##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
 OR
 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: 001-15063
 Endocare, Inc.
 (Exact name of Registrant as Specified in Its Charter)
 DELAWARE
    
    33-0618093(State of Incorporation)
    
    (I.R.S. Employer I.D. No.)
 201 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA 92618  (Address of Principal Executive Office, Including Zip Code)
 (949) 450-5400  (Registrants Telephone Number, Including Area Code)
 þ o þ o
  o þ o
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##### Table of Contents



Endocare, Inc.
 INDEX
 Part I. Financial InformationItem 1. Condensed Consolidated Financial Statements (Unaudited)
    
    
    3Condensed Consolidated Statements of Operations  Three months and nine months ended September
30, 2006 and 2005
    
    
    3Condensed Consolidated Balance Sheets  September 30, 2006 and December 31, 2005
    
    
    4Condensed Consolidated Statements of Cash Flows  Nine months ended September 30, 2006 and 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4. Controls and Procedures
    
    
    25Part II. Other InformationItem 1. Legal Proceedings
    
    
    26Item 1A. Risk Factors
    
    
    27Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    28Item 3. Defaults Upon Senior Securities
    
    
    28Item 4. Submission of Matters to a Vote of Security Holders
    
    
    28Item 5. Other Information
    
    
    28Item 6. Exhibits
    
    
    28Signatures
    
    
    29EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 ENDOCARE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS  (Unaudited)
 Three Months Ended
    
    
    Nine months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands, except per share data)Total revenues
    
    $
    6,700
    
    
    $
    7,008
    
    
    $
    20,870
    
    
    $
    20,794Costs and expenses:Costs of revenues
    
    
    2,677
    
    
    
    3,809
    
    
    
    9,699
    
    
    
    11,919Research and development
    
    
    581
    
    
    
    542
    
    
    
    2,067
    
    
    
    1,653Selling and marketing
    
    
    3,725
    
    
    
    3,253
    
    
    
    11,398
    
    
    
    9,791General and administrative
    
    
    3,196
    
    
    
    3,393
    
    
    
    9,262
    
    
    
    10,182Impairment charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26Total costs and expenses
    
    
    10,179
    
    
    
    10,997
    
    
    
    32,426
    
    
    
    33,571Loss from operations
    
    
    (3,479
    )
    
    
    (3,989
    )
    
    
    (11,556
    )
    
    
    (12,777
    )Interest expense, net
    
    
    1,330
    
    
    
    562
    
    
    
    3,375
    
    
    
    (389
    )Loss from continuing operations before taxes
    
    
    (2,149
    )
    
    
    (3,427
    )
    
    
    (8,181
    )
    
    
    (13,166
    )Tax benefit on continuing operations
    
    
    
    
    
    
    
    
    
    
    151
    
    
    
    Loss from continuing operations
    
    
    (2,149
    )
    
    
    (3,427
    )
    
    
    (8,030
    )
    
    
    (13,166
    )Income from discontinued operations
    
    
    
    
    
    
    537
    
    
    
    245
    
    
    
    1,575Net loss
    
    $
    (2,149
    )
    
    $
    (2,890
    )
    
    $
    (7,785
    )
    
    $
    (11,591
    )Income (loss) per share  basic and diluted:Continuing operations
    
    $
    (0.07
    )
    
    $
    (0.11
    )
    
    $
    (0.27
    )
    
    $
    (0.45
    )Discontinued operations
    
    
    
    
    
    
    0.01
    
    
    
    0.01
    
    
    
    0.05Net loss
    
    $
    (0.07
    )
    
    $
    (0.10
    )
    
    $
    (0.26
    )
    
    $
    (0.40
    )Weighted average shares of common stock outstanding
    
    
    30,175
    
    
    
    30,069
    
    
    
    30,162
    
    
    
    28,975
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ENDOCARE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)(In thousands,except per share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    5,471
    
    
    $
    8,108Accounts receivable, net
    
    
    2,955
    
    
    
    3,549Inventories, net
    
    
    2,457
    
    
    
    2,462Prepaid expenses and other current assets
    
    
    1,117
    
    
    
    1,213Assets of discontinued operations
    
    
    
    
    
    
    9,624Total current assets
    
    
    12,000
    
    
    
    24,956Property and equipment, net
    
    
    1,106
    
    
    
    1,794Intangibles, net
    
    
    3,751
    
    
    
    4,167Investments and other assets
    
    
    2,401
    
    
    
    1,320Total assets
    
    $
    19,258
    
    
    $
    32,237LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,352
    
    
    $
    2,680Accrued compensation
    
    
    2,623
    
    
    
    3,614Other accrued liabilities
    
    
    3,956
    
    
    
    6,629Liabilities of discontinued operations
    
    
    
    
    
    
    1,461Total current liabilities
    
    
    9,931
    
    
    
    14,384Common stock warrants
    
    
    2,082
    
    
    
    5,023Total liabilities
    
    
    12,013
    
    
    
    19,407Stockholders equity:Preferred stock, $0.001 par value; 1,000
shares authorized; none issued and
outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value; 50,000
shares authorized; 30,175 and 30,089
issued and outstanding as of September
30, 2006 and December 31, 2005,
respectively
    
    
    30
    
    
    
    30Additional paid-in capital
    
    
    180,678
    
    
    
    178,477Accumulated deficit
    
    
    (173,463
    )
    
    
    (165,677
    )Total stockholders equity
    
    
    7,245
    
    
    
    12,830Total liabilities and stockholders equity
    
    $
    19,258
    
    
    $
    32,237
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ENDOCARE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine months EndedSeptember 30,2006
    
    
    2005(Unaudited)(In thousands)Cash flows from operating activities:Net loss
    
    $
    (7,785
    )
    
    $
    (11,591
    )Adjustments to reconcile net loss to net cash used in operating activities:Gain on divestiture
    
    
    (418
    )
    
    
    Depreciation and amortization
    
    
    1,227
    
    
    
    2,502Loss on disposals of fixed assets
    
    
    423
    
    
    
    107Stock compensation expense
    
    
    1,986
    
    
    
    49Costs related to assets held for sale
    
    
    
    
    
    
    (583
    )Minority interests
    
    
    
    
    
    
    (214
    )Interest expense related to common stock warrants
    
    
    (2,941
    )
    
    
    625Changes in operating assets and liabilities:Accounts receivable
    
    
    826
    
    
    
    (184
    )Inventories
    
    
    (330
    )
    
    
    (368
    )Prepaid expenses and other current assets
    
    
    430
    
    
    
    (239
    )Accounts payable
    
    
    392
    
    
    
    224Accrued compensation
    
    
    (1,013
    )
    
    
    (151
    )Other accrued liabilities
    
    
    (2,685
    )
    
    
    (1,986
    )Net cash used in operating activities
    
    
    (9,888
    )
    
    
    (11,809
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (144
    )
    
    
    (246
    )Proceeds from divestitures
    
    
    7,287
    
    
    
    850Purchases of intangible assets
    
    
    
    
    
    
    (330
    )Net cash provided by investing activities
    
    
    7,143
    
    
    
    274Cash flows from financing activities:Borrowings under the credit facility
    
    
    250
    
    
    
    Repayments under the credit facility
    
    
    (250
    )
    
    
    Stock options and warrants exercised
    
    
    108
    
    
    
    81Proceeds from sale of common stock, net of issuance costs
    
    
    
    
    
    
    14,596Net cash provided by financing activities
    
    
    108
    
    
    
    14,677Net increase (decrease) increase in cash and cash equivalents
    
    
    (2,637
    )
    
    
    3,142Cash and cash equivalents, beginning of period
    
    
    8,108
    
    
    
    7,985Cash and cash equivalents, end of period
    
    $
    5,471
    
    
    $
    11,127Non-cash activities:Transfer of inventory to property and equipment
    
    $
    361
    
    
    $
    418Note receivable received in divestiture
    
    $
    1,425
    
    
    $
    
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ENDOCARE, INC. AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Tabular numbers in thousands, except per share data)
(Unaudited)
 1. Organization and Operations
   2. Basis of Presentation
   3. Recent Operating Results and Liquidity
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4. Sale of Timm Medical
  7




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Accounting for the Impairment or Disposal of
Long-Lived Assets,
   Assets:Cash, inventories and other current assets
    
    $
    1,216Property and equipment, net
    
    
    75Goodwill, net
    
    
    4,552Intangibles, net
    
    
    3,716Other assets
    
    
    65Total assets
    
    $
    9,624Liabilities:Accounts payable and other current liabilities
    
    $
    942Other accrued liabilities
    
    
    519Total liabilities
    
    
    1,461Net assets
    
    $
    8,163
  5. Private Placement of Common Stock and Warrants
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Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled In,
a Companys Own Stock,
 
    
    First, we used the Black-Scholes option-pricing model with the following assumptions:
an expected life equal to the remaining contractual term of the warrants (3.50 years); no
dividends; a risk free rate of 4.61 percent, which equals the yield on Treasury bonds at
constant (or fixed) maturity equal to the remaining contractual term of the warrants; and
volatility of 58.6 percent. Under these assumptions, the Black-Scholes option-pricing model
yielded a value of $0.61 for each of the Series A warrants and $0.54 for each of the Series
B warrants, for an aggregate value of $2.2 million;
    
    Second, since the warrants are limited in the amount of realizable profit to the
holders as a result of the call provision described above, we reduced the value of the
warrants to account for the probability that the stock price will reach or exceed $6.50 and
$7.50, respectively (i.e., the prices above which we have the right to call the Series A
and Series B warrants, effectively compelling the holders to exercise their warrants). We
used a statistical formula to calculate the probability that our stock price will reach or
exceed $6.50 and $7.50, respectively. Based on this formula, we calculated that, for the
Series A warrants, the probability that the
 9




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stock price of $6.50 will be reached or
exceeded is approximately 2.0 percent. Similarly, we calculated that, for the Series B
warrants, the probability that the stock price of $7.50 will be reached or exceeded is
approximately 0.6 percent. Based on these probabilities, we reduced the valuation of each
of the Series A warrants to $0.59 (which equals one minus 2.0 percent, multiplied by $0.61)
and we reduced the valuation of each of the Series B warrants to $0.53 (which equals one
minus 0.6 percent, multiplied by $0.54). This yields an aggregate value of the warrants
equal to $2.2 million; and
    
    Third, we further reduced the value of the warrants on the assumption that our stock
price on the day that the warrants are exercised will be affected by dilution as a result
of the additional stock introduced into the market. Given that we have approximately 30.2
million shares outstanding, we calculated that the exercise of the warrants will result in
dilution of approximately 6.2 percent. Using the dilution figure of 6.2 percent, we reduced
the value of each of the Series A warrants to $0.56 and the Series B warrants to $0.50.
This yields an aggregate value of the warrants equal to $2.1 million. As a result of this
fair value calculation, we recorded a reduction to net interest expense of $1.2 million and
$2.9 million, respectively, for the three and nine months ended September 30, 2006
(compared to reduction of interest expense of $0.5 million and net interest expense of
$0.6 million, respectively, for the three and nine months ended September 30, 2005), which
represents the change in the fair value of the warrants from June 30, 2006 and December 31,
2005, respectively, primarily as a result in the decrease in the fair value of the
underlying stock.The $1.2 million reduction in the fair value of the warrants during the third quarter of 2006
from $3.3 million at June 30, 2006 to $2.1 million at September 30, 2006 is primarily the
result of the decrease in the our share price from $2.50 at June 30, 2006 to $2.00 at
September 30, 2006 and the decrease in the overall volatility of our common shares. The $2.9
million reduction to net interest expense for the nine months ended September 30, 2006
includes a $0.8 million ($0.03 per basic and diluted share) reduction in the fair value of
the warrants as calculated at December 31, 2005 due to changes in the methodology we used to
measure volatility in conjunction with the adoption of SFAS No. 123R, Share Based Paymentas
further discussed in Note 7  Stock-Based Compensation below. This reduction was a change
in estimate and was recorded in 2006 first quarter operations.
  6. Capital Stock and Net Loss Per Share
  7. Stock-Based Compensation
 Accounting for Stock Issued to Employees Accounting for Stock Based Compensation
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Share Based Payment
 Share-Based Payment
 a.
    
    We increased the expected term from five years to 6.25 years using the shortcut
method under SAB 107 (an expected term based on the mid point between the vesting date
and the end of the contractual term). The use of the short cut method is permitted
through December 31, 2007. We will convert to company-specific experience on or before
January 1, 2008. The options have a maximum contractual term of 10 years and vest
pro-rata over four years, which is the requisite service period.b.
    
    While we continue to use historical volatility (based on daily trading prices) to
estimate the fair value of options granted, we have increased the period over which
volatility is measured from three years to 6.25 years. We have excluded the period from
October 24, 2002 to January 16, 2003 (inclusive) during which our common stock
experienced unusually high volatility as a result of announcement of our failure to file
the September 30, 2002 Form 10-Q, temporary suspension of trading, delisting of our
shares from NASDAQ, and an investigation commenced by the SEC.c.
    
    These changes resulted in a net decrease in volatility from previous estimates.
Average volatility for options granted in 2005 and during the nine months ended September
30, 2006 was approximately 90.3 percent and 69.5 percent, respectively. We did not
incorporate implied volatility since there are no actively traded option contracts on our
common stock and sufficient data for an accurate measure of implied volatility were not
available.
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d.
    
    Prior to January 1, 2006, we accounted for forfeitures as they occurred.
Compensation expense related to unvested forfeited options was reversed in the period the
employee was terminated. Upon adoption of SFAS No. 123R, we have estimated an average
forfeiture rate of approximately 33.7 percent based on historical experience from 2001
through September 30, 2006. Stock-based compensation expense recorded in the 2006 periods
is net of expected forfeitures. We will periodically assess the forfeiture rate. Changes
in estimates will be recorded in the period of adjustment, if any. During the three
months ended September 30, 2006, we increased the estimated forfeiture rate from 25
percent to 33 percent as a result of our periodic review of estimated forfeiture rates
compared to historical experience. The change in estimate resulted in a cumulative
adjustment to reduce stock-based compensation expense during the three months ended
September 30, 2006 by $0.4 million.
  Share Based
Payment
  Three Months
    
    
    Nine MonthsEnded
    
    
    EndedSeptember
    
    
    September30, 2005
    
    
    30, 2005Net loss, as reported
    
    $
    (2,890
    )
    
    $
    (11,591
    )Add: Stock-based employee
compensation expense included in
reported net loss for all awards
    
    
    
    
    
    
    Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards
    
    
    (936
    )
    
    
    (2,756
    )Net loss, as adjusted
    
    $
    (3,826
    )
    
    $
    (14,347
    )Basic and diluted loss per share:As reported
    
    $
    (0.10
    )
    
    $
    (0.40
    )As adjusted
    
    $
    (0.13
    )
    
    $
    (0.50
    )
 12




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RemainingNumber of
    
    
    Weighted
    
    
    Contractual
    
    
    AggregateOptions
    
    
    Average
    
    
    Term
    
    
    Intrinsic Value(in thousands)
    
    
    Exercise Price
    
    
    (in years)
    
    
    (in thousands)Options
outstanding at
December 31, 2005
    
    
    6,006
    
    
    $
    4.27Granted
    
    
    612
    
    
    
    3.25Exercised
    
    
    (66
    )
    
    
    0.79Canceled
    
    
    (121
    )
    
    
    4.09Options outstanding
at March 31, 2006
    
    
    6,431
    
    
    
    4.21Granted
    
    
    66
    
    
    
    3.31Exercised
    
    
    (20
    )
    
    
    2.81Canceled
    
    
    (176
    )
    
    
    4.38Options outstanding
at June 30, 2006
    
    
    6,301
    
    
    
    4.20Granted
    
    
    429
    
    
    
    2.20Exercised
    
    
    
    
    
    
    Canceled
    
    
    (391
    )
    
    
    3.32Options outstanding
at September 30,
2006
    
    
    6,339
    
    
    $
    4.12
    
    
    
    7.47
    
    
    $
    Options
exercisable at
September 30, 2006
    
    
    3,502
    
    
    $
    4.96
    
    
    
    6.50
    
    
    $
    
  WeightedNumber
    
    Average
    
    
    
    
    
    NumberOutstanding As
    
    Remaining
    
    Weighted
    
    Exercisable As of
    
    Weightedof September
    
    Contractual
    
    Average
    
    September 30,
    
    AverageRange of Exercise Prices
    
    30, 2006
    
    Life(Years)
    
    Exercise Price
    
    2006
    
    Exercise Price$  2.00
    
    
    
    $
    2.22
    
    
    
    754,000
    
    
    
    8.44
    
    
    $
    2.15
    
    
    
    215,729
    
    
    $
    2.11$  2.25
    
    
    
    $
    2.36
    
    
    
    705,000
    
    
    
    6.63
    
    
    $
    2.26
    
    
    
    626,875
    
    
    $
    2.26$  2.50
    
    
    
    $
    2.80
    
    
    
    888,000
    
    
    
    8.16
    
    
    $
    2.75
    
    
    
    282,000
    
    
    $
    2.72$  2.83
    
    
    
    $
    3.29
    
    
    
    639,445
    
    
    
    8.52
    
    
    $
    3.04
    
    
    
    174,435
    
    
    $
    3.05$  3.30
    
    
    
    $
    3.45
    
    
    
    687,140
    
    
    
    9.05
    
    
    $
    3.36
    
    
    
    88,984
    
    
    $
    3.44$  3.69
    
    
    
    $
    4.20
    
    
    
    450,250
    
    
    
    7.34
    
    
    $
    4.07
    
    
    
    308,270
    
    
    $
    4.08$  4.27
    
    
    
    $
    4.27
    
    
    
    1,000,000
    
    
    
    7.20
    
    
    $
    4.27
    
    
    
    618,750
    
    
    $
    4.27$  4.50
    
    
    
    $
    5.13
    
    
    
    688,459
    
    
    
    6.17
    
    
    $
    4.75
    
    
    
    660,126
    
    
    $
    4.75$  6.19
    
    
    
    $
    18.84
    
    
    
    525,923
    
    
    
    4.98
    
    
    $
    12.98
    
    
    
    525,923
    
    
    $
    12.98$21.23
    
    
    
    $
    21.23
    
    
    
    1,000
    
    
    
    5.09
    
    
    $
    21.23
    
    
    
    1,000
    
    
    $
    21.23$  2.00
    
    
    
    $
    21.23
    
    
    
    6,339,217
    
    
    
    7.47
    
    
    $
    4.12
    
    
    
    3,502,092
    
    
    $
    4.96
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8. Inventories
   September 30,
    
    
    December 31,2006
    
    
    2005Raw materials
    
    $
    1,794
    
    
    $
    1,646Work in process
    
    
    350
    
    
    
    275Finished goods
    
    
    878
    
    
    
    911Total inventories
    
    
    3,022
    
    
    
    2,832Less: inventory reserve
    
    
    (565
    )
    
    
    (370
    )Inventories, net
    
    $
    2,457
    
    
    $
    2,462
 9. Commitments and Contingencies
 Litigation and Regulatory Investigations
    14




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Other
  10. Income Taxes
  15




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11. Results of Operations
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Cryocare Surgical Systems
    
    $
    423
    
    
    $
    132
    
    
    $
    814
    
    
    $
    404Cryoablation disposable products and procedure fees
    
    
    5,952
    
    
    
    6,653
    
    
    
    19,024
    
    
    
    19,690Cardiac royalties (CryoCath) and other revenues
    
    
    325
    
    
    
    223
    
    
    
    1,032
    
    
    
    700$
    6,700
    
    
    $
    7,008
    
    
    $
    20,870
    
    
    $
    20,794Cost of Revenues:Cryocare Surgical Systems
    
    $
    41
    
    
    $
    107
    
    
    $
    639
    
    
    $
    405Cryoablation disposable products and procedure fees
    
    
    2,636
    
    
    
    3,702
    
    
    
    9,060
    
    
    
    11,514$
    2,677
    
    
    $
    3,809
    
    
    $
    9,699
    
    
    $
    11,919
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Disposable products
    
    $
    3,460
    
    
    $
    1,927
    
    
    $
    9,061
    
    
    $
    4,727Procedure fees
    
    
    2,492
    
    
    
    4,726
    
    
    
    9,963
    
    
    
    14,963$
    5,952
    
    
    $
    6,653
    
    
    $
    19,024
    
    
    $
    19,690
  12. Subsequent Events
   13. Recent Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes Accounting for
Income Taxes
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Accounting Changes and Error Corrections Accounting
Changes Reporting Changes in Interim Financial Statements
  
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The following discussion and analysis should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto included in Part I  Item 1 of this
report, and the audited consolidated financial statements and notes thereto, and Managements
Discussion and Analysis of Financial Condition and Results of Operations contained in the Annual
Report on Form 10-K for the fiscal year ended December 31, 2005.
 This discussion contains forward-looking statements based on our current expectations. There
are various factors  many beyond our control  that could cause our actual results or the
occurrence or timing of expected events to differ materially from those anticipated in these
forward-looking statements. Some of these factors are described below and other factors are
described elsewhere in this Quarterly Report on Form 10-Q or under Risk Factors in our Annual
Report on Form 10-K referred to above. In addition, there are factors not described in this
Quarterly Report on Form 10-Q or in our Annual Report on Form 10-K that could cause our actual
results or the occurrence or timing of expected events to differ materially from those anticipated
in these forward-looking statements. All forward-looking statements included in this Quarterly
Report on Form 10-Q are based on information available to us as of the date hereof, and we assume
no obligation to update any such forward-looking statements.
 Overview
   17




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Strategy, Key Metrics and Developments
        18




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Results of Operations
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Cryocare Surgical Systems
    
    $
    423
    
    
    $
    132
    
    
    $
    814
    
    
    $
    404Cryoablation disposable products and procedure fees
    
    
    5,952
    
    
    
    6,653
    
    
    
    19,024
    
    
    
    19,690Cardiac royalties (CryoCath) and other revenues
    
    
    325
    
    
    
    223
    
    
    
    1,032
    
    
    
    700$
    6,700
    
    
    $
    7,008
    
    
    $
    20,870
    
    
    $
    20,794Costs of Revenues:Cryocare Surgical Systems
    
    $
    41
    
    
    $
    107
    
    
    $
    639
    
    
    $
    405Cryoablation disposable products and procedure fees
    
    
    2,636
    
    
    
    3,702
    
    
    
    9,060
    
    
    
    11,514$
    2,677
    
    
    $
    3,809
    
    
    $
    9,699
    
    
    $
    11,919
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Disposable products
    
    $
    3,460
    
    
    $
    1,927
    
    
    $
    9,061
    
    
    $
    4,727Procedure fees
    
    
    2,492
    
    
    
    4,726
    
    
    
    9,963
    
    
    
    14,963$
    5,952
    
    
    $
    6,653
    
    
    $
    19,024
    
    
    $
    19,690
    19




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##### Table of Contents



Share Based Payment Accounting for Stock Issued to
Employees,
 Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005
 Revenues.
  20




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##### Table of Contents



Cost of Revenues.
 Gross Margins.
 Research and Development Expenses.
 Selling and Marketing Expenses.
 General and Administrative Expenses.
 Interest Expense, Net.
 21




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##### Table of Contents



Loss from Continuing Operations.
 Income from Discontinued Operations.
 Net Loss.
 Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
 Revenues.
 Costs of Revenues.
 Gross Margins.
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##### Table of Contents



Research and Development Expenses. .
 Selling and Marketing Expenses.
 General and Administrative Expenses.
 Interest Expense, Net.
 Loss from Continuing Operations.
 Income from Discontinued Operations.
 Net Loss.
 23




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Liquidity and Capital Resources
       24




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures.
  Changes in Internal Controls.
 25




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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  Governmental Investigations
      Lawsuit Against KPMG LLP
  26




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##### Table of Contents



Item 1A. Risk Factors
  We may require additional financing to sustain our operations and without it we may not be able to
continue operations.
     Even despite the availability of funds from Fusion Capital and Silicon Valley Bank, our independent
auditor may issue a qualified opinion, to the effect that there is substantial doubt about our
ability to continue as a going concern.
  The sale of our common stock to Fusion Capital may cause dilution and the sale of the shares of
common stock acquired by Fusion Capital could cause the price of our common stock to decline.
  27




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
  28




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##### Table of Contents



SIGNATURES
  ENDOCARE, INC.By:
    /s/ CRAIG T. DAVENPORTCraig T. DavenportChief Executive Officer, President and
Chairman of the Board
(Duly Authorized Officer)By:
    /s/ MICHAEL R. RODRIGUEZMichael R. RodriguezSenior Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)  29




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##### Table of Contents



EXHIBIT INDEX
 ExhibitNo.
    
    Description2.1(1)
    
    Partnership Interest Purchase Agreement, dated as of December 30, 2004, by and between the
Company and Advanced Medical Partners, Inc.2.2(2)
    
    Stock Purchase Agreement, dated as of January 13, 2006, by and among the Company, Plethora
Solutions Holdings plc and Timm Medical Technologies, Inc. The schedules and other
attachments to this exhibit were omitted. The Company agrees to furnish a copy of any
omitted schedules or attachments to the Securities and Exchange Commission upon request.2.3(3)
    
    $1,425,000 Secured Convertible Promissory Note, dated as of February 10, 2006, from
Plethora Solutions Holdings plc to the Company.3.1(4)
    
    Certificate of Amendment of Restated Certificate of Incorporation of the Company.3.2(4)
    
    Certificate of Designation of Series A Junior Participating Preferred Stock of the Company.3.3(4)
    
    Restated Certificate of Incorporation.3.4(5)
    
    Amended and Restated Bylaws of the Company.4.1(6)
    
    Form of Stock Certificate.4.2(7)
    
    Form of Series A Warrant.4.3(7)
    
    Form of Series B Warrant.4.4(8)
    
    Rights Agreement, dated as of September 30, 1999, between the Company and U.S. Stock
Transfer Corporation, which includes the form of Certificate of Designation for the Series
A Junior Participating Preferred Stock as Exhibit A, the form of Rights Certificate as
Exhibit B and the Summary of Rights to Purchase Series A Preferred Shares as Exhibit C.4.5(9)
    
    Amendment No. 1 to Rights Agreement, dated as of September 24, 2005, between the Company
and U.S. Stock Transfer Corporation.10.1
    
    Non-Prosecution Agreement, dated as of July 18, 2006, by and between the Company and the
United States Department of Justice.10.2
    
    Consent to Entry of Judgment, dated as of July 14, 2006, in favor of the United States
Securities and Exchange Commission.31.1
    
    Certification under Section 302 of the Sarbanes-Oxley Act of 2002 for Craig T. Davenport.31.2
    
    Certification under Section 302 of the Sarbanes-Oxley Act of 2002 for Michael R. Rodriguez.32.1
    
    Certification under Section 906 of the Sarbanes-Oxley Act of 2002 for Craig T. Davenport.32.2
    
    Certification under Section 906 of the Sarbanes-Oxley Act of 2002 for Michael R. Rodriguez.
 
 (1)
    
    Previously filed as an exhibit to our Form 8-K filed on January 6, 2005.(2)
    
    Previously filed as an exhibit to our Form 8-K filed on January 18, 2006.(3)
    
    Previously filed as an exhibit to our Form 10-K filed on March 16, 2006. 30




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(4)
    
    Previously filed as an exhibit to our Registration Statement on Form S-3 filed on September 20, 2001.(5)
    
    Previously filed as an exhibit to our Form 10-K filed on March 15, 2004.(6)
    
    Previously filed as an exhibit to our Form 10-K for the year ended December 31, 1995.(7)
    
    Previously filed as an exhibit to our Form 8-K filed on March 16, 2005.(8)
    
    Previously filed as an exhibit to our Form 8-K filed on September 3, 1999.(9)
    
    Previously filed as an exhibit to our Form 8-K filed on June 28, 2005. 31