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 June 30, 2007

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, an 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):

 

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 August 6, 2007, 8,799,955 shares of Common Stock of the registrant were issued and outstanding.

HEMACARE CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q

FOR THE THREE AND SIX MONTH PERIODS ENDED

JUNE 30, 2007

				Page Number
PART I		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets as of June 30, 2007 (unaudited) and December 31, 2006		1
		Condensed Consolidated Statements of Income (Operations) for the Three and Six Months ended June 30, 2007 and 2006 (unaudited)		2
		Condensed Consolidated Statements of Cash Flows for the Six Months ended June 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		30
Item 4.		Controls and Procedures		31
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings		32
Item 1A.		Risk Factors		32
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		32
Item 3.		Defaults Upon Senior Securities		32
Item 4T.		Submission of Matters to a Vote of Security Holders		32
Item 5.		Other Information		32
Item 6.		Exhibits		33
SIGNATURES				34

 

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PART 1   FINANCIAL INFORMATION

Item 1.                          Financial Statements

HEMACARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

 

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

1

HEMACARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF (OPERATIONS) INCOME
(Unaudited)

 

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

2

HEMACARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 

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

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HemaCare Corporation
Notes to Unaudited Condensed Consolidated Financial Statements

Note 1—Basis of Presentation and General Information

BASIS OF PRESENTATION

In the opinion of management, the accompanying (a) consolidated balance sheet as of December 31, 2006, which has been derived from audited financial statements, and (b) the unaudited interim condensed consolidated financial statements for the three and six months ended June 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 June 30, 2007, the results of its operations for the three and six months ended June 30, 2007 and 2006, and its cash flows for the six months ended June 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 notes from the consolidated financial statements for 2006 are incorporated by reference to 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 six months ended June 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.

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.

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 mobile therapeutics sales, 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 $957,000 and $736,000 as of June 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 cost for all share-based payments granted subsequent to the balance sheet date, 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.

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 second quarter of each year. The Company will use the 2006 Equity Incentive Plan approved by shareholders at the 2006 annual meeting to grant options since the 1996 Stock Incentive Plan expired in 2006. The Company applied for a permit with the California Department of Corporations for the 2006 Equity Incentive Plan, which was approved on July 12, 2007.

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, to be issued following the approval of the 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

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vesting of non-employee Director options, the Company recorded $73,000 and $119,000 of share-based compensation for the first three months and six months of 2007, respectively, utilizing the Black-Scholes valuation model.

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 June 30, 2007 and December 31, 2006, the Company had uninsured cash and cash equivalents of $603,000 and $832,000, respectively.

APPLICATION OF NEW ACCOUNTING STANDARDS

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.

RECENT ACCOUNTING PRONOUNCEMENTS

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.

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 the 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 us as of the specified effective date. Unless otherwise discussed, our management believes that the impact of recently issued standards that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.

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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:

 

Note 3—Acquisition of Teragenix Corporation

On August 29, 2006, the Company acquired all of the outstanding stock of Teragenix Corporation, subsequently renamed HemaCare BioScience, Inc. (“HemaBio”) for $4.8 million comprised of (i) $1,372,000 in cash, (ii) up to an additional $250,000 in cash, subject to the Company’s right to set-off, (iii) 285,895 shares of the Company’s common stock, (iv) secured, subordinated promissory notes issued by the Company in the aggregate principal amount of $200,000, (v) 248,000 additional shares of the Company’s common stock based on the “EBIT” (as defined) of HemaBio for the twelve month period ended March 31, 2007, and (vi) up to an additional $1,300,000 in cash based on the EBIT of HemaBio for the three fiscal years ended December 31, 2008, 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. The Company allocated the purchase price per SFAS 141 to the fair value of the assets acquired, net of liabilities assumed. The remaining portion of the purchase price, or $3,078,000, was allocated to goodwill representing the amount of the purchase price in excess of the fair value of the assets, net of liabilities acquired, subject to possible adjustment during the allocation period which will not exceed one year from August 29, 2006.

The acquisition agreement requires a cash payment of $500,000 as additional consideration to the sellers if the full annual 2006 EBIT (as defined in the agreement) of HemaBio exceeded $427,500. The Company determined the required EBIT target was achieved, and therefore the additional obligation was recognized as a current liability and as an increase in goodwill on the Company’s balance sheet as of December 31, 2006. In the first quarter of 2007, the Company paid this obligation to the sellers.

The acquisition agreement also requires the Company to issue 248,000 shares of common stock to the sellers if the EBIT of HemaBio for the twelve month period ending March 31, 2007 exceeded $325,000. The Company determined the required EBIT target was achieved. On April 30, 2007, the Company issued the required shares to the sellers. Therefore the value of the shares issued, based on the closing stock price on the issue date, or $657,000, was recognized as an increase in the common stock component of shareholders’ equity and as an increase in goodwill on the Company’s balance sheet as of June 30, 2007.

The acquisition agreement also requires a cash payment to the sellers for any differences in their tax liability as a result of the treatment of the acquisition as an asset acquisition for tax purposes instead of as a stock acquisition. The difference of $24,000 was paid to the sellers in the second quarter of 2007 and resulted in an increase goodwill on the Company’s balance sheet as of June 30, 2007.

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The acquisition agreement also requires contingent cash payments of up to $400,000 in additional consideration based on EBIT for each twelve month period ending December 31, 2007 and December 31, 2008. The minimum EBIT required before additional consideration is due to the sellers is $1,000,000 and $1,280,000 for 2007 and 2008, respectively.

The following table summarizes the components of the consideration paid to acquire HemaBio:

 

The following table summarizes the allocation of the consideration to the assets acquired, net of liabilities assumed:

 

HemaCare’s primary reason for acquiring Teragenix is its focus on providing blood products and support services to research-focused customers. HemaCare identified research support as a strategic growth opportunity, and believes the combination of the two companies will provide HemaCare with a market advantage by providing research customers with a wide range of biological samples and clinical research support services.

As of December 31, 2006 and June 30, 2007, the balance sheet of HemaBio is consolidated with the Company’s balance sheet. The statement of income of HemaBio for the first three month and six month periods of 2007 is consolidated with the Company’s statement of income for the three month and six month periods ended on June 30, 2007. The statement of cash flows for HemaBio for the first six months of 2007 is included with the Company’s statement of cash flows for the six month period ended June 30, 2007.

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.

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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. This amount is included as accrued payroll and payroll taxes on the Company’s balance sheet as of June 30, 2007.

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 June 30, 2007, the rate associated with this credit facility was 8.00%. 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 June 30, 2007, the Company had borrowed $2,500,000 against this line of credit, and the Company had unused availability of $1,500,000. During the first six months of 2007, the Company incurred $78,000 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 June 30, 2007, the Company was in compliance with all of the financial covenants, except the $75,000 minimum quarterly income covenant. The Company requested, and Comerica issued, a waiver for this covenant violation.

As part of the consideration to acquire HemaBio, the Company entered into two notes with 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, 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. Each note is secured by all of the assets of HemaBio, but are subordinate to Comerica Bank.

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 starts 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

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added $13,250 per month in rent expense, and adjusts annually by 3.9% on the anniversary of the lease commencement date.

The Company invested approximately $1.7 million in tenant improvements in the new facility. As part of the lease agreement, the Company received approximately $400,000 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 amortization is $525,000, of which $96,000 is included as other accrued expenses, and $429,000 is included as other long-term liabilities on the Company’s balance sheet as of June 30, 2007.

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.

For the six months ended June 30, 2007, the Company recognized non-cash share-based compensation costs of $154,000 per SFAS 123R, including $119,000 of estimated share-based compensation for non-employee director options. (see Note 1)

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

 

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

 

As of June 30, 2007, there was $211,000 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 3.4 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:

 

The Company adjusted the assumptions used to calculate share-based compensation expense based on the recent behavior of option holders. In particular, the Company adjusted the expected option term and expected forfeiture rate. The impact of these adjustments is recognized in the current period.

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 stockholder 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 issue options under the 2006 Plan, which was approved on July 12, 2007. No options were issued under the 2006 Plan prior to June 30, 2007. As of August 8, 2007, options to purchase 135,000 shares  had been granted under the 2006 Plan.

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Note 8—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 1,592,000 shares of common stock for the three and six months ended June 30, 2007 have been excluded from the above calculation because their effect would have been anti-dilutive.

Options and warrants outstanding of 0 shares and 490,000 shares of common stock for the three and six months ended June 30, 2006, respectively, have been excluded from the above calculation because their effect would have been anti-dilutive.

Note 9—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 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. 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 from prior periods that will be available in 2007 to eliminate most of any potential federal tax liability. The Company has recognized income in each of the prior three years, 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.

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 wrote-up the deferred tax asset by this amount, 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. As of June 30, 2007, the Company recalculated the valuation reserve to include the results of operations in the quarter which resulted in no net change in the deferred tax asset reported on the balance sheet. The Company may choose to change this reserve in future periods.

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Since the Company incurred a loss in the second quarter of 2007, no federal income taxes were recognized in the quarter; however, $7,000 was recognized to the provision for income taxes due to anticipated state and local taxes. As described in Note 6, 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 $38,000 in compensation expense related to SFAS 123R in the second quarter of 2007. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $9,000. 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 valuation reserve for its deferred tax reserve, 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.

·       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 six month periods ended June 30, 2007, and June 30, 2006.

Note 11—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.

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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 the Company.” 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”) 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 have improved as a result of the successful implementation of management’s plan. 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.

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.

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Results of Operations

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

Overview

The Company generated revenue in the second quarter of 2007 of $9,646,000, an increase of $1,214,000, or 14%, compared to the same period of 2006. Blood products revenue increased $1,190,000, or 18%, as a result of revenue from HemaBio operations, which was acquired in the third quarter of 2006. Blood services revenue increased $24,000, or 1.5%, mostly as a result of an increase in the number of procedures performed.

Gross profit in the second quarter of 2007 decreased $165,000, or 11%, compared to the second quarter of 2006. The decline in gross profit is attributable to a $142,000, or 12%, decrease in gross profit for the Company’s blood products business segment, and a $23,000, or 9%, decrease in gross profit for the Company’s blood services business segment.

The Company generated a net loss of $413,000 for the second quarter of 2007, representing a $773,000 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, and the recognition of $326,000 in severance expenses associated with the resignation of the Company’s President and Chief Executive Officer. Excluding this one time charge, the Company’s operations produced a loss of $87,000, representing a $260,000 improvement over the first quarter of 2007.

Blood Products

For the three months ended June 30, 2007, blood product revenues increased $1,190,000, or 18%, compared with the same quarter of 2006. This increase is attributable to revenue produced by the Company’s Florida based research blood products operation, which the Company acquired in August 2006. Revenue for the Company’s other blood products operations was modestly lower during the quarter compared to the second quarter of 2006.

For the three months ended June 30, 2007, gross profit for the blood products segment decreased $142,000 or 12%, to $1,087,000 from $1,229,000 in second quarter of 2006. The decrease reflects a decline in California collection volumes resulting from increased competition for blood drive sponsors and turnover of donor recruitment staff, and competition in the California market which restricted the Company’s ability to pass along cost increases for staff, supplies, fuel, newly available blood tests, and regulatory costs. Additionally, an overall decrease in the supply of purchased blood products, resulted in an increase in the cost of these products compared to the second quarter of 2006. Gross profit from the Company’s Maine operations improved in the quarter compared to the same period in 2006, mostly as a result of higher collection volumes, and lower staff related costs. The Company’s Florida blood products operations generated a modest profit for the quarter. The gross profit percentage for blood products decreased to 14% in the second quarter of 2007, from 18% for the same quarter of 2006 as the result of i) increases in the cost of purchased blood products and other supplies, ii) decreased operational efficiencies in the Company’s California operations as a result of lower collection volumes, and iii) increased fuel and facility related expenses.

Blood Services

Blood services revenue increased $24,000, or 1.5%, to $1,657,000 in the second quarter of 2007 from $1,633,000 generated in the same period of 2006 due to a 2% increase in the number of therapeutic apheresis procedures performed. 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”

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procedures. Operator only fees reflect charges principally for staff time to perform the procedure and exclude charges for equipment and supplies.

Gross profit for blood services decreased $23,000, or 9%, from $261,000 in the second quarter of 2006 to $238,000 during the same period of 2007 reflecting a decline in gross profit percentage from 16% to 14%. 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 $610,000, or 55%, to $1,731,000 in the second quarter of 2007 from $1,121,000 in the same period of 2006. The increase reflects a $326,000 charge for severance expenses, $134,000 increase in outside professional and temporary personnel costs, $44,000 increase in interest expense, $39,000 increase in depreciation, $36,000 increase in bad-debt expense, $14,000 increase in rent expense and a $12,000 increase in the cost of forms, computer and other office supplies. These increases in costs were partially off-set by a $61,000 reduction in cash-based compensation and benefit expenses.

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. 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 for 2007 and an increase in the cost of temporary personnel to fill various open positions. The increase in interest expense is the result of outstanding debt incurred to finance the acquisition of HemaBio in August 2006. 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 bad debt expense is due to a decrease in the bad debt reserve in the second quarter of 2006 that did not occur in the second quarter of 2007. The increase in rent expense is the result of the Company’s move of the corporate office to a higher cost facility in November of 2006. The increase in forms, computer and other office supplies pertains to forms associated with new regulatory compliance documentation requirements and efforts to improve the protection of the Company’s computer assets from internet threats. Offsetting these increases in cost is a $61,000 reduction in cash-based compensation and benefits, primarily from a reduction in the bonus accrual that is directly related to the decrease in profitability in 2007 compared to 2006.

Income Taxes

No federal income tax provision was recognized in the second quarter of 2007 due to the Company’s net loss in the second quarter of 2007; 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. Management has calculated an estimated $7,000 tax liability in the first six 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

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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 $38,000 in compensation expense related to SFAS 123R in the second quarter of 2007. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $9,000. 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 wrote-up the deferred tax asset by this amount, 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. As of June 30, 2007, the Company recalculated the valuation reserve to include the results of operations in the quarter which resulted in no net change in the deferred tax asset reported on the balance sheet. The Company may choose to change this reserve in future periods.

Six months ended June 30, 2007 compared to the six months ended June 30, 2006

Overview

The Company generated revenue in the first six months of 2007 of $19,002,000, an increase of $2,382,000, or 14%, compared to the same period of 2006. Blood products revenue increased $2,312,000, or 18%, as a result of revenue from HemaBio operations, which was acquired in the third quarter of 2006. Blood services revenue increased $70,000, or 2%, mostly as a result of an increase in the number of procedures performed.

Gross profit in the first six months of 2007 decreased $686,000, or 22%, compared to the same period of 2006, due to a $643,000, or 27%, decrease in gross profit for the Company’s blood products business segment, and a $43,000, or 6%, decrease in gross profit for the Company’s blood services business segment.

The Company generated a net loss of $760,000 for the first six months of 2007, representing a $1,205,000 decrease from the same period in 2006. This decrease is mostly attributable to the decline in the Company’s blood products gross profit, and the recognition of $326,000 in severance expenses associated with the resignation of the Company’s President and Chief Executive Officer. Excluding this one-time severance expense, the net loss in the period would have been $434,000.

Blood Products

For the six months ended June 30, 2007, blood products revenue increased $2,312,000 or 18%, compared with the same period of 2006. The increase is attributable to revenue produced by the Company’s Florida based research blood products operation, which the Company acquired in August 2006. Revenue for other blood products operations was marginally higher during the first six months of 2007 compared to the same period of 2006.

For the six months ended June 30, 2007, gross profit for the blood products segment decreased $643,000, or 27%, to $1,765,000 from $2,408,000 in same period of 2006. The decrease, mostly in the first quarter of 2007, reflects a decline in California collection volumes resulting from increased competition for blood drive sponsors and turnover of donor recruitment staff, and competition in the California market which restricted the Company’s ability to pass along cost increases for staff, supplies, fuel, newly available blood tests, and regulatory costs. Additionally, costs of purchased blood products increased compared to the first six months of 2006. Gross profit from the Company’s Maine operations improved in the first six

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months of 2007 compared to the same period in 2006, mostly as a result of higher collection volumes, and lower staff related costs. The gross profit percentage for blood products decreased to 11% in the first six months of 2007, from 18% for the same period of 2006 as the result of i) increases in the cost of purchased blood products and other supplies, ii) decreased operational efficiencies in the Company’s California operations as a result of lower collection volumes, and iii) increased fuel and facility related expenses.

Blood Services

Blood services revenue increased $70,000, or 2%, to $3,524,000 in the first six months of 2007 from $3,454,000 generated in the same period of 2006 due to a 8% 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 $43,000, or 6%, from $730,000 in the first six months of 2006 to $687,000 during the same period of 2007 reflecting a decline in gross profit percentage from 21% to 19%. 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 $538,000, or 20%, to $3,205,000 in the first six months of 2007 from $2,667,000 in the same period of 2006. The increase includes a $326,000 charge for severance expenses, $122,000 increase in outside professional service and temporary personnel costs, $80,000 increase in interest expense, $77,000 increase in depreciation, $48,000 increase in bad-debt expense, $26,000 increase in the cost of forms, computer and other office supplies, $25,000 increase in rent expense, and a $25,000 reduction in interest income. These were partially off-set by a $208,000 decrease in non-cash share-based compensation expense and a $96,000 decrease in cash-based compensation and benefit expenses.

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. 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 for 2007 and the cost of temporary personnel to fill various open positions. The increase in interest expense is the result of outstanding debt incurred to finance the acquisition of HemaBio in August 2006. 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 bad debt expense is due to a decrease in the bad debt reserve in the second quarter of 2006 that did not occur in the second quarter of 2007. The increase in forms, computer and other office supplies pertains to forms associated with new regulatory compliance documentation requirements and efforts to improve the protection of the Company’s computer assets from internet threats. The increase in rent expense is associated with the Company’s move of the corporate office to a higher cost facility in November of 2006.

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Finally, the decrease in interest income is the result of a reduction of excess cash available to invest in interest bearing investments as a result of the cash consumed to complete the acquisition of HemaBio in August 2006. Offsetting these increases is a $208,000 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. In addition, cash-based compensation and benefits decreased $96,000, primarily from a reduction in the bonus accrual that is directly related to the decrease in profitability in 2007 compared to 2006.

Income Taxes

No federal income tax provision was recognized in the first six 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 $7,000 in tax liability in the first six months of 2007 for state and local taxes.

In the second 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 $154,000 in compensation expense related to SFAS 123R in the first six months of 2007. As a result of the temporary difference created, the Company’s deferred tax asset balance increased $38,000. 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 wrote-up the deferred tax asset by this amount, 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. As of June 30, 2007, the Company recalculated the valuation reserve to include the results of operations during the first six months of 2007 which resulted in no net change in the deferred tax asset reported on the balance sheet. 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 six 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 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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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.

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 June 30, 2007, the Company’s cash and cash equivalents were $908,000, and the Company had working capital of $1,700,000.

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 June 30, 2007, the rate associated with this credit facility was 8%. 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 June 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 require minimum levels of profitability and prohibit the payment of dividends. As of June 30, 2007, the Company was in compliance with all of the financial covenants, except the $75,000 minimum quarterly income covenant. The Company

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requested, and Comerica issued, a waiver for this covenant violation. During the first six months of 2007, the Company incurred $78,000 in interest expense associated with the Comerica credit facility.

The Company also had a capital equipment lease with GE Capital used to finance the acquisition of vehicles. During the first quarter of 2007, the Company paid off the remaining outstanding balance on this obligation of $7,000.

As part of the consideration to aquire HemaBio, the Company entered into two notes with 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, 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. Each note is secured by all of the assets of HemaBio, but are subordinate to Comerica Bank.

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

 

For the six months ended on June 30, 2007, net cash used for operating activities was $84,000, compared to $166,000 for the six months ended June 30, 2006. Significant differences in some of the components of cash used for operating activities occurred between the two periods. In the first six months of 2007, the Company experienced a net decrease in accounts receivable of $1,154,000 compared to a net increase of $59,000 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 six months of 2007. As of June 30, 2007, days outstanding were 53 days, compared to 58 days outstanding as of December 31, 2006, and is the principal reason for the net decrease in net accounts receivables as of June 30, 2007. In the first six months of 2006, the Company increased inventories, supplies and prepaid expenses by $926,000, whereas for the same period of 2007 this category decreased by $28,000. This occurred because in the first half of 2006 the Company increased inventory of selected medical supplies in response to anticipated price increases and to avoid albumin supply shortages which was difficult to obtain for most of 2006. Finally, for the first half of 2007, accounts payable, accrued expenses and other liabilities decreased $1,404,000, whereas this category only decreased $340,000 during the same period of 2006. The move of the Company’s corporate offices in November 2006 caused some delay receiving vendor invoices, which resulted in a temporary increase in accounts payable at the end of 2006. Since the beginning of 2007, the Company brought most of the vendor accounts current, causing the large decrease in accounts payable in the first six months of 2007.

For the six months ended on June 30, 2007, net cash used for investing activities was $488,000, compared to $686,000 for the same period in 2006. This $198,000 decrease is the result of lower investments in leasehold improvements in 2007.

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For the six months ended June 30, 2007, net cash provided for financing activities was $344,000, compared to $28,000 in cash used for financing activities for the six months ended June 30, 2006. The difference is primarily due to $475,000 in additional borrowing against the Company’s line of credit with Comerica Bank.

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 costs a total of $2 million; portions of this project are scheduled for completion in late 2007 with full implementation in 2008.

Management anticipates that 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.

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 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.

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.

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

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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.

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

Competition in the blood products and services industries is primarily based on fees charged to customers. 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.

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.

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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.

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.

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.

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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.

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.

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 $1,334,000 in pre-tax income in 2006; 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 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

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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, 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

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significant delay in resuming operations in either region following such an event could cause a material adverse impact on the profitability of the Company.

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

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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.

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

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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 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 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. 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.

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. There is no assurance that we will be able to implement a formal and rigorous system of internal control at HemaBio and that we will be able to provide a report that contains no significant deficiencies with respect to 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.

Item 3.                          Quantitative and Qualitative Disclosures About Market Risk

As of June 30, 2007, the Company has $700,000 of debt in the form of notes payable with fixed interest rates. As of June 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,

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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.

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, 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.

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, which management believes prevents any material misstatement of the Company’s financial statements.

The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 require management’s assessment 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 assessment 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. If a material weakness is discovered, corrective action may also 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. 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.

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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

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.

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

As disclosed under Note 3 to the financial statements, in connection with the acquisition of Teragenix Corporation, the Company issued 248,000 shares of common stock to the sellers on April 30, 2007. Such shares of common stock were issued directly, without the services of an underwriter, and without registration under the Securities Act of 1933, as amended, in reliance on Section 4(2) of that Act. The agreement to issue these shares had been previously disclosed in the Company’s Current Report on Form 8-K/A filed on November 15, 2006.

Item 3.                          Defaults Upon Senior Securities

None.

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

a.                 The Company’s Annual Meeting of Shareholders (the “Meeting”) was held on May 23, 2007.

b.                The following table shows the tabulation of votes for all matters put to vote at the Meeting:

 

Item 5.                          Other Information

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

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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.

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.

Item 6.                          Exhibits

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

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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.

Date	August 14, 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 INDEX

 

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