SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                           

Commission File Number: 0-15223

HEMACARE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(818) 226-1968

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o          Accelerated filer o          Non-accelerated filer x

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

As of May 2, 2006, 8,200,060 shares of Common Stock of the registrant were issued and outstanding.

HEMACARE CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q

FOR THE THREE MONTHS ENDED
MARCH 31, 2006

				Page
				Number
PART I		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Balance Sheets as of March 31, 2006 (unaudited) and December 31, 2005			1
		Consolidated Statements of Income for the three months ended March 31, 2006 and 2005 (unaudited)			2
		Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005 (unaudited)			3
		Notes to Unaudited Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			10
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			22
Item 4.		Controls and Procedures			22
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings			23
Item 1A.		Risk Factors			23
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			23
Item 3.		Defaults Upon Senior Securities			23
Item 4.		Submission of Matters to a Vote of Security Holders			23
Item 5.		Other Information			23
Item 6.		Exhibits			23
SIGNATURES					24

 

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PART I   FINANCIAL INFORMATION

Item 1.                          Financial Statements

HEMACARE CORPORATION
CONSOLIDATED BALANCE SHEETS

 

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

1

HEMACARE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

(1)          Includes impact of Company’s adoption of SFAS 123R in the three month period ended March 31, 2006 of $309,000 in non-cash share-based compensation expense.

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

2

HEMACARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 

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

3

HemaCare Corporation

Notes to Unaudited Consolidated Financial Statements

Note 1—Basis of Presentation and General Information

BASIS OF PRESENTATION

In the opinion of management, the accompanying unaudited consolidated financial statements for the three months ended March 31, 2006 and 2005 include all adjustments (consisting of normal recurring accruals) which management considers necessary to present fairly the financial position of the Company as of March 31, 2006, the results of its operations for the three months ended March 31, 2006 and 2005, and its cash flows for the three months ended March 31, 2006 and 2005 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, 2005, as filed with the Securities and Exchange Commission on March 21, 2006 which should be read in conjunction with this Quarterly Report on Form 10-Q. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the consolidated results of operations to be expected for the full fiscal year ending December 31, 2006. Certain information and footnote disclosures normally included in the financial statements presented in accordance with accounting principles generally accepted in the United States have been condensed or omitted.

USE OF ESTIMATES

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.

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”), in the first quarter of fiscal year 2006, the Company started to recognize 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 December 31, 2005, based on the grant date fair value estimated in accordance with SFAS No 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, 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;

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(c)          Expected life of the stock option, which is estimated based on the historical stock option exercise behavior of employees.

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.

CONCENTRATION OF CREDIT RISK

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 March 31, 2006 and December 31, 2005, the Company had uninsured cash and cash equivalents of $2,021,000 and $2,401,000, respectively.

Note 2—Line of Credit and Notes Payable

The Company, together with Coral Blood Services, Inc., a subsidiary, has a working capital line of credit with Comerica Bank—California (“Comerica”). This credit facility is scheduled to terminate June 30, 2007, and limits the amount the Company may borrow to the lesser of: 75% of eligible accounts receivable or $2 million. Interest is payable monthly at a rate of prime minus 0.25%; as of March 31, 2006 the rate associated with this credit facility was 7.50%. In addition, the Company has the option to draw against this facility for thirty (30), sixty (60), or ninety (90) days using LIBOR as the relevant rate of interest. As of March 31, 2006, the Company had no net borrowing on this line of credit, and the Company had unused availability of $2 million.

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 require minimum levels of profitability and prohibit the payment of dividends. As of March 31, 2006, the Company was in full compliance with all of the financial covenants. During the first quarter of 2006, the Company did not incur any interest expense associated with the Comerica credit facility.

The Company also has a capital equipment lease with GE Capital used to finance the acquisition of vehicles. As of March 31, 2006, the balance outstanding on this lease was $67,000, all of which is included in current obligations. This lease is scheduled to terminate in January 2007, and has a fixed interest rate of 8.0%.

Finally, the Company has a capital equipment lease with Toshiba Financial Services associated with the acquisition of photocopier equipment. As of March 31, 2006, the balance outstanding on this lease was $1,000, all of which is included in current obligations. This lease is scheduled to terminate in May 2006.

Note 3—Shareholders’ Equity

Through the end of fiscal 2005, the Company measured compensation expense for stock-based incentive programs utilizing the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Under this method, the Company did not record compensation expense when stock options were granted to eligible participants as long as the exercise price was not less than the fair market value of the stock when the option was granted. In accordance with SFAS 123R, the Company disclosed the pro forma net income per share as if the fair value-based method had been applied in measuring compensation expense for share-based incentive awards. No share-based compensation cost was recognized in the Condensed Consolidated Statement of Income for the three months ended March 31, 2005 for options granted under the Company’s 1996 Stock Incentive Plan, as all unvested options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.

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In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 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. Pro forma disclosure of fair value recognition, as prescribed under SFAS 123, is no longer an alternative.

In the first quarter of fiscal 2006, the Company adopted the fair value recognition provisions of SFAS 123R utilizing the modified prospective transition method, as prescribed by SFAS 123R. Under that transition method, compensation cost recognized during the three months ended March 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Under the modified prospective transition method, results for the prior periods have not been restated.

For the three months ended March 31, 2006, the Company recognized non-cash share-based compensation costs of $309,000 as a result of the adoption of SFAS 123R. The effect of the change in applying the original provisions of SFAS 123 resulted in lowering income from continuing operations, income before taxes, net income, and basic and diluted earnings per share are as follows:

 

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The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123R to options granted under the Company’s stock option plans in all periods presented. The Company did not recognize any compensation expense related to the issuance of stock options in 2005. The effect of applying SFAS 123R resulted in lowering income from continuing operations, income before taxes, net income and basic and diluted earnings per share are as follows:

 

The following summarizes the activity of the Company’s stock options for the three months ended March 31, 2006:

 

The following summarizes the activity of the Company’s stock options that have not vested for the three months ended March 31, 2006.

 

As of March 31, 2006, there was $528,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under existing stock option plans. This cost is

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expected to be recognized over a weighted-average period of 3.65 years. The total measurement fair value of shares vested during the three-months ended March 31, 2006 was $408,000.

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:

 

Note 4—Earnings per Share

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

 

Options and warrants outstanding of 465,000 shares and 140,000 shares of common stock for the three months ended March 31, 2006 and 2005, respectively, have been excluded from the above calculation because their effect would have been anti-dilutive.

Note 5—Provision for Income Taxes

The Company has substantial net operating losses from prior periods that will be available in 2006 to eliminate most of any potential federal tax liability. The Company has recognized income in each of the last ten quarters, and as a result, and to the degree that the Company incurs any tax liability, the Company will reduce the valuation reserve against its deferred tax assets to reflect some potential future benefit from the future utilization of the Company’s net operating losses. The Company will continue to evaluate the deferred tax asset valuation reserve each quarter based on the reportable income for each quarter. At this time, the Company will not reduce the 100% deferred tax valuation reserve, but may choose to reduce this reserve in future periods.

As a result of federal alternative minimum taxes and other state taxes, the Company estimates that $16,000 in taxes has been incurred as a result of reportable income during the first quarter of 2006. As described in Note 3, 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.

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The Company recognized $309,000 in compensation expense related to SFAS 123R in the first quarter of 2006. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $85,000. Since the Company maintains a 100% valuation reserve for its deferred tax reserve, none of the increase in deferred taxes is reflected in the income statement.

Note 6—Business Segments

HemaCare operates two business segments as follows:

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

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

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.

Note 7—Commitments and Contingencies

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 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 8—Subsequent Events

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 is taking prompt action to address issues noted in the warning letter, and fully intends to respond with a complete action plan within the required time frame.

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 our Business.” The Company does not undertake to update its forward-looking statements to reflect later events and circumstances or actual outcomes.

General

HemaCare Corporation (“HemaCare” or the “Company”) collects, processes and distributes blood products to hospitals, and others, in the United States. The blood products distributed consist of those produced by the Company and purchased from other suppliers. 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 services are provided on an in-patient and out-patient basis under contract with hospitals, as an outside purchased service.

The Company has operated in Southern California since 1979. In 1998, the Company expanded operations, through the acquisition of a similar business, into portions of the eastern U.S. In 2003, new management, following a comprehensive evaluation of the Company’s operations, decided to reduce the number of geographic areas served, reduce the overhead costs associated with supporting the organization, and improve the revenue potential from the remaining geographic areas served by the Company. Management’s current strategy is to continue to build upon its profitable foundation, and to explore opportunities for growth in existing or new lines of business.

Although most blood suppliers 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 blood supplier with significant operations in the U.S.

Results of Operations

Three months ended March 31, 2006 compared to the three months ended March 31, 2005

Overview

The Company generated revenue for the first quarter of 2006 of $8,187,000, an increase of $1,104,000, or 15.6%, compared to the same period of 2005. Blood products revenue increased $748,000, or 13.3%, as a result of increased blood products sales from the Company’s fixed site California operations, and increases in selected product prices.

Blood services revenue increased $356,000, or 24.3%, mostly as a result of an increase in the number of procedures performed.

Gross profit in the first quarter of 2006 increased $183,000, or 12.5%, compared to the first quarter of 2005. The improvement is attributable to a $200,000, or 74.6%, improvement in gross profit for the

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Company’s blood services business segment, whereas the blood products segment reported a $17,000, or 1.4%, decrease in gross profit.

Income from operations for the first quarter of 2006 was $101,000, compared with $276,000 reported for the same quarter of 2005, representing a decrease of $175,000, or 63.4%. This decrease is attributable to the recognition of $309,000 of non-cash share-based compensation expense in the first quarter of 2006 as a result of the Company’s adoption of SFAS 123R. Eliminating this expense results in income from operations of $410,000 for the first quarter of 2006, which represents an increase of $134,000, or 48.6%, compared to the same period in 2005. Most of this improvement is attributable to the increase in gross profit for the blood services segment.

The Company generated $85,000 of net income for the first quarter of 2006, representing an $191,000, or 69.2%, decrease from the same period in 2005. This decrease is attributable to the recognition of $309,000 of non-cash share-based compensation expense in the first quarter of 2006 as a result of the Company’s adoption of SFAS 123R. It is expected the charge in the first quarter of 2006 for share-based compensation expense will represent approximately 75% of the share-based expense for all of 2006. This first quarter weighting of stock option expense is due to vesting of grants that historically occur in the first quarter.

Eliminating the impact of the adoption of SFAS 123R in the quarter results in net income of $394,000, which represents an increase of $118,000, or 42.8%, compared to the same period in 2005. Share-based compensation expense in the first quarter is expected to be higher than in other quarters based on stock options that are historically granted in March.

Blood Products

For the three months ended March 31, 2006, blood product revenues increased $748,000, or 13.3%, compared with the same quarter of 2005. This increase is attributable to an increase in sales volume of blood products in California and an increase in the prices charged for selected products.

For the three months ended March 31, 2006, gross profit for the blood products segment decreased $17,000, or 1.4%, to $1,180,000 from $1,197,000 generated in first quarter of 2005. This decrease is due to a significant decline in gross profit from the Company’s Maine blood products operations, and increased regulatory salary expenses. The decrease in gross profit from the Company’s Maine operations was mostly attributable to a decrease in collection volumes resulting from donor recruitment staff turnover. The gross profit percentage for blood products decreased to 18.5% in the first quarter of 2006, from 21.3% for the same quarter of 2005 as the result of i) increases in the cost of selected supplies, ii) decreased operational efficiencies in the Company’s Maine operations as a result of lower volumes, and iii) increased regulatory compliance staffing expenses.

Blood Services

Revenues from blood services increased $356,000, or 24.3%, to $1,820,000 in the first quarter of 2006 from $1,464,000 generated in the same period of 2005, and represents the highest quarterly revenue for this business segment since the fourth quarter of 2004. The increase was mainly due to a 17% increase in the number of therapeutic apheresis procedures performed during the quarter compared to the same quarter in 2005, and is mostly as a result of increases in procedure volumes.

Gross profit for the blood services segment increased $200,000, or 74.6%, from $268,000 in the first quarter of 2005 to $468,000 during the same period of 2006. For the quarter, this business segment produced a gross profit percentage of 25.7%, compared with 18.3% for the same quarter in 2005. This increase is primarily the result of increased operational efficiencies associated with an increase in procedure volumes.

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General and Administrative Expenses

General and administrative expenses increased by $358,000, or 30.1%, to $1,547,000 in the first quarter of 2006 from $1,189,000 in the same period of 2005. This increase was primarily due to the Company’s adoption of SFAS 123R in the first quarter of 2006. As a result, the Company recognized $300,000 in non-cash share-based compensation expense in the first quarter of 2006 associated with options issued under the Company’s 1996 Stock Incentive Plan. Under the transition method incorporated into SFAS 123R, the Company did not adjust any prior periods for share-based compensation expense. The other causes for the increase in general and administrative expense in the quarter include, a $52,000 increase in non-share-based compensation expense, a $35,000 increase in the cost of liability insurance, and a $25,000 increase in bad debt expense. The increase in non-share-based compensation expense reflects higher salaries paid to senior management as approved by the Compensation Committee in March 2005 after completing an extensive evaluation of management compensation relative to the marketplace. The cost of general and professional liability insurance increased as a result of higher insurance premiums upon renewal of the Company’s insurance policies during the second quarter of 2005. Finally, the increase in bad debt expense is mostly related to an increase in the age of selected customer receivable balances. The increases in general and administrative expenses in the first quarter of 2006 were offset by a $62,000 reduction in the cost for consultants, outside services and temporary personnel. This decrease was the result of the completion of several projects that required outside assistance during the first quarter of 2005, and filling several open positions since the first quarter of 2005, which minimized the use of outside temporary resources.

Income Taxes

The Company has sufficient net operating loss carryforwards to avoid most federal income tax expense for the first quarter of 2006. However, management anticipates that the Company will be subject to federal alternative minimum tax in 2006. In addition, management anticipates that the Company will be subject to various state and local taxes which are unaffected by the net operating loss carryforward. Management has calculated an estimated tax liability that includes the potential for federal alternative minimum tax, and has calculated estimated tax liability for each state and local jurisdiction using the tax basis each jurisdiction uses to assess taxes. During the first quarter of 2006, the Company recorded $16,000 to the provision for income taxes based on these estimates. 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 $309,000 in compensation expense related to SFAS 123R in the first quarter of 2006. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $85,000. Since the Company maintains a 100% valuation reserve for its deferred tax reserve, none of the increase in deferred taxes is reflected in the income statement.

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

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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.

Accounting for Share-Based Incentive Programs

In accordance with SFAS 123R, in the first quarter of 2006 the Company recognized 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 December 31, 2005, based on the grant date fair value estimated in accordance with SFAS No 123, adjusted for an estimated future forfeiture rate, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, 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.

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 was appropriate, the Company would record a credit or a charge to general and administrative expense in the period in which such a determination is made.

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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.

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. Management continually evaluates if the deferred tax asset is likely to be realized. If management determines that the deferred tax asset is not likely to be realized, a write-down of that asset would be required and would be reflected in the provision for taxes in the accompanying period.

Liquidity and Capital Resources

As of March 31, 2006, the Company’s cash and cash equivalents were $2,232,000 and the Company had working capital of $4,361,000.

The Company, together with Coral Blood Services, Inc., a subsidiary, has a working capital line of credit with Comerica Bank—California (“Comerica”). This credit facility is scheduled to terminate June 30, 2007, and limits the amount the Company may borrow is the lesser of: 75% of eligible accounts receivable or $2 million. Interest is payable monthly at a rate of prime minus 0.25%; as of March 31, 2006 the rate associated with this note was 7.50%. In addition, the Company has the option to draw against this facility for thirty (30), sixty (60), or ninety (90) days using LIBOR as the relevant rate of interest. As of March 31, 2006, the Company had no net borrowing on this line of credit, and the Company had unused availability of $2 million.

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 require minimum levels of profitability and prohibit the payment of dividends. As of March 31, 2006 the Company was in full compliance with all of the financial covenants. During the first quarter of 2006, the Company did not incur any interest expense associated with the Comerica credit facility.

The Company also has a capital equipment lease with GE Capital used to finance the acquisition of vehicles. As of March 31, 2006, the balance outstanding on this lease was $67,000, all of which is included in current obligations. This lease is scheduled to terminate in January 2007, and has a fixed interest rate of 8.0%.

Finally, the Company has a capital equipment lease with Toshiba Financial Services associated with the acquisition of photocopier equipment. As of March 31, 2006, the balance outstanding on this lease was $1,000, all of which is included in current obligations. This lease is scheduled to terminate in May 2006.

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

 

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For the three months ended on March 31, 2006, net cash provided by operating activities was $13,000, compared to $60,000 for the three months ended March 31, 2005. The decrease of $47,000 in cash provided between the two periods is primarily due to an increase in cash used for inventories, supplies and prepaid expenses of $264,000 compared to a decrease of $65,000 in 2005. In addition, there was an increase in accounts receivables of $92,000 in the first three months of 2006, compared to only $33,000 for the first three months of 2005 which contributed to the lower cash provided by operating activities. This is mostly the result of higher revenue in the first three months of 2006 compared to the same period of 2005. As of March 31, 2006, the days sales outstanding statistic stood at 44 days, compared to 41 days outstanding as of December 31, 2005. The Company has experienced some increase in the age of selected customer receivable balances during the quarter.

For the three months ended on March 31, 2006, net cash used in investing activities was $373,000, compared to $38,000 for the same period in 2005. The increase of $335,000 is primarily due to the Company’s investments during the first three months of 2006 in vehicles and computer equipment. The Company did not make similar investments in plant or equipment during the same period of 2005.

For the three months ended March 31, 2006, net cash used by financing activities was $20,000 compared with $53,000 for the three months ended March 31, 2005. Most of the difference is due to a reduction in the amount paid for debt obligations since the Company has significantly reduced outstanding debt over the last year.

The Company had previously decided to initiate a new information technology project to enhance the automation of its blood product operations. The Company has identified a preferred blood bank information system developer to provide this system, and is currently in contract negotiations. This project is expected to take approximately two years to complete, and will involve considerable financial and managerial resources. Management expects approximately $2 million will be needed to complete this project. The Company also entered into a lease to occupy a building located in Van Nuys, California for new corporate headquarters and to relocate the Company’s blood processing and distribution operations from Sherman Oaks, California. It is anticipated the Company will need to make investments of approximately $1.2 million in this new facility for improvements and relocation costs.

Management anticipates that cash on hand, cash generated by operations and available borrowing on the bank line of credit, 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 and facility improvements.

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.

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 Quaterly 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

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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.

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.

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 have decreased the 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.

Steady or declining market prices 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 increased 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. Increased costs may reduce profitability and may have a material adverse effect on the business and results of operations.

Competition may cause a loss of customers and an increase in costs and impact profitability

Competition within the blood services and blood products industries is constantly changing. Recent consolidations of blood services providers has changed the competitive environment for the Company’s blood services segment. Competition for customers and trained apheresis nurses is increasing. This has caused the Company to incur significant recruitment costs to replace nurses, dramatically increase nurses’ compensation and incur higher marketing related expenses in order to attract and retain customers. In addition, consolidations and affiliations within the hospital industry have changed the market for the blood products segment. The newly consolidated or affiliated hospitals have started to negotiate with the Company as a group, and therefore exert 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 and other 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

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strong. If the Company is unable to attract and retain a staff of qualified professionals, operations may be adversely affected.

Industry regulation could impact operations

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 is required and intends to respond by documenting an action plan to address each issue. Failure to promptly correct these issues may result in regulatory action without notice.

In addition, state and federal laws include anti-kickback and self-referral prohibitions and other regulations that affect the shipping 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 additional 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 hospitals. 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.

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.

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.

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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. Significant price increases, or disruptions in the ability of these vendors to provide products and services, may force the Company to find alternative vendors. Alternative vendors may not be available, or may not provide their products and services at the 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 result 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 as providers seek 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.

Future technological developments or alternative treatments could jeopardize business

As a result of the risks posed by blood-borne diseases, many companies are currently seeking to develop alternative treatments for blood product transfusions or synthetic substitutes for human blood products. HemaCare’s business consists of collecting, processing and distributing human blood products and providing blood related therapuetic services. The introduction and acceptance in the market of alternative treatments or synthetic blood substitutes 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.

Potential inability to meet future capital needs could affect plans to finance future expansion

Currently, the Company believes it has sufficient cash available through its cash on hand, bank credit facilities and funds from operations to finance its operations for the next year. The Company generated $1,655,000 in net income in 2005; however, there is no assurance this performance will be sustainable, and the Company may need to raise additional capital in the debt or equity markets. 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.

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

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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.

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 to test its 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.

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

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 the 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.

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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 for the Company.

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 our 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.

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.

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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 and Nasdaq 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 a national securities exchange. As a result, an investor may find it difficult to dispose of our 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.

Lack of dividend payments

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 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, 2007.

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This process will be expensive and time consuming, and will require significant attention of management. Management can give no assurance that 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. If a material weakness is discovered, corrective action may be time consuming, costly and further divert the attention of management. 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.

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.

Item 3.                          Quantitative and Qualitative Disclosures About Market Risk

The Company has $68,000 of debt, all of which is in the form of notes payable and capitalized leases with fixed interest rates. As of March 31, 2006, the Company has no debt at variable interest rates, and therefore there is no risk from changes in interest rates at this time. The Company has the ability to draw against the working capital line of credit, which has an interest rate linked to the prime interest rate, or at the election of the Company, LIBOR. Accordingly, if the Company did draw against this line of credit, interest rate expense could fluctuate with rate changes in the U.S.

Item 4.                          Controls and Procedures

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, except as described below, the Company’s disclosure controls and procedures were 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).

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.

There was no change in the Company’s internal control over financial reporting, that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Company continues to evaluate the existing internal control structure. As a result, management has identified several internal control weaknesses. Of these, the Company has alternative controls in place, which management believes prevents any material misstatement of the Company’s financial statements. Nevertheless, management intends to modify the existing internal control structure to eliminate any significant weaknesses with the objective of eliminating or reducing reliance on alternative controls.

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PART II.   OTHER INFORMATION

Item 1.                          Legal Proceedings

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.

Item 1A.                Risk Factors

None.

Item 2.                          Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.                          Defaults Upon Senior Securities

None.

Item 4.                          Submission of Matters to a Vote of Security Holders

None.

Item 5.                          Other Information

None.

Item 6.                          Exhibits

a.    Exhibits

 

 

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SIGNATURES

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.

 

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EXHIBIT INDEX

 

 

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