**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

## **FORM 10-QSB**

## ** **

**(Mark One)**

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

 
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13**                                                                                                                                                                                                                                                                            |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | **OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                                                                                                                                                                                                                    |
| ** ** | ** **                                                                                                                                                                                                                                                                                                                   |
| ** ** | **For the transition period from                           to                       ** |

 

## **Commission File Number 0-31152**

## ** **

**CRDENTIA CORP.**

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

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

 

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

(Address of principal executive offices)

 

**(972) 850-0780**

(Issuer’s telephone number)

 

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

 

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

 

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

 

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

 

 

----

 

**CRDENTIACORP.**

 

Form 10-QSB QuarterlyReport

For Quarterly Period Ended September 30,2005

 

**Table ofContents**

 
| ** **                                   | ** **                                                                                                                             | **Page** |
|----------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                         |                                                                                                                                   |     |
| **PART I — FINANCIAL INFORMATION** | 3                                                                                                                                      |     |
|                                         |                                                                                                                                   |     |   |
| Item 1.                                      | Unaudited Condensed Consolidated Financial Statements                                                                                  | 3        |   |
|                                         |                                                                                                                                   |     |   |
|                                         | Unaudited Condensed Consolidated Balance Sheets at September 30,  2005 and December 31, 2004                                 | 3        |   |
|                                         |                                                                                                                                   |     |   |
|                                         | Unaudited Condensed Consolidated Statements of Operations for the  Three Months and Nine Months Ended September 30, 2005 and 2004 | 4        |   |
|                                         |                                                                                                                                   |     |   |
|                                         | Unaudited Condensed Consolidated Statements of Cash Flows for the  Nine Months Ended September 30, 2005 and 2004                  | 5        |   |
|                                         |                                                                                                                                   |     |   |
|                                         | Notes to Unaudited Condensed Consolidated Financial Statements                                                                         | 6        |   |
|                                         |                                                                                                                                   |     |   |
| Item  2.                                     | Management’s  Discussion and Analysis or Plan of Operation                                                                        | 22       |   |
|                                         |                                                                                                                                   |     |   |
| Item  3.                                     | Controls  and Procedures                                                                                                               | 37       |   |
|                                         |                                                                                                                                   |     |   |
| **PART II  — OTHER INFORMATION**   | 38                                                                                                                                     |     |
|                                         |                                                                                                                                   |     |   |
| Item  1.                                     | Legal  Proceedings                                                                                                                     | 38       |   |
|                                         |                                                                                                                                   |     |   |
| Item  2.                                     | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                           | 38       |   |
|                                         |                                                                                                                                   |     |   |
| Item  6.                                     | Exhibits                                                                                                                               | 38       |   |
|                                         |                                                                                                                                   |     |   |
| **SIGNATURES**                               | 40                                                                                                                                     |     |

 

----

 

**PART 1. FINANCIAL INFORMATION**

**Item 1. Unaudited Condensed ConsolidatedFinancial Statements**

 

**CRDENTIACORP.**

**Unaudited Condensed Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                           | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| Current assets:                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                           |       | $                      | 302,578    |                  | $          | 362,472 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $99,838 in 2005 and  $114,957 in 2004                                                                                                                                                                |       | 4,804,828              |       | 2,908,403             |       |
| Unbilled  receivables                                                                                                                                                                                                                                                |       | 644,257                |       | 303,626               |       |
| Other  current assets                                                                                                                                                                                                                                                |       | 805,934                |       | 495,579               |       |
| Total current assets                                                                                                                                                                                                                                                 |       | 6,557,597              |       | 4,070,080             |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Property and equipment, net                                                                                                                                                                                                                                          |       | 421,753                |       | 293,600               |       |
| Goodwill                                                                                                                                                                                                                                                             |       | 22,734,825             |       | 12,974,973            |       |
| Intangible assets, net                                                                                                                                                                                                                                               |       | 2,308,479              |       | 1,660,717             |       |
| Other assets                                                                                                                                                                                                                                                         |       | 648,245                |       | 837,061               |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Total assets                                                                                                                                                                                                                                                         |       | $                      | 32,670,899 |                  | $          | 19,836,431 |   |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Accounts  payable and accrued expenses                                                                                                                                                                                                                               |       | $                      | 1,347,664  |                  | $          | 2,523,069 |   |
| Accrued  dividends on convertible preferred stock                                                                                                                                                                                                                    |       | —                 |       | 1,027,254             |       |
| Accrued  employee compensation and benefits                                                                                                                                                                                                                          |       | 456,138                |       | 554,945               |       |
| Revolving  lines of credit                                                                                                                                                                                                                                           |       | 5,057,451              |       | 2,521,598             |       |
| Current  portion of note payable to lender, net of discount                                                                                                                                                                                                          |       | —                 |       | 2,049,816             |       |
| Note payable  to stockholder                                                                                                                                                                                                                                         |       | —                 |       | 400,000               |       |
| Current  portion of notes payable to sellers                                                                                                                                                                                                                         |       | 1,107,578              |       | 184,948               |       |
| Other  current liabilities                                                                                                                                                                                                                                           |       | 242,739                |       | 100,017               |       |
| Subordinated  convertible note, net of discount                                                                                                                                                                                                                      |       | 25,000                 |       | 50,000                |       |
| Total current liabilities                                                                                                                                                                                                                                            |       | 8,236,570              |       | 9,411,647             |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Note payable to lender, less current  portion, net of discount                                                                                                                                                                                                       |       | 2,237,416              |       | —                |       |
| Long term bonus payable                                                                                                                                                                                                                                              |       | 953,590                |       | 884,962               |       |
| Notes payable to sellers, less current  portion                                                                                                                                                                                                                      |       | 2,107,912              |       | —                |       |
| Other long-term liabilities                                                                                                                                                                                                                                          |       | 5,273                  |       | 33,045                |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Total liabilities                                                                                                                                                                                                                                                    |       | 13,540,761             |       | 10,329,654            |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Commitments and contingencies                                                                                                                                                                                                                                        |       |                   |       |                  |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Convertible preferred stock, 10,000,000  shares authorized:                                                                                                                                                                                                          |       |                   |       |                  |       |
| Series B  convertible preferred stock $0.0001 par value, no shares outstanding at 2005  and 3,750,000 shares outstanding at 2004 (liquidation preference of $750,000  in 2004)                                                                                  |       | —                 |       | 750,000               |       |
| Series B-1  convertible preferred stock $0.0001 par value, no shares outstanding at 2005  and 93,043 shares outstanding at 2004 (liquidation preference of $5,582,580  in 2004)                                                                                 |       | —                 |       | 30,123,400            |       |
| Series C  convertible preferred stock $0.0001 par value, 183,028 shares outstanding at  2005 and 52,501 shares outstanding at 2004 (liquidation preference of  $54,908,400 in 2005 and $15,750,300 in 2004)                                                     |       | 10,020,048             |       | 1,070,510             |       |
| Series C  preferred stock warrants                                                                                                                                                                                                                              |       | 839,555                |       | 2,079,910             |       |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Stockholders’ equity (deficit):                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Common  stock, par value $0.0001, 150,000,000 shares authorized in 2005 and  50,000,000 shares authorized in 2004,   31,621,040 shares issued and 30,544,634 shares outstanding in 2005 and  14,202,883 shares issued and 13,126,477 shares outstanding in 2004 |       | 3,162                  |       | 1,420                 |       |
| Additional  paid in capital                                                                                                                                                                                                                                          |       | 112,081,975            |       | 68,447,288            |       |
| Treasury  stock, 1,076,406 shares at cost                                                                                                                                                                                                                            |       | —                 |       | —                |       |
| Deferred  non-cash stock compensation                                                                                                                                                                                                                                |       | (6,267,258             | )          | (648,746              | )          |
| Accumulated  deficit                                                                                                                                                                                                                                                 |       | (97,547,344            | )          | (92,317,005           | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                                            |       | 8,270,535              |       | (24,517,043           | )          |
|                                                                                                                                                                                                                                                                 |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                                                                                                                           |       | $                      | 32,670,899 |                  | $          | 19,836,431 |   |

 

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

 

3

----

 

**CRDENTIA CORP.**

**Unaudited Condensed Consolidated Statementsof Operations**

 
| ** **                                                                                                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue from services                                                                                     |       | $                                         | 9,637,560  |                                     | $          | 5,526,945 |   | $ | 23,967,381 |   | $ | 17,234,443 |   |
| Direct operating expenses                                                                                 |       | 7,203,321                                 |       | 4,266,717                                |       | 18,362,258 |   | 13,522,086 |   |
| Gross profit                                                                                              |       | 2,434,239                                 |       | 1,260,228                                |       | 5,605,123 |   | 3,712,357 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Operating expenses:                                                                                       |       |                                      |       |                                     |       |   |   |   |   |
| Selling,  general, and administrative expenses                                                            |       | 2,425,475                                 |       | 2,561,217                                |       | 6,316,626 |   | 6,766,896 |   |
| Loss on  impairment of customer related intangibles                                                       |       | —                                    |       | 121,440                                  |       | — |   | 121,440 |   |
| Non-cash  stock based compensation                                                                        |       | 401,154                                   |       | 140,425                                  |       | 671,488 |   | 299,880 |   |
| Total operating expenses                                                                                  |       | 2,826,629                                 |       | 2,823,082                                |       | 6,988,114 |   | 7,188,216 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Loss from operations                                                                                      |       | (392,390                                  | )          | (1,562,854                               | )          | (1,382,991 | ) | (3,475,859 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Non-cash expense for conversion of debt                                                                   |       | —                                    |       | (7,497,250                               | )          | — |   | (7,497,250 | ) |
| Interest expense, net                                                                                     |       | (485,451                                  | )          | (713,266                                 | )          | (1,484,369 | ) | (1,712,376 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Loss before income taxes                                                                                  |       | (877,841                                  | )          | (9,773,370                               | )          | (2,867,360 | ) | (12,685,485 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Income tax expense                                                                                        |       | —                                    |       | —                                   |       | — |   | — |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Net loss                                                                                                  |       | $                                         | (877,841   | )                                        | $          | (9,773,370 | ) | $ | (2,867,360 | ) | $ | (12,685,485 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Deemed  dividend related to beneficial conversion feature on Series A convertible  preferred stock   |       | —                                    |       | —                                   |       | — |   | (1,000,000 | ) |
| Deemed  dividend related to beneficial conversion feature on Series B convertible  preferred stock   |       | —                                    |       | —                                   |       | — |   | (1,250,000 | ) |
| Deemed  dividend related to beneficial conversion feature on Series B-1 convertible  preferred stock |       | —                                    |       | (1,233,480                               | )          | — |   | (1,233,480 | ) |
| Deemed  dividend related to beneficial conversion feature on Series B-1 warrants  issued             |       | —                                    |       | (360,000                                 | )          | — |   | (360,000 | ) |
| Deemed  dividend related to beneficial conversion feature on Series C  convertible preferred stock   |       |                                      |       | (677,382                                 | )          | — |   | (677,382 | ) |
| Non-cash preferred stock dividends                                                                        |       | —                                    |       | —                                   |       | (2,362,979 | ) | — |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Net loss attributable to common  stockholders                                                             |       | $                                         | (877,841   | )                                        | $          | (12,044,232 | ) | $ | (5,230,339 | ) | $ | (17,206,347 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Basic and  diluted loss per common share attributable to common stockholders                              |       | $                                         | (0.03      | )                                        | $          | (1.86 | ) | $ | (0.23 | ) | $ | (2.71 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Weighted  average number of common shares outstanding                                                     |       | 26,841,329                                |       | 6,478,271                                |       | 22,445,325 |   | 6,349,072 |   |

 

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

 

4

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**CRDENTIACORP.**

**Unaudited Condensed Consolidated Statementsof Cash Flows**

 
| ** **                                                                   | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| **Operating activities**                                                     |       |                                     |       |   |   |
| Net loss                                                                     |       | $                                        | (2,867,360 | ) | $ | (12,685,485 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                     |       |   |   |
| Amortization  of subordinated convertible note discounts                     |       | —                                   |       | 654,167 |   |
| Amortization  of lender note discounts                                       |       | 187,600                                  |       | 40,503 |   |
| Amortization  of debt issue costs                                            |       | 250,184                                  |       | 283,732 |   |
| Amortization  of long-term bonus payable                                     |       | 68,628                                   |       | 62,202 |   |
| Non-cash  stock based expense related to short-term borrowings               |       | 162,500                                  |       | — |   |
| Non-cash  expense for conversion of debt                                     |       | —                                   |       | 7,497,250 |   |
| Depreciation  and amortization                                               |       | 601,072                                  |       | 740,226 |   |
| Bad debt  expense                                                            |       | —                                   |       | 50,050 |   |
| Non-cash  stock based compensation                                           |       | 671,488                                  |       | 299,880 |   |
| Loss on  impairment of customer intangibles                                  |       | —                                   |       | 121,440 |   |
| Changes in  operating assets and liabilities, net of effects of acquisitions |       |                                     |       |   |   |
| Accounts  receivable                                                         |       | (851,578                                 | )          | 91,155 |   |
| Unbilled  receivables                                                        |       | (340,631                                 | )          | (50,030 | ) |
| Other assets  and liabilities                                                |       | (180,282                                 | )          | (217,805 | ) |
| Accounts  payable and accrued expenses                                       |       | (1,325,405                               | )          | 1,243,162 |   |
| Accrued  employee compensation and benefits                                  |       | (67,375                                  | )          | (109,817 | ) |
| Net cash used in operating activities                                        |       | (3,691,159                               | )          | (1,979,370 | ) |
|                                                                         |       |                                     |       |   |   |
| **Investing activities**                                                     |       |                                     |       |   |   |
| Purchases of property and equipment                                          |       | (117,415                                 | )          | (166,648 | ) |
| Cash paid for acquisition of subsidiaries,  net of cash received             |       | (4,956,980                               | )          | (4,213,933 | ) |
| Other                                                                        |       | 23,829                                   |       | — |   |
| Net cash used in investing activities                                        |       | (5,050,566                               | )          | (4,380,581 | ) |
|                                                                         |       |                                     |       |   |   |
| **Financing activities**                                                     |       |                                     |       |   |   |
| Issuance of preferred stock                                                  |       | —                                   |       | 5,060,760 |   |
| Exercise of warrants for Series C  preferred stock, net of expenses     |       | 7,709,183                                |       | — |   |
| Net increase (decrease) in revolving lines  of credit                        |       | 1,594,463                                |       | (548,126 | ) |
| Repayment of subordinated convertible note                                   |       | (25,000                                  | )          | — |   |
| Proceeds from notes payable to majority  stockholder                         |       | 1,050,000                                |       | — |   |
| Repayment of notes payable to majority  stockholder                          |       | (1,450,000                               | )          | — |   |
| Proceeds from notes payable to lender                                        |       | —                                   |       | 2,697,802 |   |
| Repayment of note payable to lender                                          |       | —                                   |       | (719,444 | ) |
| Repayment of notes payable to sellers                                        |       | (184,948                                 | )          | (257,494 | ) |
| Debt issuance costs                                                          |       | (11,867                                  | )          | (1,105,703 | ) |
| Net cash provided by financing activities                                    |       | 8,681,831                                |       | 5,127,795 |   |
|                                                                         |       |                                     |       |   |   |
| Net decrease in cash and cash equivalents                                    |       | (59,894                                  | )          | (1,232,156 | ) |
| Cash and cash equivalents at beginning of  period                            |       | 362,472                                  |       | 1,469,076 |   |
| Cash and cash equivalents at end of period                                   |       | $                                        | 302,578    |   | $ | 236,920 |   |

 

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

 

5

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**CRDENTIA CORP.**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2005**

 

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

 

Organization

 

CrdentiaCorp (the “Company”), a Delaware corporation, is a provider of healthcarestaffing services in the United States. Such services include travel nursing, per diem staffing, contractualclinical services and private duty home health care. The Company considersthese services to be one segment. Each of these services relate solely toproviding healthcare staffing to customers and the Company utilizes commonprocedures, processes and similar methods of identifying and serving thesecustomers.

 

At thebeginning of 2003, the Company was a development stage company with nocommercial operations. During that year, the Company pursued its operationalplan of acquiring companies in the healthcare staffing field and completed theacquisition of four operating companies. The companies acquired in 2003 — BakerAnderson Christie, Inc., New Age Nurses, Inc., Nurses Network, Inc.,and PSR Nurses, Ltd. (through the acquisition of PSR Nurses Holdings Corp. andPSR Nurse Recruiting, Inc., which hold the limited partner and generalpartner interests in PSR Nurses, Ltd.) — provide the foundation for futuregrowth. During 2004, the Company completed the acquisitions of Arizona HomeHealth Care/Private Duty, Inc. and Care Pros Staffing, Inc. On March 29,2005, the Company acquiredTravMed USA, Inc.and Health Industry Professionals, LLC. On May 4, 2005, the Companyacquired Prime Staff, LP and Mint Medical Staffing Odessa.

 

Theaccompanying financial statements include the results of the wholly-ownedsubsidiaries discussed above from their respective dates of acquisition.  All intercompany transactions have beeneliminated in consolidation.

 

Basis ofPresentation

 

Theaccompanying unaudited financial data as of and for the three and nine monthsended September 30, 2005 and 2004 have been prepared by the Companypursuant to the rules and regulations of the Securities and ExchangeCommission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to such rules and regulations. These unaudited condensedconsolidated financial statements should be read in conjunction with theaudited financial statements and the notes thereto included in the Company’sannual Report on Form 10-KSB for the year ended December 31, 2004.

 

In theopinion of management, all adjustments (which include only normal recurringadjustments) necessary to present fairly the financial position, results ofoperations, and cash flows as of and for the three and nine months ended September 30,2005 have been made. The results of operations for the nine months ended September 30,2005 are not necessarily indicative of the operating results for the full year.

 

6

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Liquidity

 

The Company generated a net loss of $2,867,360 for the nine monthsended September 30, 2005 and used cash in operations of $3,691,159 duringthe first nine months of 2005. Additionally, although the Company ended the first nine months of 2005with a working capital deficit of $1.7 million, the Company was able to secureadditional funding during 2004 and the first nine months of 2005 to finance itsoperations as it continues to execute its business plan to acquire and growcompanies involved in healthcare staffing. As discussed in Note 8, in March 2005 the Company’s majoritystockholder exercised warrants to purchase 108,333 shares of Series CConvertible Preferred Stock providing $6.4 million to the Company.  Also, as discussed in Note 8, in May 2005the Company’s majority stockholder exercised warrants to purchase 22,187 sharesof Series C Convertible Preferred Stock providing $1.3 million to theCompany.  The infusion of $7.7 millioninto the Company enabled it to acquire additional companies and to retirecertain liabilities. Also, following the three acquisitions discussed in Note2, the Company increased its borrowings under its accounts receivable line, butat September 30, 2005, there is no additional borrowing availability underthis line.  In the third quarter of 2005,additional short-term funding of $600,000 in the form of an over-advance on theaccounts receivable line was secured from Bridge Healthcare Finance, LLC.  The Company will need to raise $1.5 millionto $2.0 million before calendar year end 2005 or pursue other strategic optionsto fund operations.

 

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

 

Stock-BasedCompensation

 

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

 

If theCompany had elected the fair value method of accounting for employeestock-based compensation, compensation cost would be recorded at the estimatedfair value of the stock award grants over the service period, regardless oflater changes in stock prices and price volatility.  The date of grant fair values for optionsgranted have been estimated based on the Black-Scholes pricing model.

 

7

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Thetable below shows net loss per share attributable to common stockholders forthe three and nine months ended September 30, 2005 and 2004 as if theCompany had elected the fair value method of accounting for stock options.

 
| ** **                                                                                                                | ** ** | **Three**              | ** ** | **Three**              | ** ** | **Nine**               | ** ** | **Nine**               | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                | ** ** | **Months**             | ** ** | **Months**             | ** ** | **Months**             | ** ** | **Months**             | ** ** |
| ** **                                                                                                                | ** ** | **Ended**              | ** ** | **Ended**              | ** ** | **Ended**              | ** ** | **Ended**              | ** ** |
| ** **                                                                                                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004**               | ** ** |
|                                                                                                                      |       |                   |       |                   |       |                   |       |                   |       |
| Net loss attributable to common  stockholders as reported                                                                 |       | $                      | (877,841   | )                      | $          | (12,044,232            | )          | $                      | (5,230,339 | ) | $ | (17,206,347 | ) |
| Add:  stock-based employee compensation in reported net loss, net of related tax  effects                                 |       | 401,154                |       | 140,425                |       | 671,488                |       | 299,880                |       |
|                                                                                                                      |       |                   |       |                   |       |                   |       |                   |       |
| Deduct:  stock-based employee compensation determined under fair value method for all  awards, net of related tax effects |       | (465,902               | )          | (2,144,537             | )          | (790,116               | )          | (2,352,628             | )          |
|                                                                                                                      |       |                   |       |                   |       |                   |       |                   |       |
| Proforma net  loss attributable to common stockholders, as adjusted                                                       |       | $                      | (941,779   | )                      | $          | (14,048,344            | )          | $                      | (5,348,967 | ) | $ | (19,259,095 | ) |
|                                                                                                                      |       |                   |       |                   |       |                   |       |                   |       |
| Loss per share attributable to common  stockholders:                                                                      |       |                   |       |                   |       |                   |       |                   |       |
| Basic and  diluted, as reported                                                                                           |       | $                      | (.03       | )                      | $          | (1.86                  | )          | $                      | (.23       | ) | $ | (2.71 | ) |
| Basic and  diluted, as adjusted                                                                                           |       | $                      | (.04       | )                      | $          | (2.17                  | )          | $                      | (.24       | ) | $ | (3.03 | ) |

 

EarningsPer Share

 

Basicper share data has been computed on the loss attributable to commonstockholders for each period divided by the weighted average number of sharesof common stock outstanding for each period (excluding the restricted commonstock issued to certain officers in May 2005 as discussed in Note 9).   Diluted earnings per common share include boththe weighted average number of common shares and any common share equivalentssuch as convertible securities, options or warrants in the calculation.  As the Company recorded net losses for thethree and nine months ended September 30, 2005 and 2004, common shareequivalents outstanding would be anti-dilutive, and as such, have not beenincluded in diluted weighted average shares outstanding.  Common share equivalents that were excludedin the September 30, 2005 calculations totaled 41,546,158.

 

NewAccounting Pronouncements

 

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

 

8

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

 

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

 

**Note 2. Acquisitions**

 

TravMed USA, Inc.

 

On March 29, 2005, the Company acquired TravMed USA, Inc.(“TravMed”) in exchange for $3,215,490 in cash, $3,215,490 in notes payable,and $125,650 of net acquisition costs. The primary purpose of the acquisitionwas to enable the Company to expand its market share in the nurse staffingindustry. The following table summarizes the assets acquired and liabilitiesassumed as of the closing date:

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

 

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

 

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Health Industry Professionals, LLC

 

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

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

 

The acquisition was accounted for using the purchase method of accounting.  Customer related intangible assets will be amortized over their estimated useful life of five years.  The purchase price allocated to customer relationships was determined by management’s estimate based on a consistent model for all acquisitions developed by a professional valuation group.  Goodwill represents the excess of merger consideration over the fair value of assets acquired. The Company will be required to issue shares of its Common Stock to the former stockholders of HIP should its results of operations exceed performance standards established in the merger agreement.****The goodwill acquired may not be amortized for federal income tax purposes.

 

Prime Staff, LP and Mint Medical Staffing Odessa

 

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

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

 

10

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The acquisition was accounted for using the purchase method of accounting.  Customer related intangible assets will be amortized over their estimated useful life of five years.  The purchase price allocated to customer relationships was determined by management’s estimate based on a consistent model for all acquisitions developed by a professional valuation group.  Goodwill represents the excess of merger consideration over the fair value of assets acquired.  The goodwill acquired may not be amortized for federal income tax purposes.

 

Unaudited Pro Forma Summary Information

 

The following unauditedpro forma summary approximates the consolidated results of operations as if allacquisitions (including 2004 acquisitions) had occurred as of the beginning ofeach period presented, after giving effect to certain adjustments, includingamortization of specifically identifiable intangibles and interestexpense.  The pro forma financialinformation does not purport to be indicative of the results of operations thatwould have occurred had the transactions taken place at the beginning of theperiods presented or of future results of operations.

 
| ** **                                                                       | ** ** | **Three Months**       | ** ** | **Nine Months**        | ** ** | **Nine Months**        | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                       | ** ** | **Ended**              | ** ** | **Ended**              | ** ** | **Ended**              | ** ** |
| ** **                                                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                       | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004**               | ** ** |
| ** **                                                                       | ** ** | ** **             | ** ** | ** **             | ** ** | ** **             | ** ** |
| Revenue from services                                                            |       | $                      | 13,165,567 |                   | $          | 30,252,502             |       | $ | 41,814,519 |   |
|                                                                             |       |                   |       |                   |       |                   |       |
| Net loss                                                                         |       | (9,382,434             | )          | (2,601,197             | )          | (11,529,551            | )          |
|                                                                             |       |                   |       |                   |       |                   |       |
| Net loss attributable to common  stockholders                                    |       | (11,653,296            | )          | (4,964,176             | )          | (16,050,413            | )          |
| Basic and  diluted net loss per common share attributable to common stockholders |       | (1.43                  | )          | (.22                   | )          | (2.01                  | )          |
| Weighted-average shares of common stock  outstanding (basic and diluted)         |       | 8,126,997              |       | 22,929,376             |       | 7,997,798              |       |
|                                                                                  |            |                        |            |                        |            |                        |            |  |  |  |

 

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

 

Accounts payable and accrued expenses consistof the following:

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

 

**Note 4. Revolving Line of Credit**

 

On June 16, 2004, the Company enteredinto a Loan and Security Agreement with Bridge Healthcare Finance, LLC,pursuant to which the Company obtained a revolving credit facility up to$15,000,000 (the “Loan”).  During the firstquarter of 2005, the revolving line of credit facility was reduced to$10,000,000 permitting the Company to lower its effective interest rate throughlower unused line fees.  The Loan had anoriginal term of three years and bears interest at a rate equal to the greaterof three percent (3.0%) per annum over the prime rate or nine and one-halfpercent (9.5%) per annum (9.75% at September 30, 2005).  Interest is payable monthly.  Accounts receivable serves as security forthe Loan and the Loan is subject to certain financial and reportingcovenants.  Customer payments are used torepay the advances on the credit facility after deducting charges for interestexpense, unused line and account management fees.  Except in certain limited circumstances, theLoan cannot be prepaid in full without the Company incurring a significantprepayment penalty.  The financialcovenants are for the maintenance of minimum tangible net worth, minimum debtservice coverage ratios, minimum EBITDA, maximum capital expenditure limits andmaximum operating lease obligations.* *In May 2005, the covenantswere restructured and, at September 30, 2005, the Company was incompliance with the restructured covenants. The Loan includes events of default (with grace periods as applicable)and provides that, upon the occurrence of certain events of default, payment ofall amounts payable under the Loan, including the principal amount of, andaccrued interest on, the Loan may be accelerated.  There are also cross default provisionsbetween the Loan and the Term Loan discussed in Note 5.  The outstanding balance on the Loan is$4,457,451 at September 30, 2005 (excluding the over-advance of $600,000described below), which represents the total availability under the linerelative to the amount of receivables outstanding at that date.

 

During the third quarter of 2005, Bridge Healthcare Finance, LLC made a$600,000 credit line available to the Company in the form of an over-advance onthe Company’s Loan.  The line of creditwill be used as necessary to pay certain remaining amounts due on acquisitionscompleted

 

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in March, 2005 and forworking capital purposes.  The lineaccrues interest at 9.5%.  The $600,000has been completely drawn down at September 30, 2005, and must be repaidby December 31, 2005.  As additionalconsideration for the line, the Company is required to pay a monthly fee of$15,000 through December 31, 2005. The maturity date of the related revolving credit Loan discussed aboveis being extended for an additional year through June 2008.  The prepayment penalty discussed above isapplicable for the one-year extension period except the amount is reduced inthe event of a change in control of the Company.

 

**Note 5.  Notes Payable to Lender**

 

Pursuant to a 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 Finance, LLC. The Company mayobtain loans under the agreement to fund permitted acquisitions.  Any loans obtained under the Term Loan are dueand 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 assets of the Company. 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.  To date, this is the only advance receivedunder the Term Loan and no principal payments have been made by the Company toreduce this amount.

 

The Term Loan providesthat the Company shall issue warrants to purchase shares of Common Stock to thelender up to 12% of the Company’s overall capitalization on the date ofborrowing. On August 31, 2004, the Company issued warrants to purchase 905,758shares of Common Stock at a price of $3.15 per share in connection with thefirst borrowing under the credit facility. As a result, the Term Loan has been recorded net of a discount of$810,000 which represents the estimated fair market value related to thewarrants at the date of issuance.  Thediscount is being amortized to interest expense over the life of the Term Loan.

 

Exceptin certain limited circumstances, the Term Loan cannot be prepaid in fullwithout the Company incurring a significant prepayment penalty.  The Term Loan also contains certain financialcovenants, including the maintenance of minimum tangible net worth, minimumdebt service coverage ratios, minimum EBITDA, maximum capital expenditurelimits and maximum operating lease obligations. At March 31, 2005, theCompany was out of compliance with certain financial covenants of the TermLoan, for which a waiver was received from the lender. In May 2005, thecovenants were restructured and, at September 30, 2005, the Company was incompliance with the restructured covenants. The Term Loan includes events ofdefault (with grace periods as applicable) and provides that, upon theoccurrence of certain events of default, payment of all amounts payable underthe Term Loan, including the principal amount of, and accrued interest on, theTerm Loan may be accelerated.  There arealso cross default provisions between the Term Loan and the Loan.

 

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**Note 6.  Notes Payable toStockholders**

 

On November 29, 2004, MedCap Partners L.P., the Company’smajority stockholder, loaned the Company $400,000 for working capitalpurposes.  During the first quarter of2005, the Company borrowed an additional $1,050,000 from the majoritystockholder for working capital purposes. The notes required interest at 5% and were payable on demand.  These notes plus accrued interest were repaidon March 29, 2005.  As an incentiveto the majority stockholder to provide the working capital until acquisitionswere consummated in the first quarter of 2005, the Company issued 77,751 sharesof common stock to the majority stockholder at an average market value of $2.09per share.  The related expense of$162,500 was recorded as interest expense in the accompanying statement ofoperations during the first quarter of 2005.

 

**Note 7.  Notes Payable to Sellers**

 

Aspartial consideration for the acquisition of TravMed USA, Inc. on March 29,2005, the Company issued unsecured subordinated notes to the former TravMed stockholdersin the total amount of $3,215,490. The notes are three-year convertible notesbearing interest at 7.75%.  Monthlyinterest payments are required for the first six months followed by principaland interest payments the next thirty months to fully repay the debt.  See additional discussion in Note 11.

 

**Note 8.   Convertible PreferredStock**

 

Convertible Preferred Stock Issued and Outstanding

 

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

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

 

The conversion price of all Convertible Preferred Stock is subject toappropriate adjustment in the event of stock splits, stock dividends, reversestock splits, capital reorganizations, recapitalizations, reclassifications,and similar occurrences, as well as the issuance of Common Stock inconsideration of an amount less than the then effective conversion price.

 

14

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All Convertible Preferred Shares issued and outstanding are convertiblecurrently at the option of the holder. The Company has evaluated the potentialeffect of any beneficial conversion terms related to convertible instruments.As a result, the convertible instruments may have a carrying amount thatdiffers significantly from its redemption amount. In such cases, the differencebetween the carrying amount and the redemption amount (limited to the actualproceeds received) is recorded as a beneficial conversion feature and deducted asa deemed dividend in determining net loss attributable to common stockholders.The table below summarizes the redemption requirements and beneficialconversion of the Convertible Preferred Shares outstanding as of September 30,2005:

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

 

Series B Convertible Preferred Stock (Series B)

 

Theholder of the Series B is entitled to receive a quarterly dividend in anamount equal to .00833 shares of Common Stock for each share of outstanding Series Bheld by them. In the event of any liquidation or winding up of the Company, theholder of the Series B shares will be entitled to receive in preference tothe holders of Common Stock, and any other series of Preferred Stock, an amountequal to the amount of their purchase price. The Series B is convertibleat the option of the holder into common shares at an initial conversion ratioof one share of Common Stock for three shares of Series B.  The conversion ratio upon voluntaryconversion is subject to adjustment under certain circumstances.  Unless previously voluntarily converted priorto such time the Series B shares will be automatically converted intoCommon Stock at a conversion ratio of one share of Common Stock for threeshares of Series B upon the earlier of the closing of an underwrittenpublic offering of Common Stock pursuant to a registration statement under theSecurities Act of 1933, as amended, with aggregate net proceeds of at least $25million, or the date specified by written consent or agreement of the holdersof a majority of the then outstanding shares of Series B.

 

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

 

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

 

15

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theBoard of Directors declared a dividend to the Series B holder.  The dividend consisted of quarterly dividendsthat were payable on December 31, 2004 which had an estimated fair valueof $81,218 and quarterly dividends that were payable on March 31, 2005which had an estimated fair value of $59,375. The dividends were paid through the issuance of 62,488 shares of commonstock during March 2005.

 

OnSeptember 30, 2004, the holder voluntarily converted 2,500,000 shares of Series Binto 833,333 shares of Common Stock.   OnMarch 29, 2005, the holder voluntarily converted 3,750,000 shares of Series Binto 1,250,000 shares of Common Stock.

 

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

 

The holders of the Series B-1are entitled to receive a quarterly dividend in an amount equal to 2.5 sharesof Common Stock for each share of outstanding Series B-1 held by them. Ifany dividend is declared on the Common Stock, the holders of the Series B-1will be entitled to receive dividends out of the legally available funds as ifeach share of Series B-1 had been converted to Common Stock. The holdersof the Series B-1 have the right, at the option of the holder at any time,to convert shares of the Series B-1 into shares of the Company’s CommonStock at an initial conversion ratio of one hundred shares of Common Stock foreach one share of Series B-1. The Series B-1 is convertible at the option of the holder intocommon shares at an initial conversion ratio of one hundred shares of CommonStock for each share of Series B-1. The conversion ratio upon voluntary conversion is subject to adjustmentunder certain circumstances.  Unlesspreviously voluntarily converted prior to such time the Series B-1 shareswill be automatically converted into Common Stock at an initial conversionratio of one hundred shares of Common Stock for each share of Series B-1upon the earlier of the closing of an underwritten public offering of CommonStock pursuant to a registration statement under the Securities Act of 1933, asamended, with aggregate net proceeds of at least $25 million, or the datespecified by written consent or agreement of the holders of a majority of thethen outstanding shares of Series B-1.

 

On August 9, 2004,the Company issued 3,750 shares of Series B-1 Convertible Preferred Stockat a per share price of $60 to an investor for cash proceeds of $225,000.  The Company recorded a deemed dividend due to the beneficial conversionprice of $225,000 which represents the lesser of the proceeds or the beneficialconversion feature of $937,500.

 

Also on August 9,2004, the Company issued 4,166 shares of Series B-1 Convertible PreferredStock at a per share price of $60 to the Company’s Chairman and Chief ExecutiveOfficer for cash proceeds of $249,960. The Company recorded a deemed dividend due to the beneficial conversionprice of $249,960 which represents the lesser of the proceeds or the beneficialconversion feature of $1.0 million.

 

On August 9, 2004,the Company issued 29,990 shares of Series B-1 Convertible PreferredStock, issued 40,822 shares of Common Stock and paid approximately $225,000 incash in exchange for the cancellation of all the outstanding principal andaccrued and unpaid interest

 

16

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under certain promissorynotes (Seller Notes) that were issued in 2003 in connection with the purchaseof certain subsidiaries.

 

On September 30,2004, the Company issued 12,642 shares of Series B-1 Convertible PreferredStock in exchange for the conversion of $758,640 in outstanding principal plusaccrued and unpaid interest under certain Convertible Subordinated PromissoryNotes (Notes) issued in 2003. The holders of such Notes included the Company’s Chairman and ChiefExecutive Officer, a member of the Company’s Board of Directors and an entitywhose managing member is also on the Company’s Board of Directors. The Companyrecorded a deemed dividend due to the beneficial conversion price of $758,640which represents the lesser of the cancelled principal and accrued interest orthe beneficial conversion feature of $3.7 million.

 

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

 

On September 30,2004, the Board ofDirectors declared a dividend and distribution to the Series B-1 holders.The dividend and distribution consisted of quarterly dividends that werepayable on September 30, 2004 for shares not converted and a distributionequal to the dividends that would have been payable on September 30, 2004,December 31, 2004, March 31, 2005 and June 30, 2005 to thoseshareholders electing early conversion of their 4,112 shares of Series B-1into Common Stock.  As a result, 157,203shares of Common Stock were issued on September 30, 2004 related to thedividend and distribution.  On March 22,2005, the Board of Directors declared a dividend to the Series B-1holders.  The dividend consisted of quarterlydividends that were payable on December 31, 2004 which had an estimatedfair value of $604,780, and quarterly dividends that were payable on March 31,2005 which had an estimated fair value of $441,940.  The dividends were paid through the issuanceof 465,208 shares of common stock during March 2005.

 

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

 

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

 

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

 

On March 29, 2005,holders of all of the Convertible Preferred Series B-1 voluntarilyconverted their 93,043 shares of preferred Series B-1 into 9,304,300shares of Common Stock.

 

17

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Series CConvertible Preferred Stock (Series C)

 

Theholders of Series C are entitled to receive, when declared by the Board ofDirectors, a dividend on each quarter end beginning September 30, 2004 andending December 31, 2005 in an amount equal to 2.5 shares of Common Stockfor each share of outstanding Series C held by them. In the event of anyliquidation or winding up of the Company, the holders of the Series C willbe entitled to receive in preference to the holders of Common Stock an amountequal to five times their initial purchase price plus any declared but unpaiddividends and any remaining liquidation proceeds will thereafter be distributedon a pro rata basis to the holders of the Company’s Common Stock and any otherseries of Preferred Stock expressly entitled to participate in suchdistribution.  Assuming exercise of allof the warrants to purchase shares of Series C Preferred Stock, upon aliquidation or winding up of the Company, the holders of Series C PreferredStock would be entitled to receive approximately $92,000,000 prior to thepayment of any amounts to the holders of other equity securities.  The Series C is convertible at theoption of the holder into common shares at an initial conversion ratio of onehundred shares of Common Stock for each share of Series C.  The conversion ratio upon voluntaryconversion is subject to adjustment under certain circumstances.  Unless previously voluntarily converted priorto such time, the Series C will be automatically converted into CommonStock at an initial conversion ratio of one hundred shares of Common Stock foreach share of Series C upon the earlier of (i) the closing of anunderwritten public offering of our Common Stock pursuant to a registrationstatement under the Securities Act of 1933, as amended, with aggregate netproceeds of at least $25 million, or (ii) the date specified by writtenconsent or agreement of the holders of a majority of the then outstandingshares of Series C. The description of the foregoing rights, preferencesand privileges of the Series C is qualified in its entirety by theCertificate of Designations, Preferences and Rights of Series C filed withthe Secretary of State of the State of Delaware on August 31, 2004.

 

Warrants to PurchaseConvertible Preferred Stock

 

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

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

 

On March 29,2005, 108,333 of the Series C warrants were exercised providing proceeds,net of issue costs, of $6,435,687.  On May 2,2005, 22,187 of the Series C warrants were exercised providing netproceeds of $1,273,496.  Dividends accrueon warrants but are payable only upon exercise. Accordingly, dividends declared for the quarters September 30,2004, December 31, 2004 and March 31, 2005 became payable on the warrantsexercised at March 31, 2005,  withan estimated fair value of $1,411,464.  Thesedividends were paid in March 2005 through the issuance of 705,732 sharesof common stock.  Dividends relative tothe 22,187 warrants

 

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exercised in May 2005amounted to $200,792 and were paid in the second quarter of 2005 through theissuance of 110,935 shares of common stock.

 

**Note 9.  Common Stock**

 

The Company is authorized to issue 150,000,000 shares of common stockat a par value of $0.0001.  Theauthorized shares were increased in January 2005 from 50,000,000 shares.

 

In connection with an agreement, 250,000 shares of Common Stock weredelivered by parties to the agreement, to an escrow agent.  These shares will be released from escrow asfollows:  (i) beginning on July 1,2004 and continuing on the first day of each month through and including June 1,2005, the Company, or its assignee, shall pay $31,250 to the escrow agent, andthe escrow agent shall cause 10,417 shares to be transferred to the Company orits assignee; and (ii) beginning on July 1, 2005 and continuing onthe first day of each month through and including June 1, 2006, theCompany, or its assignee, shall pay $46,875 to the escrow agent, and the escrowagent shall cause 10,417 shares to be released to the Company or its assignee.  The escrow agent shall distribute fundsreceived from the Company, or its assignee, to the stockholders who are partiesto the Stock Purchase Agreement. For July, 2004, through December, 2004, theCompany assigned its right to purchase under the Stock Purchase Agreement to anexisting shareholder.  Neither theCompany nor its assignee purchased shares subsequent to December, 2004, and, inaccordance with the agreement, the transfer agent was authorized to return allremaining shares to the parties who initially tendered their shares to theescrow agent.

 

On May 31, 2005, the Company granted 3,700,000 shares ofrestricted stock to four of its officers. The restricted stock has been valued at $6,290,000, which represents thetrading value of the stock as quoted on the OTC Bulletin Board on May 31,2005.  All shares of restricted stockvest in five years or earlier in the event the average daily trading volume forthe Company’s common stock reaches specified levels or in certain othercircumstances.  The $6,290,000 value hasbeen reflected as common stock issued and outstanding with an offsetting amountincluded in the equity section as deferred non-cash stockcompensation.  The deferred non-cashstock compensation amount is being amortized monthly over the five year expectedvesting period of the restricted stock grant. The President’s restricted stock grant of 900,000 shares is subject toforfeiture of 300,000 shares per quarter for the second, third and fourthquarters of 2005 if certain revenue and EBITDA targets are not achieved.  The second quarter and third quarter targetswere not achieved, but forfeiture has not yet been reflected since theachievement of targets is ultimately measured on a cumulative basis through December 31,2005.  The remaining grants are notsubject to forfeiture except in the event grantee’s continuous service isterminated for any reason, other than death or disability prior to the fifthanniversary of the grant date.  Non-cashstock based compensation in the accompanying statement of operations for the thirdquarter and nine months ended September 30, 2005 includes $314,500 and $419,333,respectively, related to these grants.

 

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In May 2005, the Board of Directors approved the grant of optionsto key employees to purchase 831,050 shares of the Company’s common stock underthe 2004 option plan at $1.70 per share (fair market value on the date of grant).  The options vest 25% after one year andmonthly thereafter on a straight-line basis over three years.  The options expire in ten years.

 

In August 2005, the Board of Directors approved the grant ofoptions to key employees to purchase 95,850 shares of the Company’s commonstock under the 2004 option plan at $1.60 per share (fair market value on thedate of grant).  The options vest 25%after one year and monthly thereafter on a straight-line basis over threeyears.  The options expire in ten years.

 

**Note 10.  Supplemental Disclosureto the Cash Flow Statement**

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

 

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**Note 11.  Subsequent Events**

 

The Company did not makethe October 31, 2005 debt service payments of $118,246 required by termsof the $3.2 million of notes payable to sellers.  Accordingly, the Company received a notice ofdefault in early November 2005.  Thedue date of the notes may be accelerated such that the entire balance of thenotes payable to sellers is due, but such acceleration option cannot beexercised until November 21, 2005.  Ifsellers exercise their option, the Company has six months to cure thedefault.  If cured, payment due datesrevert back to the original non-accelerated terms.  The default under the notes payable tosellers triggers defaults under the revolving loan and term loan discussed inNotes 4 and 5.  The Company expects to curethe defaults on the notes payable to sellers, revolving loan and term loan by November 30,2005; accordingly, the notes payable to sellers due beyond one year and theterm loan continue to be classified as non-current.  Also, as a result of this default, Bridge HealthcareFinance, LLC has an option to discontinue making revolving credit loans to theCompany on receivables of TravMed USA, Inc., the acquisition which gaverise to the notes payable to sellers.  OnNovember 9, 2005, Bridge Healthcare Finance, LLC waived their right toexercise this option through November 30, 2005.

 

In November 2005,the Board of Directors declared second quarter and third quarter 2005 dividendson the Series C Preferred Stock, which will require the issuance of 915,140shares of common stock.  Also, in November 2005,the Board of Directors approved the grant of options to key employees anddirectors to purchase 177,417 shares of the Company’s common stock under the2004 option plan @ $2.00 per share (fair market value on the date ofgrant).  The options vest 25% after oneyear and monthly thereafter on a straight-line basis over three years.  The options expire in ten years.

 

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

 

*This report contains forward-looking statements.  These statements relate to future events orour future financial performance.  Insome cases, you can identify forward-looking statements by terminology such as “may,”“will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,”“potential” or “continue,” the negative of such terms or other comparableterminology.  These statements are onlypredictions.  Actual events or resultsmay differ materially.*

 

*Although we believe that the expectations reflected in theforward-looking statements are reasonable, we cannot guarantee future results,levels of activity, performance or achievements.  Moreover, neither we, nor any other person,assume responsibility for the accuracy and completeness of the forward-lookingstatements.  We are under no obligationto update any of the forward-looking statements after the filing of thisQuarterly Report to conform such statements to actual results or to changes inour expectations.*

 

*The following discussion of our financial condition andresults of operations should be read in conjunction with our consolidatedfinancial statements and the related notes and other financial informationappearing elsewhere in this Quarterly Report. Readers are also urged tocarefully review and consider the various disclosures made by us which attemptto advise interested parties of the factors which affect our business,including without limitation the disclosures made under the caption “Management’sDiscussion and Analysis or Plan of Operation,” under the caption “Risk Factors,”and the audited consolidated financial statements and related notes included inour Annual Report on Form 10-KSB for the year ended December 31,2004, previously filed with the Securities and Exchange Commission.*

 

**OVERVIEW**

 

We are a provider of healthcare staffing services, focusingon the areas of travel nursing, per diem staffing, contractual clinicalservices, and private duty home care. Our travel nurses are recruited domestically as well as internationally,and placed on temporary assignments at healthcare facilities across the UnitedStates.  Our per diem nurses are localnurses placed at healthcare facilities on short-term assignments.  Our contractual clinical services groupprovides complete clinical management and staffing for healthcare facilitiesand our private duty home care group provides nursing case management andstaffing for skilled and non-skilled care in the home. We consider thedifferent services described above to be one segment as each of these servicesrelate solely to providing healthcare staffing to customers that are healthcareproviders and utilize similar distribution methods, common procedures,processes and similar methods of identifying and serving these customers.

 

During 2003, we pursued our operational plan ofacquiring companies in the healthcare staffing field and completed acquisitionsof four companies. In 2004, we purchased two additional companies, and in thefirst nine months of 2005 purchased three additional companies.  We have contracted with more than 1500healthcare facilities across 49 U.S. states and the District of Columbia.

 

The companies we acquired in 2003 — Baker AndersonChristie, Inc., New Age Nurses, Inc., Nurses Network, Inc., andPSR Nurses, Ltd. (through our acquisition of PSR Nurses Holdings Corp. and PSRNurse Recruiting, Inc., 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 staffand began streamlining the operations. We continued our acquisition program in 2004 and acquired Care ProsStaffing, Inc. and Arizona Home Health Care/Private Duty, Inc.  On March 29, 2005, we acquired TravMedUSA, Inc. and Health Industry Professionals, LLC.  On May 4, 2005, we acquired PrimeStaff,LP and Mint Medical Staffing Odessa.  Wehave achieved our goal to acquire at least three companies in 2005.

 

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Although we have raised $8 million to date in 2005,we will need to raise $1.5 million to $2 million before calendar year end 2005and additional capital during the next twelve months to satisfy debt servicerequirements and other working capital needs. If additional capital is not readily available, our business could failif we cannot successfully scale back our operations until our income exceedsour expenses or pursue other strategic alternatives.

 

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

 

•        We areidentifying innovative ways to attract and retain nurses such as a nurse stockprogram and competitive compensation packages.

 

•        We areinstalling new operating software to assist us in more effectively managinggross profits by nurse and by healthcare facility.

 

•        We arevigorously managing professional liability insurance costs, workerscompensation insurance costs, and health care costs to enhance gross margins.

 

•        We areexpanding our home health business in an effort to improve gross marginsthrough a better mix of the services provided.

 

•        We aredevoting 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.

 

•        We arecurrently working to raise $8 million to $10 million of debt and equity forworking capital needs, for debt retirement and for acquisitions..

 

•        We areworking to resolve the significant (in excess of $92 million) Series CPreferred Stock liquidation preference (assuming exercise of all Series Cwarrants).

 

•        We areseeking to list our common stock on the Nasdaq Market or another nationalexchange (our common stock is currently quoted on the OTC Bulletin Board).

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Although we have raised $8 milion to date in 2005,we will need to raise additional capital during the next twelve months tosatisfy debt service requirements and working capital needs.  We are currently working to raise $8 millionto $10 million in a combination of debt and equity in a private placementtransaction with qualified investors.  Ifwe are successful in raising more than the $2 million to $3 million needed tosatisfy debt service requirements and working capital needs, we will employadditional funds for internal growth, retirement of higher cost debt, and to alesser extent targeted acquisitions which satisfy our due diligence review.

 

In June 2004, we obtained a $15 millionrevolving line of credit facility from Bridge Healthcare Finance, LLC (reducedto $10 million in March 2005).  In August 2004,we obtained a $10 million term loan credit facility from Bridge OpportunityFinance, LLC.  Bridge OpportunityFinance, LLC is an affiliate of Bridge Healthcare Finance, LLC.  During the third quarter of 2005, BridgeHealthcare finance, LLC made a $600,000 credit line available to us in the formof an over-advance on our revolving line of credit.  We had $2,521,598 and $5,057,451 outstandingat December 31, 2004 and September 30, 2005, respectively, under ourrevolving line of credit facility (including any over-advances) and $2,697,802of principal  (after adding back thediscount) of term loan outstanding at December 31, 2004 and September 30,2005.  Agreements for both the revolvingline of credit facility and the term loan facility contain financial covenantsfor the maintenance of minimum net worth, minimum EBITDA, maximum capitalexpenditure limits and maximum

 

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operatinglease obligations.  At March 31,2005, we were out of compliance with financial covenants in both agreements,for which waivers were received from the lenders.  In May 2005 we renegotiated covenantsrelated to both the revolving line of credit facility and the term loan and, atSeptember 30, 2005, were in compliance with the revised covenants.  Accordingly, the term loan (which matures on April 30,2007) has been classified as a long-term liability at September 30,2005.  Failure to satisfy these covenantswould severely restrict or eliminate our ability to obtain additional fundingunder these agreements.

 

We generated a net loss of $2,867,360 for the ninemonths ended September 30, 2005 and used cash in operations of $3,691,159during the first nine months of 2005. Additionally, although we ended the first nine months of 2005 with aworking capital deficit of $1.7 million, we were able to secure additionalfunding during 2004 and the first nine months of 2005 to finance our operationsas we continue to execute our business plan to acquire and grow companies involvedin healthcare staffing.  In March 2005our majority stockholder exercised warrants to purchase 108,333 shares of Series CConvertible Preferred Stock providing $6.4 million to us.  Also, in May 2005 our majoritystockholder exercised warrants to purchase 22,187 shares of Series CConvertible Preferred Stock providing $1.3 million to us.  The infusion of $7.7 million enabled us toacquire additional companies and to retire certain liabilities. Also, followingthe three acquisitions during the first nine months of 2005, we increased ourborrowings under our accounts receivable line, but at September 30, 2005,there is no additional borrowing availability under this line.  In the third quarter of 2005, additionalshort-term funding of $600,000 in the form of an over-advance on the accountsreceivable line was secured from Bridge Healthcare Finance, LLC.  Although we have raised $8 million to date in2005, we will need to raise an additional $2 million to $3 million during thenext twelve months to satisfy debt service requirements and working capitalneeds.  There is no assurance that wewill be able to raise the amount of debt or equity capital required to meet ourobjectives.  Our challenging financialcircumstances may make the terms, conditions and cost of any available capitalrelatively unfavorable.  If additionaldebt or equity capital is not readily available, we will be forced to scaleback our acquisition activities and our operations until our income exceeds ourexpenses.  This would result in anoverall slowdown of our development.  Ourshort-term need for capital may force us to consider and potentially pursueother strategic options sooner than we might otherwise have desired.

 

We did not make the October 31, 2005 debtservice payments of $118,246 required by terms of the $3.2 million of notespayable to sellers.  Accordingly, wereceived a notice of default in early November 2005.  The due date of the notes may be acceleratedsuch that the entire balance of the notes payable to sellers is due, but suchacceleration option cannot be exercised until November 21, 2005.  If sellers exercise their option, we have sixmonths to cure the default.  If cured,payment due dates revert back to the original non-accelerated terms.  The default under the notes payable tosellers triggers defaults under the revolving loan and term loan discussed inNotes 4 and 5.  We expect to cure thedefaults on the notes payable to sellers, revolving loan and term loan by November 30,2005; accordingly, the notes payable to sellers due beyond one year and theterm loan continue to be classified as non-current.  Also, as a result of this default, BridgeHealthcare Finance, LLC has an option to discontinue making revolving creditloans to us on receivables of TravMed USA, Inc., the acquisition whichgave rise to the notes payable to sellers. On November 9, 2005, Bridge Healthcare Finance, LLC waived theirright to exercise this option through November 30, 2005.

 

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

 

**CRITICAL ACCOUNTING POLICIES AND MANAGEMENT JUDGEMENT**

 

The preparation of the financial statements inaccordance with accounting principles generally accepted in the United Statesof America requires 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 that require significant judgments, estimates, andassumptions include the assignment of fair values upon acquisition of goodwilland other intangible assets, testing for impairment of long-lived assets andvaluation of the stock used to consummate our acquisitions. We use historicalexperience, qualified independent consultants and all

 

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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.

 

**Accounts Receivable**

 

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

 

**Purchase Accounting, Goodwill andIntangible Assets**

 

All business acquisitions have been accounted forusing the purchase method of accounting and, accordingly, the statements ofoperations include the results of each acquired business since the date ofacquisition.  The assets acquired andliabilities assumed are recorded at their estimated fair value as determined bymanagement and supported in some cases by an independent third-partyvaluation.  We finalize the  allocation of the  purchase price to the fair value of the  assets acquired  and  liabilities assumed  when we obtaininformation sufficient to complete the allocation,  but in any case, withinone year after acquisition.

 

Goodwill arising from the acquisitions of businessesis recorded as the excess of the purchase price over the estimated fair valueof the net assets of the businesses acquired. Statement of Financial Accounting Standards No. 142 (“Goodwill andOther Intangible Assets”) provides that goodwill is to be tested for impairmentannually or more frequently if circumstances indicate potentialimpairment.  Consistent with thisstandard, we will review goodwill, as well as other intangible assets andlong-term assets, for impairment annually or more frequently as warranted, andif circumstances indicate that the recorded value of any such other asset isimpaired, such asset 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.

 

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**RESULTS OFOPERATIONS**

 

The following condensed financial informationincludes Crdentia Corp. plus the results of operations of all companiesacquired from their respective dates of acquisition (in thousands).

 
| ** **                                          | ** ** | **For the three months**     | ** ** | **For the nine months**      | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                          | ** ** | **ended September 30,** | ** ** | **ended September 30,** | ** ** |
| ** **                                          | ** ** | **2005**                     | ** ** | **2004**                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Revenue from services                               |       | $                            | 9,637      |                         | $          | 5,527 |   | $ | 23,967 |   | $ | 17,234 |   |
| Direct operating expenses                           |       | 7,203                        |       | 4,267                        |       | 18,362 |   | 13,522 |   |
| Gross profit                                        |       | 2,434                        |       | 1,260                        |       | 5,605 |   | 3,712 |   |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Operating expenses:                                 |       |                         |       |                         |       |   |   |   |   |
| Selling, general and administrative  expenses       |       | 2,425                        |       | 2,562                        |       | 6,317 |   | 6,767 |   |
| Loss on impairment of customer related  intangibles |       | —                       |       | 121                          |       | — |   | 121 |   |
| Non-cash stock based compensation                   |       | 401                          |       | 140                          |       | 671 |   | 300 |   |
| Total operating expenses                            |       | 2,826                        |       | 2,823                        |       | 6,988 |   | 7,188 |   |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Loss from operations                                |       | (392                         | )          | (1563                        | )          | (1,383 | ) | (3,476 | ) |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Non-cash expense for conversion of debt             |       | —                       |       | (7,497                       | )          | — |   | (7,497 | ) |
| Interest expense, net                               |       | (486                         | )          | (713                         | )          | (1,484 | ) | (1,712 | ) |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Loss before income taxes                            |       | (878                         | )          | (9,773                       | )          | (2,867 | ) | (12,685 | ) |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Income tax expense                                  |       | —                       |       | —                       |       | — |   | — |   |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Net loss                                            |       | (878                         | )          | (9,773                       | )          | (2,867 | ) | (12,685 | ) |
|                                                |       |                         |       |                         |       |   |   |   |   |
| Deemed dividends                                    |       | —                       |       | (2,271                       | )          | — |   | (4,521 | ) |
| Non-cash preferred stock dividends                  |       | —                       |       | —                       |       | (2,363 | ) | — |   |
| Net loss attributable to common  stockholders       |       | $                            | (878       | )                            | $          | (12,044 | ) | $ | (5,230 | ) | $ | (17,206 | ) |

 

***Three months ended September 30, 2005 comparedto the three months ended September 30, 2004***

 

Revenues in the thirdquarter of 2005 were $9,637,000 compared to revenues of $5,527,000 in the thirdquarter of 2004.  Revenues have increasedin the third quarter of 2005 compared to the third quarter of 2004 due toacquisitions in August 2004 and March and May of 2005.  However, the loss of certain larger customersin 2004 and 2005 and the soft demand experienced in the industry offset asignificant portion of the increase in revenue due to acquisitions.  In the third quarter of 2005 approximately 38%(57% in the third quarter of 2004) of our revenue was derived from theplacement of travel nurses on assignment, typically 13 weeks in length.  Such assignments generally involve temporaryrelocation to the geographic

 

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area of the assignment.  In the third quarter of 2005, we alsoprovided per diem nurses to satisfy the very short-term needs of healthcarefacilities.  Per diem services provided54% of our revenue in the third quarter of 2005 (29% in the third quarter of2004).  Per diem revenue became a largerportion of our revenue in the third quarter of 2005 compared to the thirdquarter of 2004 because of our acquisition of per diem businesses late in the thirdquarter of 2004.  The remaining amount ofour revenue in the third quarter of 2005 and 2004 came from providing clinicalmanagement and staffing to healthcare facilities and private dutyhomecare.  During the third quarter of2005 and 2004, most of our customers were acute care hospitals locatedthroughout the continental United States.

 

Our overall gross profit inthe third quarter of 2005 was $2,434,000 or 25.3% of revenues compared to$1,260,000 or 22.8% of revenues in the third quarter of 2004. Our gross profitis the difference between the revenue we realize when we bill our customers forthe services of our healthcare professionals and our direct operating costs,which include the cost of the healthcare professionals and the related housingand travel costs, certain employment related taxes and workers compensationinsurance coverage.  The gross profitpercentage in the third quarter of 2005 has improved reflecting higher grossprofits reported by our 2004 and 2005 acquisitions and better management ofgross margins with a new operating system and improved cost control.

 

Our selling, general and administrative costs were$2,425,000******or 25.2% of revenues in thethird quarter of 2005 compared to $2,562,000  or 46.3%******ofrevenues in the third quarter of 2004. Selling, general and administrative expenses are comprised primarily ofpersonnel costs, legal and audit fees related to being a public company andvarious other office and administrative expenses.   Selling, general and administrative costs asa percentage of revenue are down in the third quarter of 2005 following theelimination of redundant costs in our travel business in October 2004.  Also, the dollar amount of selling, generaland administrative costs has remained constant even though revenue hasincreased indicating that we have been able to effectively achieve economies ofscale with a larger revenue base.

 

Non-cash stock based compensation expense increasedfrom $140,000 in the third quarter of 2004 to $401,000 in the third quarter of2005 reflecting incremental amortization related to granting 3,700,000 sharesof restricted stock to officers of the Company in May 2005.

 

The $7,497,000 non-cash charge for conversion ofdebt in 2004 represents a charge related to inducement to convert seller debtto preferred stock.  The amount was calculatedby considering the fair market value of the preferred stock issued uponconversion of the seller debt.

 

Interest costs decreased from $713,000 in the thirdquarter of 2004 to $486,000 in the third quarter of 2005 which decreasereflects lower overall rates on the new debt facilities we obtained in 2004(which were restructured in the first quarter of 2005).

 

Deemed dividends were $2,271,000 in the thirdquarter of 2004.  The deemed dividendsrelate to beneficial conversion features of our Series B-1 and Series Cconvertible preferred stock and beneficial conversion features of Series B-1warrants issued.

 

***Nine months ended September 30, 2005 comparedto the nine  months ended September 30,2004***

 

Revenues for the first ninemonths of 2005 were $23,967,000 compared to revenues of $17,234,000 for thefirst nine months of 2004.  Revenues haveincreased in the first nine months of 2005 compared to the first nine months of2004 due to acquisitions in August 2004 and March and May of2005.  However, the loss of certainlarger customers in 2004 and 2005 and the soft demand experienced in theindustry offset a significant portion of the increase in revenue due toacquisitions.  In the first nine monthsof 2005 approximately 37% (77% in the first nine months of 2004) of our revenuewas derived from the placement of travel nurses on assignment, typically 13weeks in length.  Such assignmentsgenerally involve temporary

 

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

 

Our overall gross profit inthe first nine months of 2005 was $5,605,000 or 23.4% of revenues compared to$3,712,000 or 21.5% of revenues in the first nine months of 2004. Our grossprofit 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.  Thegross profit percentage in the first nine months of 2005 has improvedreflecting higher gross profits reported by our 2004 and 2005 acquisitions andbetter management of gross margins with a new operating system and improvedcost control.

 

Our selling, general and administrative costs were$6,317,000******or 26.4% of revenues in thefirst nine months of 2005 compared to $6,767,000 or 39.3%******ofrevenues in the first nine months of 2004. Selling, general and administrative expenses are comprised primarily ofpersonnel costs, legal and audit fees related to being a public company andvarious other office and administrative expenses.   Selling, general and administrative costs asa percentage of revenue are down in the first nine months of 2005 following theelimination of redundant costs in our travel business in October 2004.  Also, the dollar amount of selling, generaland administrative costs has decreased even though revenue has increasedindicating that we have been able to effectively achieve economies of scalewith a larger revenue base.

 

Non-cash stock based compensation expense increasedfrom $300,000 in the first nine months of 2004 to $671,000 in the first ninemonths of 2005 reflecting incremental amortization related to granting3,700,000 shares of restricted stock to officers of the Company in May 2005.

 

The $7,497,000 non-cash charge for conversion ofdebt in 2004 represents a charge related to inducement to convert seller debtto preferred stock.  The amount wascalculated by considering the fair market value of the preferred stock issuedupon conversion of the seller debt.

 

Interest costs decreased from $1,712,000 in thefirst nine months of 2004 compared to $1,484,000 in the first nine months of2005 which decrease reflects lower overall rates on the new debt facilities weobtained in 2004 (which were restructured in the first quarter of 2005).

 

Deemed dividends were 4,521,000 in the first ninemonths of 2004.  The deemed dividendsrelate to beneficial conversion features of our Series A, Series B, Series B-1and Series C convertible preferred stock and beneficial conversionfeatures of Series B-1 warrants issued.

 

The non-cash preferred stock dividends in the firstnine months of 2005 relate to common stock dividends declared by the Board ofDirectors on our Series B, Series B-1 and Series C convertiblepreferred stock as well as cumulative common stock dividends declared for September 30,2004, December 31, 2004 and March 31, 2005 related to the warrantsexercised on March 29, 2005 for 108,333 shares of Series Cconvertible preferred stock and cumulative common stock dividends declared for December 31,2004 and March 31, 2005 related to the warrants exercised on May 2,2005 for 22,187 shares of Series C convertible preferred stock.   The common stock dividends on the warrantsare payable once the warrants are exercised.

 

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**Risk Factors**

 

We were formed in November 1997, and commencedoperations on August 7, 2003 following our acquisition of Baker AndersonChristie, Inc.  Any investment inour 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, before you decide to buy our Common Stock.  The risks and uncertainties described beloware 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 includingthose contained in the section captioned “Management’s Discussion andAnalysis or Plan of Operation” under Item 2. In such case, the trading price of our Common Stock could decline, andyou may lose all or part of the money you paid to buy our Common Stock.

 

**If we fail to raise additional capital in the near future, our businesswill fail.**

 

We have limited cash resources and will needto raise additional capital through public or private financings or otherarrangements in order to meet current commitments and continue development ofour business.  We cannot assure you thatadditional capital will be available to us when needed, if at all, or, ifavailable, will be obtained on terms attractive to us.  Our failure to raise additional capital whenneeded could cause us to cease our operations.

 

We have financed our operations sinceinception primarily through the private placement of equity and debt securitiesand loan facilities.  Although ourmanagement recognizes the need to raise funds in the near future, there can beno assurance that we will be successful in consummating any fundraisingtransaction, or if we do consummate such a transaction, that its terms andconditions will not require us to give investors warrants or other valuablerights to purchase additional interest in our company, or be otherwiseunfavorable to us.  Among other things,the agreements under which we issued some of our existing securities include,and any securities that we may issue in the future may also include, terms thatcould impede our ability to raise additional funding.  The issuance of additional securities couldimpose additional restrictions on how we operate and finance our business.  In addition, our current debt financing arrangementsinvolve significant interest expense and restrictive covenants that limit ouroperations.

 

**We may face difficultiesintegrating our acquisitions into our operations and our acquisitions may beunsuccessful, involve significant cash expenditures or expose us to unforeseenliabilities.**

 

Wecontinually evaluate opportunities to acquire healthcare staffing companiesthat complement or enhance our business and frequently have preliminaryacquisition discussions with some of these companies. In addition, beginning inAugust 2003 and through May 2005 we acquired eight businesses.

 

Theseacquisitions involve numerous risks, including:

 

•      potential loss of revenuesfollowing the acquisition;

 

•      difficulties integrating acquired personneland distinct cultures into our business;

 

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

 

•      diversion of management attention fromexisting operations; and

 

•      assumption of liabilities and exposure tounforeseen liabilities of acquired companies, including

 

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liabilities for their failure to comply withhealthcare regulations.

 

These acquisitions may also involve significant cashexpenditures, debt incurrence and integration expenses that could seriouslyharm our financial condition and results of operations. We may fail to achieveexpected efficiencies and synergies. Any acquisition may ultimately have anegative impact on our business and financial condition.

 

**Our Series C Convertible Preferred Stock has a significantliquidation preference.**

 

As of November 1, 2005, we had (i) 183,028shares of Series C Preferred Stock outstanding and (ii) warrants (the“Warrants”) to purchase 124,077 shares of Series C Preferred Stockoutstanding.  We anticipate sellingadditional shares of Series C Preferred Stock and issuing additionalwarrants to purchase shares of Series C Preferred Stock.  Each share of Series C Preferred stockis convertible into one hundred (100) shares of our common Stock.  In the event of any liquidation or winding upof our company, the holders of the Series C Preferred Stock will beentitled to receive, in preference to the holders of our other equitysecurities, an amount equal to five times the original purchase price pershare, or $300 per share, plus any dividends declared on the Series CConvertible Preferred Stock but not paid. Assuming the exercise of all outstanding Warrants, upon a liquidation orwinding up of our company the holders of our Series C Preferred Stockwould be entitled to receive approximately $92,000,000 prior to the payment ofany amounts to the holders of our other equity securities.  As a result, upon a liquidation or winding upof the Company, there may not be sufficient proceeds, following the payment ofthe Series C liquidation preference described above, to make anydistribution to the holders of our other equity securities.

 

**There is a lack of an active public market for our Common Stock, andthe trading price of our common stock is subject to volatility.**

 

The quotation of shares of our Common Stockon the OTC Bulletin Board began on June 3, 2003.  There can be no assurance, however, that amarket will develop or continue for our Common Stock.  Our Common Stock may be thinly traded, iftraded at all, even if we achieve full operation and generate significantrevenue and is likely to experience significant price fluctuations.  In addition, our stock is 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 “pennystock” includes securities of companies which are not listed on the principalstock exchanges or the National Association of Securities Dealers AutomatedQuotation System (“Nasdaq”) or National Market System (“Nasdaq NMS”) and have abid price in the market of less than $5.00; and companies with net tangibleassets of less than $2,000,000 ($5,000,000 if the issuer has been in continuousoperation for less than three years), or which have recorded revenues of lessthan $6,000,000 in the last three years. “Penny stocks” are subject to rule 15g-9, which imposes additionalsales practice requirements on broker-dealers that sell such securities topersons other than established customers and “accredited investors” (generally,individuals with net worth in excess of $1,000,000 or annual incomes exceeding$200,000, or $300,000 together with their spouses, or individuals who areofficers or directors of the issuer of 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 mayadversely affect the ability of broker-dealers to sell our Common Stock, andtherefore, may adversely affect the ability of our stockholders to sell CommonStock in the public market.

 

The trading price of our common stock islikely to be subject to wide fluctuations. Factors affecting the trading price of our common stock may include:

 

•      Variations in our financial results;

 

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

 

•      Recruitment or departure of key personnel;

 

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

 

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

 

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

 

**Our need to raise additional capital in the future could have adilutive effect on your investment.**

 

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

 

If we sell additional shares of our CommonStock, such sales will further dilute the percentage of our equity that ourexisting stockholders own.  In addition,our recent private placement financings have involved the issuance ofsecurities at a price per share that represented a discount to the tradingprices listed for our Common Stock on the OTC Bulletin Board and it is possiblethat we will close future private placements involving the issuance ofsecurities at a discount to prevailing trading prices.  Depending upon the price per share ofsecurities that we sell in the future, a stockholder’s interest in us will befurther diluted by any adjustments to the number of shares and the applicableexercise price required pursuant to the terms of the agreements under which wepreviously issued securities.  Noassurance can be given that previous or future investors, finders or placementagents will not claim that they are entitled to additional anti-dilutionadjustments or dispute our calculation of any such adjustments.  Any such claim or dispute could require us toincur material costs and expenses regardless of the resolution and, if resolvedunfavorably to us, to effect dilutive securities issuances or adjustments topreviously issued securities.  Inaddition, future financings may include provisions requiring us to makeadditional payments to the investors if we fail to obtain or maintain the effectivenessof SEC registration statements by specified dates or take other specifiedaction.  Our ability to meet theserequirements may depend on actions by regulators and other third parties, overwhich we will have no control.  Theseprovisions may require us to make payments or issue additional dilutivesecurities, or could lead to costly and disruptive disputes.  In addition, these provisions could requireus to record additional non-cash expenses.

 

**Our credit facility imposes significant expenses and restrictivecovenants upon us.**

 

In June 2004 we obtained a $15 millionrevolving credit facility, which was reduced in 2005 to $10 million, (the “RevolvingFacility”) 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 HealthcareFinance, LLC.

 

The Credit Facility involves significant interestexpenses and other fees.  In addition,except in certain limited circumstances, the Revolving Facility cannot bepre-paid in full without us incurring a significant pre-payment penalty.

 

The Credit Facility imposes various restrictions onour activities without the consent of the lenders, including a prohibition onfundamental changes to us or our direct or indirect subsidiaries (includingcertain

 

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consolidations, mergers andsales and transfer of assets, and limitations on our ability or any of ourdirect or indirect subsidiaries to grant liens upon our property orassets).  In addition, under the CreditFacility we must meet certain net worth, earnings and debt service coveragerequirements.  The Credit Facilityincludes events of default (with grace periods, as applicable) and providesthat, upon the occurrence of certain events of default, payment of all amountspayable under the Credit Facility, including the principal amount of, andaccrued interest on, the Credit Facility may be accelerated.  In addition, upon the occurrence of certaininsolvency or bankruptcy related events of default, all amounts payable underthe Credit Facility, including the principal amount of, and accrued intereston, the Credit Facility shall automatically become immediately due and payable.

 

The expenses and restrictions associated with theCredit Facility have the effect of limiting our operations.  In addition, our failure to pay requiredinterest expenses and other fees or to meet restrictions under the CreditFacility would have a material adverse affect on us.

 

**MedCap Partners L.P. controls a majority of our outstanding capitalstock, and this may delay or prevent change of control of our company oradversely affect our stock price.**

 

MedCap Partners L.P. controls approximately52% of our outstanding capital stock, on a fully diluted as-convertedbasis.  As a result, MedCap is able toexercise control over matters requiring stockholder approval, such as the electionof directors 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.

 

**The ability to attract and retain highly qualified personnel to operateand manage our operations is extremely important and our failure to do so couldadversely affect us.**

 

Presently, we are dependent upon the personalefforts of our management team.  The lossof any of our officers or directors could have a material adverse effect uponour business and future prospects.  We donot presently have key-person life insurance upon the life of any of ourofficers or directors. Additionally, as we continue our planned expansion ofcommercial operations, we will require the services of additional skilledpersonnel.  There can be no assurancethat we can attract persons with the requisite skills and training to meet ourfuture needs or, even if such persons are available, that they can be hired onterms favorable to us.

 

**We have had a short operating history.**

 

We wereformed in November 1997 and commenced operations on August 7, 2003with our acquisition of Baker Anderson Christie, Inc.  We are a “start-up” operation and subject toall the risks inherent in a new business venture, many of which are beyond ourcontrol, including the ability to implement successful operations, lack ofcapital to finance acquisitions and failure to achieve market acceptance.  In addition, as a start-up venture we willface significant competition from many companies virtually all of which arelarger, better financed and have significantly greater market recognition thanus.

 

**The successful implementation of our business strategy depends upon theability of our management to monitor and control costs.**

 

Withrespect to our planned operations, management cannot accurately project or giveany assurance with respect to our ability to control development and operatingcosts and/or expenses in the future.

 

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Consequently, as we expand ourcommercial operations, management may not be able to control costs and expensesadequately, and such operations may generate losses.

 

**We may become subject to governmental regulations and oversight, whichcould adversely affect our ability to continue or expand our business strategy.**

 

Althoughour operations are currently not subject to any significant governmentregulations, it is possible that, in the future, such regulations may belegislated. Although we cannot predict the extent of any such futureregulations, a possibility exists that future or unforeseen changes may have anadverse impact upon our ability to continue or expand our operations aspresently planned.

 

**If we are unable to attract qualified nursesand healthcare professionals for our healthcare staffing business, our businesscould 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 competefor healthcare staffing personnel with other temporary healthcare staffingcompanies and with hospitals and healthcare facilities. We must continuallyevaluate and expand our temporary healthcare professional network to keep pacewith our hospital and healthcare facility clients’ needs. Currently, there is ashortage of qualified nurses in most areas of the United States, competitionfor nursing personnel is increasing, and salaries and benefits have risen. Wemay be unable to continue to increase the number of temporary healthcareprofessionals that we recruit, decreasing the potential for growth of ourbusiness. Our ability to attract and retain temporary healthcare professionalsdepends on several factors, including our ability to provide temporaryhealthcare professionals with assignments that they view as attractive and toprovide them with competitive benefits and wages. We cannot assure you that wewill be successful in any of these areas. The cost of attracting temporaryhealthcare professionals and providing them with attractive benefit packagesmay be higher than we anticipate and, as a result, if we are unable to passthese costs on to our hospital and healthcare facility clients, our lossescould increase. Moreover, if we are unable to attract and retain temporaryhealthcare professionals, the quality of our services to our hospital andhealthcare facility clients may decline and, as a result, we could loseclients.

 

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

 

Thetemporary staffing industry is highly competitive and fragmented, with limitedbarriers to entry. We compete in national, regional and local markets withfull-service agencies and in regional and local markets with specializedtemporary staffing agencies. Some of our competitors include AMN HealthcareServices, Inc., Cross Country, Inc., Medical Staffing NetworkHoldings, Inc. and On Assignment, Inc. All of these companies havesignificantly greater marketing and financial resources than we do. Our abilityto attract and retain clients is based on the value of the service we deliver,which in turn depends principally on the speed with which we fill assignmentsand the appropriateness of the match based on clients’ requirements and theskills and experience of our temporary employees. Our ability to attractskilled, experienced temporary professionals is based on our ability to paycompetitive wages, to provide competitive benefits, to provide multiple,continuous assignments and thereby increase the retention rate of theseemployees. To the extent that competitors seek to gain or retain market shareby reducing prices or increasing marketing expenditures, we could lose revenuesand our margins could decline, which could seriously harm our operating resultsand cause the trading price of our stock to decline. As we expand into newgeographic markets, our success will depend in part on our ability to gainmarket share from competitors. We expect competition for clients to increase inthe future, and the success and growth of our business depend on our ability toremain competitive.

 

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

 

Wegenerally do not have long-term agreements or exclusive guaranteed ordercontracts with our hospital and healthcare facility clients. The success of ourbusiness depends upon our ability to continually secure new orders fromhospitals and other healthcare facilities and to fill those orders with ourtemporary healthcare professionals. Our hospital and healthcare facilityclients are free to place orders with our competitors and may choose to usetemporary healthcare professionals that our competitors offer them. Therefore,we must maintain positive relationships with our hospital and healthcarefacility clients. If we fail to maintain positive relationships with ourhospital and healthcare facility clients, we may be unable to generate newtemporary healthcare professional orders and our business may be adverselyaffected.

 

**Fluctuations in patientoccupancy at our clients’ hospitals and healthcare facilities may adverselyaffect the demand for our services and therefore the profitability of ourbusiness.**

 

Demand forour temporary healthcare staffing services is significantly affected by thegeneral level of patient occupancy at our hospital and healthcare clients’facilities. When occupancy increases, hospitals and other healthcare facilitiesoften add temporary employees before full-time employees are hired. Asoccupancy decreases, hospitals and other healthcare facilities typically reducetheir use of temporary employees before undertaking layoffs of their regularemployees. In addition, we may experience more competitive pricing pressureduring periods of occupancy downturn. Occupancy at our clients’ hospitals andhealthcare facilities also fluctuates due to the seasonality of some electiveprocedures. We are unable to predict the level of patient occupancy at anyparticular time and its effect on our revenues and earnings.

 

**Healthcare reform couldnegatively impact our business opportunities, revenues and margins.**

 

The U.S.government has undertaken efforts to control increasing healthcare coststhrough legislation, regulation and voluntary agreements with medical careproviders and drug companies. In the recent past, the U.S. Congress hasconsidered several comprehensive healthcare reform proposals. The proposalswere generally intended to expand healthcare coverage for the uninsured andreduce the growth of total healthcare expenditures. While the U.S. Congress didnot adopt any comprehensive reform proposals, members of Congress may raise similarproposals in the future. If any of these proposals are approved, hospitals andother healthcare facilities may react by spending less on healthcare staffing,including nurses. If this were to occur, we would have fewer businessopportunities, which could seriously harm our business.

 

Stategovernments have also attempted to control increasing healthcare costs. Forexample, the state of Massachusetts has recently implemented a regulation thatlimits the hourly rate payable to temporary nursing agencies for registerednurses, licensed practical nurses and certified nurses’ aides. The state ofMinnesota has also implemented a statute that limits the amount that nursingagencies may charge nursing homes. Other states have also proposed legislationthat would limit the amounts that temporary staffing companies may charge. Anysuch current or proposed laws could seriously harm our business, revenues andmargins.

 

Furthermore,third party payers, such as health maintenance organizations, increasinglychallenge the prices charged for medical care. Failure by hospitals and otherhealthcare facilities to obtain full reimbursement from those third partypayers could reduce the demand or the price paid for our staffing services.

 

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

 

Thehealthcare industry is subject to extensive and complex federal and state lawsand regulations related to professional licensure, conduct of operations,payment for services and payment for referrals. If we fail to comply with thelaws and regulations that are directly applicable to our business, we could suffercivil and/or criminal penalties or be subject to injunctions or cease anddesist orders.

 

Ourbusiness is generally not subject to the extensive and complex laws that applyto our hospital and healthcare facility clients, including laws related to Medicare,Medicaid and other federal and state healthcare programs. However, these lawsand regulations could indirectly affect the demand or the prices paid for ourservices. For example, our hospital and healthcare facility clients couldsuffer civil or criminal penalties or be excluded from participating inMedicare, Medicaid and other healthcare programs if they fail to comply withthe laws and regulations applicable to their businesses. In addition, ourhospital and healthcare facility clients could receive reduced reimbursements,or be excluded from coverage, because of a change in the rates or conditionsset by federal or state governments. In turn, violations of or changes to theselaws and regulations that adversely affect our hospital and healthcare facilityclients could also adversely affect the prices that these clients are willingor able to pay for our services.

 

Inaddition, improper actions by our employees and other service providers maysubject us to regulatory and litigation risk.

 

**Competition for acquisition opportunities may restrict our futuregrowth by limiting our ability to make acquisitions at reasonable valuations.**

 

Ourbusiness strategy includes increasing our market share and presence in thetemporary healthcare staffing industry through strategic acquisitions ofcompanies that complement or enhance our business. We have historically facedcompetition for acquisitions. In the future, such competition could limit ourability to grow by acquisitions or could raise the prices of acquisitions andmake them less attractive to us.

 

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

 

In recentyears, healthcare providers have become subject to an increasing number oflegal actions alleging malpractice, product liability or related legaltheories. Many of these actions involve large claims and significant defensecosts. In addition, we may be subject to claims related to torts or crimescommitted by our employees or temporary healthcare professionals. In some instances,we are required to indemnify our clients against some or all of these risks. Afailure of any of our employees or healthcare professionals to observe ourpolicies and guidelines intended to reduce these risks, relevant clientpolicies and guidelines or applicable federal, state or local laws, rules andregulations could result in negative publicity, payment of fines or otherdamages. 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. If we are unable to maintain adequateinsurance coverage or if our insurers deny coverage we may be exposed tosubstantial liabilities.

 

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

 

Because weare in the 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 such claims, even if groundless, could besubstantial and the

 

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associated negative publicitycould adversely affect our ability to attract and retain qualified healthcareprofessionals in the future.

 

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

 

Executionof our business 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 of qualified sales personnel candidates islimited. We commit substantial resources to the recruitment, training,development and operational support of our sales personnel. There can be noassurance that we will be able to recruit, develop and retain qualified salespersonnel in sufficient numbers or that our sales personnel will achieveproductivity levels sufficient to enable growth of our business. Failure toattract and retain productive sales personnel could adversely affect ourbusiness, financial condition and results of operations.

 

**We have a substantial amount of goodwill andother intangible assets on our balance sheet. Our level of goodwill and otherintangible assets may have the effect of decreasing our earnings or increasingour losses.**

 

As of September 30,2005, we had $25.0 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 September 30, 2005, goodwill andother intangible assets represented 77% of our total assets.

 

In July 2001,the Financial Accounting Standards Board issued SFAS No. 141, *Business Combinations*, and SFAS No. 142,*Goodwill and Other Intangible Assets*.SFAS No. 141 requires that the purchase method of accounting be used forall business combinations initiated after June 30, 2001, as well as allpurchase method business combinations completed after June 30, 2001. SFAS No. 142requires that, subsequent to January 1, 2002, goodwill not be amortizedbut rather that it be reviewed annually for impairment. In the event impairmentis identified, a charge to earnings would be recorded. We have adopted theprovisions of SFAS No. 141 and SFAS No. 142. Although it does notaffect our cash flow, an impairment charge of goodwill to earnings has theeffect of decreasing our earnings or increasing our losses, as the case may be.If we are required to write down a substantial amount of goodwill, our stockprice could be adversely affected.

 

**Demand for medical staffing services issignificantly affected by the general level of economic activity andunemployment in the United States.**

 

Wheneconomic activity increases, temporary employees are often added beforefull-time employees are hired. However, as economic activity slows, manycompanies, including our hospital and healthcare facility clients, reduce theiruse of temporary employees before laying off full-time employees. In addition,we may experience more competitive pricing pressure during periods of economicdownturn. Therefore, any significant economic downturn could have a materialadverse impact on our financial position and results of operations.

 

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**ITEM 3.  CONTROLS AND PROCEDURES**

 

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms and that suchinformation is accumulated and communicated to our management including ourChief Executive Officer and our Chief Financial Officer, as appropriate, toallow for timely decisions regarding required disclosure.  In designing and evaluating the disclosurecontrols and procedures, management recognizes that any controls andprocedures, 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.

 

As required by Rule 13a-15(b) under theExchange Act, we conducted an evaluation under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures as of the end of the period covered bythis report.  Based upon the foregoingevaluation, our principal executive officer and our principal financial officerconcluded that our disclosure controls and procedures were effective at thereasonable assurance level as of the end of the fiscal period covered by thisreport.

 

There has been no change in our internal controlsover financial reporting during our most recent fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrols over financial reporting.

 

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## *** ***

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

## *** ***

**Item 1.****                    LegalProceedings**

 

The Company issubject to legal proceedings and claims which have arisen in the ordinarycourse of its business and have not been finally adjudicated.  Although there can be no assurance as to theultimate disposition of these matters, it is the opinion of the Company’smanagement, based upon the information available at this time, that theexpected outcome of these matters, individually or in the aggregate, will nothave a material adverse effect on the results of operations and financialcondition of the Company.

 

**Item 2.****                    UnregisteredSales of Equity Securities and Use of Proceeds**

 

None.

 

**Item 6.****                    Exhibits**

 

(a)           Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                        |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(2)               |       | Restated Certificate of Incorporation.                                                                                                 |
|                 |       |                                                                                                                                   |
| 3.2(3)               |       | Certificate of Amendment to Restated Certificate of Incorporation.                                                                     |
|                 |       |                                                                                                                                   |
| 3.3(4)               |       | Certificate of Amendment to Restated Certificate of Incorporation.                                                                     |
|                 |       |                                                                                                                                   |
| 3.4(4)               |       | Certificate of Correction of Certificate of Amendment to Restated  Certificate of Incorporation.                                       |
|                 |       |                                                                                                                                   |
| 3.5(4)               |       | Certificate of Correction of Certificate of Amendment to Restated  Certificate of Incorporation.                                       |
|                 |       |                                                                                                                                   |
| 3.6(2)               |       | Restated Bylaws.                                                                                                                       |
|                 |       |                                                                                                                                   |
| 3.7(5)               |       | Certificate of Designations, Preferences and Rights of Series A  Preferred Stock of Crdentia Corp.                                |
|                 |       |                                                                                                                                   |
| 3.8(6)               |       | Certificate of Amendment of Certificate of Designations, Preferences  and Rights of Series A Preferred Stock of Crdentia Corp.    |
|                 |       |                                                                                                                                   |
| 3.9(7)               |       | Certificate of Designations, Preferences and Rights of Series B  Preferred Stock of Crdentia Corp.                                |
|                 |       |                                                                                                                                   |
| 3.10(8)              |       | Certificate of Correction of Certificate of Designations, Preferences  and Rights of Series B Preferred Stock of Crdentia Corp.   |
|                 |       |                                                                                                                                   |
| 3.77(9)              |       | Certificate of Designations, Preferences and Rights of  Series B-1 Preferred Stock of Crdentia Corp.                              |
|                 |       |                                                                                                                                   |
| 3.12(10)             |       | Certificate of Correction of Certificate of Designations, Preferences  and Rights of Series B-1 Preferred Stock of Crdentia Corp. |
|                 |       |                                                                                                                                   |
| 3.13(11)             |       | Certificate of Designations, Preferences and Rights of Series C  Preferred Stock of Crdentia Corp.                                |
|                 |       |                                                                                                                                   |
| 3.14(10)             |       | Certificate of Correction of Certificate of Designations, Preferences  and Rights of Series C Preferred Stock of Crdentia Corp.   |

 

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| 3.15(12) |   | Certificate of Amendment to Amended and Restated Certificate of  Incorporation of Crdentia Corp.                                    |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                |
| 3.16(13) |   | Certificate of Amendment of Certificate of Designations, Preferences  and Rights of Series C Preferred Stock of Crdentia Corp. |
|     |   |                                                                                                                                |
| 31.1     |   | Certification of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                           |
|     |   |                                                                                                                                |
| 31.2     |   | Certification of Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                           |
|     |   |                                                                                                                                |
| 32.1     |   | Certification of Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley act of 2002.                           |
|     |   |                                                                                                                                |
| 32.2     |   | Certification of Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley act of 2002.                           |

 

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

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

(4)           Filed with an amended Current Report on Form 8-K/Adated June 28, 2004.

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

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

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

(8)           Filed with an amended Current Report on Form 8-K/Adated October 10, 2004.

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

(10)         Filed with an amended Current Report on Form 8-K/Adated October 10, 2004.

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

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

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

 

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***SIGNATURES***

 

In accordance with the requirements of Section 13 of 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed in its behalf by the undersigned, thereunto duly authorized.

 
| Date: November 14, 2005 | By                                    | /S/ James D. Durham   |   |
|------------------------------|---------------------------------------|-----------------------|--------|
|                         | James D.  Durham                      |
|                         | Chairman and  Chief Executive Officer |
|                         |                                  |
| Date: November 14, 2005 | By                                    | /S/ James J. TerBeest |   |
|                         | James J.  TerBeest                    |
|                         | Chief Financial  Officer              |

 

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