefits, to provide multiple, continuous assignments andthereby increase the retention rate of these employees.  To the

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extent thatcompetitors seek to gain or retain market share by reducing prices orincreasing marketing expenditures, we could lose revenues and our margins coulddecline, which could seriously harm our operating results and cause the tradingprice of our stock to decline.  As weexpand into new geographic markets, our success will depend in part on ourability to gain market share from competitors. We expect competition for clients to increase in the future, and thesuccess and growth of our business depend on our ability to remain competitive.

**Ourbusiness depends upon our continued ability to secure and fill new orders fromour hospital and healthcare facility clients, because we do not have long-termagreements or exclusive contracts with them.**

We generally donot have long-term agreements or exclusive guaranteed order contracts with ourhospital and healthcare facility clients. The success of our business depends upon our ability to continuallysecure new orders from hospitals and other healthcare facilities and to fillthose orders with our temporary healthcare professionals.  Our hospital and healthcare facility clientsare free to place orders with our competitors and may choose to use temporaryhealthcare professionals that our competitors offer them.  Therefore, we must maintain positiverelationships with our hospital and healthcare facility clients.  If we fail to maintain positive relationshipswith our hospital and healthcare facility clients, we may be unable to generatenew temporary healthcare professional orders and our business may be adverselyaffected.

**Fluctuationsin patient occupancy at our clients’ hospitals and healthcare facilities mayadversely affect the demand for our services and therefore the profitability ofour business.**

Demand for ourtemporary healthcare staffing services is significantly affected by the generallevel of patient occupancy at our hospital and healthcare clients’facilities.  When occupancy increases,hospitals and other healthcare facilities often add temporary employees beforefull-time employees are hired.  As occupancydecreases, hospitals and other healthcare facilities typically reduce their useof temporary employees before undertaking layoffs of their regularemployees.  In addition, we mayexperience more competitive pricing pressure during periods of occupancydownturn.  Occupancy at our clients’hospitals and healthcare facilities also fluctuates due to the seasonality ofsome elective procedures.  We are unableto predict the level of patient occupancy at any particular time and its effecton our revenues and earnings.

**Healthcarereform could negatively impact our business opportunities, revenues andmargins.**

The U.S.government has undertaken efforts to control increasing healthcare coststhrough legislation, regulation and voluntary agreements with medical careproviders and drug companies.  In therecent past, the U.S. Congress has considered several comprehensive healthcarereform proposals.  The proposals weregenerally intended to expand healthcare coverage for the uninsured and reducethe growth of total healthcare expenditures. While the U.S. Congress did not adopt any comprehensive reformproposals, members of Congress may raise similar proposals in the future.  If any of these proposals are approved,hospitals and other healthcare facilities may react by spending less onhealthcare staffing, including nurses. If this were to occur, we would have fewer business opportunities, whichcould seriously harm our business.

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

Furthermore, thirdparty payers, such as health maintenance organizations, increasingly challengethe prices charged for medical care. Failure by hospitals and other healthcare facilities to obtain fullreimbursement from those third party payers could reduce the demand or theprice paid for our staffing services.

**Weoperate in a regulated industry and changes in regulations or violations ofregulations may result in increased costs or sanctions that could reduce ourrevenues and profitability.**

The healthcareindustry is subject to extensive and complex federal and state laws andregulations related to professional licensure, conduct of operations, paymentfor services and payment for referrals. If we fail to comply with the laws and 

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regulations thatare directly applicable to our business, we could suffer civil and/or criminalpenalties or be subject to injunctions or cease and desist orders.

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

In addition,improper actions by our employees and other service providers may subject us toregulatory and litigation risk.

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

Our businessstrategy includes increasing our market share and presence in the temporaryhealthcare staffing industry through strategic acquisitions of companies thatcomplement or enhance our business.  Wehave historically faced competition for acquisitions.  In the future, such competition could limitour ability to grow by acquisitions or could raise the prices of acquisitionsand make them less attractive to us.

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

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

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

Because we are inthe business of placing our temporary healthcare professionals in theworkplaces of other companies, we are subject to possible claims by ourtemporary healthcare professionals alleging discrimination, sexual harassment,negligence and other similar activities by our hospital and healthcare facilityclients.  The cost of defending suchclaims, even if groundless, could be substantial and the associated negativepublicity could adversely affect our ability to attract and retain qualifiedhealthcare 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 ourbusiness strategy and continued growth of our business are substantiallydependent upon our ability to attract, develop and retain qualified and skilledsales personnel who engage in selling and business development for ourservices.  The available pool ofqualified sales personnel candidates is limited.  We commit substantial resources to therecruitment, training, development and operational support of our salespersonnel.  There can be no assurancethat we will be able to recruit, develop and retain qualified sales personnelin sufficient numbers or that our sales personnel will achieve productivity levelssufficient to enable growth of our business. Failure to attract and retainproductive sales personnel could adversely affect our business, financialcondition and results of operations.

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**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 June 30,2006, we had $26.5 million of goodwill and other unamortized intangible assetson our balance sheet, which represents the excess of the total purchase priceof our acquisitions over the fair value of the net assets acquired.  At June 30, 2006, goodwill and otherintangible assets represented 76% of our total assets.

In July 2001, theFinancial Accounting 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 all purchasemethod business combinations completed after June 30, 2001.  SFAS No. 142 requires that, subsequent toJanuary 1, 2002, goodwill not be amortized but rather that it be reviewedannually for impairment.  In the eventimpairment is identified, a charge to earnings would be recorded.  We have adopted the provisions of SFAS No.141 and SFAS No. 142.  Although it doesnot affect our cash flow, an impairment charge of goodwill to earnings has theeffect of decreasing our earnings or increasing our losses, as the case maybe.  If we are required to write down asubstantial amount of goodwill, our stock price could be adversely affected.

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

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

**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 Chief FinancialOfficer, as appropriate, to allow for timely decisions regarding requireddisclosure.  In designing and evaluatingthe disclosure controls and procedures, management recognizes that any controlsand procedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives and managementis required to apply its judgment in evaluating the cost-benefit relationshipof possible controls and procedures.

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

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

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**PART II —OTHER INFORMATION**

**Item 1.    Legal Proceedings**

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

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

From time to time,we may become involved in various lawsuits and legal proceedings which arise inthe ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverseresult in these or other matters may arise from time to time that may harm ourbusiness.  We are not currently aware ofany such legal proceedings or claims that we believe will have, individually orin the aggregate, a material adverse affect on our business, financialcondition or operating results.

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

None

**Item 3.    Defaults Upon Senior Securities**

The disclosure setforth in Notes 5, 6, 7 and 8 to our Unaudited Condensed Consolidated FinancialStatements dated June 30, 2006 included in Item 1 of Part I of this QuarterlyReport, to the extent applicable, is incorporated herein by reference.

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

None

**Item 5.    Other Information**

None

**Item 6.    Exhibits**

(a)                                  Exhibits

 

| Exhibit No. | ** ** | **Description**                                                                                                                                                                            |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1(1)           |       | Asset Purchase Agreement dated April 10, 2006 by and  among Crdentia Corp., CRDE Corp., Staff Search Acquisition Corp., Staff  Search, Ltd., SSL GP, LCC and J.W. Iden.                    |
|             |       |                                                                                                                                                                                       |
| 2.2(1)           |       | First Amendment to Asset Purchase Agreement dated  April 18, 2006 by and among Crdentia Corp., CRDE Corp., Staff Search  Acquisition Corp., Staff Search, Ltd., SSL GP, LCC and J.W. Iden. |
|             |       |                                                                                                                                                                                       |
| 3.1(2)           |       | Restated Certificate of Incorporation.                                                                                                                                                     |
|             |       |                                                                                                                                                                                       |
| 3.2(3)           |       | Certificate of Amendment to Restated Certificate of  Incorporation.                                                                                                                        |
|             |       |                                                                                                                                                                                       |

 

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| 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 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(14)  |   | Certificate of Amendment to Restated Certificate of  Incorporation.                                                                     |
|      |   |                                                                                                                                    |
| 3.17(14)  |   | Certificate of Correction of Certificate of  Amendment to Restated Certificate of Incorporation.                                        |
|      |   |                                                                                                                                    |
| 3.17(14)  |   | Certificate of Correction of Certificate of  Amendment to Restated Certificate of Incorporation.                                        |
|      |   |                                                                                                                                    |
| 3.18(13)  |   | Certificate of Amendment of Certificate of  Designations, Preferences and Rights of Series C Preferred Stock of  Crdentia Corp.    |
|      |   |                                                                                                                                    |
| 10.72(15) |   | Promissory Note Issued by Crdentia to Staff Search  Ltd.                                                                                |
|      |   |                                                                                                                                    |
| 10.75(16) |   | Amendment to Executive Employment Agreement dated  July 18, 2006 among Crdentia Corp. and James J. TerBeest.                            |
|      |   |                                                                                                                                    |
| 31.1      |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                               |
|      |   |                                                                                                                                    |
| 31.2      |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                               |
|      |   |                                                                                                                                    |
| 32.1      |   | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley act of 2002.                               |
|      |   |                                                                                                                                    |
| 32.2      |   | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley act of 2002.                               |

 

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(1)                                  Previouslyfiled a Quarterly Report on Form 10-QSB dated May 15, 2006 and incorporatedherein by reference.

(2)                                  Previouslyfiled with a Current Report on Form 8-K dated August 22, 2002 andincorporated herein by reference.

(3)                                  Previouslyfiled with a Quarterly Report on Form 10-QSB dated August 12, 2003and incorporated herein by reference.

(4)                                  Previouslyfiled with an amended Current Report on Form 8-K/A dated June 28,2004 and incorporated herein by reference.

(5)                                  Previouslyfiled with a Current Report on Form 8-K dated December 30, 2003 andincorporated herein by reference.

(6)                                  Previouslyfiled with a Current Report on Form 8-K dated February 20, 2004 andincorporated herein by reference.

(7)                                  Previouslyfiled with a Current Report on Form 8-K dated June 22, 2004 andincorporated herein by reference.

(8)                                  Previouslyfiled with an amended Current Report on Form 8-K/A dated October 10,2004 and incorporated herein by reference.

(9)                                  Previouslyfiled with a Current Report on Form 8-K dated August 24, 2004 andincorporated herein by reference.

(10)                            Previouslyfiled with an amended Current Report on Form 8-K/A dated October 10,2004 and incorporated herein by reference.

(11)                            Previouslyfiled with a Current Report on Form 8-K dated September 7, 2004 andincorporated herein by reference.

(12)                            Previouslyfiled with a Current Report on Form 8-K dated January 1, 2005 andincorporated herein by reference.

(13)                            Previouslyfiled with a Current Report on Form 8-K dated March 21, 2005 andincorporated herein by reference.

(14)                            Previouslyfiled on Post-Effective Amendment No. 1 to Registration Statement on Form SB-2with theSecurities and Exchange Commission on April 4, 2006 and incorporated herein byreference.

(15)         Previouslyfiled with a Current Report on Form 8-K dated April 18, 2006 andincorporated herein by reference.

(16)         Previously filed with a Current Reporton Form 8-K dated July 18, 2006 and incorporated herein by reference.

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this Report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                         |   | CRDENTIA CORP.                |
|-------------------------|--------|-------------------------------|
|                    |   |                          |
| Dated: August  14, 2006 | By:    | /s/ James D. Durham           |
|                    |   | James D. Durham               |
|                    |   | Chief Executive Officer and   |
|                    |   | Chairman of the Board         |
|                    |   | (Principal Executive Officer) |
|                    |   |                          |
|                    |   |                          |
| Dated: August  14, 2006 | By:    | /s/ James J. TerBeest         |
|                    |   | James J. TerBeest             |
|                    |   | Chief Financial Officer       |
|                    |   | (Principal Financial Officer) |

 

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