FOR THE THREE AND NINE MONTH PERIODS ENDED

		Page
		Number
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2007 (unaudited) and December 31, 2006	1
	Condensed Consolidated Statements of (Operations) Income for the Three and Nine Months ended September 30, 2007 and 2006 (unaudited)	2
	Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2007 and 2006 (unaudited)	3
	Notes to Unaudited Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	34
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	37
Item 4.	Submission of Matters to a Vote of Security Holders	38
Item 5.	Other Information	38
Item 6.	Exhibits	39
SIGNATURES		39

 

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		September 30,			December 31,
		2007			2006
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	517,000		$	1,136,000
Accounts receivable, net of allowance for doubtful accounts—$249,000 in 2007 and $141,000 in 2006			5,457,000			6,766,000
Product inventories and supplies, net			1,308,000			1,261,000
Prepaid expenses			459,000			512,000
Deferred income taxes—current			-			560,000
Other receivables			51,000			293,000
Total current assets			7,792,000			10,528,000
Plant and equipment, net of accumulated depreciation and amortization of $4,578,000 in 2007 and $4,376,000 in 2006			5,282,000			4,778,000
Deferred income taxes—long-term			-			62,000
Goodwill			-			3,578,000
Other assets			93,000			101,000
		$	13,167,000		$	19,047,000
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	3,702,000		$	3,414,000
Accrued payroll and payroll taxes			1,037,000			1,572,000
Other accrued expenses			301,000			587,000
Obligation under acquisition agreement			-			500,000
Current obligations under capital leases			-			7,000
Current obligation under line of credit			2,500,000			2,025,000
Current obligations under notes payable			700,000			175,000
Total current liabilities			8,240,000			8,280,000
Notes payable, net of current portion			-			525,000
Other long-term liabilities			519,000			389,000
Shareholders’ equity:
Common stock, no par value—20,000,000 shares authorized, 8,799,955 and 8,495,955 shares issued and outstanding in 2007 and 2006, respectively			15,621,000			14,710,000
Accumulated deficit			(11,213,000	)		(4,857,000	)
Total shareholders’ equity			4,408,000			9,853,000
		$	13,167,000		$	19,047,000

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

 

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HEMACARE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF (OPERATIONS) INCOME

(Unaudited)

 

		Three months ended September 30,						Nine months ended September 30,
		2007			2006			2007			2006
Revenues:
Blood products		$	7,495,000		$	7,186,000		$	22,973,000		$	20,352,000
Blood services			2,066,000			1,991,000			5,590,000			5,445,000
Total revenues			9,561,000			9,177,000			28,563,000			25,797,000
Operating costs and expenses:
Blood products			7,209,000			6,079,000			20,922,000			16,837,000
Blood services			1,457,000			1,367,000			4,294,000			4,091,000
Total operating costs and expenses			8,666,000			7,446,000			25,216,000			20,928,000
Gross profit			895,000			1,731,000			3,347,000			4,869,000
General and administrative expenses			1,605,000			1,276,000			4,810,000			3,943,000
Goodwill impairment			4,259,000			-			4,259,000			-
(Loss) income before income taxes		$	(4,969,000	)	$	455,000		$	(5,722,000	)	$	926,000
Provision for income taxes			627,000			7,000			634,000			33,000
Net (loss) income		$	(5,596,000	)	$	448,000		$	(6,356,000	)	$	893,000
Basic (loss) earnings per share		$	(0.64	)	$	0.05		$	(0.74	)	$	0.11
Diluted (loss) earnings per share		$	(0.64	)	$	0.05		$	(0.74	)	$	0.10
Weighted average shares outstanding - basic			8,794,000			8,298,000			8,588,000			8,162,000
Weighted average shares outstanding - diluted			8,794,000			9,104,000			8,588,000			8,981,000

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

 

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HEMACARE CORPORATION

(Unaudited)

 

		Nine months ended September 30,
		2007			2006
Cash flows from operating activities:
Net (loss) income		$	(6,356,000	)	$	893,000
Adjustment to reconcile net (loss) income to net cash provided by (used in) operating activities:
Provision for bad debt			120,000			42,000
Increase in deferred tax asset valuation reserve			622,000			-
Depreciation and amortization			722,000			574,000
Loss on disposal of assets			50,000			4,000
Goodwill impairment			4,259,000			-
Share-based compensation expense			221,000			404,000
Changes in operating assets and liabilities:
Decrease (increase) in net accounts receivable			1,189,000			(843,000	)
Decrease in inventories, supplies and prepaid expenses			6,000			68,000
Decrease in other assets and other receivables			250,000			105,000
Decrease in accounts payable, accrued expenses and other liabilities			(903,000	)		(805,000	)
Net cash provided for operating activities			180,000			442,000
Cash flows from investing activity:
Increase in goodwill			(24,000	)		(2,224,000	)
Proceeds from sale of plant and equipment			-			5,000
Purchase of plant and equipment			(1,276,000	)		(974,000	)
Net cash used for investing activity			(1,300,000	)		(3,193,000	)
Cash flows from financing activities:
Proceeds from the exercise of stock options			33,000			13,000
Principal payments on notes payable and capitalized leases			( 7,000	)		(61,000	)
Proceeds from line of credit			475,000			1,275,000
Net cash provided for financing activities			501,000			1,227,000
Decrease in cash and cash equivalents			(619,000	)		(1,524,000	)
Cash and cash equivalents at beginning of period			1,136,000			2,612,000
Cash and cash equivalents at end of period		$	517,000		$	1,088,000
Supplemental disclosure:
Interest paid		$	126,000		$	12,000
Income taxes paid		$	116,000		$	60,000
Teragenix Acquisition:
Notes issued to sellers		$	-		$	200,000
Common Stock issued to sellers		$	657,000		$	543,000

 

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

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HemaCare Corporation

 

 

Note 1—Basis of Presentation and General Information

 

 

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements for the three and nine months ended September 30, 2007 and 2006 include all adjustments (consisting of normal recurring accruals) which management considers necessary to present fairly the financial position of the Company as of September 30, 2007, the results of its operations for the three and nine months ended September 30, 2007 and 2006, and its cash flows for the nine months ended September 30, 2007 and 2006 in conformity with accounting principles generally accepted in the United States.

 

These financial statements have been prepared consistently with the accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on April 2, 2007 which should be read in conjunction with this Quarterly Report on Form 10-Q. The reader should reference the notes from the consolidated financial statements for 2006 which are incorporated by reference from the Notes to Consolidated Financial Statements as of December 31, 2006 as described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the consolidated results of operations to be expected for the full fiscal year ending December 31, 2007. The following unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to ensure the information is not misleading.

 

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Revenues and Accounts Receivable: Revenues are recognized upon shipment of the blood products or the performance of blood services. Occasionally the Company receives advance payment against future delivery of blood products or services. Until the related products or services are delivered, the Company records advance payments as deferred revenue, which appears as a current liability on the balance sheet. Blood services revenues consist primarily of sales of mobile therapeutic services, while blood products revenues consist primarily of sales of single donor platelets, whole blood components or other blood products that are manufactured or purchased and distributed by the Company. Accounts receivable are reviewed periodically for collectibility. The Company estimates an allowance for doubtful accounts based on balances owed that are 90 days or more past due from the invoice date, unless evidence exists, such as subsequent cash collections, that specific amounts are collectable. In addition, balances less than 90 days past due are reserved based on the Company’s recent bad debt experience.

 

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Inventories and Supplies: Inventories consist of Company-manufactured platelets, whole blood components and other blood products, as well as component blood products purchased for resale. Supplies consist primarily of medical supplies used to collect and manufacture products and to provide therapeutic services. Inventories are stated at the lower of cost or market and are accounted for on a first-in, first-out basis. Management estimates the portion of inventory that might not have future value by analyzing historical sales history for the twelve months prior to any balance sheet date. For each inventory type, management establishes an obsolescence reserve equal to the value of inventory quantity in excess of twelve months of historical sales quantity, using the first-in, first-out inventory valuation methodology. The Company recorded reserves for obsolete inventory of $1,017,000 and $736,000 as of September 30, 2007 and December 31, 2006, respectively.

 

Shared-Based Compensation: In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-based Payment: An Amendment of FASB Statements No. 123 and 95 (“SFAS 123R”), the Company recognizes compensation expense related to stock options granted to employees based on: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of, the balance sheet date, based on the grant date fair value estimated in accordance with SFAS No 123, Accounting for Stock-Based Compensation (“SFAS 123”), and (b) compensation for all share-based payments granted and vested during the reporting period, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

 

The Company’s assessment of the estimated fair value of the stock options granted is affected by the price of the Company’s stock, as well as assumptions regarding a number of complex and subjective variables and the related tax impact. Management utilized the Black-Scholes model to estimate the fair value of stock options granted. Generally, the calculation of the fair value for options granted under SFAS 123R is similar to the calculation of fair value under SFAS 123, with the exception of the treatment of forfeitures.

 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. This model also requires the input of highly subjective assumptions including:

 

(a)

The expected volatility of the common stock price, which was determined based on historical volatility of the Company’s common stock;

 

(b)

Expected dividends, which are not anticipated;

 

(c)

Expected life of the stock option, which is estimated based on the historical stock option exercise behavior of employees; and

 

(d)

Expected stock option forfeitures.

 

In the future, management may elect to use different assumptions under the Black-Scholes valuation model or a different valuation model, which could result in a significantly different impact on net income or loss.

 

Income Taxes: The process of preparing the financial statements requires management estimates of income taxes in each of the jurisdictions that the Company operates. This process involves estimating current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the balance sheet. Under the provisions of SFAS No. 109, Accounting for Income Taxes, the Company must utilize an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Management must assess the likelihood that the deferred tax assets or liabilities will be realized for future periods, and to the extent management believes that realization is not likely, must establish a valuation allowance. To the extent a valuation allowance is created or adjusted in a period, the Company must include an expense or benefit, within the tax provision in the statements of operations. Significant management judgment is required in determining the provision for income taxes, deferred tax asset and liabilities and any valuation allowance recorded against net deferred tax assets. It is possible that different tax models, and the selection of different input variables, could produce a materially different estimate of the provision, asset, liability and valuation allowance. The Company increased the valuation allowance in the third quarter of 2007 to 100%, resulting in the elimination of the deferred tax asset from the Company’s balance sheet as of September 30, 2007, and a related charge to the provision for income taxes.

 

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Goodwill: In accordance with SFAS No 142, Goodwill and Other Intangible Assets, the Company must determine the fair value of any goodwill recognized as a result of prior acquisition activity. Goodwill is the portion of the total consideration paid to acquire a business that exceeds the fair market value of the assets acquired, less the value of the liabilities acquired. Any subsequent valuation of goodwill requires substantial estimation by management of the future profitability of any respective business unit, and an assessment of the fair value of the business.

 

The Company uses the income approach, along with other standard analytical approaches, to estimate the fair value of goodwill. The income approach involves estimating the present value of future cash flows by using projections of the cash flows that the business is expected to generate, and discounting these cash flows at a given rate of return. This requires the use of management estimates and assumptions, such as assumptions on growth rates for revenues, expenses, earnings before interest, income taxes, depreciation and amortization, returns on working capital, returns on other assets and capital expenditures, among others. Assumptions on discount rates and terminal growth rates are also used to determine fair value. Given the subjectivity involved in deriving these estimates in the analyses, it is possible that a different valuation model and the selection of different input variables could produce a materially different estimate of the fair value of goodwill. In the third quarter of 2007, the Company recognized a goodwill impairment charge of $4,259,000 related to HemaCare BioScience, Inc., representing 100% of the goodwill book value.

 

 

The Company maintains cash balances at various financial institutions. Deposits not exceeding $100,000 for each institution are insured by the Federal Deposit Insurance Corporation. At September 30, 2007 and December 31, 2006, the Company had uninsured cash and cash equivalents of $414,000 and $832,000, respectively.

 

 

On January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109 (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes by prescribing rules for recognition, measurement and classification in financial statements of tax positions taken or expected to be taken in a tax return. FIN No. 48 prescribes a two-step process for the financial statement measurement and recognition of a tax position. The first step involves the determination of whether it is more likely than not (greater than 50 percent likelihood) that a tax position will be sustained upon examination, based on the technical merits of the position. The second step requires that any tax position that meets the more-likely-than-not recognition threshold be measured and recognized in the financial statements at the largest amount of benefit that is greater than 50 percent likelihood of being realized upon ultimate settlement. FIN No. 48 also provides guidance on the accounting for related interest and penalties, financial statement classification and disclosure. The Company has determined that there is no material impact on the consolidated financial position, results of operations or cash flows from the adoption of FIN No. 48.

 

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 establishes a common definition for fair value to be applied to U. S. GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 157 on its consolidated financial position and results of operations.

 

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On February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities: Including an amendment of FASB Statement No. 115 (“SFAS No. 159”), to reduce earnings volatility caused by related assets and liabilities measured differently under GAAP. SFAS No. 159 allows all entities to make an irrevocable instrument-by-instrument election to measure eligible items at fair value in their entirety. In addition, unrealized gains and losses will be reported in earnings at each reporting date. SFAS No. 159 also establishes presentation and disclosure requirements that focus on providing information about the impact of electing the fair value option. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007, concurrent with the adoption of SFAS No. 157. The Company does not anticipate that the adoption of SFAS No. 159 will have a significant impact on its consolidated financial position, results of operations or cash flows.

 

From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that are adopted by management as of the specified effective date. Unless otherwise discussed, management believes that the impact of recently issued standards that are not yet effective will not have a material impact on the Company’s consolidated financial statements upon adoption.

 

Note 2—Inventory

 

Inventories consist of Company-manufactured platelets, whole blood components and other blood products, as well as component blood products purchased for resale. Supplies consist primarily of medical supplies used to collect and manufacture products and to provide therapeutic services. Inventories are stated at the lower of cost or market and are accounted for on a first-in, first-out basis.

 

Inventories are comprised of the following as of:

 

		September 30,			December 31,
		2007			2006
Blood products		$	1,677,000		$	1,225,000
Supplies			649,000			772,000
Total inventory		$	2,326,000		$	1,997,000
Less: Reserves for obsolete inventory			(1,017,000	)		(736,000	)
Net inventory		$	1,309,000		$	1,261,000

 

Note 3—Goodwill

 

 In accordance with SFAS No 142, Goodwill and Other Intangible Assets, the Company must determine the fair value of any goodwill recognized as a result of prior acquisition activity. Goodwill is the portion of the total consideration paid to acquire a business that exceeds the fair market value of the assets acquired, less the value of the liabilities acquired. Any subsequent valuation of goodwill requires substantial estimation by management of the future profitability of the respective business and an assessment of the fair value of the business.

 

In 2006, the Company acquired all of the outstanding capital stock of Teragenix Corporation, subsequently renamed HemaCare BioScience, Inc. (“HemaBio”), for cash, HemaCare stock, notes and additional cash and stock based on the future performance of HemaBio, all as more fully described in the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and November 15, 2006. Given the total consideration paid as of September 30, 2007 to acquire HemaBio, the Company determined that the consideration paid to acquire HemaBio exceeded the fair value of the assets acquired, less the value of the liabilities acquired, otherwise known as goodwill, by $4,259,000.

 

Management determined, utilizing various fair valuation estimation methodologies, that there was no fair value for HemaBio’s goodwill as of September 30, 2007. Therefore, the Company recorded a goodwill impairment charge of $4,259,000, which is shown as a separate line item on the income statement.

 

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Note 4 - Severance to Chief Executive Officer

 

On June 28, 2007, Judi Irving resigned as the Company’s President and Chief Executive Officer, and as a member of the Company’s Board of Directors. Based on the terms of Ms. Irving’s employment letter of November 26, 2002, and in exchange for a release of any employment related claims Ms. Irving could assert against the Company, the Company agreed to pay Ms. Irving one year of her salary as of the date of her separation, payable in 26 equal bi-weekly installments. In addition, the Company agreed to pay Ms. Irving’s health and dental coverage for 18 months on the same terms that existed just prior to Ms. Irving’s separation from the Company.

 

In the second quarter of 2007, the Company recognized a charge to general and administrative expenses of $326,000 as the total cost of the separation obligation to Ms. Irving.

 

Note 5 - Line of Credit and Notes Payable

 

On September 26, 2006, the Company, together with the Company’s subsidiaries Coral Blood Services, Inc. and HemaCare BioScience, Inc., entered into an Amended and Restated Loan and Security Agreement (“Agreement”) with Comerica Bank (“Comerica”) to provide a working capital line of credit. The Agreement restated the terms of the prior credit agreement with Comerica, except i) the limits on the amount the Company may borrow were changed to the lesser of 75% of eligible accounts receivable or $3 million, ii) HemaBio was added as an additional borrower, iii) Comerica was given a security interest in all of the assets of HemaBio, and iv) the term of the Agreement was extended one year to June 30, 2008. The Agreement provides that interest is payable monthly at a rate of prime minus 0.25%. On March 26, 2007, the Company entered into an amendment to the Agreement to increase the limit on the amount the Company may borrow to the lesser of 75% of eligible accounts receivable or $4 million. As of September 30, 2007, the rate associated with this credit facility was 7.50%. In addition, the Company has the option to draw against this facility for thirty, sixty or ninety days using LIBOR as the relevant rate of interest. As of September 30, 2007, the Company had borrowed $2,500,000 against this line of credit. During the first nine months of 2007, the Company incurred $127,000 in interest expense associated with the Comerica credit facility.

The Comerica credit facility is collateralized by substantially all of the Company’s assets and requires the maintenance of certain financial covenants that, among other things, requires minimum levels of profitability and prohibit the payment of dividends. As of September 30, 2007, the Company was not in compliance with any of the financial covenants. In addition, the Company is in default on the Comerica Agreement as a result of the Company’s failure to pay the first installment on the notes that are part of the acquisition of HemaBio as described below. Comerica has not communicated to the Company any intention to exercise any of its rights and remedies as a result of the defaults; however, Comerica has communicated its intention to reserve its rights and will not waive any of the defaults. Therefore, Comerica could at any time, among other remedies, demand full repayment of the outstanding balance of $2.5 million. The Company does not possess sufficient resources at this time to repay the amounts outstanding under the Agreement. If the Company is unable to repay the outstanding balance, the Agreement provides Comerica with the right to take possession of the Company’s assets and attempt to sell, or otherwise monetize, the Company’s assets in satisfaction of the unpaid obligation.

 

As part of the consideration to acquire HemaBio, the Company issued a note to each of the sellers. One note for $153,800 for the benefit of Joseph Mauro, requires four equal annual installments of $38,450 each August 29 until paid. This note pays interest at 5% annually, 12% if a default occurs, and is secured through a security agreement, by all of the assets of HemaBio, although subordinate to Comerica Bank. The second note for $46,200 for the benefit of Valentin Adia, requires four equal annual installments of $11,550 each August 29 until paid. This note pays interest at 5% annually, and is also secured through security agreement, by all of the assets of HemaBio, although subordinate to Comerica Bank.

 

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Also, when the Company acquired HemaBio, HemaBio had two $250,000 notes outstanding to Dr. Karen Raben and Dr. Lawrence Feldman. Both of these notes require four equal annual installments of $62,500 each August 29 until paid, and pay interest at 7% annually, 10% if a default occurs. Each note is secured by all of the assets of HemaBio, but is subordinate to Comerica Bank.

 

The Company failed to pay the initial payment due on August 29, 2007 on all four of the notes associated with the HemaBio acquisition, which, in the aggregate, represents principal amount of $175,000, together with accrued interest of $77,000. The Company was negotiating an amendment to the notes to defer the initial payments to early 2008. On September 4, 2007, the Company received notices from Mr. Mauro and Mr. Adia demanding the initial aggregate payment of $50,000, together with accrued interest of $23,500, by no later than September 19, 2007 or the noteholders would accelerate the payment of the entire unpaid obligation. On October 2, 2007, the Company received notice from the other two noteholders demanding the initial installment of $125,000, plus interest, by October 12, 2007, or they would consider legal remedies.

 

Each of the HemaBio notes is subordinate to Comerica Bank, and each of the noteholders previously entered into a Subordination Agreement with Comerica Bank. The Subordination Agreements provide that the noteholders will not demand, sue for, take or receive by acceleration or otherwise, any indebtedness under the notes, nor exercise any rights in collateral securing such indebtedness; provided, however, that so long as no event of default has occurred under the Comerica loan agreement, the noteholders may receive regularly scheduled payments of principal and interest under the notes.

 

The Company recorded additional interest expense of $28,000 in the third quarter of 2007 reflecting the higher default interest rate on three of the notes related to the HemaBio acquisition.

 

The foregoing descriptions of the notes and bank loan agreement are qualified in their entirety by the copies of those agreements filed as exhibits to the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and September 29, 2006.

 

Note 6 - Leases

 

On February 24, 2006, the Company entered into a lease for approximately 19,600 square feet located in Van Nuys, California intended to house corporate offices, a mobile blood drive operation, a blood component manufacturing lab and a blood products distribution operation. The Company occupied this facility in November 2006. The rent for this facility started at $36,500 per month; however, the lease provides for 3% rent escalation upon the annual anniversary of the beginning of the lease term. The lease on this space expires July 31, 2017; however, the Company has one five-year option to extend this lease at the then current market price. On April 11, 2007, the Company entered into an amendment to add approximately 7,200 square feet to this lease intended to house a donor center and supply warehouse. This amendment added $13,250 per month in rent expense, which adjusts annually by 3.9% on the anniversary of the lease commencement date.

 

The Company invested approximately $2.1 million in tenant improvements in the new facility. As part of the lease agreement, the Company received approximately $475,000 in tenant improvement allowance from the landlord. The Company amortizes the cost for tenant improvements over the term of the lease as depreciation expense. The Company recognizes the total rent obligation for this facility, net of the tenant improvement allowance, as rent expense on a straight line basis over the term of the lease. The total deferred rent as a result of this gross-up is $596,000, of which $77,000 is included as other accrued expenses, and $519,000 is included as other long-term liabilities on the Company’s balance sheet as of September 30, 2007.

 

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Note 7—Shareholders’ Equity

 

In December 2004, the FASB issued SFAS 123R. This statement requires that the cost resulting from all share-based payment transactions be recognized in the Company’s consolidated financial statements. In addition, in March 2005 the Securities and Exchange Commission (“SEC”) released SEC Staff Accounting Bulletin No. 107, Share-Based Payment (“SAB 107”). SAB 107 provides the SEC’s staff’s position regarding the application of SFAS 123R and certain SEC rules and regulations, and also provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values.

 

In the first quarter of fiscal 2006, the Company adopted the fair value recognition provisions of SFAS 123R, which requires the recognition of compensation cost to include: (a) the cost for all share-based payments granted prior to, but not yet vested as of, the beginning of the reporting period, based on the grant date fair value estimated in accordance with SFAS 123R, and (b) cost for all share-based payments granted and vested during the reporting period, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

 

On July 19, 2006 the Company’s 1996 Stock Option Plan expired. At the Company’s annual meeting of shareholders held on May 24, 2006, the shareholders approved the 2006 Equity Incentive Plan (the “2006 Plan”). The purpose of the 2006 Plan is to encourage ownership in the Company by key personnel whose long-term service is considered essential to the Company’s continued progress, thereby linking these employees directly to shareholder interests through increased stock ownership. A total of 1,200,000 shares of the Company’s common stock have been reserved for issuance under the 2006 Plan. Awards may be granted to any employee, director or consultant, or those of the Company’s affiliates. The Company submitted an application with the California Department of Corporations for a permit to grant options under the 2006 Plan, which was approved on July 12, 2007. No options were granted under the 2006 Plan prior to July 12, 2007. As of September 30, 2007, options to purchase 185,000 shares had been granted under the 2006 Plan.

 

Beginning in 2007, options granted to non-employee members of the Board of Directors vest quarterly instead of upon grant, which historically occurred in the first quarter of each year. At the March 14, 2007 meeting of the Board of Directors, the non-employee directors were awarded their 2007 annual options utilizing the closing stock price on March 14, 2007, the date of the meeting, subject to receipt of the California permit. These options were issued on August 8, 2007. Since these grants were intended as compensation for annual service, and since the vesting policy requires quarterly vesting of non-employee director options, the Company recorded $59,000 and $178,000 of share-based compensation for the three months and nine months ended September 30, 2007, respectively, utilizing the Black-Scholes valuation model.

 

The following summarizes the activity of the Company’s stock options for the nine months ended September 30, 2007 :

 

		Shares			Weighted Average Exercise Price			Weighted Average Remaining Contractual Term (Years)
Number of shares under option:
Outstanding at January 1, 2007			1,836,000		$	1.27
Granted			185,000			2.26
Exercised			(56,000	)		.61
Canceled or expired			(206,000	)		1.83
Outstanding at September 30, 2007			1,759,000			.78			5.5
Exercisable at September 30, 2007			1,555,000		$	.70			5.4

 

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The following summarizes the activity of the Company’s stock options that have not vested for the nine months ended September 30, 2007 .

 

		Shares			Weighted Average Fair Value
Nonvested at January 1, 2007			444,000			$1.51
Granted			185,000			1.72
Vested			(258,000	)		1.28
Canceled			(167,000	)		1.83
Nonvested at September 30, 2007			204,000			$1.37

 

As of September 30, 2007, there was $280,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under existing stock option plans. This cost is expected to be recognized over a weighted-average vesting period of 2.6 years.

 

The Black-Scholes option pricing model is used by the Company to determine the weighted average fair value of options. The fair value of options at date of grant and the assumptions utilized to determine such values are indicated in the following table:

		Three months ended September 30,						Nine months ended September 30,
		2007			2006			2007			2006
Weighted average fair value at date of grant for options granted during the period		$	418,250		$	-		$	418,250		$	879,000
Risk-free interest rates			5.0	%		5.0	%		5.0	%		5.0	%
Expected stock price volatility			133.2	%		91.4	%		133.2	%		91.4	%
Expected dividend yield			0.0	%		0.0	%		0.0	%		0.0	%
Expected forfeitures			6.1	%		6.1	%		6.1	%		6.1	%

 

The Company adjusted the assumptions used to calculate share-based compensation expense based on the recent behavior of option holders.

 

Note8—Earnings per Share

 

The following table provides the calculation methodology for the numerator and denominator for diluted earnings per share:

 

		Three months ended September 30,						Nine months ended September 30,
		2007			2006			2007			2006
Net (loss) income		$	(5,596,000	)	$	448,000		$	(6,356,000	)	$	893,000
Weighted average shares outstanding			8,794,000			8,298,000			8,588,000			8,162,000
Net effect of dilutive options and warrants			—			806,000			—			819,000
Diluted shares outstanding			8,794,000			9,104,000			8,588,000			8,981,000

 

Options and warrants outstanding of 1,759,000 shares of common stock for the three and nine months ended September 30, 2007 have been excluded from the above calculation because their effect would have been anti-dilutive.

 

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Options and warrants outstanding for 490,000 shares of common stock for the three and nine months ended September 30, 2006, have been excluded from the above calculation because their effect would have been anti-dilutive.

 

Note9—Provision for Income Taxes

 

The process of preparing the financial statements includes estimating income taxes in each of the jurisdictions that the Company operates. This process involves estimating current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the balance sheet. Under the provisions of SFAS No. 109, Accounting for Income Taxes, the Company must utilize an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Management must assess the likelihood that the deferred tax assets or liabilities will be realized for future periods, and to the extent management believes that realization is not likely, must establish a valuation allowance. To the extent a valuation allowance is created or adjusted in a period, the Company must include an expense, or benefit, within the tax provision in the statements of operations. Significant management judgment is required in determining the provision for income taxes, deferred tax asset and liabilities and any valuation allowance recorded against net deferred tax assets.

 

The Company has substantial net operating losses that are available to eliminate some potential federal tax liability. To the degree the Company incurs any tax federal liability, the Company will reduce the valuation reserve against its deferred tax assets.

 

As of the end of 2006, management determined that the Company was more likely than not to benefit from $622,000 in tax savings from available net operating losses to be realized in future periods, and therefore management reduced the valuation reserve by $622,000 which resulted in a deferred tax asset on the balance sheet, along with the corresponding benefit from income taxes in the accompanying period. The third quarter of 2007 loss represented the third consecutive quarterly loss for the Company. Therefore, as of September 30, 2007, the Company recalculated and increased the valuation reserve for the deferred tax asset to 100%, which resulted in an increase of $622,000 in the reserve and the elimination of the deferred tax asset as reported on the balance sheet. This change in valuation reserve was recorded to the provision for income taxes on the income statement. The Company may choose to change this reserve in future periods.

 

Since the Company incurred a loss in the third quarter of 2007, no federal income taxes were recognized in the quarter; however, $5,000 was recorded to the provision for income taxes due to anticipated state and local taxes. As described in Note 7, in the first quarter of 2006, the Company adopted the fair value recognition provisions of SFAS 123R pertaining to share-based compensation transactions. This adoption creates temporary differences between GAAP based net income and tax based net income because the compensation deduction permitted under SFAS 123R is not deductible for taxes. When option holders exercise their rights to purchase the Company’s shares, the Company is entitled to take a tax deduction, eliminating the temporary difference created when the option rights vested.

 

The Company recognized $67,000 in compensation expense related to SFAS 123R in the third quarter of 2007. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $17,000. The Company recalculated the valuation reserve to include the addition to the deferred tax asset which resulted in no net change in the deferred tax asset reported on the balance sheet. Since the Company maintains a 100% valuation reserve for its deferred tax asset, none of the increase in deferred taxes is reflected in the income statement.

 

Note 10—Business Segments

 

HemaCare operates two business segments as follows:

 

·

Blood Products—Collection, processing and distribution of blood products and donor testing.

 

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·

Blood Services—Therapeutic apheresis, stem cell collection procedures and other therapeutic services to patients.

 

Management considers the operations of HemaBio to be similar to the Company’s existing blood products business segment. HemaBio sources, processes and distributes human biological samples, manufactures quality control products and provides clinical trial services. Therefore, the financial information for HemaBio is reported as part of the Company’s blood products business segment.

 

Management uses more than one measure to evaluate segment performance. However, the dominant measurements are consistent with HemaCare’s consolidated financial statements, which present revenue from external customers and operating income for each segment.

 

There were no intersegment revenues for either the three month or nine month periods ended September 30, 2007, and September 30, 2006.

 

 

State and federal laws set forth anti-kickback and self-referral prohibitions and otherwise regulate financial relationships between blood banks and hospitals, physicians and other persons who refer business to them. While the Company believes its present operations comply with applicable regulations, there can be no assurance that future legislation or rule making, or the interpretation of existing laws and regulations, will not prohibit or adversely impact the delivery by HemaCare of its services and products.

 

Healthcare reform is continuously under consideration by lawmakers, and it is not certain as to what changes may be made in the future regarding health care policies. However, policies regarding reimbursement, universal health insurance and managed care competition may materially impact the Company’s operations.

 

The Company is party to various claims, actions and proceedings incidental to its normal business operations. The Company believes the outcome of such claims, actions and proceedings, individually and in the aggregate, will not have a material adverse effect on the business and financial condition of the Company.

 

Note 12 - Subsequent Events

 

On November 2, 2007, HemaCare BioScience, Inc., (“HemaBio”) the wholly owned Florida-based research products subsidiary of HemaCare Corporation, (the “Company”) received letters of resignation from Mr. Joseph Mauro, Company President, and Mr. Valentin Adia, Vice President of Business Development. Mr. Mauro and Mr. Adia both stated that their resignations were submitted under the “Good Reason” provisions of their employment agreements.

 

In the third quarter of 2007, HemaBio produced a net loss of approximately $300,000, and was projected to record a net loss of $125,000 in the month of October 2007. The Board of Directors of HemaBio, in consultation with, and with the approval of, the Board of Directors of the Company, determined HemaBio’s business could not operate without senior management, and that the pathway to future profitability was unclear. Therefore, the Board of Directors of HemaBio decided that it was in the best interest of HemaBio’s creditors to close all operations of HemaBio, effective November 5, 2007.

 

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Per Statement of Financial Accounting Standards No. 144, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the results of operations of HemaBio, along with any closure related costs, shall be reported in discontinued operations in the fourth quarter of 2007. The most significant closure related cost would be the obligations, if any, of HemaBio to Mr. Mauro and Mr. Adia under their employment agreements. Each of their respective employment agreements contains provisions that termination of employment by the executive for “Good Reason” would entitle the executive to the following:

 

a.

Payment of any base salary accrued but unpaid as of the date of termination;

 

b.

An amount equal to the executive’s monthly base salary in effect on the date of termination for a period equal to the greater of the remainder of the term or twelve (12) months;

 

c.

HemaBio will continue to pay executive’s health insurance coverage until the earlier of (A) the greater of (1) the remainder of the term or (2) twelve months and (B) until executive obtains full-time employment, provided that such coverage remains available with respect to executive; and

 

d.

Payment of any and all earnouts, or other consideration amounts payable by HemaBio pursuant to that certain Stock Purchase Agreement by and among the Company, HemaBio and the shareholders of HemaBio (the “Stock Purchase Agreement”), whether earned or unearned, within thirty (30) days of the date of termination, and any bonuses earned as of the date of termination.

 

Management estimates that the Company will report a loss from discontinued operations in the fourth quarter of 2007 of up to $1,000,000 related to the closure of HemaBio. Included in this estimate are i) approximately $600,000 in severance expenses to Joseph Mauro and Valentin Adia, ii) approximately $150,000 in operating losses from October 1, 2007 through the date of closure, iii) approximately $150,000 increase in allowance for bad debt as a result of customers refusal to pay existing receivables of HemaBio as a result of the termination of contractual obligations, and iv) approximately $100,000 in miscellaneous closure related expenses, including attorney’s fees. Management’s estimate is preliminary and is subject to change as the closure process proceeds. The estimated loss in the 4^th quarter does not reflect any obligation relief that HemaBio might obtain through insolvency proceedings.

 

The foregoing descriptions of the Stock Purchase Agreement and employment agreements, as amended, are qualified in their entirety by the copies of those agreements filed as exhibits to the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and September 29, 2006.

 

The following table reflects the results of operations for HemaBio for the three and nine month periods ended September 30, 2007:

 

		For the three month period ended September 30,						For the nine month period ended September 30,
		2007			2006			2007			2006
Revenue		$	1,128		$	617		$	3,358		$	617
Gross Profit			(290	)		179			(112	)		179
Gross Profit %			(25.7	)%		29.0	%		(3.3	)%		29.0	%

 

 

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Company’s financial statements and the related notes provided under “Item 1-Financial Statements” above.

 

The matters discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q that are not historical are forward-looking statements. These statements may also be identified by the use of words such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “project,” “will” and similar expressions, as they relate to the Company, its management and its industry. Investors and prospective investors are cautioned that these forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results could differ materially from those described in this report because of numerous factors, many of which are beyond the Company’s control. These factors include, without limitation, those described below under the heading “Risk Factors Affecting the Company.” The Company does not undertake to update its forward-looking statements to reflect later events and circumstances or actual outcomes.

 

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General

 

HemaCare Corporation (“HemaCare” or the “Company”) provides the customized delivery of blood products and services. The Company collects, processes and distributes blood products to hospitals and research related organizations. The Company operates and manages donor centers and mobile donor vehicles to collect transfusable blood products from donors, collects human-derived blood products which are utilized by health research related organizations, and also purchases transfusable blood products and research products from others. Additionally, the Company provides blood related services, principally therapeutic apheresis procedures, stem cell collection and other blood treatments to patients with a variety of disorders. Blood related therapeutic services are usually provided under contract as an outside purchased service.

 

The Company was incorporated in the state of California in 1978. The Company has operated in Southern California since 1979. In 1998, the Company expanded operations to include portions of the eastern U.S. In 2003, new management reduced the number of geographic regions served as part of a restructuring plan to return the Company to profitability. Since 2003, the Company’s earnings improved as a result of the successful implementation of management’s plan, and the Company reported net income in 2004, 2005 and 2006. In August 2006, the Company acquired Florida-based Teragenix Corporation, subsequently renamed HemaCare BioScience, Inc. (“HemaBio”), which sources, processes and distributes human biological specimens, manufactures quality control products and provides clinical trial management and support services. For the first nine months of 2007, the Company reported substantial operating losses as well as a sizeable charge associated with the write-off of goodwill recognized as part of the HemaBio acquisition.

 

On October 31, 2007 HemaBio received letters of resignation from Mr. Joseph Mauro, Company President, and Mr. Valentin Adia, Vice President of Business Development both former owners of HemaBio. The Board of Directors of HemaBio, in consultation with, and with the approval of, the Board of Directors of HemaCare Corporation, determined that returning HemaBio to profitability without the former owners and senior management was not probable and elected to close HemaBio, effective November 5, 2007.

 

The Company’s current strategy is to focus on increasing the utilization of existing blood products capacity in those markets currently served, expanding product and service offerings for biotechnology, pharmaceutical and other research-focused organizations through investment in expanded procurement and manufacturing capacity, and expanding the market potential for therapeutic apheresis services through physician education and other marketing efforts.

 

Although most suppliers of transfusable blood products are organized as not-for-profit, tax-exempt organizations, all suppliers charge fees for blood products to cover their costs of operations. The Company believes that it is the only investor-owned and taxable organization operating as a transfusable blood supplier with significant operations in the U.S. The research specimen industry includes many suppliers from small limited service providers to large fully integrated service organizations.

 

Results of Operations

 

Three months ended September 30, 2007 compared to the three months ended September 30, 2006

 

Overview

 

The Company generated revenue in the third quarter of 2007 of $9,561,000, an increase of $384,000, or 4%, compared to the same period of 2006. Blood products revenue increased $309,000, or 4%, as a result of revenue from HemaBio operations, which was acquired in the third quarter of 2006. Blood services revenue increased $75,000, or 4%, primarily as a result of an increase in the average sales price charge for procedures performed.

 

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Gross profit in the third quarter of 2007 decreased $836,000, or 48%, compared to the third quarter of 2006. The decline in gross profit is attributable to a $821,000, or 74%, decrease in gross profit for the Company’s blood products business segment, and a $15,000, or 2%, decrease in gross profit for the Company’s blood services business segment.

 

Per SFAS No. 142, the Company performed an evaluation as of September 30, 2007 of the fair value of the goodwill recognized as part of the HemaBio acquisition. As a result of this evaluation, the Company recorded an impairment charge of $4,259,000..

 

The third quarter of 2007 represented three consecutive losses for the Company. Therefore, as of September 30, 2007, the Company increased the valuation reserve of its deferred tax asset to 100%, which resulted in an increase of $622,000 in the valuation reserve and the elimination of the deferred tax asset as reported on the balance sheet. This change in valuation reserve was recorded to the provision for income taxes on the income statement. The Company may choose to change this reserve in future periods.

 

The Company generated a net loss of $5,596,000 for the third quarter of 2007, representing a $6,044,000 decrease from the same period in 2006. This decrease is attributable to the decline in gross profit from the Company’s blood products business segment, the recognition of $4,259,000 in goodwill impairment and a $622,000 increase in the deferred tax asset valuation reserve. Excluding the two nonrecurring charges, the Company’s operations produced a loss of $715,000, representing a $1,163,000 decrease over the third quarter of 2006.

 

Blood Products

 

For this business segment, the following table summarizes the revenues and gross profit associated with transfusable blood products and research blood products as of September 30:

 

For the three month period ended September 30,

(Revenues and Gross Profit in Thousands)

 

		Transfusable Products						Research Products						Total Segment
		2007			2006			2007			2006			2007			2006
Revenues		$	6,367		$	6,569		$	1,128		$	617		$	7,495		$	7,186
Gross Profit			576			928			(290	)		179			286			1,107
Gross Profit %			9.0	%		14.1	%		(25.7	)%		29.0	%		3.8	%		15.4	%

 

For the three months ended September 30, 2007, blood product revenues increased $309,000, or 4%, compared with the same quarter of 2006. This increase is attributable to a $511,000 increase in revenue produced by the Company’s Florida-based research blood products operation, which the Company acquired on August 29, 2006. Therefore, revenue for this operation in the third quarter of 2006 includes only 32 days after the acquisition. Revenue for the Company’s transfusable blood products operations decreased $202,000, or 3%, compared to the third quarter of 2006.

 

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For the three months ended September 30, 2007, gross profit for the blood products segment decreased $821,000 or 75%, to $286,000 from $1,107,000 in third quarter of 2006. The decrease reflects a decline in the Company’s Florida-based research products gross profit of $469,000 to a loss of $290,000, compared to a third quarter 2006 profit of $179,000 for the 32 day period after the acquisition. The decline in performance for this business unit is due to i) a decrease in clinical research support revenue, ii) increasing cost to acquire blood samples, and iii) increasing compensation expense. As a result, the gross profit percentage for this business unit declined from a positive 29% to a negative 26%. Transfusable products gross profit decreased $352,000, or 38%, to $576,000 in the three months ended September 30, 2007, from $928,000 for the same period of 2006. This is the result of i) a decline in California collection volumes resulting from increased competition for blood drive sponsors and turnover of donor recruitment staff, ii) competition in the California market which restricted the Company’s ability to pass along cost increases for staff, supplies, fuel, newly mandated blood tests, and regulatory costs, and iii) a decrease in the supply of purchased blood products, resulting in an increase in the cost of these products. Gross profit from the Company’s Maine operations improved in the quarter compared to the same period in 2006, primarily as a result of higher collection volumes, and lower staff related costs. The gross profit percentage for transfusable products decreased to 9.0% in the third quarter of 2007, from 14.1% for the same quarter of 2006. For the blood products business segment, the overall gross profit percentage decreased to 3.8% in the third quarter of 2007, from 14.8% for the same quarter of 2006.

 

Blood Services

 

Blood services revenue increased $75,000, or 4%, to $2,066,000 in the third quarter of 2007 from $1,991,000 generated in the same period of 2006 due to an increase in the average sales price charged for therapeutic apheresis procedures performed. This increase is primarily caused by a change in the mix of procedures performed that resulted in an increase in the proportion of “full service” procedures to “operator only” procedures, primarily in the Company’s Mid-Atlantic region. Operator only fees reflect charges principally for staff time to perform the procedure and exclude charges for equipment and supplies, and therefore result in a lower average sales price when compared to full service procedures.

 

Gross profit for blood services decreased $15,000, or 2%, from $624,000 in the third quarter of 2006 to $609,000 during the same period of 2007 reflecting a decline in gross profit percentage from 31% to 30%. The decrease is primarily due to increases in the cost for clinical supplies used in therapeutic apheresis procedures and fuel.

 

General and Administrative Expenses

 

General and administrative expenses increased by $329,000 to $1,605,000 in the third quarter of 2007 from $1,276,000 in the same period of 2006. The increase reflects a $190,000 increase in outside professional and temporary personnel costs, $57,000 increase in depreciation, $42,000 increase in interest expense, and $26,000 increase in the cost of non-cash share-based compensation expense.

 

The increase in outside professional and temporary costs is related to legal fees associated with the Company’s application to the California Department of Corporations for a permit to issue stock options under the Company’s 2006 Equity Incentive Plan, increases in audit related services, marketing consulting services, Sarbanes Oxley compliance consulting services, and an increase in the cost of temporary personnel to fill various open positions. The increase in depreciation expense is a result of depreciation of tenant improvements for the Company’s new facility in Van Nuys, California, which the Company occupied in November of 2006. The increase in interest expense is the result of outstanding debt incurred to finance the acquisition of HemaBio in August 2006. The increase in share-based compensation is the result of a change in vesting of options granted to members of the board of directors. In 2006, most of the options granted to non-employee members of the board vested upon grant, which occurred in the first quarter. As a result, all of the share-based compensation associated with these options was recognized in the first quarter of 2006. In 2007, options to non-employee members of the board vest in four equal amounts each quarter. As a result, share-based compensation associated with these options is recognized evenly throughout the year, and is the primary cause for the increase in this expense in the third quarter of 2007 compared to the same quarter of 2006.

 

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Goodwill Impairment

 

The goodwill impairment charge is the result of management’s application of SFAS No. 142, which requires an evaluation of the fair value of the goodwill recognized from any previous acquisition activity. In 2006, the Company acquired all of the outstanding capital stock of HemaBio, for cash, HemaCare stock, notes and additional cash and stock based on the future performance of HemaBio, all as more fully described in the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and November 15, 2006. As of September 30, 2007, the Company determined that the total consideration paid to acquire HemaBio exceeded the fair value of the assets acquired, less the value of the liabilities acquired, otherwise known as goodwill, by $4,259,000. In applying SFAS No. 142, management determined, utilizing various fair valuation estimation methodologies, that the fair value of HemaBio’s goodwill as of September 30, 2007 was less than book value, and therefore, the Company recognized a goodwill impairment charge of $4,259,000 representing 100% of the book value.

 

Income Taxes

 

No federal income tax provision was recognized in the third quarter of 2007 due to the Company’s net loss in the quarter; however, management anticipates that the Company will be subject to various state and local taxes which are unaffected by the Company’s net loss, or by the existence of a net operating loss carryforward. As a result, management estimated that the Company incurred $5,000 in tax liability from for state and local taxes in the quarter.

 

In the first quarter of 2006, the Company adopted the fair value recognition provisions of SFAS 123R pertaining to share-based compensation transactions. This adoption creates temporary differences between GAAP based net income and tax based net income because the compensation deduction permitted under SFAS 123R is not deductible for taxes. When option holders exercise their rights to purchase the Company’s shares, the Company is entitled to take a tax deduction, eliminating the temporary difference created when the option rights vested. The Company recognized $67,000 in compensation expense related to SFAS 123R in the third quarter of 2007. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $17,000. The Company recalculated the valuation reserve to include this addition to the deferred tax asset which resulted in no net change in the deferred tax asset reported on the balance sheet.

 

As of the end of 2006, management determined that the Company was more likely than not to benefit from $622,000 in tax savings from available net operating losses to be realized in future periods, and therefore reduced the deferred tax asset valuation reserve, creating a deferred tax asset on the Company’s balance sheet, along with the corresponding benefit from income taxes in the accompanying period. The Company continues to evaluate the deferred tax asset valuation reserve each quarter based on the reportable income for each quarter. The third quarter of 2007 loss represented the third consecutive quarterly loss for the Company. Therefore, as of September 30, 2007, the Company increased the valuation reserve to 100%, which resulted in an increase of $622,000 in the valuation reserve and the elimination of the deferred tax asset as reported on the balance sheet. This change in valuation reserve is recorded to the provision for income taxes on the income statement. The Company may choose to change this reserve in future periods.

 

Nine months ended September 30, 2007 compared to the nine months ended September 30, 2006

 

Overview

 

The Company generated revenue in the first nine months of 2007 of $28,563,000, an increase of $2,766,000, or 11%, compared to the same period of 2006. Blood products revenue increased $2,621,000, or 13%, as a result of revenue from HemaBio operations, which was acquired in the third quarter of 2006. Blood services revenue increased $145,000, or 3%, primarily as a result of an increase in the number of procedures performed.

 

Gross profit in the first nine months of 2007 decreased $1,522,000, or 31%, compared to the same period of 2006, due to a $1,464,000, or 42%, decrease in gross profit for the Company’s blood products business segment, and a $58,000, or 4%, decrease in gross profit for the Company’s blood services business segment.

 

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Per SFAS No. 142, the Company performed an evaluation as of September 30, 2007 of the fair value of the goodwill recognized as part of the HemaBio acquisition. As a result of this evaluation, the Company recorded an impairment charge of $4,259,000. In addition, the Company recorded a $326,000 charge to general and administrative expense for severance benefits associated with the resignation of the Company’s former President and Chief Executive Officer. Finally, the Company increased the valuation reserve by $622,000, which resulted in an increase in the provision for income taxes on the income statement.

 

The Company generated a net loss of $6,356,000 for the first nine months of 2007, representing a $7,249,000 decrease from the same period in 2006. This decrease is primarily attributable to the decline in the Company’s blood products gross profit, goodwill impairment of $4,259,000, increase of $622,000 in the deferred tax asset valuation reserve, and the recognition of $326,000 in severance expenses. Excluding the nonrecurring expenses, the net loss in the period would have been $1,149,000.

 

Blood Products

 

For this business segment, the following table summarizes the revenues and gross profit associated with transfusable blood products and research blood products as of September 30

 

For the nine month period ended September 30,

(Revenues and Gross Profit in Thousands)

 

		Transfusable Products						Research Products						Total Segment
		2007			2006			2007			2006			2007			2006
Revenues		$	19,615		$	19,735		$	3,358		$	617		$	22,973		$	20,352
Gross Profit			2,163			3,336			(112	)		179			2,051			3,515
Gross Profit %			11.0	%		16.9	%		(3.3	)%		29.0	%		8.9	%		17.3	%

 

For the nine months ended September 30, 2007, blood product revenues increased $2,621,000, or 13%, compared with the same quarter of 2006. This increase is attributable to a $2,741,000 increase in revenue produced by the Company’s Florida-based research blood products operation, which the Company acquired on August 29, 2006. Therefore, revenue for this operation in the first nine months of 2006 includes only the 32 days after the acquisition. Revenue for the Company’s transfusable blood products operations decreased $120,000, or less than 1%, compared to the third quarter of 2006.

 

For the nine months ended September 30, 2007, gross profit for the blood products segment decreased $1,464,000 or 42%, to $2,051,000 from $3,515,000 in third quarter of 2006. The decrease reflects a decline in transfusable products gross profit $1,173,000, or 35%, to $2,163,000 in the nine months ended September 30, 2007, from $3,336,000 for the same period of 2006. This is the result of i) a decline in California collection volumes resulting from increased competition for blood drive sponsors and turnover of donor recruitment staff, ii) competition in the California market which restricted the Company’s ability to pass along cost increases for staff, supplies, fuel, newly mandated blood tests, and regulatory costs, and iii) a decrease in the supply of purchased blood products, resulting in an increase in the cost of these products. Unlike the Company’s California operations, the gross profit from the Company’s Maine operations improved in the first nine months of 2007 compared to the same period in 2006, primarily as a result of higher collection volumes, and lower staff related costs. The gross profit percentage for transfusable products decreased to 11% in the first nine months of 2007, from 17% for the same period of 2006. In addition, the Company’s Florida based research products gross profit decreased to a loss of $112,000 in the first nine months of 2007 from a profit of $179,000 in 2006 for the 32 day period after the acquisition. The decline in performance for this business unit is due to i) a decrease in clinical research support revenue, ii) increasing cost to acquire blood samples, and iii) increasing compensation expense. As a result, the gross profit percentage for this business unit declined from a positive 29% to a negative 3.3%. For the blood products business segment, the overall gross profit percentage decreased to 9% in the first nine months of 2007, from 17.3% for the same period of 2006.

 

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Blood Services

 

Blood services revenue increased $145,000, or 3%, to $5,590,000 in the first nine months of 2007 from $5,445,000 generated in the same period of 2006 due to a 4% increase in the number of therapeutic apheresis procedures performed, offset by lower albumin sales. The growth in procedures was in the Company’s Mid-Atlantic region where the average revenue per procedure is lower due to a higher percentage of “operator only” procedures. Operator only fees reflect charges principally for staff time and exclude charges for equipment and supplies.

 

Gross profit for blood services decreased $58,000, or 4%, from $1,354,000 in the first nine months of 2006 to $1,296,000 during the same period of 2007, reflecting a decline in gross profit percentage from 25% to 23%. The decrease is due to the lower margins associated with the higher percentage of operator only procedures performed in the Mid-Atlantic region.

 

General and Administrative Expenses

 

General and administrative expenses increased by $867,000 to $4,810,000 in the first nine months of 2007 from $3,943,000 in the same period of 2006. The increase includes a $326,000 charge for severance expenses, $340,000 increase in outside professional service and temporary personnel costs, $135,000 increase in depreciation, $125,000 increase in interest expense, and $53,000 increase in bad-debt expense. These were partially off-set by a $170,000 decrease in non-cash share-based compensation expense.

 

The increase in severance related expenses is the result of the resignation of Judi Irving, the Company’s former President and Chief Executive Officer, on June 28, 2007. Based on the terms of Ms. Irving’s employment letter of November 26, 2002, and in exchange for a release of any employment related claims Ms. Irving could assert against the Company, the Company agreed to pay Ms. Irving one year of her salary as of the date of her separation, payable in 26 equal bi-weekly installments. In addition, the Company agreed to pay Ms. Irving’s health and dental coverage for 18 months on the same terms that existed just prior to Ms. Irving’s separation from the Company. The Company recognized $326,000 in the second quarter of 2007 related to this obligation to Ms. Irving.

 

The increase in outside professional and temporary costs is related to legal fees associated with the Company’s application to the California Department of Corporations for a permit to issue stock options under the Company’s 2006 Equity Incentive Plan, increases in audit related services, Sarbanes Oxley compliance consulting services, and the cost of temporary personnel to fill various open positions. The increase in depreciation expense is a result of depreciation of tenant improvements for the Company’s new facility in Van Nuys, California, which the Company occupied in November of 2006. The increase in interest expense is the result of outstanding debt incurred to finance the acquisition of HemaBio in August 2006. The increase in bad debt expense is due to an increase in age of selective California customer invoices. Offsetting these increases is a $170,000 decrease in share-based compensation expense primarily due to a change in the vesting of options granted non-employee members of the Board of Directors. Beginning in 2007, these options vest quarterly instead of immediately upon grant, which historically occurred in the first quarter of each year. Therefore, share-based compensation expense associated with these options is recognized more evenly throughout the year, resulting in a reduction in share-based compensation expense in the first nine months of 2007 compared to the same period of 2006.

 

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Goodwill Impairment

 

The goodwill impairment charge is the result of management’s application of SFAS No. 142, which requires an evaluation of the fair value of the goodwill recognized from any previous acquisition activity. In 2006, the Company acquired 100% of the stock of HemaBio, for cash, HemaCare stock, notes and additional cash and stock based on the future performance of HemaBio, all as more fully described in the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and November 15, 2006. As of September 30, 2007, the Company determined that the total consideration paid to acquire HemaBio exceeded the fair value of the assets acquired, less the value of the liabilities acquired, otherwise known as goodwill, by $4,259,000. In applying SFAS No. 142, management determined, utilizing various fair valuation estimation methodoligies, that the fair value of HemaBio’s goodwill as of September 30, 2007 was less than book value, and therefore, the Company recognized a goodwill impairment charge of $4,259,000, which represents 100% of the book value.

 

Income Taxes

 

No federal income tax provision was recognized in the first nine months of 2007 due to the Company’s net loss in the period; however, management anticipates that the Company will be subject to various state and local taxes which are unaffected by the Company’s net loss, or by the existence of a net operating loss carryforward. As a result, management estimated that the Company incurred $12,000 in tax liability in the first nine months of 2007 for state and local taxes.

 

In the first quarter of 2006, the Company adopted the fair value recognition provisions of SFAS 123R pertaining to share-based compensation transactions. This adoption creates temporary differences between GAAP based net income and tax based net income because the compensation deduction permitted under SFAS 123R is not deductible for taxes. When option holders exercise their rights to purchase the Company’s shares, the Company is entitled to take a tax deduction, eliminating the temporary difference created when the option rights vested. The Company recognized $221,000 in compensation expense related to SFAS 123R in the first nine months of 2007. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $55,000. The Company recalculated the valuation reserve to include the addition to the deferred tax asset which resulted in no net change in the deferred tax asset reported on the balance sheet.

 

As of the end of 2006, management determined that the Company was more likely than not to benefit from $622,000 in tax savings from available net operating losses to be realized in future periods, and therefore reduced the deferred tax asset valuation reserve, creating a deferred tax asset on the Company’s balance sheet, along with the corresponding benefit from income taxes in the accompanying period. The Company will continue to evaluate the deferred tax asset valuation reserve each quarter based on the reportable income for each quarter. The Company reported a substantial operating loss in the first nine months of 2007. As a result the Company recalculated and increased the valuation reserve to 100%, which resulted in an increase of $622,000 in the valuation reserve and the elimination of the deferred tax asset as reported on the balance sheet. This change in valuation reserve was recorded to the provision for income taxes on the income statement. The Company may choose to change this reserve in future periods.

 

Critical Accounting Policies and Estimates

 

Use of Estimates

 

The Company’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to valuation reserves, income taxes and intangibles. The Company bases its estimates on historical experience and on various other assumptions that management believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

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Accounting for Share-Based Incentive Programs

 

In the first nine months of 2007 the Company recognized compensation expense related to stock options granted to employees based on: (a) the cost for all share-based payments granted prior to, but not yet vested as of December 31, 2006, based on the grant date fair value estimated in accordance with SFAS 123R, adjusted for an estimated future forfeiture rate, and (b) the cost for all share-based payments granted subsequent to December 31, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

 

The Company’s assessment of the estimated fair value of the stock options granted is affected by the price of the Company’s stock, as well as assumptions regarding a number of complex and subjective variables and the related tax impact. Management utilized the Black-Scholes model to estimate the fair value of stock options granted. Generally, the calculation of the fair value for options granted under SFAS 123R is similar to the calculation of fair value under SFAS 123, with the exception of the treatment of forfeitures.

 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. This model also requires the input of highly subjective assumptions including:

 

(a)

The expected volatility of the common stock price, which was determined based on historical volatility of the Company’s common stock;

 

(b)

Expected dividends, which are not anticipated;

 

(c)

Expected life of the stock option, which is estimated based on the historical stock option exercise behavior of employees; and

 

(d)

Expected forfeitures.

 

In the future, management may elect to use different assumptions under the Black-Scholes valuation model or a different valuation model, which could result in a significantly different impact on net income or loss.

 

Allowance for Doubtful Accounts

 

The Company makes ongoing estimates relating to the collectibility of accounts receivable and maintains a reserve for estimated losses resulting from the inability of customers to meet their financial obligations to the Company. In determining the amount of the reserve, management considers the historical level of credit losses and makes judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since management cannot predict future changes in the financial stability of customers, actual future losses from uncollectible accounts may differ from the estimates. If the financial condition of customers were to deteriorate, resulting in their inability to make payments, a larger reserve may be required. In the event it is determined that a smaller or larger reserve is appropriate, the Company will record a credit or a charge to general and administrative expense in the period in which such a determination is made.

 

Inventory

 

Inventories consist of Company-manufactured platelets, whole blood components and other blood products, as well as component blood products purchased for resale. Supplies consist primarily of medical supplies used to collect and manufacture products and to provide therapeutic services. Inventories are stated at the lower of cost or market and are accounted for on a first-in, first-out basis. Management estimates the portion of inventory that might not have future value by analyzing historical sales history for the twelve months prior to any balance sheet date. For each inventory type, management establishes an obsolescence reserve equal to the value of inventory quantity in excess of twelve months of historical sales quantity, using the first-in, first-out inventory valuation methodology.

 

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Income Taxes

 

As part of the process of preparing the financial statements, the Company is required to estimate income taxes in each of the jurisdictions that the Company operates. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the balance sheet. Management must then assess the likelihood that the deferred tax assets will be recovered from future taxable income, and to the extent management believes that recovery is not likely, must establish a valuation allowance. To the extent a valuation allowance is created or adjusted in a period, the Company must include an expense, or benefit, within the tax provision in the statements of income.

 

Goodwill

 

 In accordance with SFAS No 142, the Company must determine the fair value of any goodwill recognized as a result of prior acquisition activity. Goodwill is the portion of the total consideration paid to acquire a business that exceeds the fair market value of the assets acquired, less the value of the liabilities acquired. Any subsequent valuation of goodwill requires substantial estimation by management of the future profitability of any respective business unit, and an assessment of the fair value of the business.

 

The Company uses the income approach, along with other standard analytical approaches, to estimate the fair value of goodwill. The income approach involves estimating the present value of future cash flows by using projections of the cash flows that the business is expected to generate, and discounting these cash flows at a given rate of return. This requires the use of management estimates and assumptions, such as assumptions on growth rates for revenues, expenses, earnings before interest, income taxes, depreciation and amortization, returns on working capital, returns on other assets and capital expenditures, among others. Assumptions on discount rates and terminal growth rates are also used to determine fair value. Given the subjectivity involved in deriving these estimates in the analyses, it is possible that a different valuation model and the selection of different input variables could produce a materially different estimate of the fair value of goodwill.

 

Liquidity and Capital Resources

 

As of September 30, 2007, the Company’s cash and cash equivalents were $517,000, and the Company had a negative working capital of $448,000.

 

On September 26, 2006, the Company, together with the Company’s subsidiaries Coral Blood Services, Inc. and HemaCare BioScience, Inc., entered into an Amended and Restated Loan and Security Agreement (“Agreement”) with Comerica Bank (“Comerica”) to provide a working capital line of credit. The Agreement restated the terms of the prior credit agreement with Comerica, except i) the limits on the amount the Company may borrow were changed to the lesser of 75% of eligible accounts receivable or $3 million, ii) HemaBio was added as an additional borrower, iii) Comerica was given a security interest in all of the assets of HemaBio, and iv) the term of the Agreement was extended one year to June 30, 2008. The Agreement provides that interest is payable monthly at a rate of prime minus 0.25%. On March 26, 2007, the Company entered into an amendment to the Agreement to increase the limit on the amount the Company may borrow to the lesser of 75% of eligible accounts receivable or $4 million. As of September 30, 2007, the rate associated with this credit facility was 7.5%. In addition, the Company has the option to draw against this facility for thirty, sixty or ninety days using LIBOR as the relevant rate of interest. As of September 30, 2007, the Company had borrowed $2,500,000 against this line of credit, and the Company had unused availability of $1,500,000.

 

The Comerica credit facility is collateralized by substantially all of the Company’s assets and requires the maintenance of certain financial covenants that, among other things, requires minimum levels of profitability and prohibits the payment of dividends. As of September 30, 2007, the Company was not in compliance with any of the financial covenants. In addition, the Company is in default on the Comerica Agreement as a result of the Company’s failure to pay the first installment on the notes that are part of the acquisition of HemaBio as described below. Comerica has not communicated to the Company any intention to exercise any of their rights and remedies as a result of the defaults; however, Comerica has communicated their intention to reserve their rights and will not waive any of the defaults. Therefore, Comerica could at any time, among other remedies, demand full repayment of the outstanding balance of $2.5 million. The Company does not possess sufficient resources at this time to repay the amounts outstanding under the Agreement. If the Company is unable to repay the outstanding balance, the Agreement provides Comerica with the right to take possession of the Company’s assets and attempt to sell, or otherwise monetize, the Company’s assets in satisfaction of the unpaid obligation.

 

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As part of the consideration to acquire HemaBio, the Company issued a note to each of the sellers. One note for $153,800 for the benefit of Joseph Mauro, requires four equal annual installments of $38,450 each August 29 until paid. This note pays interest at 5% annually, 12% if a default occurs, and is secured through a security agreement, by all of the assets of HemaBio, although subordinate to Comerica Bank. The second note for $46,200 for the benefit of Valentin Adia, requires four equal annual installments of $11,550 each August 29 until paid. This note pays interest at 5% annually, and is also secured through security agreement, by all of the assets of HemaBio, although subordinate to Comerica Bank.

Also, when the Company acquired HemaBio, HemaBio had two $250,000 notes outstanding to Dr. Karen Raben and Dr. Lawrence Feldman. Both of these notes require four equal annual installments of $62,500 each August 29 until paid, and pay interest at 7% annually, 10% if a default occurs. Each note is secured by all of the assets of HemaBio, but are subordinate to Comerica Bank.

 

The Company failed to pay the initial payment due on August 29, 2007 on all four of the notes associated with the HemaBio acquisition, which, in the aggregate, represents principal amount of $175,000, together with accrued interest of $77,000. On September 4, 2007, the Company received notices from Mr. Mauro and Mr. Adia demanding the initial aggregate payment of $50,000, together with accrued interest of $23,500, by no later than September 19, 2007 or the noteholders would accelerate the payment of the entire unpaid obligation. On October 2, 2007, the Company received notice from the other two noteholders demanding the initial installment of $125,000, plus interest, by October 12, 2007, or they would consider legal remedies.

 

Each of the HemaBio notes is subordinate to Comerica Bank, and each of the noteholders previously entered into a Subordination Agreement with Comerica Bank. The Subordination Agreements provide that the noteholders will not demand, sue for, take or receive by acceleration or otherwise, any indebtedness under the notes, nor exercise any rights in collateral securing such indebtedness; provided, however, that so long as no event of default has occurred under the Comerica loan agreement, the noteholders may receive regularly scheduled payments of principal and interest under the notes.

 

The foregoing descriptions of the notes and bank loan agreement are qualified in their entirety by the copies of those agreements filed as exhibits to the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and September 29, 2006.

 

The following table summarizes our contractual obligations by year (in thousands):

 

					Less than			1 - 3			3 - 5			More than
		Total			1 Year			Years			Years			5 Years
Operating leases		$	6,242		$	927		$	1,479		$	1,305		$	2,531
Notes payable			3,200			3,200			-			-			-
Totals		$	9,442		$	4,127		$	1,479		$	1,305		$	2,531

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For the nine months ended on September 30, 2007, net cash provided by operating activities was $180,000, compared to $442,000 for the nine months ended September 30, 2006. In the first nine months of 2007, the Company experienced a net decrease in accounts receivable of $1,189,000 compared to a net increase of $843,000 for the same period of 2006. This occurred because in late 2006, net accounts receivable increased as a result of delays receiving customer payments since the Company moved the corporate offices in November 2006. Since the beginning of 2007, the Company made significant progress directing customers to send payments to the Company’s new address, resulting in a significant decrease in net receivables in the first nine months of 2007. As of September 30, 2007, receivable days outstanding were 50 days, compared to 58 days outstanding as of December 31, 2006, and is the principal reason for the net decrease in net accounts receivables in the first nine months of 2007. Offsetting the decrease in accounts receivable is the significant loss recorded during the first nine months of 2007, compared to net income for the same period of 2006.

 

For the nine months ended on September 30, 2007, net cash used in investing activities was $1,300,000, compared to $3,193,000 for the same period in 2006. This $1,893,000 decrease is the result of lower investments in goodwill in 2007 related to the acquisition of HemaBio compared to the third quarter of 2006, and a reduction in investment in leasehold improvements during the first nine months of 2007 compared to the same period of 2006.

 

For the nine months ended September 30, 2007, net cash provided for financing activities was $501,000, compared to $1,227,000 for the nine months ended September 30, 2006. The difference is primarily due to a reduction in the borrowings against the Company’s line of credit with Comerica Bank in the first nine months of 2007, compared to the same period of 2006 when the Company used its line of credit to facilitate the acquisition of HemaBio.

In December 2006, the Company signed a contract with Information Data Management, a subsidiary of Haemonetics, for a license agreement, support and implementation services associated with a new information technology project to enhance the automation of the Company’s blood product operations. This project is expected to take approximately two years to complete, and will involve considerable financial and managerial resources. Management expects the project to cost a total of $2 million.

Management is uncertain that cash generated by operations will be sufficient to provide funding for the Company’s needs during the next year, including working capital requirements, equipment purchases, operating lease commitments and to fund the new information technology project. Presently, the Company cannot obtain any additional funding under the Comerica credit facility. The Company may need to obtain a new source of financing to fund future cash requirements.

The Company’s primary sources of liquidity include cash on hand, available borrowing on the line of credit and cash generated from operations. Liquidity depends, in part, on timely collections of accounts receivable. Any significant delays in customer payments could adversely affect the Company’s liquidity. Liquidity also depends on maintaining compliance with the various loan covenants. Presently, the Company is in default on the Comerica Agreement and the four notes related to the HemaBio acquisition. The Company may not have sufficient liquidity to pay any or all of these outstanding obligations if required to do so.

Risk Factors Affecting the Company

 

The Company’s short and long-term success is subject to many factors that are beyond management’s control. Shareholders and prospective shareholders of the Company should consider carefully the following risk factors, in addition to other information contained in this report. The matters discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q that are not historical are forward-looking statements. These statements may also be identified by the use of words such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “project,” “will” and similar expressions, as they relate to the Company, its management and its industry. Investors and prospective investors are cautioned that these forward-looking statements are not guarantees of future performance and involve risks and uncertainties, many of which will be beyond the control of the Company. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various risks and uncertainties, including those described below or in other filings by the Company with the Securities and Exchange Commission. The Company does not undertake to update its forward-looking statements to reflect later events and circumstances or actual outcomes.

 

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Company has reported losses for three consecutive quarters and may not return to profitability

 

The Company has reported losses in each quarter of 2007. Management can not be certain the Company will return to profitability soon. Continued losses could result in a drain of cash, and threaten the ability of the Company to continue to operate.

 

Increasing losses at the Company’s Florida-based research operations may hinder the Company’s ability to generate profits

 

The Company’s Florida-based research operations have recorded a decrease in revenue and a related increase in operating losses. Continued losses at this operation hinder the ability of the Company to recognize a return to overall profitability. On November 5, 2007, management closed this operation to avoid further losses. This action could temporarily increase costs, utilize scarce financial resources, and distract management and have a material adverse effect on the Company and its results of operations.

 

Steady or declining market prices and increased costs could reduce profitability

 

The cost of collecting, processing and testing blood products has risen significantly in recent years and will likely continue to increase. These cost increases are related to new and improved testing procedures, increased regulatory requirements related to blood safety, and higher staff and supply costs related to collecting and processing blood products. Competition and fixed price contracts may limit the Company’s ability to maintain existing operating margins. Some competitors have greater resources than the Company to sustain periods of marginally profitable or unprofitable sales. Steady or declining market prices, and increased costs, may reduce profitability and may have a material adverse effect on the business and results of operations.

 

Company is in default under the Comerica credit agreement and HemaBio notes which could result in acceleration of note obligations which the Company has insufficient resources to satisfy

 

The Company is in default on the Comerica Agreement as a result of the Company’s failure to pay the first installment on the notes that are part of the acquisition of HemaBio. Comerica has not communicated to the Company any intention to exercise any of their rights and remedies as a result of the defaults; however, Comerica has communicated their intention to reserve their rights and will not waive any of the defaults. Therefore, Comerica could at any time, among other remedies, demand full repayment of the outstanding balance of $2.5 million. The Company does not possess sufficient resources at this time to repay the amounts outstanding under the Comerica Agreement. If the Company is unable to repay the outstanding balance, Comerica has the right to take possession of the Company’s assets and attempt to sell, or otherwise monetize, the Company’s assets in satisfaction of the unpaid obligation. Such an action would have a severe negative impact on the Company’s ability to operate.

 

Changes in demand for blood products could affect profitability

 

The Company’s operations are structured to produce particular blood products based on customers’ existing demand, and perceived potential changes in demand, for these products. Sudden or unexpected changes in demand for these products could have an adverse impact on the Company’s profitability. Increasing demand could harm relationships with customers if the Company is unable to alter production capacity, or purchase products from other suppliers, adequately to fill orders. This could result in a decrease in overall revenues and profits. Decreases in demand may require the Company to make sizeable investments to restructure operations away from declining products to the production of new products. Lack of access to sufficient capital, or lack of adequate time to properly respond to such a change in demand, could result in declining revenue and profits as customers transfer to other suppliers.

 

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Declining blood donations could affect profitability

 

The business depends on the availability of donated blood. Only a small percentage of the population donates blood, and regulations intended to reduce the risk of introducing infectious diseases in the blood supply result in a decreased pool of potential donors. If the level of donor participation declines, the Company may not be able to reduce costs sufficiently to maintain profitability in blood products.

 

Competition may cause a loss of customers and an inability to pass on increases in costs thereby impacting profitability

Competition in the blood products and services industries is primarily based on fees charged to customers. The Company’s primary competition in the blood products market is the American Red Cross (“ARC”), which owns a significant market share advantage over the Company in the regions the Company operates. As a result, the ARC possesses significant market power to influence prices, which can prevent the Company from passing along increases in costs to customers. In addition, Hospital consolidations and affiliations allow certain customers to negotiate as a group, exerting greater price pressure on the Company. These changes may have a negative impact on the Company’s future revenue, and may negatively impact future profitability.

 

Operations depend on services of qualified professionals and competition for their services is strong

 

The Company is highly dependent upon obtaining the services of qualified professionals. In particular, the Company’s operations depend on the services of registered nurses, medical technologists, regulatory and quality assurance professionals, and others with knowledge of the blood industry. Nationwide, the demand for these professionals exceeds the supply and competition for their services is strong. The Company incurs significant costs to hire and retain staff. If the Company is unable to attract and retain a staff of qualified professionals, operations may be adversely affected and therefore adversely impact profitability.

 

Industry regulations and standards could increase operating costs

 

The business of collecting, processing and distributing blood products is subject to extensive and complex regulation by the state and federal governments. The Company is required to obtain and maintain numerous licenses in different legal jurisdictions regarding the safety of products, facilities and procedures, and regarding the purity and quality of blood products. In January 2006, the Food and Drug Administration (“FDA”) performed an inspection of the Company’s California operations. On May 5, 2006, the Company received a warning letter from the FDA pertaining to specific observations during the inspection. The Company has responded and implemented an action plan to address each issue.

 

The Company is presently undergoing an FDA inspection of the Company’s California operations. Although this inspection is not completed, the Company is expecting to receive specific observations as a result of the current inspection, and management has no reason to believe that the warning letter will be lifted.

 

In July 2007, the AABB performed an inspection of the Company’s California operations. On July 31, 2007, the Company received a list of observations based on this inspection. The observations covered blood product operations and stem cell standard operating procedure deficiencies. The AABB has placed the Company’s stem cell collection accreditation on hold pending a reinspection in early 2008. The Company is implementing an action plan to address each of the observations in preparation for the reinspection.

 

On November 3, 2006, the AABB provided recommendations to reduce the risk of transfusion-related acute lung injury (“TRALI”). This recommendation, to be fully implemented for high-plasma volume blood products and platelets by November 2007 and 2008, respectively, may reduce the volume of products available to customers, which may negatively impact the Company’s operations and profitability.

 

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On December 14, 2006, the AABB provided recommendations to reduce the risk to patients for contracting Chagas’ disease as a result of receiving a transfusion of donated blood products. The recommendations include the implementation of new blood tests to detect the presence of the protozoan known to cause Chagas’ disease. The new test is costly and the Company may not be able to raise prices to cover the cost of this new test, and therefore may negatively impact the Company’s profitability.

 

State and federal laws include anti-kickback and self-referral prohibitions and other regulations that affect the shipment of blood products and the relationships between blood banks, hospitals, physicians and other persons who refer business to each other. Health insurers and government payers, such as Medicare and Medicaid, also limit reimbursement for products and services, and require compliance with certain regulations before reimbursement will be made.

 

The Company devotes substantial resources to complying with laws and regulations; however, the possibility cannot be eliminated that interpretations of existing laws and regulations will result in findings that the Company has not complied with significant existing regulations. Such a finding could materially harm the business. Moreover, healthcare reform is continually under consideration by regulators, and the Company does not know how laws and regulations will change in the future.

 

Decrease in reimbursement rates may affect profitability

 

Reimbursement rates for blood products and services provided to Medicaid, Medicare and commercial patients, impact the fees that the Company is able to negotiate with customers. In addition, to the degree that the Company’s hospital customers receive lower reimbursement for the products and services provided by the Company, these customers may reduce their demand for these goods and services, and adversely affect the Company’s revenue. If the Company is unable to increase prices for goods and services, the Company’s profitability may be adversely affected.

 

Not-for-profit status gives advantages to competitors

 

HemaCare is the only significant blood products supplier to hospitals in the U.S. that is operated for profit and investor owned. The not-for-profit competition is exempt from federal and state taxes, and has substantial community support and access to tax-exempt financing. The Company may not be able to continue to compete successfully with not-for-profit organizations and the business and results of operations may suffer material adverse harm.

 

Potential inability to meet future capital needs could impact ability to operate

 

The Company may not generate sufficient operating cash in the future to finance its operations for the next year. Currently the Company is unable to utilize its credit facility with Comerica due to an existing default on the Agreement with Comerica. The Company may need to raise additional capital in the debt or equity markets in order to finance future operations and procure necessary equipment. There can be no assurance that the Company will be able to obtain such financing on reasonable terms or at all. Additionally, there is no assurance that the Company will be able to obtain sufficient capital to finance future expansion. Finally, the Company is in default on the Comerica Agreement and the four notes related to the HemaBio acquisition. The Company may not have sufficient liquidity to pay any or all of these outstanding obligations if required to do so. Failure to do so could result in the seizure of some of the Company’s assets to satisfy the outstanding obligations, which could severely and negatively impact the Company’s ability to operate.

 

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Reliance on relatively few vendors for significant supplies and services could affect the Company’s ability to operate

 

The Company currently relies on a relatively small number of vendors to supply important supplies and services. The Company receives many of its research related specimens from foreign suppliers, who operate in countries with unstable business environments. Significant price increases, or disruptions in the ability to obtain products and services from existing vendors, may force the Company to find alternative vendors. Alternative vendors may not be available, or may not provide their products and services at favorable prices. If the Company cannot obtain the products and services it currently uses, or alternatives at reasonable prices, the Company’s ability to produce products and provide services may be severely impacted and resulting in a reduction of revenue and profitability.

 

Potential adverse effect from changes in the healthcare industry, including consolidations, could affect access to customers

 

Competition to gain patients on the basis of price, quality and service is intensifying among healthcare providers who are under pressure to decrease the costs of healthcare delivery. There has been significant consolidation among healthcare providers seeking to enhance efficiencies, and this consolidation is expected to continue. As a result of these trends, the Company may be limited in its ability to increase prices for products in the future, even if costs increase. Further, customer attrition as a result of consolidation or closure of hospital facilities may adversely impact the Company.

 

Targeted partner blood drives involve higher collection costs

 

Part of the Company’s current operations involves conducting blood drives in partnership with hospitals. Blood drives are conducted under the name of the hospital partner and require that all promotional materials and other printed material include the name of the hospital partner. This strategy lacks the efficiencies associated with blood drives that are not targeted to benefit particular hospital partners. As a result, collection costs might be higher than those experienced by the Company’s competition and may affect profitability and growth plans.

 

Future technological developments or alternative treatments could jeopardize business

 

As a result of the risks posed by blood-borne diseases, many companies and healthcare providers are currently seeking to develop alternative treatments for blood product transfusions. HemaCare’s business consists of collecting, processing and distributing human blood products and providing blood related therapeutic services. The introduction and acceptance in the market of alternative treatments may cause material adverse harm to the business. In addition, recent technological developments to extend the shelf-life of products currently offered by the Company could increase the available supply in the market, and put downward pressure on the price for these products. This may cause a material adverse impact on the future profitability for these products.

 

Limited access to insurance could affect ability to defend against possible claims

 

The Company currently maintains insurance coverage consistent with the industry; however, if the Company experiences losses or the risks associated with the blood industry increase in the future, insurance may become more expensive or unavailable. The Company also cannot give assurance that as the business expands, or the Company introduces new products and services, that additional liability insurance on acceptable terms will be available, or that the existing insurance will provide adequate coverage against any and all potential claims. Also, the limitations on liability contained in various agreements and contracts may not be enforceable and may not otherwise protect the Company from liability for damages. The successful assertion of one or more large claims against the Company that exceed available insurance coverage, or changes in insurance policies, such as premium increases or the imposition of large deductibles or co-insurance requirements, may materially and adversely affect the business.

 

Ability to attract, retain and motivate management and other skilled employees

 

The Company’s success depends significantly on the continued services of key management and skilled personnel. Competition for qualified personnel is intense and there are a limited number of people with knowledge of, and experience in, the blood product and blood service industries. The Company does not have employment agreements with most key employees, nor maintain life insurance policies on them. The loss of key personnel, especially without advance notice, or the Company’s inability to hire or retain qualified personnel, could have a material adverse affect on revenue and on the Company’s ability to maintain a competitive advantage. The Company cannot guarantee that it can retain key management and skilled personnel, or that it will be able to attract, assimilate and retain other highly qualified personnel in the future.

 

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Product safety and product liability could provide exposure to claims and litigation

 

Blood products carry the risk of transmitting infectious diseases, including, but not limited to, hepatitis, HIV and Creutzfeldt-Jakob disease. HemaCare screens donors, uses highly qualified testing service providers, and conducts selective blood testing, to test blood products for known pathogens in accordance with industry standards, and complies with all applicable safety regulations. Nevertheless, the risk that screening and testing processes might fail, or that new pathogens may be undetected by them, cannot be completely eliminated. There is currently no test to detect the pathogen responsible for Creutzfeldt-Jakob disease. If patients are infected by known or unknown pathogens, claims may exceed insurance coverage and materially and adversely affect the Company’s financial condition. In addition, improper handling of the Company’s disease state research specimens could expose the Company’s personnel, customers or third parties to infection. Claims resulting from exposure could exceed the Company’s available insurance coverage and materially and adversely impact the Company’s financial condition.

 

Environmental risks could cause the Company to incur substantial costs to maintain compliance

 

HemaCare’s operations involve the controlled use of bio-hazardous materials and chemicals. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result, and any such liability could exceed the resources of the Company and its insurance coverage. The Company may incur substantial costs to maintain compliance with environmental regulations as it develops and expands its business.

 

Business interruption due to terrorism and increased security measures in response to terrorism could adversely impact profitability

 

HemaCare’s business depends on the free flow of products and services through the channels of commerce and freedom of movement for patients and donors. Delays or stoppages in the transportation of perishable blood products and interruptions of mail, financial or other services could have a material adverse effect on the Company’s results of operations and financial condition. Furthermore, the Company may experience an increase in operating costs, such as costs for transportation, insurance and security, as a result of terrorist activities and potential activities, which may target health care facilities or medical products. The Company may also experience delays in receiving payments from payers that have been affected by terrorist activities and potential activities. The U.S. economy in general is adversely affected by terrorist activities, and potential activities, and any economic downturn may adversely impact the Company’s results of operations, impair its ability to raise capital or otherwise adversely affect its ability to grow its business.

 

Business interruption due to hurricanes or earthquakes could adversely impact profitability

 

HemaCare’s principal blood products and blood services operations, as well as the Company’s corporate headquarters, are located in Southern California, which is an area known for potentially destructive earthquakes. In addition, the Company’s principal research products operation is located in Southern Florida, an area known for potentially destructive hurricanes. A severe event in either of these locations could have substantial negative impact on the ability of the Company to continue to operate. Any significant delay in resuming operations in either region following such an event could cause a material adverse impact on the profitability of the Company.

 

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Evaluation and consideration of strategic alternatives, and other significant projects, may distract management from reacting appropriately to business challenges and lead to reduced profitability

 

As a publicly traded Company, management must constantly evaluate and consider new strategic alternatives, and other significant projects, in an attempt to maximize shareholder value. The Company does not possess a large management team that can both consider strategic alternatives and manage daily operations. Therefore, management distractions associated with the evaluation and consideration of strategic alternatives, could prevent management from dedicating appropriate time to immediate business challenges or other significant business decisions. This may cause a material adverse impact on the future profitability of the Company.

 

Strategy to acquire companies may result in unsuitable acquisitions or failure to successfully integrate acquired companies, which could lead to reduced profitability

 

The Company may embark on a growth strategy through acquisitions of companies or operations that complement existing product lines, customers or other capabilities. The Company may be unsuccessful in identifying suitable acquisition candidates, or may be unable to consummate a desired acquisition. To the extent any future acquisitions are completed, the Company may be unsuccessful in integrating acquired companies or their operations, or if integration is more difficult than anticipated, the Company may experience disruptions that could have a material adverse impact on future profitability. Some of the risks that may affect the Company’s ability to integrate, or realize any anticipated benefits from, acquisitions include:

 

·

unexpected losses of key employees or customer of the acquired company;

 

·

difficulties integrating the acquired company’s standards, processes, procedures and controls;

 

·

difficulties coordinating new product and process development;

 

·

difficulties hiring additional management and other critical personnel;

 

·

difficulties increasing the scope, geographic diversity and complexity of the Company’s operations;

 

·

difficulties consolidating facilities, transferring processes and know-how;

 

·

difficulties reducing costs of the acquired company’s business;

 

·

diversion of management’s attention from the management of the Company; and

 

·

adverse effects on existing business relationships with customers.

 

Articles of Incorporation and Rights Plan could delay or prevent an acquisition or sale of HemaCare

 

HemaCare’s Articles of Incorporation empower the Board of Directors to establish and issue a class of preferred stock, and to determine the rights, preferences and privileges of the preferred stock. This gives the Board of Directors the ability to deter, discourage or make more difficult for a change in control of HemaCare, even if such a change in control would be in the interest of a significant number of shareholders or if such a change in control would provide shareholders with a substantial premium for their shares over the then-prevailing market price for the Company’s common stock.

 

In addition, the Board of Directors has adopted a Shareholder’s Rights Plan designed to require a person or group interested in acquiring a significant or controlling interest in HemaCare to negotiate with the Board. Under the terms of our Shareholders’ Rights Plan, in general, if a person or group acquires more than 15% of the outstanding shares of common stock, all of the other shareholders would have the right to purchase securities from the Company at a discount to the fair market value of the common stock, causing substantial dilution to the acquiring person or group. The Shareholders’ Rights Plan may inhibit a change in control and, therefore, may materially adversely affect the shareholders’ ability to realize a premium over the then-prevailing market price for the common stock in connection with such a transaction. For a description of the Shareholders’ Rights Plan see the Company’s Current Report on Form 8-K filed with the SEC on March 5, 1998.

 

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Quarterly revenue and operating results may fluctuate in future periods, and the Company may fail to meet investor expectations

 

The Company’s quarterly revenue and operating results have fluctuated significantly in the past, and are likely to continue to do so in the future due to a number of factors, many of which are not within the Company’s control. If quarterly revenue or operating results fall below the expectations of investors, the price of the Company’s common stock could decline significantly. Factors that might cause quarterly fluctuations in revenue and operating results include the following:

 

·

changes in demand for the Company’s products and services, and the ability to attain the required resources to satisfy customer demand;

 

·

ability to develop, introduce, market and gain market acceptance of new products or services in a timely manner;

 

·

ability to manage inventories, accounts receivable and cash flows;

 

·

ability to control costs; and

 

·

ability to attract qualified blood donors.

 

The amount of expenses incurred depends, in part, on expectation regarding future revenue. In addition, since many expenses are fixed in the short term, the Company cannot significantly reduce expenses if there is a decline in revenue to avoid losses.

 

Stocks traded on the OTC Bulletin Board are subject to greater market risks than those of exchange-traded stocks since they are less liquid

 

HemaCare’s common stock was delisted from the Nasdaq Small Cap Market on October 29, 1998 because of the failure to maintain Nasdaq’s requirement of a minimum bid price of $1.00. Since November 2, 1998, the common stock has traded on the OTC Bulletin Board, an electronic, screen-based trading system operated by the National Association of Securities Dealers, Inc. Securities traded on the OTC Bulletin Board are, for the most part, thinly traded and generally are not subject to the level of regulation imposed on securities listed or traded on the Nasdaq Stock Market or on another national securities exchange. As a result, an investor may find it difficult to dispose of the Company’s common stock or to obtain accurate quotations as to its price.

 

Stock price could be volatile

 

The price of HemaCare’s common stock has fluctuated in the past and may be more volatile in the future. Factors such as the announcements of government regulation, new products or services introduced by the Company or by the competition, healthcare legislation, trends in health insurance, litigation, fluctuations in operating results and market conditions for healthcare stocks in general could have a significant impact on the future price of HemaCare’s common stock. In addition, the stock market has from time to time experienced extreme price and volume fluctuations that may be unrelated to the operating performance of particular companies. The generally low volume of trading in HemaCare’s common stock makes it more vulnerable to rapid changes in price in response to market conditions.

 

Future sales of equity securities could dilute the Company’s common stock

 

The Company may seek new financing in the future through the sale of its securities. Future sales of common stock or securities convertible into common stock could result in dilution of the common stock currently outstanding. In addition, the perceived risk of dilution may cause some shareholders to sell their shares, which may further reduce the market price of the common stock.

 

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Lack of dividend payments could impact the price of the Company’s common stock

 

The Company intends to retain any future earnings for use in its business, and therefore does not anticipate declaring or paying any cash dividends in the foreseeable future. The declaration and payment of any cash dividends in the future will depend on the Company’s earnings, financial condition, capital needs and other factors deemed relevant by the Board of Directors. In addition, the Company’s credit agreement prohibits the payment of dividends during the term of the agreement.

 

Evaluation of internal control and remediation of potential problems will be costly and time consuming and could expose weaknesses in financial reporting

 

The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 require an assessment of the effectiveness of the Company’s internal control over financial reporting beginning with its Annual Report on Form 10-K for the fiscal year ending December 31, 2007. The Company’s independent auditors will be required to confirm in writing whether management’s assessment of the effectiveness of the internal control over financial reporting is fairly stated in all material respects, and separately report on whether they believe management maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008.

 

This process will be expensive and time consuming, and will require significant attention of management. The portion of this process completed thus far has revealed material weaknesses in internal controls that will require remediation. The remediation process may also be expensive and time consuming, and management can give no assurance that the remediation effort will be completed on time or be effective. In addition, management can give no assurance that additional material weaknesses in internal controls will not be discovered. Management also can give no assurance that the process of evaluation and the auditor’s attestation will be completed on time. The disclosure of a material weakness, even if quickly remedied, could reduce the market’s confidence in the Company’s financial statements and harm the Company’s stock price, especially if a restatement of financial statements for past periods is required.

 

On August 29, 2006, the Company acquired privately-owned Teragenix Corporation, subsequently renamed HemaCare BioScience, Inc. (“HemaBio”). Private companies generally may not have as formal or comprehensive internal controls and compliance systems in place as public companies. On November 5, 2007, management closed the operations of HemaBio. Therefore, no further effort is underway to implement internal control systems at HemaBio.

 

If the Company is unable to adequately design its internal control systems, or prepare an “internal control report” to the satisfaction of the Company’s auditors, the Company’s auditors may issue a qualified opinion on the Company’s financial statements.

 

 

As of September 30, 2007, the Company has $700,000 of debt in the form of notes payable with fixed interest rates. As of September 30, 2007, the Company has $2,500,000 outstanding on the line of credit with Comerica that is based on a variable interest rate linked to the prime interest rate, or at the election of the Company, LIBOR. Accordingly, the Company’s interest rate expense will fluctuate with changes in either of these rates. If interest rates increase or decrease by 1% for the year, the Company’s interest expense would increase or decrease by approximately $25,000.

 

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The Company’s management, with the participation of the Company’s chief executive officer and the principal financial officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Based upon that evaluation, the chief executive officer and the principal financial officer believe that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective at the reasonable assurance level in making known to them in a timely manner material information relating to the Company (including its consolidated subsidiaries, required to be included in this report) for the reasons described below.

 

Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established process.

 

The Company has remediated, or is in the process of remediating, some of the identified weaknesses in the Company’s internal control over financial reporting. The Company has alternative controls, which management believes prevents any material misstatement of the Company’s financial statements. The Company continues to evaluate the existing internal control structure.

 

The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 require management’s attestation of the effectiveness of the Company’s internal control over financial reporting beginning with the Annual Report on Form 10-K for the fiscal year ending December 31, 2007. Beginning with the fiscal year ending December 31, 2008, the Company’s independent registered public accounting firm will be required to confirm in writing whether management’s attestation of the effectiveness of internal controls over financial reporting is fairly stated in all material respects and whether maintained, in all material respects, effective internal control over financial reporting.

 

The Company has started the process of documenting and testing the internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act. This process will require significant attention of management, and consume the Company’s time and resources. The portion of this process completed thus far has revealed material weaknesses in internal controls, such as inadequate segregation of duties and inadequate spreadsheet controls, that will require remediation. The remediation process may also be expensive and time consuming, and management can give no assurance that the remediation effort will be completed on time or be effective. The disclosure of a material weakness, even if quickly remedied, could reduce the market’s confidence in the Company’s financial statements and harm the Company’s stock price, especially if a restatement of financial statements for past periods is required. During the course of testing, deficiencies may be identified which management may not be able to remediate in time to meet the deadline for compliance with Section 404. Management may not be able to conclude, on an ongoing basis, that effective internal controls over financial reporting exist in accordance with Section 404, and the Company’s independent registered public accounting firm may not be able or willing to issue a favorable assessment of management’s conclusions. Failure to achieve and maintain an effective internal control environment could harm operating results and could cause a failure to meet reporting obligations. Inferior internal controls could also cause investors to lose confidence in the Company’s reported financial information, which could have a negative effect on the Company’s stock price.

 

 

 

From time to time, the Company is involved in various routine legal proceedings incidental to the conduct of its business. Management does not believe that any of these legal proceedings will have a material adverse impact on the business, financial condition or results of operations of the Company, either due to the nature of the claims, or because management believes that such claims should not exceed the limits of the Company’s insurance coverage.

 

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The risk factors disclosed under the caption “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 have not materially changed other than as set forth below.

 

The following risk factors were added since the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

Company has reported losses for three consecutive quarters and may not return to profitability

 

The Company has reported losses in each quarter of 2007. Management can not be certain the Company will return to profitability soon. Continued losses could result in a drain of cash, and threaten the ability of the Company to continue to operate.

 

Increasing losses at the Company’s Florida-based research operations may hinder the Company’s ability to generate profits

 

The Company’s Florida-based research operations have recorded a decrease in revenue and a related increase in operating losses. Continued losses at this operation hinder the ability of the Company to recognize a return to overall profitability. On November 5, 2007, management closed this operation to avoid further losses. This action could temporarily increase costs, utilize scarce financial resources, and distract management and have a material adverse effect on the Company and its results of operations.

 

Company is in default under the Comerica credit agreement and HemaBio notes which could result in acceleration of note obligations which the Company has insufficient resources to satisfy

 

The Company is in default on the Comerica Agreement as a result of the Company’s failure to pay the first installment on the notes that are part of the acquisition of HemaBio. Comerica has not communicated to the Company any intention to exercise any of their rights and remedies as a result of the defaults; however, Comerica has communicated their intention to reserve their rights and will not waive any of the defaults. Therefore, Comerica could at any time, among other remedies, demand full repayment of the outstanding balance of $2.5 million. The Company does not possess sufficient resources at this time to repay the amounts outstanding under the Comerica Agreement. If the Company is unable to repay the outstanding balance, Comerica has the right to take possession of the Company’s assets and attempt to sell, or otherwise monetize, the Company’s assets in satisfaction of the unpaid obligation. Such an action would have a severe negative impact on the Company’s ability to operate.

 

The following risk factors were changed since the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

Competition may cause a loss of customers and an inability to pass on increases in costs thereby impacting profitability

Competition in the blood products and services industries is primarily based on fees charged to customers. The Company’s primary competition in the blood products market is the American Red Cross (“ARC”), which owns a significant market share advantage over the Company in the regions the Company operates. As a result, the ARC possesses significant market power to influence prices, which can prevent the Company from passing along increases in costs to customers. In addition, Hospital consolidations and affiliations allow certain customers to negotiate as a group, exerting greater price pressure on the Company. These changes may have a negative impact on the Company’s future revenue, and may negatively impact future profitability.

 

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Industry regulations and standards could increase operating costs

 

The business of collecting, processing and distributing blood products is subject to extensive and complex regulation by the state and federal governments. The Company is required to obtain and maintain numerous licenses in different legal jurisdictions regarding the safety of products, facilities and procedures, and regarding the purity and quality of blood products. In January 2006, the Food and Drug Administration (“FDA”) performed an inspection of the Company’s California operations. On May 5, 2006, the Company received a warning letter from the FDA pertaining to specific observations during the inspection. The Company has responded and implemented an action plan to address each issue.

 

The Company is presently undergoing an FDA inspection of the Company’s California operations. Although this inspection is not completed, the Company is expecting to receive specific observations as a result of the current inspection, and management has no reason to believe that the warning letter will be lifted.

 

In July 2007, the AABB performed an inspection of the Company’s California operations. On July 31, 2007, the Company received a list of observations based on this inspection. The observations covered blood product operations and stem cell standard operating procedure deficiencies. The AABB has placed the Company’s stem cell collection accreditation on hold pending a reinspection in early 2008. The Company is implementing an action plan to address each of the observations in preparation for the reinspection.

 

On November 3, 2006, the AABB provided recommendations to reduce the risk of transfusion-related acute lung injury (“TRALI”). This recommendation, to be fully implemented for high-plasma volume blood products and platelets by November 2007 and 2008, respectively, may reduce the volume of products available to customers, which may negatively impact the Company’s operations and profitability.

 

On December 14, 2006, the AABB provided recommendations to reduce the risk to patients for contracting Chagas’ disease as a result of receiving a transfusion of donated blood products. The recommendations include the implementation of new blood tests to detect the presence of the protozoan known to cause Chagas’ disease. The new test is costly and the Company may not be able to raise prices to cover the cost of this new test, and therefore may negatively impact the Company’s profitability.

 

State and federal laws include anti-kickback and self-referral prohibitions and other regulations that affect the shipment of blood products and the relationships between blood banks, hospitals, physicians and other persons who refer business to each other. Health insurers and government payers, such as Medicare and Medicaid, also limit reimbursement for products and services, and require compliance with certain regulations before reimbursement will be made.

 

The Company devotes substantial resources to complying with laws and regulations; however, the possibility cannot be eliminated that interpretations of existing laws and regulations will result in findings that the Company has not complied with significant existing regulations. Such a finding could materially harm the business. Moreover, healthcare reform is continually under consideration by regulators, and the Company does not know how laws and regulations will change in the future.

 

Potential inability to meet future capital needs could impact ability to operate

 

The Company may not generate sufficient operating cash in the future to finance its operations for the next year. Currently the Company is unable to utilize its credit facility with Comerica due to an existing default on the Agreement with Comerica. The Company may need to raise additional capital in the debt or equity markets in order to finance future operations and procure necessary equipment. There can be no assurance that the Company will be able to obtain such financing on reasonable terms or at all. Additionally, there is no assurance that the Company will be able to obtain sufficient capital to finance future expansion. Finally, the Company is in default on the Comerica Agreement and the four notes related to the HemaBio acquisition. The Company may not have sufficient liquidity to pay any or all of these outstanding obligations if required to do so. Failure to do so could result in the seizure of some of the Company’s assets to satisfy the outstanding obligations, which could severely and negatively impact the Company’s ability to operate.

 

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Evaluation of internal control and remediation of potential problems will be costly and time consuming and could expose weaknesses in financial reporting

 

The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 require an assessment of the effectiveness of the Company’s internal control over financial reporting beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2007. The Company’s independent auditors will be required to confirm in writing whether management’s assessment of the effectiveness of the internal control over financial reporting is fairly stated in all material respects, and separately report on whether they believe management maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008.

 

This process will be expensive and time consuming, and will require significant attention of management. The portion of this process completed thus far has revealed material weaknesses in internal controls that will require remediation. The remediation process may also be expensive and time consuming, and management can give no assurance that the remediation effort will be completed on time or be effective. In addition, management can give no assurance that additional material weaknesses in internal controls will not be discovered. Management also can give no assurance that the process of evaluation and the auditor’s attestation will be completed on time. The disclosure of a material weakness, even if quickly remedied, could reduce the market’s confidence in the Company’s financial statements and harm the Company’s stock price, especially if a restatement of financial statements for past periods is required.

 

On August 29, 2006, the Company acquired privately-owned Teragenix Corporation, subsequently renamed HemaCare BioScience, Inc. (“HemaBio”). Private companies generally may not have as formal or comprehensive internal controls and compliance systems in place as public companies. On November 5, 2007, management closed the operations of HemaBio. Therefore, no further effort is underway to implement internal control systems at HemaBio.

 

If the Company is unable to adequately design its internal control systems, or prepare an “internal control report” to the satisfaction of the Company’s auditors, the Company’s auditors may issue a qualified opinion on the Company’s financial statements.

 

The Comerica credit agreement prohibits the Company to make any distribution or declare or pay any dividend to any shareholder or on any of its capital stock.

 

On September 26, 2006, the Company, together with the Company’s subsidiaries Coral Blood Services, Inc. and HemaCare BioScience, Inc., entered into an Amended and Restated Loan and Security Agreement (“Agreement”) with Comerica Bank (“Comerica”) to provide a working capital line of credit. The Agreement restated the terms of the prior credit agreement with Comerica, except i) the limits on the amount the Company may borrow were changed to the lesser of 75% of eligible accounts receivable or $3 million, ii) HemaBio was added as an additional borrower, iii) Comerica was given a security interest in all of the assets of HemaBio, and iv) the term of the Agreement was extended one year to June 30, 2008. On March 26, 2007, the Company entered into an amendment to the Agreement to increase the limit on the amount the Company may borrow to the lesser of 75% of eligible accounts receivable or $4 million. As of September 30, 2007, the Company had borrowed $2,500,000 against this line of credit, and the Company had unused availability of $1,500,000.

The Comerica credit facility is collateralized by substantially all of the Company’s assets and requires the maintenance of certain financial covenants that, among other things, requires minimum levels of profitability and prohibit the payment of dividends. As of September 30, 2007, the Company was not in compliance with any of the financial covenants. In addition, the Company is in default on the Comerica Agreement as a result of the Company’s failure to pay the first installment on the notes that are part of the acquisition of HemaBio as described below. Comerica has not communicated to the Company any intention to exercise any of their rights and remedies as a result of the defaults; however, Comerica has communicated their intention to reserve their rights and will not waive any of the defaults. Therefore, Comerica could at any time, among other remedies, demand full repayment of the outstanding balance of $2.5 million. The Company does not possess sufficient resources at this time to repay the amounts outstanding under the Agreement. If the Company is unable to repay the outstanding balance, the Agreement provides Comerica with the right to take possession of the Company’s assets and attempt to sell, or otherwise monetize, the Company’s assets in satisfaction of the unpaid obligation.

 

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As part of the consideration to acquire HemaBio, the Company issued a note to each of the sellers. One note for $153,800 for the benefit of Joseph Mauro, requires four equal annual installments of $38,450 each August 29 until paid. This note pays interest at 5% annually, 12% if a default occurs, and is secured through a security agreement, by all of the assets of HemaBio, although subordinate to Comerica Bank. The second note for $46,200 for the benefit of Valentin Adia, requires four equal annual installments of $11,550 each August 29 until paid. This note pays interest at 5% annually, and is also secured through security agreement, by all of the assets of HemaBio, although subordinate to Comerica Bank.

 

Also, when the Company acquired HemaBio, HemaBio had two $250,000 notes outstanding to Dr. Karen Raben and Dr. Lawrence Feldman. Both of these notes require four equal annual installments of $62,500 each August 29 until paid, and pay interest at 7% annually, 10% if a default occurs. Each note is secured by all of the assets of HemaBio, but are subordinate to Comerica Bank.

 

The Company failed to pay the initial payment due on August 29, 2007 on all four of the notes associated with the HemaBio acquisition, which, in the aggregate, represents principal amount of $175,000, together with accrued interest of $77,000. On September 4, 2007, the Company received notices from Mr. Mauro and Mr. Adia demanding payment of the initial aggregate payment of $50,000, together with accrued interest of $23,500, by no later than September 19, 2007 or the noteholders would accelerate the payment of the entire unpaid obligation. On October 2, 2007, the Company received notice from the other two noteholders demanding the initial installment of $125,000, plus interest, by October 12, 2007, or they would consider legal remedies.

 

Each of the HemaBio notes is subordinate to Comerica Bank, and each of the noteholders previously entered into a Subordination Agreement with Comerica Bank. The Subordination Agreements provide that the noteholders will not demand, sue for, take or receive by acceleration or otherwise, any indebtedness under the notes, nor exercise any rights in collateral securing such indebtedness; provided, however, that so long as no event of default has occurred under the Comerica loan agreement, the noteholders may receive regularly scheduled payments of principal and interest under the notes.

 

The foregoing descriptions of the notes and bank loan agreement are qualified in their entirety by the copies of those agreements filed as exhibits to the Company’s Current Reports on Form 8-K filed with the SEC on September 5, 2006 and September 29, 2006.

 

 

None.

 

 

Under certain circumstances, shareholders are entitled to present proposals at stockholder meetings. Any such proposal to be included in the proxy statement for the 2008 annual meeting of shareholders must be received at the Company’s executive offices at 15350 Sherman Way, Suite 350, Van Nuys, CA, 91406, addressed to the attention of the Corporate Secretary by December 21, 2007 in a form that complies with applicable regulations. If the date of the 2008 annual meeting of shareholders is advanced or delayed more than 30 days from the date of the 2007 annual meeting, stockholder proposals intended to be included in the proxy statement for the 2008 annual meeting must be received by the Company within a reasonable time before the Company begins to print and mail the proxy statement for the 2008 annual meeting. Upon any determination that the date of the 2008 annual meeting will be advanced or delayed by more than 30 days from the date of the 2007 annual meeting, the Company will disclose the change in the earliest practicable Quarterly Report on Form 10-Q.

 

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The Securities and Exchange Commission’s rules provide that, in the event a stockholder proposal is not submitted to the Company prior to March 6, 2008, the proxies solicited by the Board for the 2008 annual meeting of shareholders will confer authority on the holders of the proxy to vote the shares in accordance with their best judgment and discretion if the proposal is presented at the 2008 annual meeting of stockholder without any discussion of the proposal in the proxy statement for such meeting. If the date of the 2008 annual meeting is advanced or delayed by more than 30 days from the date of the 2007 annual meeting, then the shareholder proposal must not have been submitted to the Company within a reasonable time before the Company mails the proxy statement for the 2008 annual meeting.

 

 

a.

Exhibits

 

3.1	Restated Articles of Incorporation of the Registrant incorporated by reference to Exhibit 3.1 to Form 10-K of the Registrant for the year ended December 31, 2002.
3.2	Amended and Restated Bylaws of the Registrant, as amended, incorporated by reference to Exhibit 3.1 to Form 8-K of the Registrant filed on March 28, 2007.
11	Net Income (loss) per Common and Common Equivalent Share
31.1	Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act
31.2	Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act
32.1	Certification Pursuant to 18 U.S.C. 1350 and Rule 13a-14(b) Under the Securities Exchange Act of 1934

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date	November 16, 2007		HemaCare Corporation
			(Registrant)
			By:	/s/ JULIAN STEFFENHAGEN
				Julian Steffenhagen, Chief Executive Officer
			By:	/s/ Robert S. Chilton
				Robert S. Chilton, Chief Financial Officer (Duly authorized officer and principal financial and chief accounting officer)

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Exhibit
3.1		Restated Articles of Incorporation of the Registrant incorporated by reference to Exhibit 3.1 to Form 10-K of the Registrant for the year ended December 31, 2002.
3.2		Amended and Restated Bylaws of the Registrant, as amended, incorporated by reference to Exhibit 3.1 to Form 8-K of the Registrant filed on March 28, 2007.
11		Net Income (loss) per Common and Common Equivalent Share
31.1		Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act
31.2		Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act
32.1		Certification Pursuant to 18 U.S.C. 1350 and Rule 13a-14(b) Under the Securities Exchange Act of 1934

 

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