UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington
D.C. 20549


Form 10-K





(Mark
      One)x
                        ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the fiscal year ended December 31, 2008oro
                        TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934
                          For
      the transition period
      from          to





Commission
File Number 001-33874





Xcorporeal,
Inc.


(Exact
name of registrant as specified in its charter)





Delaware
            75-2242792(State
      or other jurisdiction of
              Incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      Number)





12121
Wilshire Blvd., Suite 350


Los
Angeles, California 90025


(Address
of principal executive offices and zip code)





Registrant’s
telephone number, including area code: (310) 923-9990





Securities
registered pursuant to Section 12(b) of the Act:





Title of Each Class
                
                Name of Each Exchange on Which
      RegisteredCommon
      Stock, $0.0001 par value
                
                NYSE
      Amex





Securities
registered pursuant to Section 12(g) of the Act:


None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes £    No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  Yes £     No x





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 £





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K(§229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer £
            Accelerated
      filer £
            Non-accelerated
      filer £
              (Do
      not check if a smaller reporting company)
            Smaller
      reporting company x









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





The
aggregate market value of the voting common stock held by non-affiliates of the
registrant computed by reference to the closing price of the registrant’s common
stock on June 30, 2008, as reported on the NYSE Amex, was approximately
$7,288,459. For purposes of this disclosure, shares of common stock held by
persons who hold more than 5% of the outstanding shares of common stock and
shares held by executive officers and directors of the registrant have been
excluded because such persons may be deemed to be affiliates. This determination
of executive officer or affiliate status is not necessarily a conclusive
determination for other purposes.





As of
March 23, 2009, the registrant had issued and outstanding 14,754,687 shares of
common stock, $0.0001 par value per share.








DOCUMENTS
INCORPORATED BY REFERENCE





None.


1


TABLE
OF CONTENTS


Forward
      Looking Statements
                                                3PART
      IItem
      1.
                                                Business
                                                4Item
      1A.
                                                Risk
      Factors
                                                11Item
      1B.
                                                Unresolved
      Staff Comments
                                                20Item
      2.
                                                Properties
                                                20Item
      3.
                                                Legal
      Proceedings
                                                20Item
      4.
                                                Submission
      of Matters to a Vote of Security Holders
                                                22PART
      IIItem
      5.
                                                Market
      For Registrant’s Common Equity, Related Stockholder Maters and Issuer
      Purchases of Equity
                                                23Item
      6.
                                                Selected
      Financial Data
                                                23Item
      7.
                                                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                                23Item
      7A.
                                                Quantitative
      and Qualitative Disclosures About Market Risk
                                                28Item
      8.
                                                Financial
      Statements and Supplementary Data
                                                29Item
      9.
                                                Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                                                50Item
      9A.
                                                Controls
      and Procedures
                                                50Item
      9B.
                                                Other
      Information
                                                51PART
      IIIItem
      10.
                                                Directors,
      Executive Officers and Corporate Governance
                                                52Item
      11.
                                                Executive
      Compensation
                                                54Item
      12.
                                                Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                                                62Item
      13.
                                                Certain
      Relationships and Related Transactions and Director
      Independence
                                                63Item
      14:
                                                Principal
      Accounting Fees and Services
                                                64PART
      IVItem
      15:
                                                Exhibits
      and Financial Statement Schedules
                                                65Signatures
                                                
                                                66




2




FORWARD
LOOKING STATEMENTS





Unless
the context otherwise indicates or requires, as used in this Annual Report on
Form 10-K, or the “Annual Report”, references to “Xcorporeal, ”“we,” “us,” “our”
or the “Company” refer to Xcorporeal, Inc., a Delaware corporation, and prior to
October 12, 2007, the company which is now our subsidiary and known as
Xcorporeal Operations, Inc., or “Operations”.





This
Annual Report contains “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995 with respect to the financial
condition, results of operations, business strategies, operating efficiencies or
synergies, competitive positions, growth opportunities for existing products,
plans and objectives of management, markets for our stock and other matters.
Statements in this Annual Report that are not historical facts are
“forward-looking statements” for the purpose of the safe harbor provided by
Section 21E of the Securities Exchange Act of 1934, as amended, or the “Exchange
Act”, and Section 27A of the Securities Act of 1933, or the “Securities Act”.
Forward-looking
statements reflect our current expectations or forecasts of future events.
Forward-looking statements generally can be identified by the use of
forward-looking terminology such as “may,” “will,” “expect,” “anticipate,”
“intend,” “estimate,” “believe,” “project,” “continue,” “plan,” “forecast,” or
other similar words.Such forward-looking statements, including, without
limitation, those relating to our future business prospects, revenues and
income, wherever they occur, are necessarily estimates reflecting the best
judgment of our senior management on the date on which they were made, or if no
date is stated, as of the date of this Annual Report. These forward-looking
statements are subject to risks, uncertainties and assumptions, including those
described in the “Risk Factors” described below, that may affect the operations,
performance, development and results of our business. Because the factors
discussed in this Annual Report could cause our actual results or outcomes to
differ materially from those expressed in any forward-looking statements made by
us or on our behalf, you should not place undue reliance on any such
forward-looking statements. New factors emerge from time to time, and it is not
possible for us to predict which factors will arise. In addition, we cannot
assess the impact of each factor on our business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements.





You
should understand that, in addition to those factors discussed in the section
captioned “Risk Factors,” and events discussed in the section captioned
“Business - Recent Developments,” factors that could affect our future results
and could cause our actual results to differ materially from those expressed in
such forward-looking statements, include, but are not limited to:





·
            the
      effect of receiving a “going concern” statement in our independent
      registered public accounting firm’s report on our 2008 financial
      statements;




·
            our
      significant capital needs and ability to obtain financing both on a
      short-term and a long-term basis;




·
            the
      results of the arbitration proceeding with National Quality Care, Inc., or
      “NQCI”;




·
            our
      ability to meet continued listing standards of NYSE Amex (formerly
      American Stock Exchange);




·
            our
      ability to successfully research and develop marketable
      products;




·
            our
      ability to obtain regulatory approval to market and distribute our
      products;




·
            anticipated
      trends and conditions in the industry in which we operate, including
      regulatory changes;




·
            general
      economic conditions; and




·
            other
      risks and uncertainties as may be detailed from time to time in our public
      announcements and filings with the U.S. Securities and Exchange
      Commission, or the “SEC”.





Although
we believe that our expectations are reasonable, we cannot assure you that our
expectations will prove to be correct. Should any one or more of these risks or
uncertainties materialize, or should any underlying assumptions prove incorrect,
actual results may vary materially from those described in this annual report as
anticipated, believed, estimated, expected or intended.





These
factors are not exhaustive, and new factors may emerge or changes to the
foregoing factors may occur that could impact our business. Except to the extent
required by law, we undertake no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information, future
events or any other reason. All subsequent forward-looking statements
attributable to us or any person acting on our behalf are expressly qualified in
their entirety by the cautionary statements contained or referred to herein. In
light of these risks, uncertainties and assumptions, the forward-looking events
discussed in this Annual Report may not occur. You should review carefully the
sections captioned “Risk Factors,” “Business - Recent Developments” and
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” included elsewhere in this Annual Report for a more complete
discussion of these and other factors that may affect our business.





3




PART
I





Item
1.                 Business





Overview




We are a
medical device company developing an innovative extra-corporeal platform
technology to be used in devices to replace the function of various human
organs. These devices will seek to provide patients with improved, efficient and
cost effective therapy. The platform leads to three initial
products:




·
            A
      Portable Artificial Kidney, or “PAK”, for attended care Renal Replacement
      Therapy, or “RRT”, for patients suffering from Acute Renal Failure, or
      “ARF”




·
            A
      PAK for home hemodialysis for patients suffering from End Stage Renal
      Disease, or “ESRD”




·
            A
      Wearable Artificial Kidney, or “WAK”, for continuous ambulatory
      hemodialysis for treatment of ESRD




We have
completed functional prototypes of our attended care and home PAKs that we plan
to commercialize after obtaining notification clearance from the Food and Drug
Administration, or “FDA”, under Section 510(k) of the Federal Food, Drug and
Cosmetic, or “FDC”, Act based on the existence of predicate devices, which,
subject to our capital limitations described below, we plan to seek in the
future. We have demonstrated a feasibility prototype of the WAK and we will
determine whether to devote any available resources to the development of the
WAK; commercialization of the WAK will require development of a functional
prototype and likely a full pre-market approval, or “PMA”, by the FDA, which
could take several years or longer. Unless we are able to raise funds to satisfy
our current liabilities and other obligations as they become due and obtain
additional debt or equity financing, as more fully described below in section
captioned “Business - Recent Developments”, we will not be able to submit a
510(k) notification with the FDA for the PAK or the WAK.





Our PAK
for the attended care market is a portable, multifunctional renal replacement
device that will offer cost-effective therapy for those patients suffering from
ARF, causing a rapid decline in kidney function. We have completed our
functional prototype of this product, which is currently undergoing bench
testing, and, subject to our capital limitations described below, plan to submit
a 510(k) filing with the FDA in the future. We plan to commercialize this
product after receiving clearance from the FDA. Timing of FDA clearance is
uncertain at this time. Unless we are able to raise funds to satisfy our current
liabilities and other obligations as they become due and obtain additional debt
or equity financing, we will not be able to submit a 510(k) notification with
the FDA for this product.





Our PAK
for the home hemodialysis market is a device for patients suffering from ESRD,
in whom the kidneys have ceased to function. We have also completed our
functional prototype of this product, which is currently undergoing bench
testing, and, subject to our capital limitations described below, we intend to
submit a 510(k) with the FDA in the future. Unless we are able to raise funds to
satisfy our current liabilities and other obligations as they become due and
obtain additional debt or equity financing, we will not be able to submit a
510(k) notification with the FDA for this product. Clinical trials would be
anticipated to commence after the FDA clearance is received.





Our WAK
is a device for the chronic treatment of ESRD. We have successfully demonstrated
a prototype system that weighs less than 6 kg., is battery operated, and can be
worn by an ambulatory patient. Assuming that the Technology Transaction
described below closes and we are able to raise funds to satisfy our current
liabilities and other obligations as they become due and obtain additional debt
or equity financing, we will evaluate the feasibility of furthering our
development of this product over the next 12 months.





In 2009,
to the extent we have or are able to obtain sufficient funds to do so, we plan
to continue testing and developing the technology for our extra-corporeal platform. We
will also implement our validation and verification strategy including bench
testing, clinical testing and regulatory strategy in the U.S. and
abroad.





While we
may eventually exploit our technology’s potential Congestive Heart Failure, or
“CHF”, applications through licensing or strategic arrangements, we will focus
initially on the renal replacement applications described above.





We have
focused much of our efforts on development of the PAK, which we do not believe
has been derived from the Technology (as defined below) covered by the License
Agreement. As described in the section captioned “Background of the Technology
Transaction,” once the Technology Transaction has closed and the results of the
arbitration proceeding are final, we will determine whether to devote any
available resources to development of the WAK. Because none of our products is
yet at a stage where it can be marketed commercially and because of the capital
limitations that we are experiencing, we are not able to predict what portion of
our future business, if any, will be derived from each of our
products.





We are a
development stage company, have generated no revenues to date and have been
unprofitable since our inception, and will incur substantial additional
operating losses for at least the next twelve months as we continue, to the
extent available, to allocate resources to research, development, clinical
trials, commercial operations, and other activities. We do not believe our
existing cash reserves will be sufficient to satisfy our current liabilities and
other obligations before we achieve profitability. Our ability to meet such
obligations as they become due will depend on our ability to secure debt or
equity financing. Unless we are able to obtain funds sufficient to support our
operations and to satisfy our ongoing capital requirements, as more fully
described below, we will not be able to develop any of our products, submit
510(k) notifications or PMA applications to the FDA, conduct clinical trials or
otherwise commercialize any of our products.  We may not be able to
obtain needed funds on acceptable terms, or at all, and there is substantial
doubt of our ability to continue as a going concern. Accordingly, our historical
operations and financial information are not indicative of our future operating
results, financial condition, or ability to operate profitably as a commercial
enterprise.





4


Our
History





We were
incorporated in the State of Delaware in 1992. As of June 30, 2007, we did not
conduct any active business and were considered a “shell company” as defined in
Rule 12(b)-2 promulgated under the Exchange Act. On August 10, 2007, we entered
into a merger agreement with Xcorporeal, Inc., referred to herein as “pre-merger
Xcorporeal”, which conducted the business described in this Annual Report before
the merger became effective on October 12, 2007. Pre-merger Xcorporeal became
our wholly-owned subsidiary and changed its name to “Xcorporeal Operations,
Inc”, referred to herein as “Operations.” We changed our name from “CT Holdings
Enterprises, Inc.” to “Xcorporeal, Inc.” All of our former officers and
directors resigned, and all of the officers and directors of pre-merger
Xcorporeal became our officers and directors, effective as of October 12,
2007.





On
September 1, 2006, Operations entered into a License Agreement with National
Quality Care, Inc. pursuant to which we obtained the exclusive rights to the
technology relating to our kidney failure treatment, and other medical devices.
As a result, we became a development stage company focused on researching,
developing and commercializing technology and products related to the treatment
of kidney failure. On December 1, 2006, Operations initiated arbitration
proceedings against NQCI for its breach of the License Agreement, which remains
pending. Throughout this Annual Report we refer to the License Agreement with
NQCI as the “License Agreement”. For a complete description of the License
Agreement and the arbitration proceedings please see section captioned “Recent
Developments - Background of the Technology Transaction” below and Item 3 -
Legal Proceedings.





Recent
Developments





Corporate Restructuring





The deterioration of the economy over
the last year, coupled with the prolonged and continuing delay in consummating
the Technology Transaction, has significantly adversely affected our Company.
Many of the expectations on which we had based our 2008 and 2009 business
development plans slowly eroded as a result of the lengthy arbitration
proceeding with NQCI commenced in 2006 and continuing into the second quarter of
2009. The possibility of an adverse decision in the arbitration proceeding with
respect to our ownership right to the Technology has been and continues to be a
major factor in our inability to secure debt or equity financing. Accordingly,
we have had to modify our activities and business. In response to the general
economic downturn affecting the development of our products and liquidity
condition, we have instituted a variety of measures in an attempt to conserve
cash and reduce our operating expenses. Our actions included:





·
            Reductions
      in our labor force – On March 13, 2009, we gave notice of employment
      termination to 19 employees. This represents a total work-force reduction
      of approximately 73%. We paid accrued vacation benefits of approximately
      $70,000 to the terminated employees. The layoffs and our other efforts
      focused on streamlining our operations designed to reduce our annual
      expenses by approximately $3.5 million to a current operating burn rate of
      approximately $200,000 per month. These actions had to be carefully and
      thoughtfully executed and we will take additional actions, if necessary.
      Most important to us in making these difficult decisions is to give as
      much consideration as possible to all of our employees, whom we greatly
      value. We hope to be in the financial position in the near future to offer
      re-employment to certain of our terminated
  employees.


·
            Refocusing
      our available assets and employee resources on the development of the
      PAK.


·
            Continuing
      vigorous efforts to minimize or defer our operating
    expenses.


·
            Exploring
      various strategic alternatives, which may include the license of certain
      of our intellectual property rights, as a means to further develop our
      technologies, among other possible transactions and
      alternatives.


·
            Intensifying
      our search to obtain additional financing to support our operations and to
      satisfy our ongoing capital requirements in order to improve our liquidity
      position.


·
            Continuing
      to prosecute our patents and take other steps to perfect our intellectual
      property rights.





In light of the unprecedented economic
slow down, lack of access to capital markets and prolonged arbitration
proceeding with NQCI, we were compelled to undertake the efforts outlined above
in order to remain in the position to continue our operations. We hope to be
able to obtain additional financing to meet our cash obligations as they become
due and otherwise proceed with our business plan. Our ability to execute on our
current business plan is dependent upon our ability to obtain equity or debt
financing, develop and market our products, and, ultimately, to generate
revenue. Unless we are able to raise financing sufficient to support our
operations and to satisfy our ongoing financing requirements, we will not be
able to develop any of our products, submit 510(k) notifications to the FDA,
conduct clinical trials or otherwise commercialize any of our products. We will
make every effort however, to continue the development of the PAK. As a result
of these conditions, there is substantial doubt about our ability to continue as
a going concern. Our ability to continue as a going concern is substantially
dependent on the successful execution of many of the actions referred to above,
on the timeline contemplated by our plans and our ability to obtain additional
financing. We cannot assure you that we will be successful now or in the future
in obtaining any additional financing on terms favorable to us, if at all. The
failure to obtain financing will have a material adverse effect on our financial
condition and operations.





5


Other Considerations – Royalty and Other Payments Under
the License Agreement





As
consideration for entering into the License Agreement, we agreed to pay to NQCI
a minimum annual royalty of $250,000, or 7% of net sales. As a result of the
transfer of the Technology (as defined below) to us, we may be able to realize
additional savings of not having to compensate NQCI for any royalty payments
accrued and not yet paid. Although we have asserted that NQCI’s breaches of the
License Agreement excused our obligation to make the minimum royalty payments,
we recorded $583,333 in royalty expenses, covering the minimum royalties, from
commencement of the License Agreement through December 31, 2008. The License
Agreement expires in 2105. If we are able to acquire the Technology from NQCI,
the arbitrator, Richard C. Neal (Ret), has indicated that the License Agreement
would be terminated simultaneously with such acquisition. As a result of the
Technology becoming our sole and exclusive property, among other benefits, we
should be able to discontinue these royalty payments to NQCI and realize
corresponding savings.





The
License Agreement also requires us to reimburse NQCI’s reasonable and necessary
expenses incurred in the ordinary course of business consistent with past
practices, or the “Licensor Expenses”, until the closing or the termination of
the Merger Agreement (as defined below). The Second Interim Award (as defined
below) states that the License Agreement will remain in full force and effect
until the Technology Transaction closes or the arbitrator determines that it
will never close. Although we have contested its right to any further payments,
NQCI has made a claim for reimbursement of approximately $690,000 in alleged
expenses under the License Agreement as of December 31, 2008. As a result of the
Technology becoming our sole and exclusive property, among other benefits, we
may be able to realize additional savings of not having to reimburse NQCI for
any Licensor Expenses accrued and not yet paid. For a complete description of
the License Agreement and the arbitration proceedings please see below section
captioned “Background of the Technology Transaction” and Item 3 - Legal
Proceedings.





Technology
Transaction





Seeking Stockholder Approval
of the Technology Transaction





We are
currently in the process of seeking approval from our stockholders to issue
9,230,000 shares of our common stock to NQCI in order to obtain ownership of the
Technology. The stockholder approval is being sought in accordance with an
Interim Award issued by the arbitrator on June 9, 2008, referred to herein as
the “Interim Award”, in an arbitration proceeding with NQCI, as modified by
later decisions, including the Amended Order Re Interim Relief Etc. issued by
the arbitrator on January 30, 2009, referred to herein as the “Order”, and in
order to minimize the risk that the arbitrator will issue an alternative award
that could have a material adverse effect on our financial condition and
operations. The arbitrator has refused to issue a final award until stockholder
approval has been obtained from our stockholders, which may effectively prevent
us from obtaining effective court review of the arbitrator’s actions. The most
material terms of the proposed transaction are summarized as
follows:





·
            Subject
      to the satisfaction of the terms of the Interim Award, as modified by the
      Order, NQCI will grant, transfer and assign to Operations all of the
      Technology covered by the License Agreement currently in effect between
      NQCI and Operations;


·
            The
      Technology includes all patents and patent applications related to a WAK
      and other portable or continuous dialysis methods or
    devices;


·
            Under
      the terms of the Interim Award, as modified by the Order, we filed a proxy
      statement with the SEC to obtain stockholder approval for the issuance of
      shares of our common stock to acquire the Technology and issue to NQCI
      9,230,000 shares of our common
stock;


·
            If
      and when we are able to do so, we will issue and deliver to
      NQCI 9,230,000 shares of our common stock in consideration for the
      Technology. As a result, NQCI will own approximately 39% of our
      outstanding common stock and become our largest
    stockholder;


·
            Except
      for its definition, indemnification, representation and warranty
      provisions, the License Agreement shall thereafter be terminated and be of
      no further force or effect; and


·
            After
      the transfer of the Technology by NQCI to us, under the Interim Award, as
      modified by the Order, we will be required to file a registration
      statement with the SEC to register for resale under the Securities Act the
      shares issued to NQCI, referred to herein as the “Registration
      Statement”.





The SEC
is continuing to review our preliminary proxy statement. We cannot predict when
we would be able to hold our stockholder meeting to obtain stockholder approval
of the share issuance.





6


Background of the Technology
Transaction





On
September 1, 2006, Operations entered into the License Agreement with NQCI
pursuant to which we obtained exclusive rights to the technology relating to the
treatment of kidney failure and other applications, with no geographic
restrictions for a license term of 99 years (or, if earlier, until the
expiration of NQCI's proprietary rights in the Technology) for an annual royalty
of 7% of net sales, with a minimum annual royalty of $250,000. The Technology
relates primarily to the WAK, and also covers “Derivative Works,” such as an
original work that is based upon one or more pre-existing works.





On
September 1, 2006, Operations also entered into a Merger Agreement with NQCI,
referred to herein as the “Merger Agreement”, which contemplated that we would
acquire NQCI as a wholly owned subsidiary pursuant to a triangular merger,
referred to herein as the “NQCI Merger”, or we would issue shares of our common
stock to NQCI stockholders in consideration of the assignment of the Technology,
referred to herein as the “Technology Transaction”. The Merger Agreement
provided that Operations had no obligation to issue or deliver any shares after
December 31, 2006, unless the parties mutually agreed to extend such date, which
they did not. In addition, on December 29, 2006, NQCI served us with written
notice that it was terminating the Merger Agreement, which we accepted.
Accordingly, the NQCI Merger was not consummated.





On
December 1, 2006, Operations initiated an arbitration proceeding against NQCI
for its breach of the License Agreement, which remains pending. NQCI claimed the
License Agreement was terminated, and we sought a declaration that the License
Agreement remained in effect until the closing of the NQCI merger or the
Technology Transaction. We later amended our claims to seek damages for NQCI’s
failure to perform its obligations under the License Agreement. NQCI filed
counterclaims seeking to invalidate the License Agreement and claiming monetary
damages against us. NQCI also filed claims against Victor Gura, M.D.,
our Chief Medical and Scientific Officer, claiming he breached his obligations
to NQCI by agreeing to serve on our Board of Directors. Following a hearing and
extensive briefing, the arbitrator denied both parties’ claims for damages.
Although NQCI never filed an amendment to its counterclaims to seek specific
performance, on June 9, 2008, the arbitrator issued an Interim Award granting
specific performance of the Technology Transaction.





The
Interim Award stated that the total aggregate shares of stock to be received by
NQCI stockholders at the closing of the Technology Transaction should equal 48%
of all Operations shares outstanding as of the date of the Merger Agreement. On
September 1, 2006, there were 10,000,000 shares of Operations common stock
outstanding.





On August
4, 2008, the arbitrator issued the Second Interim Award, referred to herein as
the “Second Interim Award”, modifying the initial Interim Award, stating that,
if we desire to close the Technology Transaction, we must obtain approval from a
majority of our stockholders and issue 9,230,000 shares of our common stock to
NQCI. As a result of our issuances of our common stock subsequent to the date of
the Merger Agreement and following the closing of the Technology Transaction,
NQCI would own approximately 39% of our total outstanding shares, which would
make NQCI our largest stockholder. In addition, pursuant to the terms of the
Second Interim Award, the arbitrator found that, with the exception of
stockholder approval, virtually all conditions to closing the Technology
Transaction have been waived, including virtually all of NQCI’s representations
and warranties concerning the Technology.





The
Second Interim Award also stated that, contrary to the assertions made by NQCI,
the License Agreement will remain in full force and effect until the Technology
Transaction closes or the arbitrator determines that it will never close. Upon
closing of the Technology Transaction and satisfaction of the terms of the
Interim Award, as modified by the Order, the License Agreement will terminate
and we will own all of the Technology.





On
September 4, 2008, the arbitrator ruled that, even though we are not a party to
any of the agreements or the arbitration, our shares of common stock should be
issued to NQCI rather than shares of Operations.





The
arbitrator has not ordered us to close the Technology Transaction. However, the
Second Interim Award states that, if our stockholders fail to approve the
issuance of stock to effectuate the Technology Transaction, all of the
Technology covered by the License shall be declared the sole and exclusive
property of NQCI, and the arbitrator shall schedule additional hearings to
address two questions: whether the PAK technology is included within that
Technology, and whether NQCI is entitled to compensatory damages and the amount
of damages under these circumstances. During the arbitration, NQCI took the
position that we had misappropriated trade secrets regarding the WAK and used
them to create the PAK. The arbitrator found that we had not misappropriated
NQCI’s trade secrets. However, should the Technology Transaction not close for
any reason, and the arbitrator rules that the licensed Technology must be
returned to NQCI, the arbitrator could find that the PAK is derived in whole or
in part from licensed Technology, and could rule that Operations must “return”
the PAK technology to NQCI or that NQCI is entitled to compensatory damages or
both.





The
Second Interim Award required that we file the Registration Statement within 30
days after the closing of the Technology Transaction. The arbitrator
acknowledged that our obligation is to file the Registration Statement and to
use reasonable efforts to have the shares registered and not to guarantee
registration and resultant actual public tradability. However, the arbitrator
nevertheless ordered that the Registration Statement must be declared effective
within 90 days. Pursuant to the terms of the Order, the arbitrator modified the
Second Interim Award by reserving on what the final terms of our obligation to
file the Registration Statement will be and stating that such registration
obligation shall be in accordance with applicable laws, including applicable
U.S. federal securities laws. While the arbitrator also retained jurisdiction to
monitor our compliance with such obligation, to award any appropriate relief to
NQCI if we fail to comply with such obligation and to render a decision on any
other matters contested in this proceeding, the time periods set forth in the
Second Interim Award and summarized in this paragraph are no longer
applicable.





7


The Order
also provided, among other things, that if we file the Proxy Statement, obtain
stockholder approval to issue to NQCI 9,230,000 shares of our common stock and
issue such shares to NQCI, the arbitrator’s awards requiring specific
performance of the Technology Transaction will be effectuated and the arbitrator
anticipates confirming that all of the Technology covered by the License
Agreement shall be declared our sole and exclusive property and that the
alternate relief NQCI seeks will be moot.





The
arbitrator held a conference call hearing with the Company and NQCI on March 13,
2009 in which the parties discussed the reasons for the difficulties in closing
the Technology Transaction and explored potential alternatives. The parties were
asked to submit letter briefs outlining their suggested alternatives for
consideration by the arbitrator. The parties submitted their respective letter
briefs on March 24, 2009.





As of the
date of this Annual Report, the arbitration proceeding with NQCI continues and
the arbitrator has not yet issued a final award to either party and has not made
a final ruling with respect to whether the closing of the Technology Transaction
shall occur or whether potential alternatives should be pursued.





The
Technology




The
Merger Agreement provides that, at the closing of the Technology Transaction,
NQCI shall absolutely, unconditionally, validly and irrevocably sell, transfer,
grant and assign to Operations all of the Technology, including, but not limited
to, the inventions embodied or described in the Licensor Patents and Patent
Applications as defined in the License Agreement.




“Technology”
includes all existing and hereafter developed Intellectual Property, Know-How,
Licensor Patents, Licensor Patent Applications, Derivative Works, and any other
technology invented, improved or developed by NQCI, or as to which NQCI owns or
holds any rights, arising out of or relating to the research, development,
design, manufacture or use of:




(a)
            any
      medical device, treatment or method as of September 1,
    2006;(b)
            any
      portable or continuous dialysis methods or devices, specifically including
      any wearable artificial kidney, or “Wearable Kidney”, and related
      devices;(c)
            any
      device, methods or treatments for congestive heart failure;
      and(d)
            any
      artificial heart or coronary
device.




“Intellectual
Property” includes:




(a)
            patents,
      patent applications, and patent rights;(b)
            trademarks,
      trademark registrations and applications;(c)
            copyrights,
      copyright registrations, and applications; and(d)
            trade
      secrets, confidential information and
know-how.




“Licensed
Products” includes all products based on or derived from the Technology,
including, but not limited to the Wearable Kidney and all related devices,
whether now-existing or hereafter developed.




Research
and Development





R&D
Team





We employ an interdisciplinary team of scientists and engineers who
are developing the PAK and a separate, interdisciplinary team developing the
WAK. However, as a result of general economic conditions in 2008 and a
deterioration of our liquidity position, coupled with the prolonged and
continuing delay in our ability to consummate the Technology Transaction, we
have been significantly adversely affected. As a result, on March 13, 2009 we
terminated 19 employees or 73% of our staff. We hope to be in the financial
position in the near future to offer re-employment to certain of our terminated
employees.





In
addition, we had previously retained Aubrey Group, Inc. (“Aubrey”), an
FDA-registered third-party contract developer and manufacturer of medical
devices, to assist with the design and development of subsystems of the PAK,
referred to herein as the “Aubrey Agreement.” As of December 31, 2008, Aubrey
substantially completed its work and we intend to terminate this agreement. A
variation of this device will be developed for chronic home
hemodialysis.





8


We
incurred $20.9 million and $7.1 million in research and development costs in
fiscal years 2008 and 2007, respectively, including the August 4, 2008, $10.2
million fair value accrual for a potential 9.23 million shares issuance to
effectuate the Technology Transaction in accordance to the Second Interim Award.
Excluding the accrual for shares issuable, we incurred $10.7 million and $7.1
million in research and development costs in fiscal years 2008 and 2007,
respectively.





Portable Artificial
Kidney





The PAK
is a multifunctional device that will perform hemodialysis, hemofiltration and
ultrafiltration under direct medical supervision. A variation of this device
will be developed for chronic home hemodialysis. An initial prototype of the
PAK, capable of performing the basic functions of a hemodialysis machine, and
demonstrating our unique new fluidics circuit, was completed at the end of 2007.
The first physical prototype including industrial design of the PAK was
completed in October 2008. We hope to further refine this prototype by adding to
it safety sensors and electronic controls. Subject to our ability to obtain debt
or equity financing to satisfy our current liabilities and other obligations as
they become due, as more fully described above in the section captioned “Recent
Developments,” we hope to complete the final product design of the PAK. The PAK
units will undergo final verification and validation prior to a 510(k)
submission for clinical use under direct medical supervision. A clinical study
will not be required for this submission.





Wearable Artificial
Kidney





In a
clinical feasibility study conducted in London in March 2007, a research
prototype of the WAK was demonstrated in eight patients with end-stage renal
disease. Patients were treated for up to eight hours with adequate clearances of
urea and creatinine. The device was well tolerated and patients were able to
conduct activities of normal daily living including walking and sleeping. There
were no serious adverse events although clotting of the dialyzer occurred in two
patients. To our knowledge, this is the first successful demonstration of a WAK
in humans. Assuming that the Technology Transaction closes and sufficient
working capital is available to us, we hope to make substantial improvements to
the WAK. This work will result in a WAK Generation 2.0. Pending FDA approval of
an investigational Device Exemption (IDE), additional clinical studies will be
conducted upon completion of the Generation 2.0 WAK prototype.





If we
successfully obtain additional financing, we plan to make improvements to the
WAK design intended to move it from a feasibility prototype to a product
prototype. These include improvement of the heparin pumping system intended to
address the dialyzer clotting problem, the addition of safety sensors required
for commercial dialysis equipment, the addition of electrical controls to
provide a convenient user interface, improvements to the blood flow circuit and
further miniaturization of the device to improve fit to the human body.
Additional clinical studies will be conducted upon completion of the
prototype.





Third-party
Arrangements





In July
2007, we entered into the Aubrey Agreement. The PAK will be designed for
intermittent hemodialysis or Continuous Renal Replacement Therapy (CRRT) in an
attended care setting as well as for treatments in a home setting. As of
December 31, 2008, Aubrey substantially completed its work and we intend to
terminate this agreement. At the inception of the Aubrey Agreement, total labor
and material costs over the term of the agreement were budgeted to amount to
approximately $5.1 million and as of December 31, 2008, the agreement was
substantially completed under the budgeted amount at a cost of $3.2
million.





We also
contract with other third parties to assist in our research and development
efforts and to supplement our internal resources while we continue to grow our
organization.





Government
Regulation





US
Regulation





We are subject to extensive government
regulation relating to the development and marketing of our products. Due to the
relatively early nature of our development efforts, we have not yet confirmed
with the FDA its view of the regulatory status of any of our
products.





To support a regulatory submission,
the FDA may require clinical studies to show safety and effectiveness. While we
cannot currently state the nature of the studies the FDA may require due to our
early stage of product development, it is likely that some products we attempt
to develop will require time-consuming clinical studies in order to secure
approval.





Outside the US, our ability to market
potential products is contingent upon receiving market application
authorizations from the appropriate regulatory authorities. These foreign
regulatory approval processes may involve different requirements from those of
the FDA, but also generally include many, if not all, of the risks associated
with the FDA approval process described above, depending on the country
involved.





9


In the US, medical devices are
classified into three different classes, Class I, II and III, on the basis of
controls deemed reasonably necessary to ensure the safety and effectiveness of
the device. Class I devices are subject to general controls, including
labelling, pre-market notification and adherence to the FDA’s Good Manufacturing
Practices, or “GMP”, Class II devices are subject to general and special
controls, including performance standards, post-market surveillance, patient
registries and FDA guidelines, and Class III devices are those which must
receive pre-market approval by the FDA to ensure their safety and effectiveness,
that is, life-sustaining, life-supporting and implantable devices, or new
devices, which have been found not to be substantially equivalent to legally
marketed devices. Because of their breakthrough nature, some of our devices may
be considered Class III.





Before new class II medical devices,
such as our current and pipeline products, can be marketed, marketing clearance
must be obtained through a pre-market notification under Section 510(k) of the
FDC Act. Non-compliance with applicable requirements can result in fines,
injunctions, civil penalties, recall or seizure of products, total or partial
suspension of production, refusal to authorize the marketing of new products or
to allow us to enter into supply contracts and criminal prosecution. A 510(k)
clearance will typically be granted by the FDA if it can be established that the
device is substantially equivalent to a “predicate device,” which is a legally
marketed Class I or II device or a pre-amendment Class III device (that is, one
that has been marketed since a date prior to May 28, 1976), for which the FDA
has not called for PMA. The FDA has been requiring an increasingly rigorous
demonstration of substantial equivalence, which may include a requirement to
submit human clinical trial data. It generally takes 4 to 12 months from the
date of a 510(k) submission to obtain clearance, but it may take
longer.





If clearance or approval is obtained,
any device manufactured or distributed by us will be subject to pervasive and
continuing regulation by the FDA. We will be subject to routine inspection by
the FDA and will have to comply with the host of regulatory requirements that
usually apply to medical devices marketed in the U.S. including labelling
regulations, GMP requirements, Medical Device Reporting (MDR) regulation, which
requires a manufacturer to report to the FDA certain types of adverse events
involving its products, and the FDA’s prohibitions against promoting products
for unapproved or “off-label” uses.





European
Community





International Organization for
Standards, or “ISO”, standards were developed by the European Community, or
“EC”, as a tool for companies interested in increasing productivity, decreasing
cost and increasing quality. The EC uses ISO standards to provide a universal
framework for quality assurance and to ensure the good quality of products and
services across borders. The ISO standards (now ISO13485) have facilitated trade
throughout the EC, and businesses and governments throughout the world are
recognizing the benefit of the globally accepted uniform standards. Any
manufacturer we utilize for purposes of producing our products (including us, if
we manufacture any of our own products) will be required to obtain ISO
certification to facilitate the highest quality products and the easiest market
entry in cross-border marketing. This will enable us to market our products in
all of the member countries of the EC. We also will be required to comply with
additional individual national requirements that are outside the scope of those
required by the European Economic Area.





Any medical device that is legally
marketed in the US may be exported anywhere in the world without prior FDA
notification or approval. The export provisions of the FDC Act apply only to
unapproved devices. While FDA does not place any restrictions on the export of
these devices, certain countries may require written certification that a firm
or its devices are in compliance with US law. In such instances FDA will
accommodate US firms by providing a Certificate for Foreign Government. In cases
where there are devices which the manufacturer wishes to export during the
interim period while their 510(k) submission is under review, exporting may be
allowed without prior FDA clearance under certain limited
conditions.





Competition





We compete directly and indirectly
with other biotechnology and healthcare equipment businesses, including those in
the dialysis industry. The major competitors for our platform technology are
those companies manufacturing and selling dialysis equipment and supplies. We
anticipate that some of our primary competitors will be companies such as
Baxter, Fresenius, Gambro, NxStage and B Braun. We will compete with these
companies in the critical care markets as well as dialysis clinics, and the home
and wearable application markets. In many cases, these competitors are larger
and more firmly established than we are. In addition, our competitors have
greater marketing and development budgets and greater capital resources than our
company. Others are working on portable and wearable peritoneal dialysis
machines and competitors are working on portable hemodialysis machines, but we
are not aware of any other wearable hemodialysis machines currently under
development.





Patents
and Trademarks





We have
exclusive licenses to three issued U.S. patents, U.S. Patent No. 7,309,323
entitled “Wearable continuous renal replacement therapy device,” No. 7,276,042
entitled “Low hydraulic resistance cartridge,” and No. 6,960,179 entitled
“Wearable continuous renal replacement therapy device.” We also have exclusive
licenses to several pending U.S. patent applications, including U.S. Patent
Application No. 11/500,572 entitled “Dual-ventricle pump cartridge, pump, and
method of use in a wearable continuous renal replacement therapy
device.”





10


In addition to our exclusive licenses,
we are actively protecting inventions that are commercially important to our
business by developing our own intellectual property and filing and prosecuting
our own patents. We currently have 24 pending U.S. patent applications and 3 PCT
applications.





We also have pending applications to
register our trademarks, “Xcorporeal” and “Xcorporeal WAK.”





Employees





As of December 31, 2008, we had
approximately 24 full-time employees. However, as discussed above in the section
captioned “Recent Developments,” during the first quarter of 2009, we had to
adjust our employee headcount to more closely match our capital availability
and, as a result, terminated the employment of 19 employees. Assuming that we
have sufficient resources, we hope to increase our headcount in the future. We
also utilize, whenever appropriate, contract and part-time professionals in
order to advance our technologies while conserving cash and
resources.





Reports
to Security Holders





Our
Internet address is www.xcorporeal.com. The content on our website is available
for information purposes only. It should not be relied upon for investment
purposes, nor is it incorporated by reference into this Annual
Report.







We
make available free of charge through our Internet website under the heading
“Investors,” our Annual Report on Form 10-K or 10-KSB, Quarterly
Reports on Form 10-Q or 10-QSB, current reports on Form 8-K, Proxy
Statements on Schedule 14A and amendments to those reports and statements after
we electronically file such materials with the SEC. Copies of our key corporate
governance documents, including our Code of Ethics and charters for the
Audit Committee, the Compensation Committee and the Nominating
Committee are also available on our website. Our stockholders may
request free copies of these documents, including a copy of this Annual
Report, without charge by writing us at: Investor Relations, Xcorporeal, Inc,
12121 Wilshire Blvd. Suite 350, Los Angeles, California
90025.





Our
filed Annual and Quarterly Reports, Proxy Statements and other previously filed
SEC reports are also available to the public through the SEC’s website at
http://www.sec.gov. Materials we file with the SEC may also be read and copied
at the SEC’s Public Reference Room at 100 F Street, NE, Washington D.C.
20549. Information on the operation of the Public Reference Room may be obtained
by calling the SEC at 1-800-SEC-0330.





Item
1A.                      Risk
Factors





You should carefully consider and
evaluate all of the information in this Annual Report, including the risk
factors listed below. While we describe each risk separately, some of these
risks are interrelated and certain risks could trigger the applicability of
other risks described below. Also, the risks and uncertainties described below
are not the only ones that we may face. Additional risks and uncertainties not
presently known to us, or that we currently do not consider significant, could
also potentially impair, and have a material adverse effect on, our business,
results of operations and financial condition. If any of these risks occur, our
business, results of operations and financial condition could be harmed, the
price of our common stock could decline, and future events and circumstances
could differ significantly from those anticipated in the forward-looking
statements contained in this Annual Report.





Risks
Related to Our Business




There
is substantial doubt about our ability to continue as a going
concern.





Our independent registered public
accounting firm has issued a report on our financial statements for the fiscal
year ended December 31, 2008, that states that our recurring losses from
operations and net capital deficiency raise substantial doubt about our ability
to continue as a going concern. Our plans concerning these matters are discussed
in the section captioned “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and in Note 1, “Nature of Operations and
Going Concern Uncertainty” to the financial statements filed as part of this
Annual Report. Our ability to operate is dependent on meeting our cash
obligations as they become due which will depend on our ability to secure debt
or equity financing on acceptable terms or otherwise address these matters. If
we fail to do so for any reason, we would not be able to continue as a going
concern and could potentially be forced to seek relief through a filing under
the U.S. Bankruptcy Code.




We
need financing to continue our ongoing operations and will need additional
financing in the future.




We need
financing to continue our ongoing operations and pay our liabilities and we will
need additional financing to maintain and expand our business, and financing may
not be available on favorable terms, if at all.





We may finance our business through the
private placement or public offering of equity or debt securities. If we raise
additional funds by issuing equity securities, such financing may result in
further dilution to our stockholders. Any equity securities issued also may
provide for rights, preferences or privileges senior to those of holders of our
common stock. If we raise additional funds by issuing additional debt
securities, these debt securities would have rights, preferences and privileges
senior to those of holders of our common stock, and the terms of the debt
securities issued could impose significant restrictions on our operations. If we
raise additional funds through collaborations and licensing arrangements, we
might be required to relinquish significant rights to our technology or
products, or to grant licenses on terms that are not favorable to us. If we need
funds and cannot raise them on acceptable terms, we may not be able to execute
our business plan and our stockholders may lose substantially all of their
investment.




11


We
expect to continue to incur operating losses, and if we are not able to raise
necessary additional funds we may have to reduce or stop
operations.





We have not generated revenues or
become profitable, may never do so, and may not generate sufficient working
capital to cover the cost of operations. Our existing cash, cash equivalents and
marketable securities may not be sufficient to fund our business until we can
become cash flow positive and we may never become cash flow positive. No party
has guaranteed to advance additional funds to us to provide for any operating
deficits. Until we begin generating revenue, we may seek funding through the
sale of equity, or securities convertible into equity, which could result in
further dilution to our then existing stockholders. If we raise additional
capital through the incurrence of debt, our business may be affected by the
amount of leverage we incur, and our borrowings may subject us to restrictive
covenants. Such funding may not be available to us on acceptable terms, or at
all. If we are unable to obtain adequate financing on a timely basis, we may be
required to delay, reduce or stop operations, any of which would have a material
adverse effect on our business.




An
unfavorable result in the pending arbitration could have a material adverse
effect on our business.




We
consider the protection of our proprietary technology for treatment of kidney
failure, which we have licensed and are developing, to be critical to our
business prospects. We obtained the rights to some of our most significant
patented and patent-pending technologies through a License Agreement with NQCI.
On December 1, 2006, Operations initiated arbitration against NQCI for its
breach of the License Agreement, which remains pending. NQCI subsequently filed
counterclaims seeking to invalidate the License Agreement and claiming monetary
damages against us. On June 9, 2008, the arbitrator issued an Interim Award
granting specific performance of the Technology Transaction in consideration of
NQCI stockholders receiving 48% of all Operations shares outstanding as of the
date of the Merger Agreement. On August 4, 2008, the arbitrator issued a Second
Interim Award, modifying the initial Interim Award, stating that, if we desire
to close the Technology Transaction, we must obtain approval from a majority of
our stockholders and issue 9,230,000 shares of our common stock to NQCI. On
August 15, 2008, the arbitrator awarded NQCI $1.87 million of over $4 million it
claimed in attorneys’ fees and costs. The award has no effect on the additional
amount of approximately $690,000 claimed by NQCI in unpaid royalties and alleged
expenses under the License Agreement. The arbitrator has not yet ruled on this
claim.





On
September 4, 2008, the arbitrator issued an order that we should issue and
deliver the 9,230,000 shares directly to NQCI, rather than directly to NQCI
stockholders, if we obtain stockholder approval and elect to proceed with the
Technology Transaction.





On
January 30, 2009, the arbitrator issued the Order, which provides, among other
things, that if we file the Proxy Statement, obtain stockholder approval to
issue to NQCI 9,230,000 shares of our common stock as consideration for the
closing of the Technology Transaction and issue such shares to NQCI, the
arbitrator anticipates confirming that all of the Technology covered by the
License Agreement shall be declared our sole and exclusive
property.





The
arbitrator held a conference call hearing with the Company and NQCI on March 13,
2009 in which the parties discussed the reasons for the difficulties in closing
the Technology Transaction and explored potential alternatives. The parties were
asked to submit letter briefs outlining their suggested alternatives for
consideration by the arbitrator. The parties submitted their respective letter
briefs on March 24, 2009.





The
arbitrator has stated that he has not yet issued a final award that may be
confirmed or challenged in a court of competent jurisdiction. A party to the
arbitration could challenge the interim award in court, even after stockholders
approve the transaction. In addition, the arbitrator could again change the
award by granting different or additional remedies, even after stockholders
approve the transaction. We cannot guarantee that the arbitrator would order
that stockholders be given another opportunity to vote on the transaction, even
if such changes are material. Arbitrators have broad equitable powers, and
arbitration awards are difficult to challenge in court, even if the arbitrator
makes rulings that are inconsistent or not in accordance with the law or the
evidence.





Should
the arbitrator order a material change to the Second Interim Award, as modified
by the Order, after the vote of our stockholders, and further order that our
stockholders not be given another opportunity to vote on such proposal or on
such material change, such order could conflict with applicable federal
securities laws or NYSE Amex rules to which we are subject. In such event, we
would ask the arbitrator to amend such changed award or attempt to seek review
of the changed award in a court of competent jurisdiction. The closing of the
Technology Transaction may render any court review or appeal moot, effectively
preventing us from challenging any of the arbitrator’s awards in
court.





12


If the
arbitrator were to further modify any interim awards or orders, or if NQCI were
to prevail on some or all of its claims, we could be prevented from using some
or all of the patented technology we licensed from NQCI. That could
significantly impact our ability to use and develop our technologies, which
would have a material adverse effect on our business and results of
operations.





Our
limited operating history may make it difficult to evaluate our business to date
and our future viability.




We are in the early stage of
operations and development, and have only a limited operating history on which
to base an evaluation of our business and prospects, having commenced operations
in August 2006 in accordance with our new business plan and entry into the
medical devices industry. In addition, our operations and developments are
subject to all of the risks inherent in the growth of an early stage company. We
will be subject to the risks inherent in the ownership and operation of a
company with a limited operating history such as regulatory setbacks and delays,
fluctuations in expenses, competition, the general strength of regional and
national economies, and governmental regulation. Any failure to successfully
address these risks and uncertainties would seriously harm our business and
prospects. We may not succeed given the technological, marketing, strategic and
competitive challenges we will face. The likelihood of our success must be
considered in light of the expenses, difficulties, complications, problems and
delays frequently encountered in connection with the growth of a new business,
the continuing development of new technology, and the competitive and regulatory
environment in which we operate or may choose to operate in the future. We have
generated no revenues to date, and there can be no assurance that we will be
able to successfully develop our products and penetrate our target
markets.




Our
success will depend on our ability to retain our managerial personnel and to
attract additional personnel.




Competition for desirable personnel is
strong, and we cannot guarantee that we will be able to attract and retain the
necessary staff. The loss of members of managerial, sales or scientific staff
could have a material adverse effect on our future operations and on successful
development of products for our target markets. The failure to maintain our
management, particularly Kelly J. McCrann, our Chairman of the Board and Chief
Executive Officer, Robert Weinstein, our Chief Financial Officer and Secretary,
and Victor Gura, M.D., our Chief Medical and Scientific Officer, and to attract
additional key personnel could materially adversely affect our business,
financial condition and results of operations. Although we will provide
incentive compensation to attract and retain our key personnel, we cannot
guarantee that these efforts will be successful.




We will need to expand our finance,
administrative, product development, sales and marketing, and operations staff.
There are no assurances that we will be able to make such hires. However, as
discussed above in the section captioned “Recent Developments,” during the first
quarter of 2009, we had to adjust our employee headcount to more closely match
our capital availability and, as a result, terminated the employment of 19
employees. Assuming that we have sufficient resources, we hope to increase our
headcount in the future. In addition, we may be required to enter into
relationships with various strategic partners and other third parties necessary
to our business. Planned personnel may not be adequate to support our future
operations, management may not be able to hire, train, retain, motivate and
manage required personnel or management may not be able to identify, manage and
exploit existing and potential strategic relationships and market opportunities.
If we fail to manage our growth or personnel needs effectively, it could have a
material adverse effect on our business, results of operations and financial
condition.




We
need to develop our financial and reporting processes, procedures and controls
to support our anticipated growth.




We have begun investing in our
financial and reporting systems. To comply with our public reporting
requirements, and manage the anticipated growth of our operations and personnel,
we will be required to continue to improve existing or implement new operational
and financial systems, processes and procedures, and to expand, train and manage
our employee base. Our current and planned systems, procedures and controls may
not be adequate to support our future operations.




The laws and regulations affecting
public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and
rules adopted or proposed by the SEC, will result in increased costs to us as we
evaluate the implications of any new rules and respond to their requirements.
New rules could make it more difficult or more costly for us to obtain certain
types of insurance, including director and officer liability insurance, and we
may be forced to accept reduced policy limits and coverage or incur
substantially higher costs to obtain the same or similar coverage. In addition,
the need to comply with any new rules and regulations will continue to place
significant demands on our financial and accounting staff, financial, accounting
and information systems, and our internal controls and procedures, any of which
may not be adequate to support our anticipated growth. We cannot predict or
estimate the amount of the additional costs we may incur or the timing of such
costs to comply with any new rules and regulations, or if compliance can be
achieved.




We
cannot assure you that we will be able to complete development and obtain
necessary approvals for our proposed products even if we obtain sufficient
funding.




We will need additional financing to
maintain and expand our business, and such financing may not be available on
favorable terms, if at all. Even if we obtain sufficient funding, no assurance
can be given that we will be able to design or have designed parts necessary for
the manufacture of our products or complete the development of our proposed
products within our anticipated time frames, if at all. Such a situation could
have a material adverse effect upon our ability to remain in business. For
additional risks that we may encounter as a result of our need for additional
financing, please see risk factor below captioned “We need financing to continue
our ongoing operations and will need additional financing in the
future”.




13


The
success of our business will depend on our ability to develop and protect our
intellectual property rights, which could be expensive.




Patent and other proprietary rights
are essential to our business. Our success and the competitiveness of our
products are heavily dependent upon our proprietary technology and our ability
to obtain and enforce patents and licenses to patent rights, both in the U.S.
and in other countries. We cannot be certain that the patents that we license
from others will be enforceable and afford protection against competitors. We
rely on a combination of trademark and copyright laws, trade secrets and
know-how to develop, confidentiality procedures and contractual provisions to
maintain and strengthen our competitive position. Such means of protecting our
proprietary rights may not be adequate because such laws provide only limited
protection.  While we protect our proprietary rights to the extent
possible, we cannot guarantee that third parties will not know, discover or
develop independently equivalent proprietary information or techniques, that
they will not gain access to our trade secrets or disclose our trade secrets to
the public. Therefore, we cannot guarantee that we can maintain and protect
unpatented proprietary information and trade secrets. Misappropriation of our
intellectual property would have an adverse effect on our competitive position,
may cause us to incur substantial litigation costs and could harm our business,
financial condition and results of operations and your investment.




Generally, we enter into
confidentiality and non-disclosure of intellectual property agreements with our
employees, consultants and many of our vendors, and generally control access to
and distribution of our proprietary information. Notwithstanding these
precautions, it may be possible for a third party to copy or otherwise obtain
and use our proprietary information without authorization or to develop similar
information independently.




Additionally, our patent rights may
not provide us with proprietary protection or competitive advantages against
competitors with similar technologies. Even if such patents are valid, we cannot
guarantee that competitors will not independently develop alternative
technologies that duplicate the functionality of our technology. Our competitors
may independently develop similar or superior technology. Policing unauthorized
use of proprietary rights is difficult, and some international laws do not
protect proprietary rights to the same extent as United States laws. Litigation
periodically may be necessary to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Litigation is costly and may not be successful.
Our failure to protect our proprietary technology or manufacturing processes
could harm our business, financial condition and results of operations and your
investment.




We may be subject to claims that we
infringe the intellectual property rights of others and unfavorable outcomes
could harm our business.




Our future operations may be subject
to claims, and potential litigation, arising from our alleged infringement of
patents, trade secrets or copyrights owned by other third parties, including
third party rights in patents that have not yet been issued.  We
intend to fully comply with the law in avoiding such infringements. However,
within the medical devices industry, established companies have actively pursued
such infringements, and have initiated such claims and litigation, which has
made the entry of competitive products more difficult. We may experience such
claims or litigation initiated by existing, better-funded
competitors.




If we do
infringe, the holder of the patent may seek to cause us to cease using the
technology subject to the patent, or require us to enter into a license or other
similar agreement and pay for our use of the intellectual property. In either
case, such event may have a material negative impact on our performance.
Court-ordered injunctions may prevent us from bringing new products to market,
and the outcome of litigation and any resulting loss of revenues and expenses of
litigation may substantially affect our ability to meet our expenses and
continue operations. Also, since we rely upon unpatented proprietary technology,
there is no assurance that others may not acquire or independently develop the
same or similar technology.




Patent
applications in the United States are maintained in secrecy until patents are
issued, and the publication of discoveries in the scientific literature tends to
lag behind actual discoveries. Therefore, we cannot guarantee that we will be
the first creator of future inventions for which we seek patents or the first to
file patent applications for any of our inventions.




Patent
applications filed in foreign countries are subject to laws, rules and
procedures which differ from those of the United States.  We cannot be
certain that:




·  patents
will be issued from future applications;


·  any
future patents will be sufficient in scope or strength to provide meaningful
protection or any commercialadvantage to us;


·  foreign
intellectual property laws will protect our intellectual property;
or


·  others
will not independently develop similar products, duplicate our products or
design around any patentswhich may be issued to us.





Policing
unauthorized use of intellectual property is difficult.  The laws of
other countries may afford little or no effective protection of our technology.
We cannot assure you that the steps taken by us will prevent misappropriation of
our technology, which may cause us to lose customers and revenue opportunities.
In addition, pursuing persons who might misappropriate our intellectual property
could be costly and divert the attention of management from the operation of our
business.




14


We are
not aware and do not believe that any of our technologies or products infringe
the proprietary rights of third parties. Nevertheless, third parties may claim
infringement with respect to our current or future technologies or products or
products manufactured by others and incorporating our technologies. Responding
to any such claims, whether or not they are found to have merit, could be time
consuming, result in costly litigation, cause development delays, require us to
enter into royalty or license agreements, or require us to cease using the
technology that is the intellectual property of a third party. Royalty or
license agreements may not be available on acceptable terms or at all. As a
result, infringement claims could have a material adverse affect on our
business, operating results, and financial condition.




Confidentiality
agreements with employees, licensees and others may not adequately prevent
disclosure of trade secrets and other proprietary information.




In order
to protect our proprietary technology and processes, we rely in part on
confidentiality provisions in our agreements with employees, licensees, and
others. These agreements may not effectively prevent disclosure of confidential
information and may not provide an adequate remedy in the event of unauthorized
disclosure of confidential information. In addition, others may independently
discover trade secrets and proprietary information. Costly and time-consuming
litigation could be necessary to enforce and determine the scope of our
proprietary rights, and failure to obtain or maintain trade secret protection
could adversely affect our competitive business position.




We
compete against other dialysis equipment manufacturers with much greater
financial resources and better established products and customer relationships,
which may make it difficult for us to penetrate the market and achieve
significant sales of our products.




Our proposed products will compete
directly against equipment produced by Fresenius Medical Care AG, Baxter
Healthcare Corporation, Gambro AB, NxStage Medical, Inc., B Braun and others,
each of which markets one or more FDA-cleared medical devices for the treatment
of acute or chronic kidney failure.




Each of these competitors offers
products that have been in use for a longer time than our products and are more
widely recognized by physicians, patients and providers. Most of our competitors
have significantly more financial and human resources, more established sales,
service and customer support infrastructures and spend more on product
development and marketing than we do. Many of our competitors also have
established relationships with the providers of dialysis therapy. Most of these
companies manufacture additional complementary products enabling them to offer a
bundle of products and have established sales forces and distribution channels
that may afford them a significant competitive advantage.




The healthcare business in general, and
the market for our products in particular, is competitive, subject to change and
affected by new product introductions and other market activities of industry
participants, including increased consolidation of ownership of clinics by large
dialysis chains. If we are successful, our competitors are likely to develop
products that offer features and functionality similar to our proposed products.
Improvements in existing competitive products or the introduction of new
competitive products may make it more difficult for us to compete for sales,
particularly if those competitive products demonstrate better safety,
convenience or effectiveness or are offered at lower prices. If we are unable to
compete effectively against existing and future competitors and existing and
future alternative treatments and pharmacological and technological advances, it
will be difficult for us to penetrate the market and achieve significant sales
of our products.




We
have not commissioned or obtained marketing studies which support the likelihood
of success of our business plan.




No independent studies with regard to
the feasibility of our proposed business plan have been conducted by any
independent third parties with respect to our present and future business
prospects and our capital requirements. In addition, there can be no assurances
that our products or our treatment modality for ESRD will find sufficient
acceptance in the marketplace to enable us to fulfil our long and short term
goals, even if adequate financing is available and our products are approved to
come to market, of which there can be no assurance.




Our
ability to utilize net operating loss carry forwards may be
limited.




At
December 31, 2008, we had net operating loss carry forwards (NOLs) for U.S.
federal and state income tax purposes of approximately $24.3 million. These NOLs
may be used to offset future taxable income, to the extent we generate any
taxable income, and thereby reduce or eliminate our future U.S. federal and
California income taxes otherwise payable.  Section 382 of the
Internal Revenue Code of 1986, as amended, or the “Code”, imposes limitations on
a corporation’s ability to utilize NOLs if it experiences an “ownership change”
as defined in Section 382 of the Code. In general terms, an ownership
change may result from transactions that have the effect of increasing the
percentage ownership of certain stockholders in the stock of a corporation by
more than 50 percentage points over a three-year period. In the event of an
ownership change, a corporation’s utilization of NOLs generated prior to the
ownership change is subject to an annual limitation determined by multiplying
the value of the corporation at the time of the ownership change by the
“applicable long-term tax-exempt rate,” as defined in the Code. Any unused
annual limitation may be carried over to later years. Our NOLs for federal and
state income tax purposes begin to expire in 2021.





15


In 2007,
we determined that an ownership change occurred under Section 382. The
utilization of our federal NOLs, capital loss carryforwards and other tax
attributes related to our company prior to the merger with pre-merger Xcorporeal
therefore will be limited to zero. Accordingly, we have reduced our NOLs and
capital loss and minimum tax credit carryforwards to the amount that we estimate
that we would be able to utilize in the future, if profitable, considering the
above limitations. At December 31, 2008, after Section 382 reductions we had
NOLs for U.S. federal income tax purposes of approximately $24.3 million which
NOLs will begin to expire in 2021. $24.3 million of the net NOLs are also valid
for state income tax purposes and will begin to expire in 2021.





The
occurrence of one or more natural disasters or acts of terrorism could adversely
affect our operations and financial performance.





The
occurrence of one or more natural disasters or acts of terrorism could result in
physical damage to or the temporary closure of our corporate office and/or
operating facility. It may also result in the temporary lack of an adequate work
force in a market and/or the temporary or long term disruption in the supply of
materials (or a substantial increase in the cost of those materials) from
suppliers. One or more natural disasters or acts of terrorism could materially
and adversely affect our operations and financial performance. Furthermore,
insurance costs associated with our business may rise significantly in the event
of a large scale natural disaster or act of terrorism.





Terrorist
attacks and other attacks or acts of war may adversely affect the markets on
which our common stock trades, which could have a materially adverse effect on
our financial condition, our results of operations and the price of our common
stock.





On
September 11, 2001, the United States was the target of terrorist attacks of
unprecedented scope. In March 2003, the United States and allied nations
commenced a war in Iraq. These attacks and the war in Iraq caused global
instability in the financial markets. There could be further acts of terrorism
in the United States or elsewhere that could have a similar impact. Armed
hostilities or further acts of terrorism could cause further instability in
financial markets and could directly impact our financial condition, our
results


of
operations and the price of our common stock.





Risks
Related to Our Industry




Our
business will always be strictly regulated by the federal and other governments
and we cannot assure you that we will remain in compliance with all applicable
regulation.




The
healthcare industry is highly regulated and continues to undergo significant
changes as third-party payers, such as Medicare and Medicaid, traditional
indemnity insurers, managed care organizations and other private payers increase
efforts to control cost, utilization and delivery of healthcare services.
Healthcare companies are subject to extensive and complex federal, state and
local laws, regulations and judicial decisions. In addition, clinical testing,
manufacture, promotion and sale of our proposed products are subject to
extensive regulation by numerous governmental authorities in the U.S.,
principally the FDA, and corresponding foreign regulatory agencies. Compliance
with laws and regulations enforced by regulatory agencies who have broad
discretion in applying them may be required for the medical products developed
or used by us. Many healthcare laws and regulations applicable to our business
are complex, applied broadly and subject to interpretation by courts and
government agencies. Regulatory, political and legal action and pricing
pressures could prevent us from marketing some or all of our products and
services for a period of time or permanently. Moreover, changes in existing
regulations or adoption of new regulations or policies could prevent us from
obtaining, or affect the timing of, future regulatory approvals or clearances.
We cannot assure you that we will be able to obtain necessary regulatory
clearances or approvals on a timely basis, or if at all, or that we will not be
required to incur significant costs in obtaining or maintaining such foreign
regulatory approvals. Delays in receipt of, or failure to receive, such
approvals or clearances, the loss of previously obtained approvals or clearances
or the failure to comply with existing or future regulatory requirements could
have a material adverse effect on our business, financial condition and results
of operations.




Any
enforcement action by regulatory authorities with respect to past or future
regulatory non-compliance could have a material adverse effect on our business,
financial condition and results of operations. Non-compliance with applicable
requirements can result in fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, refusal to
authorize the marketing of new products or to allow us to enter into supply
contracts and criminal prosecution.




Even if
our proposed products are approved for sale, we will be subject to continuing
regulation. We continuously will be subject to routine inspection by the FDA and
will have to comply with the host of regulatory requirements that usually apply
to medical devices marketed in the U.S. including labelling regulations, Quality
System requirements, MDR regulations (which requires a manufacturer to report to
the FDA certain types of adverse events involving its products), and the FDA’s
prohibitions against promoting products for unapproved or “off-label” uses. Our
failure to comply with applicable regulatory requirements could result in
enforcement action by the FDA, which could have a material adverse effect on our
business, financial condition and results of operations.




In
addition, foreign laws, regulations and requirements applicable to our business
and products are often vague and subject to change and interpretation. Failure
to comply with applicable international regulatory requirements can result in
fines, injunctions, civil penalties, recalls or seizures of products, total or
partial suspensions of production, refusals by foreign governments to permit
product sales and criminal prosecution. Furthermore, changes in existing
regulations or adoption of new regulations or policies could prevent us from
obtaining, or affect the timing of, future regulatory approvals or clearances.
There can be no assurance that we will be able to obtain necessary regulatory
clearances or approvals on a timely basis, or if at all, or that we will not be
required to incur significant costs in obtaining or maintaining such foreign
regulatory approvals. Delays in receipt of, or failure to receive, such
approvals or clearances, the loss of previously obtained approvals or clearances
or the failure to comply with existing or future regulatory requirements could
have a material adverse effect on our business, financial condition and results
of operations. Any enforcement action by regulatory authorities with respect to
past or future regulatory non-compliance could have a material adverse effect on
our business, financial condition and results of operations.





16


Our
failure to respond to rapid changes in technology and its applications and
intense competition in the medical devices industry could make our treatment
system obsolete.




The medical devices industry is subject
to rapid and substantial technological development and product innovations. To
be successful, we must respond to new developments in technology, new
applications of existing technology and new treatment methods. Our response may
be stymied if we require, but cannot secure, rights to essential third-party
intellectual property. We may compete against companies offering alternative
treatment systems to ours, some of which have greater financial, marketing and
technical resources to utilize in pursuing technological development and new
treatment methods. Our financial condition and operating results could be
adversely affected if our medical device products fail to compete favorably with
these technological developments, or if we fail to be responsive on a timely and
effective basis to competitors’ new devices, applications, treatments or price
strategies.




Product
liability claims could adversely affect our results of operations.




The risk of product liability claims,
product recalls and associated adverse publicity is inherent in the testing,
manufacturing, marketing and sale of medical products. In an effort to minimize
our liability we purchase product liability insurance coverage. In the future,
we may not be able to secure product liability insurance coverage on acceptable
terms or at reasonable costs when needed. Any liability for mandatory damages
could exceed the amount of our coverage. A successful product liability claim
against us could require us to pay a substantial monetary award. Moreover, a
product recall could generate substantial negative publicity about our products
and business and inhibit or prevent commercialization of other future product
candidates.




Risks
Related to Our Common Stock




If
we fail to meet continued listing standards of NYSE Amex, our common stock may
be delisted which would have a material  adverse effect on the price
of our common stock.





Our
common stock is currently traded on the NYSE Amex under the symbol “XCR”. In
order for our securities to be eligible for continued listing on NYSE Amex, we
must remain in compliance with certain NYSE Amex continued listing standards. As
of December 31, 2008 we were not in compliance with Sections 1003(a)(i),
1003(a)(ii) and 1003(a)(iii) of the Amex Company Guide because our stockholders’
equity was below the level required by the NYSE Amex continued listing
standards. Our stockholders’ equity fell below the required standard due to
several years of operating losses. NYSE Amex will normally consider suspending
dealings in, or removing from the listing of, securities of a company under
Section 1003(a)(i) for a company that has stockholders’ equity of less than
$2,000,000 if such company has sustained losses from continuing operations
and/or net losses in two of its three most recent fiscal years, under Section
1003(a)(ii) for a company that has stockholders’ equity of less than $4,000,000
if such company has sustained losses from continuing operations and/or net
losses in three of its four most recent fiscal years or under Section
1003(a)(iii) for a company that has stockholders’ equity of less than $6,000,000
if such company has sustained losses from continuing operations and/or net
losses in its five most recent fiscal years. As of December 31, 2008, our
stockholders' equity was below that required under Sections 1003(a)(i),
1003(a)(ii) and 1003(a)(iii) of the Amex Company Guide and we have sustained net
losses in our five most recent fiscal years. If  we receive
notification from the NYSE Amex that we are no longer in compliance with their
minimum listing requirements and if we fail to regain compliance with such
continued listing requirements, our  common stock may be delisted
which would have a material adverse affect on the price and liquidity of our
common stock.





Furthermore, we cannot assure you that
we will continue to satisfy other requirements necessary to remain listed on the
NYSE Amex or that the NYSE Amex will not take additional actions to delist our
common stock. As a result of the resignation of Marc Cummins from his positions
of a member of our Board of Directors and a member of the Audit Committee of the
Board of Directors, effective March 6, 2009, we are no longer in compliance with
Section 803(A)(1) of the Amex Company Guide because a majority of the members of
our Board of Directors are not independent directors. In order to fill the
vacancy in the Audit Committee created by such resignation, effective March 26,
2009, Hans-Dietrich Polaschegg, a member of our Board of Directors, was
appointed to the Audit Committee.





If for any reason, our common stock
were to be delisted from the NYSE Amex, we may not be able to list our common
stock on another national exchange or market. If our common stock is not listed
on a national exchange or market, the trading market for our common stock may
become illiquid.





17




If
we are delisted from NYSE Amex, our common stock may be subject to the “penny
stock” rules of the SEC, which would make transactions in our common stock
cumbersome and may reduce the value of an investment in our stock.





The
SEC has adopted Rule 3a51-1 under the Exchange Act which establishes the
definition of a “penny stock,” for the purposes relevant to us, as any equity
security that has a market price of less than $5.00 per share or with an
exercise price of less than $5.00 per share, subject to certain exceptions. For
any transaction involving a penny stock, unless exempt, Rule 15g-9
requires:





·
            that  a  broker  or  dealer  approve  a  person's   account  for
      transactions in penny stocks; and


·
            the  broker  or  dealer  receive  from
      the  investor  a  written
      agreement  to
      the  transaction,  setting  forth the
      identity and quantity of the penny stock to be
  purchased.





In order
to  approve  a  person's  account  for  transactions  in
penny stocks, the broker or dealer must:





·
              obtain   financial   information   and   investment   experience
      objectives of the person; and


·
              make
      a reasonable  determination  that the transactions in
      penny
      stocks  are   suitable  for  that  person  and  the  person  has
      sufficient  knowledge and experience in
      financial  matters to be capable of evaluating the risks of
      transactions in penny stocks.





The
broker or dealer must also deliver,  prior to
any  transaction  in a penny stock, a
disclosure  schedule  prescribed by the SEC relating to the
penny stock market, which, in highlight form:





·
              sets  forth  the
      basis on which  the  broker or dealer  made
      the suitability determination;
and


·
              that
      the broker or dealer received a
      signed,  written  agreement from the investor prior to
      the transaction.





Generally, brokers may be less willing
to execute transactions in securities subject to the “penny stock” rules. This
may make it more difficult for our investors to dispose of our common stock and
cause a decline in the market value of our stock.





Disclosure also has to be made about
the risks of investing in penny stocks in both public offerings and in secondary
trading and about the commissions payable to both the broker-dealer and the
registered representative, current quotations for the securities and the rights
and remedies available to an investor in cases of fraud in penny stock
transactions. Finally, monthly statements have to be sent to investors
disclosing recent price information for the penny stock held in the account and
information on the limited market in penny stocks.





Our
stock price is volatile and accordingly, you could lose all or part of the value
of your shares of our common stock.




Our
common stock is traded on the NYSE Amex and trading volume is often limited and
sporadic. As a result, the trading price of our common stock on NYSE Amex is not
necessarily a reliable indicator of our fair market value. The market price of
our common stock has historically been highly volatile and may continue to
fluctuate significantly due to a number of factors, some of which may be beyond
our control, including:




·
            the
      number of shares available for sale in the
  market;


·
            sales
      of our common stock by shareholders because our business profile does not
      fit their investment objectives;


·
            actual
      or anticipated fluctuations in our operating
  results;


·
            developments
      relating to our products and related proprietary
  rights;


·
            actual
      or anticipated announcements of new data and announcements relating to our
      operating performance;


·
            government
      regulations and changes thereto and regulatory investigations or
      determinations;


·
            our
      ability to meet continued listing standards of NYSE
  Amex


·
            announcements
      of our competitors or their success in the biotechnology and healthcare
      equipment business, including those in the dialysis
    industry;


·
            recruitment
      or departures of key personnel;


·
            the
      gain or loss of significant
customers;


·
            the
      operating and stock price performance of other comparable
      companies;


·
            developments
      and publicity regarding our industry;
and


·
            general
      economic and market conditions in our industry and the economy as a
      whole.





In addition, the stock market in
general has experienced volatility that has often been unrelated to the
operating performance of individual companies. These broad market fluctuations
may adversely affect the trading price of our common stock, regardless of our
actual performance, and could enhance the effect of any fluctuations that do
relate to our operating results.





18


Over
42% of our stock is controlled by a single stockholder which has the ability to
substantially influence the election of directors and the outcome of matters
submitted to our stockholders.




As of December 31, 2008, Consolidated
National, LLC, a limited liability company, or “CNL”, of which Terren S. Peizer,
a member of our Board of Directors, is the sole managing member and beneficial
owner, directly owned approximately 6.23 million shares, representing
approximately 42.2% of our outstanding common stock. As a result, CNL and Mr.
Peizer presently have and are expected to continue to have the ability to
determine the outcome of issues submitted to our stockholders. The interests of
CNL or Mr. Peizer, acting in his capacity as a stockholder, may not always
coincide with our interests or the interests of our other stockholders and they
may act in a manner that advances their best interests and not necessarily those
of our stockholders. The ownership position of CNL and Mr. Peizer may make it
difficult for our stockholders to remove our management from office should they
choose to do so. It could also deter unsolicited takeovers, including
transactions in which our stockholders might otherwise receive a premium for
their shares over then current market prices.




Pursuant
to the terms of the Second Interim Award, as modified by the Order, if we desire
to close the Technology Transaction, we will be required to issue 9,230,000
shares of our common stock to NQCI and a result, NQCI would own approximately
39% of our total outstanding shares, making NQCI our largest stockholder and
giving NQCI the ability to substantially influence the election of directors and
the outcome of matters submitted to our stockholders.




On August 4, 2008, the arbitrator
issued a Second Interim Award, modifying the initial Interim Award, stating
that, if we desire to close the Technology Transaction, we must, among other
things, issue to NQCI 9,230,000 shares of our common stock. Accordingly,
following the closing of the Technology Transaction, NQCI would own
approximately 39% of our total outstanding shares, making NQCI our largest
stockholder. As a result, NQCI would have the ability to determine the outcome
of issues submitted to our stockholders. The interests of NQCI may not always
coincide with our interests or the interests of our other stockholders and it
may act in a manner that advances its best interests and not necessarily those
of our stockholders. The ownership position of NQCI may make it difficult for
our stockholders to remove our management from office should they choose to do
so. It could also deter unsolicited takeovers, including transactions in which
our stockholders might otherwise receive a premium for their shares over then
current market prices.




Sales
of common stock by our large stockholders, or the perception that such sales may
occur, could depress our stock price.





The market price of our common stock
could decline as a result of sales by, or the perceived possibility of sales by,
our large stockholders, including NQCI in the event that the Technology
Transaction closes. Most of our outstanding shares were registered on a Form S-4
registration statement in connection with our merger with pre-merger Xcorporeal,
and are eligible for public resale. As of December 31, 2008, approximately 58%
of our outstanding common stock was held by our officers, directors and
affiliates and may be sold pursuant to an effective registration statement or in
accordance with Rule 144 promulgated under the Securities Act or pursuant to
other exempt transactions. Pursuant to the terms of the Second Interim Award, as
modified by the order, we are required to issue NQCI 9,230,000 shares of our
common stock if we want to close the Technology Transaction.  Future
sales of our common stock by our significant stockholders, including NQCI if it
acquires these shares, or the perception that such sales may occur, could
depress the market price of our common stock.




Investors’
interests in our company will be diluted and investors may suffer dilution in
their net book value per share if we issue additional shares of stock or raise
funds through the sale of equity securities.




In the event that we are required to
issue any additional shares of stock or enter into private placements to raise
financing through the sale of equity securities, investors’ interests in our
company will be diluted and investors may suffer dilution in their net book
value per share depending on the price at which such securities are sold. If we
issue any such additional shares, such issuances also will cause a reduction in
the proportionate ownership and voting power of all of our other stockholders.
Further, any such issuance may result in a change in our control of our
company.




We
have never paid cash dividends and do not intend to do so.




We have never declared or paid cash
dividends on our common stock. We currently plan to retain any earnings to
finance the growth of our business rather than to pay cash dividends. Payments
of any cash dividends in the future will depend on our financial condition,
results of operations and capital requirements, as well as other factors deemed
relevant by our Board of Directors.




There
is an increased potential for short sales of our common stock due to the sales
of shares issued upon exercise of the warrants or options, which could
materially affect the market price of the stock.





Downward pressure on the market price of
our common stock that likely will result from sales of our common stock issued
in connection with an exercise of warrants or options could encourage short
sales of our common stock by market participants. Generally, short selling means
selling a security, contract or commodity not owned by the seller. The seller is
committed to eventually purchase the financial instrument previously sold. Short
sales are used to capitalize on an expected decline in the security’s price. As
the holders exercise their warrants or options, we issue shares to the
exercising holders, which such holders may then sell into the market. Such sales
could have a tendency to depress the price of the stock, which could increase
the potential for short sales.




19


We
became a publicly traded company through a merger with a public shell company,
and we could be liable for unanticipated liabilities of our predecessor
entity.





We became a publicly traded company
through a merger between Xcorporeal, Inc. and CT Holdings Enterprises, Inc., a
publicly traded “shell company” that had previously provided management
expertise including consulting on operations, marketing and strategic planning
and a single source of capital to early stage technology
companies.  Although we believe the shell company had substantially no
assets and liabilities as of the merger, we may be subject to claims related to
the historical business of the shell, as well as costs and expenses related to
the merger.





Item
1B.               Unresolved
Staff Comments





Not applicable.





Item
2:                 Properties





Corporate
Office and Operating Facility





As of
February 22, 2008, we entered into a 5 year lease agreement for 4,352 square
feet of corporate office space located in Los Angeles, California. The total
lease payments will be $1,096,878 over the 5 year period with the lease expiring
on February 28, 2013. On October 6, 2008, as modified on October 23, 2008, we
also entered into a 5 year lease agreement, commencing November 27, 2008,
through November 26, 2013, with early possession on October 27, 2008, for our
new operating facility which consists of approximately 21,400 square feet of
office and lab space in Lake Forest, California. The total lease payments will
be $1,367,507 over the lease term. Additionally, we lease two corporate
apartments, approximately 800 and 550 square feet, expiring March 31, 2009 and
April 18, 2009, respectively, located in Irvine, California, for combined
monthly rent of $3,765, which we plan to vacate after the expiration of their
lease terms. All of the space is in good condition and we expect it to remain
suitable to meet our needs for the foreseeable future. Consistent with the
actions undertaken as part of our corporate restructuring described above in
section captioned “Business - Recent Developments”, we intend to consolidate our
offices and sublease our current corporate office located in Los Angeles,
California. For more information, please see Note 11, “Leases” to our financial
statements filed as part of this Annual Report.





Item
3.                 Legal
Proceedings





From time
to time we may be a defendant or plaintiff in various legal proceedings arising
in the normal course of our business. Except as set forth below, we are
currently not a party to any material pending legal proceedings or government
actions, including any bankruptcy, receivership, or similar proceedings. In
addition, except as set forth below, our management is not aware of any known
litigation or liabilities that could affect our operations. Furthermore, with
the exception of Dr. Gura, our Chief Medical and Scientific Officer, who
according to NQCI’s preliminary Proxy Statement on Schedule 14A, Amendment No.
2, filed with the SEC on February 13, 2009, owns 15,497,250 shares of NQCI’s
common stock which includes 800,000 shares held by Medipace Medical Group, Inc.
an affiliate of Dr. Gura and includes 250,000 shares subject to warrants held by
Dr. Gura which are currently exercisable, or approximately 20.9% of its total
outstanding shares as of January 31, 2009, we do not believe that there are any
proceedings to which any of our directors, officers, or affiliates, any owner of
record who beneficially owns more than five percent of our common stock, or any
associate of any such director, officer, affiliate of the Company, or security
holder is a party adverse to the Company or has a material interest adverse to
the Company.




On
December 1, 2006, Operations initiated arbitration proceedings against NQCI for
its breach of the License Agreement, which remains pending. NQCI claimed the
License Agreement was terminated, and we sought a declaration that the License
Agreement remained in effect until the closing of the Merger or the Technology
Transaction. We later amended our claims to seek damages for NQCI’s failure to
perform its obligations under the License Agreement. NQCI filed counterclaims
seeking to invalidate the License Agreement and claiming monetary damages
against us. NQCI also filed claims against Dr. Gura, claiming he breached his
obligations to NQCI by agreeing to serve on our Board of Directors. Following a
hearing and extensive briefing, the arbitrator denied both parties’ claims for
damages. Although NQCI never filed an amendment to its counterclaims to seek
specific performance, on June 9, 2008, the arbitrator, issued an Interim Award
granting specific performance of the Technology Transaction.




The
Interim Award stated that the total aggregate shares of stock to be received by
NQCI stockholders at the closing should equal 48% of all Operations shares
outstanding as of the date of the Merger Agreement. On September 1, 2006, there
were 10,000,000 shares of Operations common stock outstanding. NQCI proposed
four possible share interest awards, arguing that it was entitled to shares
representing a 48% or 54% interest based on Operations shares outstanding at the
time of the Merger Agreement or our present number of outstanding
shares.




On August
4, 2008, the arbitrator issued a Second Interim Award, modifying the initial
Interim Award, stating that, if we desire to close the Technology Transaction,
we must obtain approval from a majority of our stockholders and issue 9,230,000
shares of our common stock to NQCI. It is our understanding that the arbitrator
based his decision as to the number of shares that we must issue on the factors
set forth below. Our understanding set forth below is derived from the terms of
the Second Interim Award and the Order, which we strongly encourage you to read
and review carefully, copies of which were attached to our Proxy Statement on
Schedule 14A, Amendment No. 5, filed with the SEC on February 10,
2009.




20




·
            In
      accordance with the second paragraph of page 7 of the Award, under the
      Merger Agreement, the number of shares of our common stock which NQCI was
      to receive at the closing of the transaction contemplated by the Merger
      Agreement was based on the number of shares or our common stock
      outstanding as of the date of the Merger Agreement, or 10,000,000
      shares.




·
            If
      the Merger Agreement was terminated, resulting in the closing of the
      Technology Transaction, (i) pursuant to Section 6(B)(2)(i) of the Merger
      Agreement, NQCI was to receive a 48% share of the aggregate amount of our
      shares of common stock if we terminated the Merger Agreement for NQCI’s
      breach or either party terminated under the December 1 or December 29
      deadlines, and (ii) pursuant to Section 6(B)(2)(ii) of the Merger
      Agreement, NQCI was to get a 54% share if we terminated for
      dissatisfaction with our due diligence, or NQCI terminated for our breach
      (as more fully described in the Merger
  Agreement).




·
            The
      arbitrator determined that NQCI was not entitled to terminate the Merger
      Agreement outright and that its notice of termination was improper.
      Therefore, the arbitrator determined that, since NQCI was at fault, NQCI
      is entitled to receive the lesser of the two alternatives (48% instead of
      54%).




·
            Therefore,
      according to the arbitrator, in order to award a 48% share to NQCI,
      assuming that there were 10,000,000 shares of our common stock outstanding
      on the date of the Merger Agreement, we must issue to NQCI 9,230,000
      shares of our common stock, which would represent 48% of the aggregate
      total of 19,230,000 shares of our common stock which would have been
      outstanding after giving effect to such
  issuance.





Following
the closing of the Technology Transaction, NQCI would own approximately 39% of
our total outstanding shares, making NQCI our largest stockholder. The
arbitrator found that, with the exception of stockholder approval, virtually all
conditions to closing the Technology Transaction have been waived, including
virtually all of NQCI’s representations and warranties concerning the
Technology.





The
Second Interim Award also stated that, contrary to the assertions made by NQCI,
the License Agreement will remain in full force and effect until the Technology
Transaction closes or the arbitrator determines that it will never close. Upon
closing of the Technology Transaction and satisfaction of the terms of the
Award, as modified by the Order, the License Agreement will terminate and we
will own all of the Technology.





On
January 3, 2008, the arbitrator issued an order denying NQCI’s motion to amend
its counterclaim to add us as a successor company following the Merger. However,
in the Second Interim Award, the arbitrator found that we are the successor to
Operations as a result of the merger, even though we are not a party to any of
the agreements or the arbitration, and ordered that our shares should be issued
to NQCI rather than shares of Operations.





The arbitrator has not ordered us to
close the Technology Transaction. However, the Second Interim Award states that,
if our stockholders fail to approve the issuance of stock to effectuate the
Technology Transaction, all of the Technology covered by the License shall be
declared the sole and exclusive property of NQCI, and the arbitrator shall
schedule additional hearings to address two questions: whether the PAK
technology is included within that Technology, and whether NQCI is entitled to
compensatory damages and the amount of damages under these circumstances. During
the arbitration, NQCI took the position that we had misappropriated trade
secrets regarding the WAK and used them to create the PAK. The arbitrator found
that we had not misappropriated NQCI’s trade secrets. However, should the
Technology Transaction not close for any reason, and the arbitrator rules that
the licensed Technology must be returned to NQCI, the arbitrator could find that
the PAK is derived in whole or in part from licensed Technology, and could rule
that Operations must “return” the PAK technology to NQCI or that NQCI is
entitled to compensatory damages or both.





On August
15, 2008, the arbitrator awarded NQCI $1.87 million of over $4 million it
claimed in attorneys’ fees and costs. The award has no effect on the additional
amount of approximately $690,000 claimed by NQCI in alleged expenses, Licensor
Expenses, under the License Agreement. The arbitrator has not yet ruled on this
claim.





In an
August 29, 2008 Order Re Issuance of Xcorporeal Shares, the arbitrator stated
that the shares should be issued directly to NQCI’s stockholders. However, on
September 4, 2008, the arbitrator issued an order that we should issue and
deliver the 9,230,000 shares directly to NQCI, rather than directly to NQCI
stockholders, if we obtain stockholder approval and elect to proceed with the
Technology Transaction.





The
Second Interim Award required that we file a registration statement under the
Securities Act to register for resale the shares to be issued to NQCI within 30
days after the closing of the Technology Transaction. The arbitrator
acknowledged that our obligation is to file the registration statement and to
use reasonable efforts to have the shares registered and not to guarantee
registration and resultant actual public tradability. However, the arbitrator
nevertheless ordered that the registration statement must be declared effective
within 90 days.





21


On
January 30, 2009, the arbitrator issued the Order, in which the arbitrator
modified the Second Interim Award by reserving on what the final terms of our
obligation to file the resale registration statement will be and stating that
such registration obligation shall be in accordance with applicable laws,
including applicable U.S. federal securities laws. While the arbitrator also
retained jurisdiction to monitor our compliance with such obligation, to award
any appropriate relief to NQCI if we fail to comply with such obligation and to
render a decision on any other matters contested in this proceeding, the time
periods set forth in the Second Interim Award and summarized in the preceding
paragraph are no longer applicable. The Order also provided, among other things,
that if we file the Proxy Statement, obtain stockholder approval to issue to
NQCI 9,230,000 shares of our common stock as consideration for the closing of
the Technology Transaction and issue such shares to NQCI, the arbitrator
anticipates confirming that all of the Technology covered by the License
Agreement shall be declared our sole and exclusive property.





The
arbitrator held a conference call hearing with the Company and NQCI on March 13,
2009 in which the parties discussed the reasons for the difficulties in closing
the Technology Transaction and explored potential alternatives. The parties were
asked to submit letter briefs outlining their suggested alternatives for
consideration by the arbitrator. The parties submitted their respective letter
briefs on March 24, 2009.





As of the
date of this Annual Report, the arbitration proceeding with NQCI continues and
the arbitrator has not yet issued a final award to either party and has not made
a final ruling with respect to whether the closing of the Technology Transaction
shall occur or whether potential alternatives should be pursued.





Furthermore,
the arbitrator has stated that he has not yet issued a final award that may be
confirmed or challenged in a court of competent jurisdiction. A party to the
arbitration could challenge the interim award in court, even after stockholders
approve the transaction. In addition, the arbitrator could again change the
award by granting different or additional remedies, even after stockholders
approve the transaction. We cannot guarantee that the arbitrator would order
that stockholders be given another opportunity to vote on the transaction, even
if such changes are material. Arbitrators have broad equitable powers, and
arbitration awards are difficult to challenge in court, even if the arbitrator
makes rulings that are inconsistent or not in accordance with the law or the
evidence.





Should
the arbitrator order a material change to the Second Interim Award, as modified
by the Order, after the vote of stockholders on this proposal, and further order
that our stockholders not be given another opportunity to vote on this proposal
or on such material change, such order could conflict with applicable federal
securities laws or NYSE Amex rules to which we are subject. In such event, we
would ask the arbitrator to amend such changed award or attempt to seek review
of the changed award in a court of competent jurisdiction. The closing of the
Technology Transaction may render any court review or appeal moot, effectively
preventing us from challenging any of the arbitrator’s awards in
court.




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





None.




22


PART
II





Item
5.                 Market
for Registrant’s Common Equity, Related Stockholder Maters and Issuer Purchases
of Equity Securities





Market
Information





Our
common stock is traded on the NYSE Amex (formerly American Stock Exchange) under
the symbol “XCR.” Prior to December 7, 2007, our common stock was quoted on the
Over-The-Counter Bulletin Board under the symbol “XCPL”.  Immediately
prior to our merger with the pre-merger Xcorporeal on October 12, 2007, a
one-for-8.27 reverse split of our common stock was executed. Historical stock
prices prior to October 12, 2007 have been adjusted for this reverse stock
split.





As of
March 4, 2009, there were approximately 797 record holders of our common stock,
representing approximately 3,654 beneficial owners.





Following
is a list by fiscal quarters of the split-adjusted closing sales prices of our
common stock. Such prices represent inter-dealer quotations, do not represent
actual transactions, and do not include retail mark-ups, markdowns or
commissions. Such prices were determined from information provided by a majority
of the market makers for the Company’s common stock.





High
                        
                        
                        LowFiscal
      Year Ended December 31, 20084th
      Quarter
                        
                        $
                        0.50
                        
                        
                        $
                        0.163rd
      Quarter
                        
                        
                        1.44
                        
                        
                        
                        0.502nd
      Quarter
                        
                        
                        4.21
                        
                        
                        
                        1.001ST
      Quarter
                        
                        
                        4.94
                        
                        
                        
                        2.34





High
                        
                        
                        LowFiscal
      Year Ended December 31, 20074th
      Quarter
                        
                        $
                        14.06
                        
                        
                        $
                        4.273rd
      Quarter
                        
                        
                        17.45
                        
                        
                        
                        3.392nd
      Quarter
                        
                        
                        6.62
                        
                        
                        
                        4.301ST
      Quarter
                        
                        
                        13.89
                        
                        
                        
                        2.40





Dividend
Policy







We did
not pay any cash dividends in 2008 or 2007 and we do not intend to pay cash
dividends in the foreseeable future.  It is our present intention to
utilize all available funds for the development of our business. Our future
dividend policy will depend on the requirements of financing agreements to which
we may be a party. Any future determination to pay dividends will be at the
discretion of our Board of Directors and will depend upon, among other factors,
our results of operations, financial condition, capital requirements and
contractual restrictions.





Securities
Authorized For Issuance Under Equity Compensation Plans





The
following table provides information about our common stock that may be issued
upon the exercise of equity instruments under all of our existing equity
compensation plans as of December 31, 2008:







Number
      of SecuritiesRemaining
      AvailableNumber
      of Securities
                    
                    
                    
                    
                    
                    for
      Future Issuancesto
      be Issued
                    
                    
                    Weighted-Average
                    
                    
                    Under
      the EquityUpon
      Exercise of
                    
                    
                    Exercise
      Price of
                    
                    
                    Compensation
      PlansOutstanding
      Options,
                    
                    
                    Outstanding
      Options,
                    
                    
                    (Excluding
      SecuritiesPlan
      Category
                    
                    Warrants and
      Rights
                    
                    
                    Warrants and
      Rights
                    
                    
                    Reflected in
      Column(a))(a)
                    
                    
                    (b)
                    
                    
                    (c)Equity
      compensation plans approved by security holders
                    
                    
                    3,877,500
                    
                    
                    $
                    5.39
                    
                    
                    
                    2,922,500Equity
      compensation plans not approved by security holders
                    
                    
                    —
                    
                    
                    $
                    —
                    
                    
                    
                    —Total
                    
                    
                    3,877,500
                    
                    
                    $
                    5.39
                    
                    
                    
                    2,922,500





In connection with our merger with
pre-merger Xcorporeal on October 12, 2007, options to purchase 3,880,000 shares
of common stock that had been granted under pre-merger Xcorporeal’s 2006
Incentive Compensation Plan were assumed by us under the Merger Agreement. Of
these shares, 2,900,000 shares remain outstanding as of December 31, 2008. Any
of our options or warrants that were outstanding prior to the merger with
pre-merger Xcorporeal were cancelled upon effectiveness of the merger. Our 2007
Incentive Compensation Plan was approved by our Board of Directors and a
majority of our stockholders at the same time and in the same manner that the
Merger Agreement was approved, and was ratified by our stockholders on November
26, 2007. As of December 31, 2008, there were 3,900,000 shares of our common
stock authorized for issuance upon the exercise of options granted or to be
granted under our 2007 Incentive Compensation Plan, of which options to purchase
977,500 shares of our common stock have already been granted.





For further information, refer to Note
17, “Stock Options and Warrants” to our financial statements filed as part of
this Annual Report.





Performance
Graph





Not required for smaller reporting
companies.





Unregistered
Sales of Equity Securities and Use of Proceeds from Registered
Securities





Other than set forth below, the
information regarding our sales of our unregistered securities for the fiscal
years ended December 31, 2008 and 2007, has been previously furnished in our
Annual Reports on Form 10-K or 10-KSB, Quarterly Reports on Form 10-Q or 10-QSB
and/or our Current Reports on Form 8-K.





On
November 10, 2008, we issued 50,000 restricted shares of our common stock to
certain third party consultant in consideration of consulting services provided
to us.





The foregoing issuance
was exempt from registration under Section 4(2) of the Securities Act and/or
Rule 506 promulgated thereunder.





Use
of Proceeds from Registered Securities





None.





Purchases
of Equity Securities by the Issuer and Affiliated Purchasers.





None.





Item
6.                 Selected
Financial Data.





Not required for smaller reporting
companies.





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





In addition to reviewing this
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” section, you should also carefully review sections captioned
“Business - Recent Developments” and “Risk Factors” above for a more complete
discussion of the current events that are affecting and other factors that may
affect our business.





Recent
Developments





Corporate
Restructuring





The deterioration of the economy over
the last year, coupled with the prolonged and continuing delay in consummating
the Technology Transaction, has significantly adversely affected our Company.
Many of the expectations on which we had based our 2008 and 2009 business
development plans slowly eroded as a result of the lengthy arbitration
proceeding with NQCI commenced in 2006 and continuing into the second quarter of
2009. The possibility of an adverse decision in the arbitration proceeding with
respect to our ownership right to the Technology (as defined below) has been and
continues to be a major factor in our inability to secure debt or equity
financing. Accordingly, we have had to modify our activities and business. In
response to the general economic downturn affecting the development of our
products and liquidity condition, we have instituted a variety of measures in an
attempt to conserve cash and reduce our operating expenses. Our actions
included:





·
            Reductions
      in our labor force – On March 13, 2009, we gave notice of employment
      termination to 19 employees. This represents a total work-force reduction
      of approximately 73%. We paid accrued vacation benefits of approximately
      $70,000 to the terminated employees. The layoffs and our other efforts
      focused on streamlining our operations designed to reduce our annual
      expenses by approximately $3.5 million to a current operating burn rate of
      approximately $200,000 per month. These actions had to be carefully and
      thoughtfully executed and we will take additional actions, if necessary.
      Most important to us in making these difficult decisions is to give as
      much consideration as possible to all of our employees, whom we greatly
      value. We hope to be in the financial position in the near future to offer
      re-employment to certain of our terminated
  employees.




23




·
            Refocusing
      our available assets and employee resources on the development of the
      PAK.


·
            Continuing
      vigorous efforts to minimize or defer our operating
    expenses.


·
            Exploring
      various strategic alternatives, which may include the license of certain
      of our intellectual property rights, as a means to further develop our
      technologies, among other possible transactions and
      alternatives.


·
            Intensifying
      our search to obtain additional financing to support our operations and to
      satisfy our ongoing capital requirements in order to improve our liquidity
      position.


·
            Continuing
      to prosecute our patents and take other steps to perfect our intellectual
      property rights.





In light of the unprecedented economic
slow down, lack of access to capital markets and prolonged arbitration
proceeding with NQCI, we were compelled to undertake the efforts outlined above
in order to remain in the position to continue our operations. We hope to be
able to obtain additional financing to meet our cash obligations as they become
due and otherwise proceed with our business plan. Our ability to execute on our
current business plan is dependent upon our ability to obtain equity or debt
financing, develop and market our products, and, ultimately, to generate
revenue. Unless we are able to raise financing sufficient to support our
operations and to satisfy our ongoing financing requirements, we will not be
able to develop any of our products, submit 510(k) notifications to the FDA,
conduct clinical trials or otherwise commercialize any of our products. We will
make every effort however, to continue the development of the PAK. As a result
of these conditions, there is substantial doubt about our ability to continue as
a going concern. Our ability to continue as a going concern is substantially
dependent on the successful execution of many of the actions referred to above,
on the timeline contemplated by our plans and our ability to obtain additional
financing. We cannot assure you that we will be successful now or in the future
in obtaining any additional financing on terms favorable to us, if at all. The
failure to obtain financing will have a material adverse effect on our financial
condition and operations.





Other
Considerations – Royalty and Other Payments Under the License
Agreement





As consideration for entering into the
License Agreement, we agreed to pay to NQCI a minimum annual royalty of
$250,000, or 7% of net sales. As a result of the transfer of the Technology to
us, we may be able to realize additional savings of not having to compensate
NQCI for any royalty payments accrued and not yet paid. Although we have
asserted that NQCI’s breaches of the License Agreement excused our obligation to
make the minimum royalty payments, we recorded $583,333 in royalty expenses,
covering the minimum royalties, from commencement of the License Agreement
through December 31, 2008. The License Agreement expires in 2105. The License
Agreement also requires us to reimburse NQCI’s Licensor Expenses until the
closing or the termination of the Merger Agreement. The Second Interim Award
states that the License Agreement will remain in full force and effect until the
Technology Transaction closes or the arbitrator determines that it will never
close. Although we have contested its right to any further payments, NQCI has
made a claim for reimbursement of approximately $690,000 in alleged expenses
under the License Agreement as of December 31, 2008. If we are able to acquire
the Technology from NQCI, the arbitrator has indicated that the License
Agreement would be terminated simultaneously with such acquisition. As a result
of the Technology becoming our sole and exclusive property, among other
benefits, we should be able to discontinue these royalty payments to NQCI,
realize corresponding savings and we may also be able to realize additional
savings of not having to reimburse NQCI for any Licensor Expenses accrued and
not yet paid.




Basis
of Presentation




This
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” section should be read in conjunction with the accompanying
financial statements which have been prepared assuming that we will continue as
a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. Our recurring
losses from operations and net capital deficiency raise substantial doubt about
our ability to continue as a going concern. Our ability to continue as a going
concern is substantially dependent on the successful execution of many of the
actions referred to above and otherwise discussed in this “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
section and in Note 1, “Nature of Operations and Going Concern Uncertainty” to
our financial statements filed as part of this Annual Report, on the timeline
contemplated by our plans and our ability to obtain additional financing. The
uncertainty of successful execution of our plans, among other factors, raises
substantial doubt as to our ability to continue as a going concern. The
accompanying financial statements do not include any adjustments that might
result from the outcome of this uncertainty.





Results
of Operations for the years ended December 31, 2008 and 2007





We have
not generated any revenues since inception. We incurred a net loss of
$22,987,273 for the year ended December 31, 2008, compared to net loss of
$17,074,051 for the year ended December 31, 2007. The increase in net loss was
primarily due to (i) research, development, and other expenses related to
advancing our kidney failure treatment technologies, (ii) stock compensation
expense related to options and warrants granted to directors, officer, employees
and consultants, and (iii) legal fees, (iv) common stock issuances as
compensation for consulting services, (v) accruals for alleged licensor expenses
and interim awards issued in the arbitration with NQCI, and (vi) increased
company personnel. At December 31, 2008, we had negative working capital of
$805,912  compared to positive working capital of $14,958,099 at the
beginning of the year. At December 31, 2008, our total assets were $4,351,073,
compared to $17,252,546 at the beginning of the year, which consisted primarily
of cash from the sale of our common stock sold in December 2006.





24


Interest
Income





Interest
income of $320,622 and $1,184,930 was reported for the years ended December 31,
2008 and 2007, respectively.





Liquidity
and Capital Resources





We expect
to incur operating losses and negative cash flows for the foreseeable future.
During the fourth quarter 2006, we raised approximately $27.3 million (net of
placement fees of $2.1 million) through a private placement. Our ability to
execute on our current business plan is dependent upon our ability to develop
and market our products, and, ultimately, to generate revenue.




As of
December 31, 2008, we had cash, cash equivalents, and marketable securities of
approximately $3.4 million. We project to expend approximately $1.9 million
in the first quarter of 2009 and expend cash at a rate of approximately $0.2
million per month based upon the recent restructuring effected by our company
going forward. See above section captioned “Recent Developments”. In addition,
we may become obligated to pay damages, costs or legal fees in connection with
the ongoing arbitration described under Part I, Item 3-Legal Proceedings above,
in an amount of $1.87 million under the Interim Award issued on August 15, 2008.
At present rates, we will have to obtain additional debt or equity financing
during the next several months.





We expect
to incur negative cash flows and net losses for the foreseeable future. In
addition, we may become obligated to pay damages, costs or legal fees in
connection with the ongoing arbitration with NQCI. Based upon our current plans,
we believe that our existing cash reserves will not be sufficient to meet our
operating expenses and capital requirements before we achieve profitability.
Accordingly, we will be required to seek additional funds through public or
private placement of shares of our preferred or common stock or through public
or private debt financing. Our ability to meet our cash obligations as they
become due and payable will depend on our ability to sell securities, borrow
funds, reduce operating costs, or some combination thereof. We may not be
successful in obtaining necessary funds on acceptable terms, if at all. The
inability to obtain financing could require us to curtail our current plans in
order to decrease spending, which could have a material adverse effect on our
plan of operations. Our ability to execute on our current business plan is
dependent upon our ability to obtain equity financing, develop and market our
products, and, ultimately, to generate revenue. As a result of these conditions,
there is substantial doubt about our ability to continue as a going
concern.





Upon
receipt of the approximately $27.3 million raised through the private placement
of our common stock in the fourth quarter of 2006, we strategically began our
operating activities and research and development efforts which resulted in a
net loss of $23.0 million in 2008.  In addition, we invested $25.0
million in high grade money market funds and marketable securities of which we
have sold $22.0 million, leaving a balance of $3.0 million as of December 31,
2008.




We have
focused much of our efforts on development of the PAK, which has not been
derived from the technology covered by the License Agreement. Through the
productive research and development efforts of the PAK, we have completed
functional prototypes of our attended care and home PAKs that we plan to
commercialize after 510(k) clearance from the FDA which we plan to submit in
2010. Prior to the 510(k) submission to the FDA for clinical use under direct
medical supervision, the units will undergo final verification and validation.
It generally takes 4 to 12 months from the date of a 510(k) submission to obtain
clearance from the FDA, although it may take longer. We expect that our monthly
expenditures will increase as we shift resources towards developing a marketing
plan for the PAK.




We have
used some of our resources for the development of the WAK and have demonstrated
a feasibility prototype. Commercialization of the WAK will require development
of a functional prototype and likely a full pre-market approval by the FDA,
which could take several years. Our rights to the WAK derive in part from the
License Agreement pursuant to which we obtained the exclusive rights to the
Technology. Once we acquire the Technology and the results of the arbitration
proceeding with NQCI are final, we will determine whether to devote additional
resources to development of the WAK.




If we
ever become obligated to reimburse all or a substantial portion of the $690,000
in NQCI’s alleged expenses related to the License Agreement and $1.87 million in
NQCI’s attorneys’ fees incurred in the arbitration awarded under the interim
award issued on August 15, 2008, these obligations could have a material adverse
effect on our liquidity and financial ability to continue with ongoing
operations as currently planned.





Because
neither the PAK nor the WAK is yet at a stage where it can be marketed
commercially, we are not able to predict the portion of our future business
which will be derived from each.





Research
and Development





Through
March 13, 2009, we employed an interdisciplinary team of scientists and
engineers who were developing the PAK and a separate, interdisciplinary team
developing the WAK. However, as discussed above during the first quarter of
2009, we had to adjust our employee headcount to more closely match our capital
availability and, as a result, terminated the employment of 19 employees. In
addition, we had retained Aubrey Group, Inc., an FDA-registered third-party
contract developer and manufacturer of medical devices, to assist with the
engineering of the PAK. As of December 31, 2008, Aubrey substantially completed
its work and we terminated this agreement. The PAK has been engineered to
perform both hemodialysis, hemofiltration and ultrafiltration under direct
medical supervision. A variation of this device will be developed for chronic
home hemodialysis. An initial laboratory prototype of the PAK, capable of
performing the functions of a hemodialysis machine, and demonstrating our unique
new fluidics circuit, was completed at the end of 2007. The first physical
prototype including industrial design of the PAK was completed in October 2008.
Further refinements to this prototype are now in progress. We hope to complete
the final product design of the PAK and submit the for final verification and
validation prior to a 510(k) submission for clinical use under direct medical
supervision. A clinical study is not required for this submission.





25


In a
clinical feasibility study conducted in London in March 2007, a research
prototype of the WAK was successfully demonstrated in eight patients with
end-stage renal disease. Patients were successfully treated for up to eight
hours with adequate clearances of urea and creatinine. The device was well
tolerated and patients were able to conduct activities of normal daily living
including walking and sleeping. There were no serious adverse events although
clotting of the dialyzer occurred in two patients. To our knowledge, this is the
first successful demonstration of a WAK in humans.





We
incurred $20.9 million and $7.1 million in research and development costs in the
fiscal years 2008 and 2007, respectively, including the August 4, 2008, $10.2
million fair value accrual for a potential 9.23 million shares issuance to
effectuate the Technology Transaction in accordance to the Second Interim Award
(as defined below). Less the accrual for shares issuable, we incurred $10.7
million and $7.1 million in research and development costs in the fiscal years
2008 and 2007, respectively. The increase in research and development costs in
2008 from 2007 is attributable to our efforts to advance our kidney failure
treatment technologies and an increase in personnel.





Contractual
Obligations and Commercial Commitments





The following table sets forth a
summary of our material contractual obligations and commercial commitments as of
December 31, 2008.




Contractual
      Obligations:
                                        
                                        Total
                                        
                                        
                                        Less than 1
                                          year
                                        
                                        
                                        1 - 3 years
                                        
                                        
                                        3 - 5 years
                                        
                                        
                                        More
      than 5 yearsCapital Lease
      Obligations
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        -Operating Lease Obligations
      (1)
                                        
                                        
                                        2,422,931
                                        
                                        
                                        
                                        411,845
                                        
                                        
                                        
                                        1,677,342
                                        
                                        
                                        
                                        333,744
                                        
                                        
                                        
                                        -Research & Development
      Contractual Commitments
                                        
                                        
                                        68,688
                                        
                                        
                                        
                                        68,688
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Other
      Liabilities
                                        
                                        
                                        34,325
                                        
                                        
                                        
                                        34,325
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -$
                                        2,525,944
                                        
                                        
                                        $
                                        514,858
                                        
                                        
                                        $
                                        1,677,342
                                        
                                        
                                        $
                                        333,744
                                        
                                        
                                        $
                                        -


(1)
Operating lease commitments for our corporate office, operating facility, Dr.
Gura’s office (a related party transaction), two corporate apartments and
equipment.





Since
Aubrey substantially completed its work under the Aubrey Agreement and we intend
to terminate this agreement, this table excludes any remaining obligations under
the Aubrey Agreement.





As of
December 31, 2008, we had no off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial condition,
results of operations or cash flows.





Legal
Proceedings





We are
involved in arbitration against NQCI as described above in section captioned
“Item 3 - Legal Proceedings”. From time to time, we may be involved in
litigation relating to claims arising out of our operations in the normal course
of business. As of the date of this Annual Report, we are not currently involved
in any other legal proceeding that we believe would have a material adverse
effect on our business, financial condition or operating results.





Critical
Accounting Policies and Estimates





The
discussion and analysis of our financial condition and results of operations is
based upon our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. Generally
accepted accounting principles require management to make estimates, judgments
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, and the disclosure of contingent assets and liabilities.
We base our estimates on experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that may not be readily apparent from other sources. Our actual results may
differ from those estimates.





We
consider our critical accounting policies to be those that involve significant
uncertainties, require judgments or estimates that are more difficult for
management to determine or that may produce materially different results when
using different assumptions. We consider the following accounting policies to be
critical:





26


Marketable
Securities





We
classify investments with maturity dates greater than three months when
purchased as marketable securities. Investments, including certificates of
deposit with maturity dates greater than three months when purchased and which
have readily determined fair values, are classified as available-for-sale
investments and reflected in current assets as marketable securities at fair
market value.  Our investment policy requires that all investments be
investment grade quality and no more than ten percent of our portfolio may be
invested in any one security or with one institution.





As of
December 31, 2008 and 2007, short-term investments classified as
available-for-sale were as follows:





December 31,
      2008Aggregate
      Fair
                                  
                                  
                                  Gross
      Unrealized
                                  
                                  
                                  Estimated
      FairValue
                                  
                                  
                                  Gains /
      (Losses)
                                  
                                  
                                  ValueCommercial
      paper
                                  
                                  $
                                  897,993
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  897,993Corporate
      securities fixed rate
                                  
                                  
                                  457,930
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  457,930Total
                                  
                                  $
                                  1,355,923
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  1,355,923




December
      31, 2007Aggregate
      Fair
                                                    
                                                    
                                                    Gross
      Unrealized
                                                    
                                                    
                                                    Estimated
      FairValue
                                                    
                                                    
                                                    Gains /
      (Losses)
                                                    
                                                    
                                                    ValueCommercial
      paper
                                                    
                                                    $
                                                    10,283,818
                                                    
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    $
                                                    10,283,818Corporate
      obligation
                                                    
                                                    
                                                    2,245,770
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    2,245,770Total
                                                    
                                                    $
                                                    12,529,588
                                                    
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    $
                                                    12,529,588


Xcorporeal
reviews impairments associated with the above in accordance with SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” and FASB
Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments,” to determine the
classification of the impairment as temporary or other-than-temporary.
Xcorporeal considers these investments not to be impaired as of December 31,
2008 and 2007.





There
were no gross unrealized gains or losses as of December 31, 2008 and
2007.





Shares
Issuable





Pursuant
to the Second Interim Award issued on August 4, 2008, which stated that, if the
Technology Transaction is submitted to and approved by our stockholders,
9,230,000 shares of our common stock should be issued to NQCI to effectuate the
transaction, we accrued for the 9,230,000 shares of our common stock. As the
Second Interim Award stated that we must issue 9,230,000 upon the closing of the
Technology Transaction and we have been unable to consummate such transaction,
such contingency is not within our control and we have therefore, recorded the
issuance as a liability, rather than as an equity issuance. Until issuance, the
shares issuable will be recorded at fair value in accordance with EITF 00-19,
with subsequent changes in fair value recorded as non-operating change in fair
value of shares issuable to our statement of operations. The fair value of the
shares will be measured using the closing price of our common stock on the
reporting date. The measured fair value of $10,153,000 for the accrued 9,230,000
shares on August 4, 2008, the date of the Second Interim Award, was accrued
under “Shares issuable” and expensed to “Research and development.” From marking
to market, the fair value of the shares issuable was revalued at $1,569,100 as
of December 31, 2008. The resulting non-operating change in fair value of
$8,583,900 to our statement of operations for the year ended December 31, 2008
was recognized as “Change in fair value of shares issuable.” Stockholder
approval for the issuance of 9,230,000 shares of our common stock to NQCI and
the issuance of such shares are pending to date.





Although
we are seeking stockholder approval for the issuance of 9,230,000 shares of our
common stock to effectuate the Technology Transaction, we are uncertain whether
the SEC will clear its review of the form of our proxy statement that we will
use to solicit stockholder approval of the transaction, whether our stockholders
will vote to approve the transaction, whether shares will be issued to NQCI, or
whether when filed, the SEC will declare effective the registration statement to
register the shares for resale. If the Technology Transaction does not close,
the arbitrator may issue alternative relief. In the event of an alternate
relief, the above accrual may be adjusted and the accrual or the actual
settlement will be recorded to coincide with the alternate award.





Stock-Based
Compensation





Statements
of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, (SFAS
123(R)) and Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 107 (SAB 107) require the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors based
on estimated fair values. We have applied the provisions of SAB 107 in its
adoption of SFAS 123(R).





27


In
determining stock based compensation, we consider various factors in our
calculation of fair value using a black-scholes pricing model. These factors
include volatility, expected term of the options and forfeiture rates. A change
in these factors could result in differences in the stock based compensation
expense.





Recent
Accounting Pronouncements





In
February 2007, the Financial Accounting Standards Board (“FASB”) issued FASB
Statement No. 159, “The Fair
Value Option for Financial Assets and Financial Liabilities — Including an
Amendment of FASB Statement No. 115, Accounting for Certain Investments
in Debt and Equity Securities”(“SFAS No. 159”). SFAS No. 159 permits
an entity to choose to measure many financial instruments and certain items at
fair value. The objective of this standard is to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reporting
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. SFAS No. 159 permits all
entities to choose to measure eligible items at fair value at specified election
dates. Entities will report unrealized gains and losses on items for which the
fair value option has been elected in earnings at each subsequent reporting
date. The fair value option: (a) may be applied instrument by instrument, with a
few exceptions, such as investments accounted for by the equity method; (b) is
irrevocable (unless a new election date occurs); and (c) is applied only to
entire instruments and not to portions of instruments. SFAS No. 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November
15, 2007, which for us is our fiscal year beginning January 1, 2008. The
adoption of SFAS No. 159 did not have any effect on our consolidated financial
statements.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS
141(R)”). SFAS 141(R) replaces SFAS No. 141, “Business Combinations”, but
retains the requirement that the purchase method of accounting for acquisitions
be used for all business combinations. SFAS 141(R) expands on the disclosures
previously required by SFAS 141, better defines the acquirer and the acquisition
date in a business combination, and establishes principles for recognizing and
measuring the assets acquired (including goodwill), the liabilities assumed and
any non-controlling interests in the acquired business. SFAS 141(R) also
requires an acquirer to record an adjustment to income tax expense for changes
in valuation allowances or uncertain tax positions related to acquired
businesses. SFAS 141(R) is effective for all business combinations with an
acquisition date in the first annual period following December 15, 2008; early
adoption is not permitted. We will adopt this statement as of January 1, 2009.
The impact of SFAS 141(R) will have on our consolidated financial statements
will depend on the nature and size of acquisitions we complete after we adopt
SFAS 141(R).





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements-an amendment of ARB No. 51” (SFAS 160). SFAS
160 requires that non-controlling (or minority) interests in subsidiaries be
reported in the equity section of the company’s balance sheet, rather than in a
mezzanine section of the balance sheet between liabilities and equity. SFAS 160
also changes the manner in which the net income of the subsidiary is reported
and disclosed in the controlling company’s income statement. SFAS 160 also
establishes guidelines for accounting for changes in ownership percentages and
for deconsolidation. SFAS 160 is effective for financial statements for fiscal
years beginning on or after December 1, 2008 and interim periods within those
years. The adoption of SFAS 160 is not expected to have a material impact on our
financial position, results of operations or cash flows.





In
March 2008, the FASB issued SFAS No. 161, Disclosures About Derivative
Instruments and Hedging Activities, or “SFAS 161”. SFAS 161 enhances the
disclosure requirements for derivative instruments and hedging activities. This
Standard is effective January 1, 2009. Since SFAS 161 requires only
additional disclosures concerning derivatives and hedging activities, adoption
of SFAS 161 will not affect the Company’s financial condition or results of
operation.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162).  SFAS 162 identifies the
sources of accounting principles and the framework for selecting the principles
used in the preparation of financial statements of nongovernmental entities that
are presented in conformity with generally accepted accounting principles in the
United States (the GAAP hierarchy).  SFAS 162 will become
effective November 15, 2008. The adoption of SFAS 162 did not have a material
impact on our financial position, results of operations or cash
flows.





In June
2008, the FASB reached a consensus on EITF Issue No. 07-5, Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own Stock, or “EITF
07-5”. EITF 07-5 requires that we apply a two-step approach in evaluating
whether an equity-linked financial instrument (or embedded feature) is indexed
to our own stock, including evaluating the instrument’s contingent exercise and
settlement provisions. EITF 07-5 is effective for fiscal years beginning after
December 15, 2008. We are currently evaluating the effects, if any, that EITF
07-5 will have on our consolidated financial statements.





Item
7A.                      Quantitative
and Qualitative Disclosures About Market Risk.





Not required for smaller reporting
companies.




28


Item
8.                 Financial
Statements and Supplementary Data.





CONTENTS





PAGEREPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
                              30FINANCIAL
      STATEMENTSBALANCE
      SHEETS AS OF DECEMBER 31, 2008 AND 2007
                              31STATEMENTS
      OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007, AND THE
      PERIOD FROM INCEPTION (MAY 4, 2001) TO DECEMBER 31, 2008
                              32STATEMENTS
      OF STOCKHOLDERS’ EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 2008
      AND 2007, AND THE PERIOD FROM INCEPTION (MAY 4, 2001) TO DECEMBER 31,
      2008
                              33STATEMENTS
      OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007, AND THE
      PERIOD FROM INCEPTION (MAY 4, 2001) TO DECEMBER 31, 2008
                              34NOTES
      TO FINANCIAL STATEMENTS
                              35




29


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM







Board of
Directors and Stockholders


Xcorporeal,
Inc.


(a
development stage company)


Los
Angeles, California




We have
audited the accompanying consolidated balance sheets of Xcorporeal, Inc. as of
December 31, 2008 and 2007 and the related consolidated statements of
operations, stockholders’ deficit, and cash flows for each of the two years in
the period ended December 31, 2008 and the period from inception (May 4, 2001)
to December 31, 2008.  These financial statements are the
responsibility of the Company’s management.  Our responsibility is to
express an opinion on these financial statements based on our
audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The Company is
not required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting.  Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting.  Accordingly, we express no such opinion.
 An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Xcorporeal, Inc. at December
31, 2008 and 2007, and the results of its operations and its cash flows for each
of the two years in the period ended December 31, 2008 and the period from
inception (May 4, 2001) to December 31, 2008, in conformity with accounting
principles generally accepted in the United States of America.




The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses from operations and has a
net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. Management’s plans in regard to these matters are
also described in Note 1.  The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.





/s/ BDO
Seidman, LLP





Los
Angeles, California


March 30,
2009





30




XCORPOREAL,
INC.


(a
Development Stage Company)


BALANCE SHEETS




Years
      endedDecember
      31,2008
                                          
                                          
                                          2007ASSETSCurrentCash
      and cash equivalents
                                          
                                          $
                                          407,585
                                          
                                          
                                          $
                                          106,495Marketable
      securities, at fair value
                                          
                                          
                                          2,955,714
                                          
                                          
                                          
                                          16,401,898Restricted
      cash
                                          
                                          
                                          301,675
                                          
                                          
                                          
                                          68,016Prepaid
      expenses & other current assets
                                          
                                          
                                          260,024
                                          
                                          
                                          
                                          408,303Tenant
      improvement allowance receivable
                                          
                                          
                                          87,658
                                          
                                          
                                          
                                          -Total
      current assets
                                          
                                          
                                          4,012,656
                                          
                                          
                                          
                                          16,984,712Property
      and equipment, net
                                          
                                          
                                          337,554
                                          
                                          
                                          
                                          266,912Other
      assets
                                          
                                          
                                          863
                                          
                                          
                                          
                                          922Total
      Assets
                                          
                                          $
                                          4,351,073
                                          
                                          
                                          $
                                          17,252,546LIABILITIESCurrentAccounts
      payable
                                          
                                          $
                                          789,827
                                          
                                          
                                          $
                                          1,125,239Accrued
      legal fees & licensing expense
                                          
                                          
                                          2,873,396
                                          
                                          
                                          
                                          312,208Accrued
      royalties
                                          
                                          
                                          583,333
                                          
                                          
                                          
                                          83,333Accrued
      professional fees
                                          
                                          
                                          211,820
                                          
                                          
                                          
                                          113,020Accrued
      compensation
                                          
                                          
                                          149,664
                                          
                                          
                                          
                                          196,541Accrued
      other liabilities
                                          
                                          
                                          54,429
                                          
                                          
                                          
                                          68,946Payroll
      liabilities
                                          
                                          
                                          7,448
                                          
                                          
                                          
                                          11,926Deferred
      rent
                                          
                                          
                                          148,651
                                          
                                          
                                          
                                          -Other
      current liabilities
                                          
                                          
                                          -
                                          
                                          
                                          
                                          115,400Total
      current liabilities
                                          
                                          
                                          4,818,568
                                          
                                          
                                          
                                          2,026,613Shares
      issuable
                                          
                                          
                                          1,569,100
                                          
                                          
                                          
                                          -COMMITMENTS
      & CONTINGENCIESSTOCKHOLDERS'
      EQUITYPreferred
      stock, $0.0001 par value, 10,000,000 shares authorized, none
      outstanding
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Common
      stock, $0.0001 par value, 40,000,000 shares authorized, 14,754,687 and
      14,372,472 issued and outstanding on December 31, 2008 and December 31,
      2007, respectively
                                          
                                          
                                          1,475
                                          
                                          
                                          
                                          1,437Additional
      paid-in capital
                                          
                                          
                                          42,547,023
                                          
                                          
                                          
                                          36,822,316Deficit
      accumulated during the development stage
                                          
                                          
                                          (44,585,093
                                          )
                                          
                                          
                                          (21,597,820
                                          )Total
      stockholders' (deficit) equity
                                          
                                          
                                          (2,036,595
                                          )
                                          
                                          
                                          15,225,933Total
      Liabilities & Stockholders' (Deficit) Equity
                                          
                                          $
                                          4,351,073
                                          
                                          
                                          $
                                          17,252,546


See
accompanying notes to these financial statements.





31





XCORPOREAL,
INC.


(a
Development Stage Company)


STATEMENTS OF OPERATIONS





May
      4, 2001 (DateYears
      ended
                                                      
                                                      
                                                      of
      Inception) toDecember
      31,
                                                      
                                                      
                                                      December
      31,2008
                                                      
                                                      
                                                      2007
                                                      
                                                      
                                                      2008Operating
      Expenses:Selling,
      general and administrative
                                                      
                                                      $
                                                      9,001,819
                                                      
                                                      
                                                      $
                                                      11,084,040
                                                      
                                                      
                                                      $
                                                      23,404,511Research and
      development
                                                      
                                                      
                                                      20,914,825
                                                      
                                                      
                                                      
                                                      7,141,170
                                                      
                                                      
                                                      
                                                      29,343,317Other
    expenses
                                                      
                                                      
                                                      1,871,430
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      1,871,430Depreciation and
      amortization
                                                      
                                                      
                                                      104,719
                                                      
                                                      
                                                      
                                                      32,171
                                                      
                                                      
                                                      
                                                      136,985Loss
      before other income, income taxes, and otherexpenses
                                                      
                                                      
                                                      (31,892,793
                                                      )
                                                      
                                                      
                                                      (18,257,381
                                                      )
                                                      
                                                      
                                                      (54,756,243
                                                      )Interest
      and other income
                                                      
                                                      
                                                      323,249
                                                      
                                                      
                                                      
                                                      1,184,930
                                                      
                                                      
                                                      
                                                      1,590,479Change
      in fair value of shares issuable
                                                      
                                                      
                                                      8,583,900
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      8,583,900Loss
      before income taxes and other expenses
                                                      
                                                      
                                                      (22,985,644
                                                      )
                                                      
                                                      
                                                      (17,072,451
                                                      )
                                                      
                                                      
                                                      (44,581,864
                                                      )Income
      taxes
                                                      
                                                      
                                                      1,629
                                                      
                                                      
                                                      
                                                      1,600
                                                      
                                                      
                                                      
                                                      3,229Net
      loss
                                                      
                                                      $
                                                      (22,987,273
                                                      )
                                                      
                                                      $
                                                      (17,074,051
                                                      )
                                                      
                                                      $
                                                      (44,585,093
                                                      )Basic
      and diluted loss per share
                                                      
                                                      $
                                                      (1.57
                                                      )
                                                      
                                                      $
                                                      (1.20
                                                      )Weighted
      average number of shares outstanding
                                                      
                                                      
                                                      14,604,274
                                                      
                                                      
                                                      
                                                      14,206,489


See
accompanying notes to these financial statements.





32




XCORPOREAL,
INC.


(a
Development Stage Company)


STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)


For
the Period May 4, 2001 (Inception) to December 31, 2008





DeficitAccumulatedAdditional
                        
                        
                        DuringCommon
      Stock
                        
                        
                        Paid-in
                        
                        
                        DevelopmentShares
                        
                        
                        Amount
                        
                        
                        Capital
                        
                        
                        Stage
                        
                        
                        TotalCommon
      stock issued for cash at $0.01 per share
                        
                        
                        2,500,000
                        
                        
                        $
                        250
                        
                        
                        $
                        24,750
                        
                        
                        
                        
                        
                        $
                        25,000Net
      Loss for the year ended December 31, 2001
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        (40,255
                        )
                        
                        
                        (40,255
                        )Balance
      as of December 31, 2001
                        
                        
                        2,500,000
                        
                        
                        
                        250
                        
                        
                        
                        24,750
                        
                        
                        
                        (40,255
                        )
                        
                        
                        (15,255
                        )Common
      stock issued for cash at $0.05 per share
                        
                        
                        1,320,000
                        
                        
                        
                        132
                        
                        
                        
                        65,868
                        
                        
                        
                        
                        
                        
                        
                        66,000Net
      Loss for the year ended December 31, 2002
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (31,249
                        )
                        
                        
                        (31,249
                        )Balance
      as of December 31, 2002
                        
                        
                        3,820,000
                        
                        
                        
                        382
                        
                        
                        
                        90,618
                        
                        
                        
                        (71,504
                        )
                        
                        
                        19,496Net
      Loss for the year ended December 31, 2003
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (12,962
                        )
                        
                        
                        (12,962
                        )Balance
      as of December 31, 2003
                        
                        
                        3,820,000
                        
                        
                        
                        382
                        
                        
                        
                        90,618
                        
                        
                        
                        (84,466
                        )
                        
                        
                        6,534Net
      Loss for the year ended December 31, 2004
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (23,338
                        )
                        
                        
                        (23,338
                        )Balance
      as of December 31, 2004
                        
                        
                        3,820,000
                        
                        
                        
                        382
                        
                        
                        
                        90,618
                        
                        
                        
                        (107,804
                        )
                        
                        
                        (16,804
                        )Net
      Loss for the year ended December 31, 2005
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (35,753
                        )
                        
                        
                        (35,753
                        )Balance
      as of December 31, 2005
                        
                        
                        3,820,000
                        
                        
                        
                        382
                        
                        
                        
                        90,618
                        
                        
                        
                        (143,557
                        )
                        
                        
                        (52,557
                        )Common
      stock issued for license rights at $0.0001 pershare
                        
                        
                        9,600,000
                        
                        
                        
                        960
                        
                        
                        
                        40
                        
                        
                        
                        
                        
                        
                        
                        1,000Capital
      stock cancelled
                        
                        
                        (3,420,000
                        )
                        
                        
                        (342
                        )
                        
                        
                        342
                        
                        
                        
                        
                        
                        
                        
                        -Warrants
      granted for consulting fees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2,162,611
                        
                        
                        
                        
                        
                        
                        
                        2,162,611Forgiveness
      of related party debt
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        64,620
                        
                        
                        
                        
                        
                        
                        
                        64,620Common
      stock issued for cash at $7.00, net of placementfees
      of $2,058,024
                        
                        
                        4,200,050
                        
                        
                        
                        420
                        
                        
                        
                        27,341,928
                        
                        
                        
                        
                        
                        
                        
                        27,342,348Stock-based
      compensation expense
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        264,251
                        
                        
                        
                        
                        
                        
                        
                        264,251Net
      loss for the period
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (4,380,212
                        )
                        
                        
                        (4,380,212
                        )Balance
      as of December 31, 2006
                        
                        
                        14,200,050
                        
                        
                        
                        1,420
                        
                        
                        
                        29,924,410
                        
                        
                        
                        (4,523,769
                        )
                        
                        
                        25,402,061Capital
      stock cancelled
                        
                        
                        (200,000
                        )
                        
                        
                        (20
                        )
                        
                        
                        20
                        
                        
                        
                        
                        
                        
                        
                        -Common
      stock issued pursuant to consulting agreement at$
                        4.90
      per share
                        
                        
                        20,000
                        
                        
                        
                        2
                        
                        
                        
                        97,998
                        
                        
                        
                        
                        
                        
                        
                        98,000Recapitalization
      pursuant to merger
                        
                        
                        352,422
                        
                        
                        
                        35
                        
                        
                        
                        (37,406
                        )
                        
                        
                        
                        
                        
                        
                        (37,371
                        )Warrants
      granted for consulting services
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2,917,309
                        
                        
                        
                        
                        
                        
                        
                        2,917,309Stock-based
      compensation expense
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        3,721,485
                        
                        
                        
                        
                        
                        
                        
                        3,721,485Additional
      proceeds from the sale of common stock in2006
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        198,500
                        
                        
                        
                        
                        
                        
                        
                        198,500Net
      loss for the period
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (17,074,051
                        )
                        
                        
                        (17,074,051
                        )Balance
      as of December 31, 2007
                        
                        
                        14,372,472
                        
                        
                        
                        1,437
                        
                        
                        
                        36,822,316
                        
                        
                        
                        (21,597,820
                        )
                        
                        
                        15,225,933Common
      stock issued as compensation for consultingservices
      at $3.61 per share
                        
                        
                        200,000
                        
                        
                        
                        20
                        
                        
                        
                        721,980
                        
                        
                        
                        
                        
                        
                        
                        722,000Common
      stock issued as compensation for consultingservices
      at $3.80 per share
                        
                        
                        20,000
                        
                        
                        
                        2
                        
                        
                        
                        75,998
                        
                        
                        
                        
                        
                        
                        
                        76,000Cashless
      exercise of warrants
                        
                        
                        112,215
                        
                        
                        
                        11
                        
                        
                        
                        (11
                        )
                        
                        
                        
                        
                        
                        
                        0Common
      stock issued as compensation for consultingservices
      at $0.32 per share
                        
                        
                        50,000
                        
                        
                        
                        5
                        
                        
                        
                        15,995
                        
                        
                        
                        
                        
                        
                        
                        16,000Reversal
      of liability from the sale of common stock in 2006
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        115,400
                        
                        
                        
                        
                        
                        
                        
                        115,400Warrants
      granted for consulting services
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        91,306
                        
                        
                        
                        
                        
                        
                        
                        91,306Stock-based
      compensation expense
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        4,704,039
                        
                        
                        
                        
                        
                        
                        
                        4,704,039Net
      loss for the period
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (22,987,273
                        )
                        
                        
                        (22,987,273
                        )Balance
      as of December 31, 2008
                        
                        
                        14,754,687
                        
                        
                        $
                        1,475
                        
                        
                        $
                        42,547,023
                        
                        
                        $
                        (44,585,093
                        )
                        
                        $
                        (2,036,595
                        )




See
accompanying notes to these financial statements.





33




XCORPOREAL,
INC.


(a
Development Stage Company)


STATEMENTS OF CASH FLOWS





May
      4, 2001 (DateYears
      ended
                                      
                                      
                                      of
      Inception) toDecember
      31,
                                      
                                      
                                      December
      31,2008
                                      
                                      
                                      2007
                                      
                                      
                                      2008Cash
      flows used in operating activitiesNet
      loss for the period
                                      
                                      $
                                      (22,987,273
                                      )
                                      
                                      $
                                      (17,074,051
                                      )
                                      
                                      $
                                      (44,585,093
                                      )Adjustments
      to reconcile net loss to net cash (used in) operating
      activities:Stock based
      compensation
                                      
                                      
                                      4,704,039
                                      
                                      
                                      
                                      3,721,485
                                      
                                      
                                      
                                      8,689,775Non-employee stock based
      compensation
                                      
                                      
                                      91,306
                                      
                                      
                                      
                                      2,917,309
                                      
                                      
                                      
                                      5,171,226Common stock issuance for
      consulting services rendered
                                      
                                      
                                      814,000
                                      
                                      
                                      
                                      98,000
                                      
                                      
                                      
                                      912,000Increase in shares
      issuable
                                      
                                      
                                      10,153,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      10,153,000Mark to market of shares
      issuable
                                      
                                      
                                      (8,583,900
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (8,583,900
                                      )Depreciation
                                      
                                      
                                      104,660
                                      
                                      
                                      
                                      32,093
                                      
                                      
                                      
                                      136,848Net change in assets and
      liabilities:Increase in
      Receivables
                                      
                                      
                                      (87,658
                                      )
                                      
                                      
                                      
                                      
                                      
                                      
                                      (87,658
                                      )Decrease (increase) in
      prepaid expenses and other current assets
                                      
                                      
                                      148,279
                                      
                                      
                                      
                                      (318,075
                                      )
                                      
                                      
                                      (260,024
                                      )Decrease in other
      assets
                                      
                                      
                                      59
                                      
                                      
                                      
                                      78
                                      
                                      
                                      
                                      (863
                                      )Increase (decrease) in
      accounts payable and accrued liabilities
                                      
                                      
                                      2,758,704
                                      
                                      
                                      
                                      (144,241
                                      )
                                      
                                      
                                      4,632,546Increase in deferred
      rent
                                      
                                      
                                      148,651
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      148,651Net
      cash used in operating activities
                                      
                                      
                                      (12,736,133
                                      )
                                      
                                      
                                      (10,767,402
                                      )
                                      
                                      
                                      (23,673,492
                                      )Cash
      flows from investing activitiesCapital
      expenditures
                                      
                                      
                                      (175,302
                                      )
                                      
                                      
                                      (295,676
                                      )
                                      
                                      
                                      (474,402
                                      )Restricted
    cash
                                      
                                      
                                      (233,659
                                      )
                                      
                                      
                                      (68,016
                                      )
                                      
                                      
                                      (301,675
                                      )Purchase of marketable
      securities
                                      
                                      
                                      (8,598,102
                                      )
                                      
                                      
                                      (25,000,000
                                      )
                                      
                                      
                                      (33,598,102
                                      )Saleof marketable
      securities
                                      
                                      
                                      22,044,286
                                      
                                      
                                      
                                      8,598,102
                                      
                                      
                                      
                                      30,642,388Net
      cash provided by (used in) investing activities
                                      
                                      
                                      13,037,223
                                      
                                      
                                      
                                      (16,765,590
                                      )
                                      
                                      
                                      (3,731,791
                                      )Cash
      flows from financing activitiesCapital stock
      issued
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      27,549,748Advances from related
      party
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      64,620Additional proceeds from
      the sale of common stock in 2006
                                      
                                      
                                      -
                                      
                                      
                                      
                                      198,500
                                      
                                      
                                      
                                      198,500Net
      cash provided by financing activities
                                      
                                      
                                      -
                                      
                                      
                                      
                                      198,500
                                      
                                      
                                      
                                      27,812,868Increase
      (decrease) in cash during the period
                                      
                                      
                                      301,090
                                      
                                      
                                      
                                      (27,334,492
                                      )
                                      
                                      
                                      407,585Cash
      at beginning of the period
                                      
                                      
                                      106,495
                                      
                                      
                                      
                                      27,440,987
                                      
                                      
                                      
                                      -Cash
      at end of the period
                                      
                                      $
                                      407,585
                                      
                                      
                                      $
                                      106,495
                                      
                                      
                                      $
                                      407,585Supplemental
      disclosure of cash flow information; cash paid for:Interest
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -Income
taxes
                                      
                                      $
                                      1,629
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      3,229


See
accompanying notes to these financial statements.




34




XCORPOREAL,
INC.


(A
DEVELOPMENT STAGE COMPANY)


NOTES
TO FINANCIAL STATEMENTS


DECEMBER
31, 2008





1.
            NATURE
      OF OPERATIONS AND GOING CONCERN
UNCERTAINTY





On
October 12, 2007, pursuant to a merger agreement with Xcorporeal, Inc.
(hereinafter referred to as “Operations”), our wholly-owned subsidiary, merged
with and into Operations, which became our wholly-owned subsidiary and changed
its name to “Xcorporeal Operations, Inc.” We changed our name from CT Holdings
Enterprises, Inc. (“CTHE”), to “Xcorporeal, Inc.” and amended our certificate of
incorporation and bylaws to read substantially as Operations. As a result, our
authorized common stock changed from 60,000,000 shares to 40,000,000 common
shares, and our authorized preferred stock changed from 1,000,000 shares to
10,000,000 shares, resulting in total authorized capital stock of 50,000,000
shares.





Immediately
prior to the merger, we caused a one-for-8.27 reverse split of our common stock.
Each share of Operations common stock was then converted into one share of our
common stock. In addition, we assumed all outstanding Operations’ options and
warrants to purchase Operations common stock.





In this
merger, CTHE was considered to be the legal acquirer and Xcorporeal to be the
accounting acquirer. As the former shareholders of Operations owned over 97% of
the outstanding voting common stock of CTHE immediately after the merger and
CTHE was a public shell company, for accounting purposes Operations was
considered the accounting acquirer and the transaction was considered to be a
recapitalization of Operations.





Historical
financial statements prior to the merger were restated to be those of
Operations. The merger was accounted for as if it were an issuance of the common
stock of Operations to acquire our net assets, accompanied by a
recapitalization. Historical stockholders’ equity of Operations was
retroactively restated for the equivalent number of shares received in the
merger, after giving effect to the difference in par value with an offset to
paid-in capital. The assets and liabilities of Operations were carried forward
at their predecessor carrying amounts. Retained deficiency of Operations was
carried forward after the merger. Operations prior to the merger were those of
Operations. Earnings per share for periods prior to the merger were restated to
reflect the number of equivalent shares received by Operations’ stockholders.
The costs of the transaction were expensed to the extent they exceed cash
received from CTHE. References to “we,” “us,” “our” and the “company” after
consummation of the merger include CTHE and Operations.





As a
result of the merger, we transitioned to a development stage company focused on
researching, developing, and commercializing technology and products related to
the treatment of kidney failure.





We expect to incur negative cash flows
and net losses for the foreseeable future. Based upon our current plans, we
believe that our existing cash reserves will not be sufficient to meet our
current liabilities and other obligations as they become due and payable.
Accordingly, we will need to seek to obtain additional debt or equity financing
through a public or private placement of shares of our preferred or common stock
or through a public or private financing. Our ability to meet such obligations
will depend on our ability to sell securities, borrow funds, reduce operating
costs, or some combination thereof. We may not be successful in obtaining
necessary financing on acceptable terms, if at all. As of December 31, 2008, we
had negative working capital of $805,912, accumulative deficit of $44,585,093,
and stockholders’ deficit of $2,036,595. Cash used in 2008 operations was
$12,736,133. As a result of these conditions, there is substantial doubt about
our ability to continue as a going concern. The financial statements filed as
part of this Annual Report do not include any adjustments that might result from
the outcome of this uncertainty.




Upon
receipt of the approximate $27.3 million raised through a private placement of
our common stock which was completed in the fourth quarter of 2006, we
strategically began our operating activities and research and development
efforts which resulted in a net loss of $23.0 million in 2008 and $17.1 million
in 2007, including approximately a net $1.6 million fair value accrual of a
potential 9.23 million shares issuance discussed in Note 4, “Legal Proceedings”
below. In addition, we invested $25.0 million in high grade money market funds
and marketable securities. We sold $22.0 million of these investments leaving a
balance of $3.0 million as of December 31, 2008.




We are a
medical device company developing an innovative extra-corporeal platform
technology to be used in devices to replace the function of various human
organs. We hope that the platform will lead to three initial products: (i) a
Portable Artificial Kidney (PAK) for hospital Renal Replacement Therapy, (ii) a
PAK for home hemodialysis and (iii) a Wearable Artificial Kidney (WAK) for
continuous ambulatory hemodialysis. Our rights to the WAK derive in part from
the License Agreement between Operations and NQCI pursuant to which we obtained
the exclusive rights to the Technology. See Note 4, “Legal Proceedings”
below.




We have
focused much of our efforts on development of the PAK, which has not been
derived from the technology covered by the License Agreement. Through our
research and development efforts, we have completed functional prototypes of our
hospital and home PAKs that we plan to commercialize after 510(k) notification
clearance from the Food and Drug Administration (FDA) which we plan to seek in
the future. Prior to the 510(k) submission to the FDA for clinical use under
direct medical supervision, the units will undergo final verification and
validation. It generally takes 4 to 12 months from the date of a 510(k)
submission to obtain clearance from the FDA, although it may take longer. We
hope to begin to shift out of the development and build phase of the prototype
equipment and into product phase, which should help us to reduce the related
spending on research and development costs as well as consulting and material
costs. See Note 19, “Product Development Agreement” below. With this transition,
there will be a shift of resources towards verification and validation of our
devices along with developing a marketing plan for the PAK.




35


In
addition, we have used some of our resources for the development of the WAK of
which we have demonstrated a feasibility prototype. Commercialization of the WAK
will require development of a functional prototype and likely a full pre-market
approval by the FDA, which could take several years. Once the Technology
Transaction has closed and the results of the arbitration proceeding described
in Note 4, “Legal Proceedings” are final, we will determine whether to devote
available resources to development of the WAK.




Because
neither the PAK nor the WAK is yet at a stage where it can be marketed
commercially, we are not able to predict the portion of our future business
which will be derived from each.





2.
            DEVELOPMENT STAGE
      COMPANY





We are a
development stage company, devoting substantially all of our efforts to the
research, development, and commercialization of kidney failure treatment
technologies.





Risks and Uncertainties — We
operate in an industry that is subject to intense competition, government
regulation, and rapid technological change. Our operations are subject to
significant risk and uncertainties including financial, operational,
technological, legal, regulatory, and other risks associated with a development
stage company, including the potential risk of business failure.




3.
            SUMMARY
      OF ACCOUNTING POLICIES





Cash and Cash Equivalents —Cash equivalents are comprised of certain highly liquid investments with
original maturities of less than three months.





Marketable Securities —We
classify investments with maturity dates greater than three months when
purchased as marketable securities. Investments, including certificates of
deposit with maturity dates greater than three months when purchased and which
have readily determined fair values, are classified as available-for-sale
investments and reflected in current assets as marketable securities at fair
market value. Our investment policy requires that all investments be investment
grade quality and no more than ten percent of our portfolio may be invested in
any one security or with one institution.





As of
December 31, 2008 and 2007, short-term investments classified as
available-for-sale were as follows:





December
      31, 2008Aggregate
      Fair
                                
                                
                                Gross
      Unrealized
                                
                                
                                Estimated
      FairValue
                                
                                
                                Gains
      / (Losses)
                                
                                
                                ValueCommercial
      paper
                                
                                $
                                897,993
                                
                                
                                $
                                -
                                
                                
                                $
                                897,993Corporate
      securities fixed rate
                                
                                
                                457,930
                                
                                
                                
                                -
                                
                                
                                
                                457,930Total
                                
                                $
                                1,355,923
                                
                                
                                $
                                -
                                
                                
                                $
                                1,355,923




December
      31, 2007Aggregate
      Fair
                        
                        
                        Gross
      Unrealized
                        
                        
                        Estimated
      FairValue
                        
                        
                        Gains
      / (Losses)
                        
                        
                        ValueCommercial
      paper
                        
                        $
                        10,283,818
                        
                        
                        $
                        -
                        
                        
                        $
                        10,283,818Corporate
      obligation
                        
                        
                        2,245,770
                        
                        
                        
                        -
                        
                        
                        
                        2,245,770Total
                        
                        $
                        12,529,588
                        
                        
                        $
                        -
                        
                        
                        $
                        12,529,588


We review
impairments associated with the above in accordance with SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” and FASB
Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments,” to determine the
classification of the impairment as temporary or other-than-temporary. We
consider these investments not to be impaired as of December 31, 2008 and
2007.





There
were no gross unrealized gains or losses as of December 31, 2008 and
2007.





36


Property and Equipment —Property and equipment are stated at cost less accumulated depreciation
and amortization, which are calculated using the straight-line method over the
shorter of the estimated useful lives of the related assets (generally ranging
from three to five years), or the remaining lease term when applicable. Gains
and losses on disposals are included in results of operations at amounts equal
to the difference between the book value of the disposed assets and the proceeds
received upon disposal. There were no gains or losses on disposals from
inception through the end of 2008. Expenditures for replacements and leasehold
improvements are capitalized, while expenditures for maintenance and repairs are
expensed as incurred.





Research and Development —Research and development is expensed as incurred. Upfront and milestone
payments made to third parties in connection with research and development
collaborations prior to regulatory approval are expensed as incurred. Payments
made to third parties subsequent to regulatory approval are capitalized and
amortized over the shorter of the remaining license or product patent life. At
December 31, 2008, we had no such capitalized research and development
costs.





Income Taxes —Under SFAS
109, “Accounting for Income Taxes,” deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the consolidated financial statements and their respective tax basis. Deferred
income taxes reflect the net tax effects of (a) temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts reported for income tax purposes, and (b) tax credit
carry-forwards. We record a valuation allowance for deferred tax assets when,
based on management’s best estimate of taxable income in the foreseeable future,
it is more likely than not that some portion of the deferred income tax assets
may not be realized.





Earnings per Share —Under
SFAS 128, “Earnings per Share,” basic earnings per share is computed by dividing
net income available to common stockholders by the weighted average number of
common shares assumed to be outstanding during the period of computation.
Diluted earnings per share reflect the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. As we had net losses for all periods presented, basic and
diluted loss per share is the same across the periods and any additional common
stock equivalents would be anti-dilutive.





Share-Based Compensation —Effective January 1, 2006, we adopted FASB Statement No. 123R, Share-Based Payment(“FAS
123R”) (see Note 17, “Stock Options and Warrants”). FAS 123R requires all
share-based payments to employees to be expensed over the requisite service
period based on the grant-date fair value of the awards and requires that the
unvested portion of all outstanding awards upon adoption be recognized using the
same fair value and attribution methodologies previously determined under FASB
Statement No. 123, Accounting
for Stock-Based Compensation. We continue to
use the Black-Scholes valuation method and applied the requirements of FAS 123R
using the modified prospective method. Prior to January 1, 2006, there was no
share-based compensation expense.





Use of Estimates —The
consolidated financial statements are prepared in conformity with accounting
principles generally accepted in the United States (“GAAP”) and, accordingly,
include certain amounts that are based on management’s best estimates and
judgments. Estimates are used in determining such items as depreciable and
amortizable lives, amounts recorded for contingencies, share-based compensation,
taxes on income. Because of the uncertainty inherent in such estimates, actual
results may differ from these estimates.





Recently
Issued Accounting Standards





In
February 2007, the Financial Accounting Standards Board (“FASB”) issued FASB
Statement No. 159, “The Fair
Value Option for Financial Assets and Financial Liabilities — Including an
Amendment of FASB Statement No. 115, Accounting for Certain Investments
in Debt and Equity Securities”(“SFAS No. 159”). SFAS No. 159 permits
an entity to choose to measure many financial instruments and certain items at
fair value. The objective of this standard is to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reporting
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. SFAS No. 159 permits all
entities to choose to measure eligible items at fair value at specified election
dates. Entities will report unrealized gains and losses on items for which the
fair value option has been elected in earnings at each subsequent reporting
date. The fair value option: (a) may be applied instrument by instrument, with a
few exceptions, such as investments accounted for by the equity method; (b) is
irrevocable (unless a new election date occurs); and (c) is applied only to
entire instruments and not to portions of instruments. SFAS No. 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November
15, 2007, which for us is our fiscal year beginning January 1, 2008. The
adoption of SFAS No. 159 did not have any effect on our consolidated financial
statements.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS
141(R)”). SFAS 141(R) replaces SFAS No. 141, “Business Combinations”, but
retains the requirement that the purchase method of accounting for acquisitions
be used for all business combinations. SFAS 141(R) expands on the disclosures
previously required by SFAS 141, better defines the acquirer and the acquisition
date in a business combination, and establishes principles for recognizing and
measuring the assets acquired (including goodwill), the liabilities assumed and
any non-controlling interests in the acquired business. SFAS 141(R) also
requires an acquirer to record an adjustment to income tax expense for changes
in valuation allowances or uncertain tax positions related to acquired
businesses. SFAS 141(R) is effective for all business combinations with an
acquisition date in the first annual period following December 15, 2008; early
adoption is not permitted. We will adopt this statement as of January 1, 2009.
The impact of SFAS 141(R) will have on our consolidated financial statements
will depend on the nature and size of acquisitions we complete after we adopt
SFAS 141(R).





37


In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements-an amendment of ARB No. 51” (SFAS 160). SFAS
160 requires that non-controlling (or minority) interests in subsidiaries be
reported in the equity section of the company’s balance sheet, rather than in a
mezzanine section of the balance sheet between liabilities and equity. SFAS 160
also changes the manner in which the net income of the subsidiary is reported
and disclosed in the controlling company’s income statement. SFAS 160 also
establishes guidelines for accounting for changes in ownership percentages and
for deconsolidation. SFAS 160 is effective for financial statements for fiscal
years beginning on or after December 1, 2008 and interim periods within those
years. The adoption of SFAS 160 is not expected to have a material impact on our
financial position, results of operations or cash flows.





In
March 2008, the FASB issued SFAS No. 161, Disclosures About Derivative
Instruments and Hedging Activities, or “SFAS 161”. SFAS 161 enhances the
disclosure requirements for derivative instruments and hedging activities. This
Standard is effective as of January 1, 2009. Since SFAS 161 requires only
additional disclosures concerning derivatives and hedging activities, adoption
of SFAS 161 will not affect our financial condition or results of
operation.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles in the
United States (the GAAP hierarchy).  SFAS 162 became effective
November 15, 2008. The adoption of SFAS 162 did not have a material impact on
our financial position, results of operations or cash flows.





In June
2008, the FASB reached a consensus on EITF Issue No. 07-5, Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own Stock, or “EITF
07-5”. EITF 07-5 requires that we apply a two-step approach in evaluating
whether an equity-linked financial instrument (or embedded feature) is indexed
to our own stock, including evaluating the instrument’s contingent exercise and
settlement provisions. EITF 07-5 is effective for fiscal years beginning after
December 15, 2008. We are currently evaluating the effects, if any, that EITF
07-5 will have on our consolidated financial statements.





4.
            LEGAL
      PROCEEDINGS





On
December 1, 2006, Operations initiated arbitration against NQCI for NQCI's
failure to fully perform its obligations under the License Agreement dated
September 1, 2006. On September 1, 2006, Operations also entered into a Merger
Agreement with NQCI which contemplated that Operations would acquire NQCI as a
wholly owned subsidiary pursuant to a triangular merger, or would issue to NQCI
shares of common stock in consideration of the assignment of the technology
relating to the WAK and other medical devices which, as listed under
“Technology” on the License Agreement, are “all existing and hereafter developed
Intellectual Property, Know-How, Licensor Patents, Licensor Patent Applications,
Derivative Works and any other technology, invented, improved or developed by
Licensor, or as to which Licensor owns or holds any rights, arising out of or
relating to the research, development, design, manufacture or use of (a) any
medical device, treatment or method as of the date of this Agreement, (b) any
portable or continuous dialysis methods or devices , specifically including any
wearable artificial kidney, or “Wearable Artificial Kidney”, and related
devices, (c) any device, methods or treatments for congestive heart failure, and
(d) any artificial heart or coronary device”, collectively referred to herein as
the “Technology Transaction”. The merger was never consummated.





On
January 3, 2008, the arbitrator issued an order denying NQCI’s motion to amend
its counterclaim to add us as a successor company following the merger. However,
in the Second Interim Award, the arbitrator found that we are the successor to
Operations as a result of the merger, even though we are not a party to any of
the agreements or the arbitration, and ordered that our shares should be issued
to NQCI rather than shares of Operations.





On June
9, 2008, the arbitrator issued an Interim Award granting specific performance of
the Technology Transaction. The Interim Award stated that the total aggregate
shares of stock to be received by NQCI at the closing should equal 48% of all
Operations shares outstanding as of the date of the Merger Agreement. On
September 1, 2006, there were 10,000,000 shares of Operations common stock
outstanding.




On August
4, 2008, the arbitrator issued a Second Interim Award, stating that 9,230,000
shares of our common stock should be issued to NQCI to effectuate the Technology
Transaction. As of December 31, 2008, there were 14,754,687 shares of our common
stock issued and outstanding. Accordingly, following closing of the Technology
Transaction, NQCI would be our largest stockholder and would own approximately
39% of our total outstanding shares.




The
arbitrator has not ordered us to close the Technology Transaction. However, the
arbitrator found that, with the exception of shareholder approval, virtually all
conditions to closing the Technology Transaction have been waived. The award
further states that, if we or our stockholders do not approve the issuance of
our stock to effectuate the Technology Transaction, all of the Technology
covered by the License Agreement will be declared the sole and exclusive
property of NQCI, and the arbitrator will schedule additional hearings to
address whether the PAK technology is included within that Technology, and
whether NQCI is entitled to compensatory damages and the amount of damages, if
any, under these circumstances. Upon closing of the Technology Transaction, the
License Agreement will terminate, and we will own all of the
Technology.





38


The
Second Interim Award also stated that the License Agreement will remain in full
force and effect until the Technology Transaction closes or the arbitrator
determines that it will never close. NQCI has made a claim for reimbursement of
approximately $690,000 in alleged expenses, Licensor Expenses, under the License
Agreement which were accrued under “Accrued legal fees & licensing expense”
as of December 31, 2008. The Licensor Expenses were accrued in the fiscal year
ended December 31, 2008, with the expenditure recorded as Licensing Expense
within research and development operating expenses.




On August
15, 2008, the arbitrator awarded NQCI $1.87 million to settle over $4 million
NQCI claimed in attorneys’ fees and costs which have been accrued under “Accrued
legal fees & licensing expense” as of December 31, 2008. The settlement of
legal fees was accrued in the year ended at December 31, 2008, with the
expenditure recognized as “Other expenses” and payment pending to
date.





The
Second Interim Award required that we file a registration statement under the
Securities Act to register for resale the shares to be issued to NQCI within 30
days after the closing of the Technology Transaction. The arbitrator
acknowledged that our obligation is to file the registration statement and to
use reasonable efforts to have the shares registered and not to guarantee
registration and resultant actual public tradability. However, the arbitrator
nevertheless ordered that the registration statement must be declared effective
within 90 days.




The
Second Interim Award requires that we file a registration statement under the
Securities Act to register for resale the shares to be issued to NQCI within 30
days after the closing of the Technology Transaction. The arbitrator
acknowledged that our obligation is to file the registration statement and to
use reasonable efforts to have the shares registered and not to guarantee
registration and resultant actual public tradability. However, the arbitrator
nevertheless ordered that the registration statement must be declared effective
within 90 days. We have no control over whether the registration statement will
be declared effective by the SEC, and no way to predict what further action, if
any, the arbitrator may order if it is not declared effective.








The
Technology Transaction will be accounted for as a purchase of the Technology in
exchange for shares of our common stock. In accordance with FASB Concepts
Statement No. 7, Using Cash
Flow Information and Present Value in Accounting Measurements, the
Technology Transaction will be measured based on the fair value of the shares
issued, which is clearly more evident than the fair value of the intellectual
property. Through the evaluation of the components of the intellectual property
and information pursuant to the arbitration suggesting it may not be
proprietary, we have determined the intellectual property is not economically
viable. However, continuing research on the technology will be useful in
developing the prototype of our Wearable Artificial Kidney. In accordance with
FASB 2,Accounting for
Research and Development Costs, and its related interpretations, we have
expensed the value of the intellectual property, determined in process research
and development, at the date of acquisition. See Note 10, “Shares
Issuable”,
below.





Pursuant
to the Second Interim Award, which stated that, if the Technology
Transaction is submitted to and approved by our stockholders, 9,230,000 shares
of our common stock should be issued to NQCI to effectuate the transaction, we
accrued for the 9,230,000 shares of our common stock. As the Second Interim
Award states that we must issue 9,230,000 upon the closing of the Technology
Transaction and we have been unable to consummate such transaction, such
contingency is not within our control and we have therefore, recorded
the obligation to issue the shares as a liability, rather than as an
equity issuance. The fair value of the 9,230,000 shares was measured using the
closing price of our common stock on August 4, 2008, the date of the Second
Interim Award, and revalued, marked to market, as of the end of the year ending
at December 31, 2008. The fair value of the accrued shares on August 4, 2008,
was $10,153,000 which is reflected in research and development expense. The
obligation to issue the shares was revalued at $1,569,100 as of December 31,
2008, resulting in a $8,583,900 non-operating gain, classified as change in fair
value of shares issuable in the statement of operations for the year ended
December 31, 2008. The net fair value of $1,569,100 was accrued under “Shares
issuable” as of December 31, 2008.  Stockholder approval and issuance
of the shares are pending to date.





39


We are
currently in the process of seeking approval from our stockholders to issue
9,230,000 shares of our common stock in order to obtain ownership of the
Technology. The stockholder approval is being sought in accordance with an
Interim Award issued on June 9, 2008, and in order to minimize the risk that the
arbitrator will issue an alternative award that could have a material adverse
effect on our financial condition and operations. The arbitrator has refused to
issue a final award until this stockholder approval has been obtained from our
stockholders, which may effectively prevent us from obtaining effective court
review of the arbitrator’s actions. If the Technology Transaction does not
close, the arbitrator may issue alternative relief. In the event of an
alternative award, the above accrual may be adjusted and the accrual or the
actual settlement will be recorded to coincide with the alternate
award.





If the
9,230,000 shares are issued pursuant to the approval of our stockholders, then
the $1,569,100 contingent liability recorded on our balance sheet will be
adjusted through earnings to an amount equal to the product of 9,230,000 shares
and the trading price of our common stock on that day and then be
eliminated by increasing the number of our issued and outstanding common shares
by 9,230,000 and increasing our stockholders’ equity by a
corresponding amount.





The
arbitrator held a conference call hearing with the Company and NQCI on March 13,
2009 in which the parties discussed the reasons for the difficulties in closing
the Technology Transaction and explored potential alternatives. The parties were
asked to submit letter briefs outlining their suggested alternatives for
consideration by the arbitrator. The parties submitted their respective letter
briefs on March 24, 2009.





As of the
date of this Annual Report, the arbitration proceeding with NQCI continues and
the arbitrator has not yet issued a final award to either party and has not made
a final ruling with respect to whether the closing of the Technology Transaction
shall occur or whether potential alternatives should be pursued.





The
arbitrator has stated that he has not yet issued a final award that may be
confirmed or challenged in a court of competent jurisdiction. A party to the
arbitration could challenge the interim award in court, even after stockholders
approve the transaction. In addition, the arbitrator could again change the
award by granting different or additional remedies, even after stockholders
approve the transaction. We cannot guarantee that the arbitrator would order
that our stockholders should be given another opportunity to vote on the
transaction, even if such changes are material. Arbitrators have broad equitable
powers, and arbitration awards are difficult to challenge in court, even if the
arbitrator makes rulings that are inconsistent or not in accordance with the law
or the evidence.





5.
            CASH EQUIVALENTS AND MARKETABLE
      SECURITIES





We invest
available cash in short-term commercial paper, certificates of deposit, money
market funds, and high grade marketable securities. We consider any liquid
investment with an original maturity of three months or less when purchased to
be cash equivalents. Investments, including certificates of deposit with
maturity dates greater than three months when purchased and which have readily
determined fair values, are classified as available-for-sale investments and
reflected in current assets as marketable securities at fair market value. Our
investment policy requires that all investments be investment grade quality and
no more than ten percent of our portfolio may be invested in any one security or
with one institution. At December 31, 2008, all of our cash was held in high
grade money market funds and marketable securities.





Restricted
cash represents deposits secured as collateral for a letter of credit pursuant
to our new operating facility lease agreement at December 31, 2008 and for a
bank credit card program at December 31, 2007.





6.
            FAIR
      VALUE MEASUREMENTS





Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS
157”). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This statement
does not require any new fair value measurements; rather, it applies to other
accounting pronouncements that require or permit fair value measurements. In
February 2008, FSP FAS 157-2, “Effective Date of FASB Statement
No. 157”, was issued, which delays the effective date of SFAS 157 to
fiscal years and interim periods within those fiscal years beginning after
November 15, 2008 for non-financial assets and non-financial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). We elected to defer the
adoption of the standard for these non-financial assets and
liabilities.





Fair
value is defined under SFAS 157 as the price that would be received to sell an
asset or paid to transfer a liability in the principal or most advantageous
market in an orderly transaction between market participants on the measurement
date. SFAS 157 also establishes a three-level hierarchy, which requires an
entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value.





Beginning
January 1, 2008, assets and liabilities recorded at fair value in the balance
sheets are categorized based upon the level of judgment associated with the
inputs used to measure their fair value. Level inputs, as defined by SFAS 157,
are as follows:





·
            Level
      I - inputs are unadjusted, quoted prices for identical assets or
      liabilities in active markets at the measurement
  date.




40




·
            Level
      II - inputs, other than quoted prices included in Level I, that are
      observable for the asset or liability through corroboration with market
      data at the measurement date.





·
            Level III - unobservable inputs
      that reflect management’s best estimate of what market participants would
      use in pricing the asset or liability at the measurement
      date.




The
following table summarizes fair value measurements by level at December 31, 2008
for assets and liabilities measured at fair value on a recurring
basis:




Level
      I
                            
                            
                            Level
      II
                            
                            
                            Level
      III
                            
                            
                            TotalCash
      and cash equivalents
                            
                            $
                            407,585
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            407,585Marketable
      securities:Commercial
      paper
                            
                            
                            897,993
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            897,993Corporate securities fixed
      rate
                            
                            
                            457,930
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            457,930Money market
      fund
                            
                            
                            1,599,791
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            1,599,791Restricted
      cash
                            
                            
                            301,675
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            301,675Total
      assets
                            
                            $
                            3,664,974
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            3,664,974Shares
      issuable
                            
                            $
                            -
                            
                            
                            $
                            1,569,100
                            
                            
                            $
                            -
                            
                            
                            $
                            1,569,100Total
      liabilities
                            
                            $
                            -
                            
                            
                            $
                            1,569,100
                            
                            
                            $
                            -
                            
                            
                            $
                            1,569,100




Liabilities
measured at market value on a recurring basis include shares issuable resulting
from the Second Interim Award in the arbitration against NQCI. Until issued, the
shares will be marked to market in accordance with Emerging Issues Task Force
No. 00-19, Accounting for
Derivative Financial Instruments Indexed to and Potentially Settled in, a
Company’s Own Stock (“EITF 00-19”), with subsequent changes in fair value
recorded as non-operating change in fair value of shares issuable to our
statement of operations. The fair value of the shares will be measured using the
closing price of our common stock on the reporting date. See Note 10, “Shares
Issuable” below, for further additional information related to the shares
issuable.





7.
            LOSS
      PER COMMON SHARE





The
following table sets forth the computation of basic and diluted loss per common
share:





Years
      endedDecember
      31,2008
                      
                      
                      2007Numerator:Net Loss
                      
                      $
                      (22,987,273
                      )
                      
                      $
                      (17,074,051
                      )Denominator:Weighted average outstanding
      shares of common stock
                      
                      
                      14,604,274
                      
                      
                      
                      14,206,489Loss per common
      share:Basic
                      
                      
                      (1.57
                      )
                      
                      
                      (1.20
                      )Diluted
                      
                      $
                      (1.57
                      )
                      
                      $
                      (1.20
                      )




Diluted
loss per common share for the years ended December 31, 2008 and 2007 does not
include the effect of stock options and warrants (see Note 17, “Stock Options
and Warrants”) since their effect would be anti-dilutive. Options and warrants
outstanding at December 31, 2008 and 2007 were approximately 4.4 million and 4.7
million, respectively. The 9,230,000 shares issuable discussed in Note 10, “Shares
Issuable,”
below, have not been taken into consideration.





8.
            INCOME
      TAXES





The
provision for income taxes for the years ended December 31, 2008 and 2007 are
summarized as follows (in thousands):




41




2008
                          
                          
                          2007Current:Federal
                          
                          $
                          -
                          
                          
                          $
                          -State
                          
                          
                          2
                          
                          
                          
                          22
                          
                          
                          
                          2Deferred:Federal
                          
                          
                          -
                          
                          
                          
                          -State
                          
                          
                          -
                          
                          
                          
                          --
                          
                          
                          
                          -Total income tax
      provision
                          
                          $
                          2
                          
                          
                          $
                          2




Deferred
tax assets (liabilities) are comprised of the following (in
thousands):





2008
                    
                    
                    2007Deferred tax
      assets:Stock based
      compensation
                    
                    $
                    5,342
                    
                    
                    $
                    3,611Accrued
      liability
                    
                    
                    1,145
                    
                    
                    
                    124Other
                    
                    
                    78
                    
                    
                    
                    -Total deferred tax
      assets
                    
                    
                    6,565
                    
                    
                    
                    3,735Deferred tax
      liabilities:Fixed
    assets
                    
                    
                    36
                    
                    
                    
                    6Prepaid
      expenses
                    
                    
                    62
                    
                    
                    
                    155Total deferred tax
      liabilities
                    
                    
                    98
                    
                    
                    
                    1616,467
                    
                    
                    
                    3,574Net operating
      loss
                    
                    
                    9,660
                    
                    
                    
                    4,834Research & development
      credits
                    
                    
                    1,446
                    
                    
                    
                    59917,573
                    
                    
                    
                    9,007Valuation
      allowance
                    
                    
                    (17,573
                    )
                    
                    
                    (9,007
                    )Net deferred tax assets or
      (liabilities)
                    
                    $
                    -
                    
                    
                    $
                    -




Valuation Allowance on Deferred
      Taxes(in
      thousands)
                            
                            
                            (in
      thousands)2008
                            
                            
                            2007Beginning
      balance
                            
                            $
                            9,007
                            
                            
                            $
                            1,917Additions
                            
                            
                            8,566
                            
                            
                            
                            7,090Ending
      balance
                            
                            $
                            17,573
                            
                            
                            $
                            9,007




Rate
Reconciliation for the U.S. federal statuary rate and the effective tax
rate:





Years
      ended12/31/08(%)
                              
                              
                              12/31/07(%)Federal statutory
      rate
                              
                              
                              (34.00
                              )
                              
                              
                              (34.00
                              )State and local income taxes, net
      of federal tax benefits
                              
                              
                              (5.83
                              )
                              
                              
                              (5.83
                              )Permanent
      differences
                              
                              
                              5.81
                              
                              
                              
                              0.68Research & development
      credits
                              
                              
                              (3.68
                              )
                              
                              
                              (2.72
                              )Other
                              
                              
                              0.45
                              
                              
                              
                              0.00Effective tax
      benefit
                              
                              
                              (37.25
                              )
                              
                              
                              (41.87
                              )Valuation
      allowance
                              
                              
                              37.25
                              
                              
                              
                              41.870.00
                              
                              
                              
                              0.00




Based
upon our development stage status and history of operating losses, realization
of our deferred tax assets does not meet the criteria under SFAS 109, and
accordingly a valuation allowance for the entire deferred tax asset amount has
been recorded at December 31, 2008 and 2007.




The
valuation allowance had an increase of $8.6 million and $7.1 million in 2008 and
2007, respectively.





42


Pursuant
to Sections 382 and 383 of the Internal Revenue Code, the utilization of net
operating losses and other tax attributes may be subject to substantial
limitations if certain ownership changes occur during a three-year testing
period (as defined).  In 2008, we determined that an ownership change
occurred under Section 382 of the Internal Revenue Code. The utilization of our
federal net operating loss carryforwards, capital loss carryforwards and other
tax attributes related to CTHE will be limited to zero. Accordingly, we have
reduced our net operating loss, capital loss and minimum tax credit
carryforwards to the amount that we estimate that we would be able to utilize in
the future, if profitable, considering the above limitations.





At
December 31, 2008, we had net operating loss carry forwards for Federal purposes
of approximately $24.3 million which begin to expire in 2021. $24.3 million of
the Federal net operating loss carry forwards are also valid for state income
tax purposes and begin to expire in 2021.





In
addition, we had research and development tax credits for Federal and state
income tax purposes of approximately $826,000 and $620,000 respectively. The
federal credits begin to expire in 2026 and state credits do not expire for
California purposes.





During
the year ended December 31, 2007, we adopted FIN 48 which clarifies the
accounting for income taxes by prescribing the minimum threshold a tax position
is required to meet before being recognized in the financial statements as well
as guidance on de-recognition, measurement, classification and disclosure of tax
positions. The adoption of FIN 48 by us did not have an effect on our financial
condition or results of operations and resulted in no cumulative effect of
accounting change being recorded as of January 1, 2007.









There was
no significant uncertain tax position identified during the year ended December
31, 2008.









9.
            PROPERTY AND
      EQUIPMENT




Property
and equipment consist of the following at:





December
      31,2008
                      
                      
                      2007Property
      and equipment
                      
                      $
                      474,402
                      
                      
                      $
                      299,100Accumulated
      depreciation
                      
                      
                      (136,848
                      )
                      
                      
                      (32,188
                      )Property
      and equipment, net
                      
                      $
                      337,554
                      
                      
                      $
                      266,912




Depreciation expense for the years
ended December 31, 2008, and 2007, was $104,660 and $32,093,
respectively.





10.
            SHARES
      ISSUABLE





Pursuant
to the August 4, 2008, Second Interim Award, which stated that, if the
Technology Transaction is submitted to and approved by our stockholders,
9,230,000 shares of our common stock should be issued to NQCI to effectuate the
transaction, we accrued for the 9,230,000 shares of our common stock. As the
Second Interim Award states that we must issue 9,230,000 upon the closing of the
Technology Transaction and we have been unable to consummate such transaction,
such contingency is not within our control and we have therefore, recorded the
issuance as a liability, rather than as an equity issuance. As of December 31,
2008, we accrued for the 9,230,000 shares of our common stock to be issued to
NQCI in accordance with FASB 5, Accounting for Contingencies,
with the initial fair value of the shares measured on August 4, 2008, the date
of the Second Interim Award.Until issued, the
shares will be marked to market in accordance with Emerging Issues Task Force
No. 00-19, Accounting for
Derivative Financial Instruments Indexed to and Potentially Settled in, a
Company’s Own Stock (“EITF 00-19”), with subsequent changes in fair value
recorded as non-operating change in fair value of shares issuable to our
statement of operations. The fair value of the shares will be measured using the
closing price of our common stock on the reporting date. The measured fair value
of $10,153,000 for the accrued 9,230,000 shares on August 4, 2008, the date of
the Second Interim Award, was accrued under “Shares issuable” and expensed to
“Research and development.” From marking to market, the fair value of the shares
issuable was revalued at $1,569,100 as of December 31, 2008. The resulting
non-operating change in fair value of $8,583,900 to the statement of operations
for the year ended December 31, 2008 was recognized as “Change in fair value of
shares issuable.” Stockholder approval and issuance of the shares are pending to
date.





We are in
the process of seeking stockholder approval for the issuance of the 9,230,000
shares of our common stock to effectuate the Technology Transaction. There can
be no assurance, that such stockholder approval will be obtained, whether shares
will be issued to NQCI or whether the SEC will declare effective the
registration statement registering the shares for resale. If the Technology
Transaction does not close, the arbitrator may issue alternative relief. In the
event of an alternative award, the above accrual may be adjusted and the accrual
or the actual settlement will be recorded to coincide with the alternate
award.




43




11.
            LEASES





As of
February 22, 2008, we entered into a 5-year lease agreement and relocated our
corporate office to a location in Los Angeles, CA. The total lease payments will
be $1,096,878 over the lease term. As of December 31, 2008, our remaining total
lease payments are $957,614.





The
following is a schedule by years of future minimum lease payments required under
the 5-year corporate office lease as of December 31, 2008:





Year
      ending December 31:2009
                        
                        $
                        215,8592010
                        
                        
                        224,6502011
                        
                        
                        233,5282012
                        
                        
                        242,8422013
                        
                        
                        40,735
                        ( 1)Total
      minimum payments required
                        
                        $
                        957,614


(1)
Initial term of the lease agreement ends February 2013




In
October 2008 we entered into a 5-year lease agreement through November 26, 2013,
for our new operating facility in Lake Forest, CA. The lease agreement includes
a tenant improvement allowance of $363,800 which 50% can be applied to rent
payments with the remaining 50% applied to tenant improvement and related
expenditures. As of December 31, 2008, we expended $87,658 in improvement and
related expenses which we are pending reimbursement in accordance to the tenant
improvement allowance. The $87,658 was recognized under “Tenant improvement
allowance receivable” as of December 31, 2008. The total lease payments,
including the 50% of the tenant improvement allowance applied to rent payments,
will be $1,367,507 over the lease term. As of December 31, 2008, our remaining
total lease payments are $1,340,828.





The
following is a schedule by years of future minimum lease payments required under
the 5-year operating facility lease as of December 31, 2008:





Year
      ending December 31:2009
                    
                    
                    135,8372010
                    
                    
                    293,7222011
                    
                    
                    303,9942012
                    
                    
                    314,2662013
                    
                    
                    293,009
                    (1)Total
      minimum payments required
                    
                    $
                    1,340,828   (1)
Initial term of the lease agreement ends February 2013
  Additionally,
we lease two corporate apartments, approximately 800 and 550 square feet,
expiring March 31, 2009 and April 18, 2009, respectively, located in Irvine, for
combined monthly rent of $3,765, which we plan to vacate after the expiration of
the leases.





All of
the space is in good condition and we expect it to remain suitable to meet our
needs for the foreseeable future. We intend to consolidate our offices and
sublease our current corporate office located in Los Angeles,
California.





12.
              NON-CASH
      TRANSACTIONS





During
the year ended December 31, 2008, there was a reversal of a non-cash liability
of $115,400.





Investing
and financing activities during the year ended December 31, 2007, that do not
have a direct impact on current cash flows have been excluded from the
statements of cash flows, as follows:





a)
Pre-merger Xcorporeal cancelled 200,000 shares of common stock pursuant to a
settlement agreement with one of our stockholders, and




44




b)
Immediately prior to the effectiveness of the merger, we caused a reverse split
of our common stock, whereby each 8.27 issued and outstanding shares of our
common stock were converted into one share of common stock.





13.
            INTEREST
      INCOME





Interest
income of $320,622 and $1,184,930 was reported for years ended December 31, 2008
and 2007, respectively.





14.
            OTHER
      EXPENSES





On August
15, 2008, the arbitrator in the NQCI arbitration issued another interim award,
awarding NQCI a total of $1,871,430 in attorney’s fees and costs. Pursuant to
the award, we accrued the liability under “Accrued legal fees & licensing
expense” and captured the expenditure in “Other expenses” in the year ended
December 31, 2008.





15.
            RELATED PARTY
      TRANSACTION





In
connection with the contribution of the assets to our company, on August 31,
2006we issued to
Consolidated National, LLC, or “CNL”, of which Terren Peizer, a member of our
Board of Directors, who beneficially owns 42.2% of our outstanding common stock
as of December 31, 2008, is the sole managing member and beneficial owner, an
aggregate of 9,600,000 shares of our common stock of which 6,232,596 shares are
still held by CNL.





Dr.
Victor Gura, our Chief Medical and Scientific Officer, owns 15,497,250 shares of
common stock of National Quality Care, Inc. (or approximately 20.9% of National
Quality Care, Inc.'s common stock outstanding as of January 31, 2009) with whom
we entered into the License Agreement. Such shares include 800,000 shares owned
by Medipace Medical Group, Inc., an affiliate of Dr. Gura (or approximately 1.1%
of NQCI's common stock outstanding as of January 31, 2009), and 250,000 shares
subject to warrants held by Dr. Gura which are currently exercisable (or
approximately 0.3% of NQCI's common stock outstanding as of January 31,
2009).





Pursuant
to a consulting agreement effective December 1, 2007, Daniel S. Goldberger, then
a director, provided consulting services to us as our interim Chief Executive
Officer. In consideration of the services, we paid Mr. Goldberger $15,000 per
month during the first two months and $12,500 per month thereafter during the
term of the consulting agreement. From execution through December 31, 2008, Mr.
Goldberger was compensated $152,500 for his services. Mr. Goldberger resigned as
interim Chief Executive Officer on October 6, 2008, and resigned as a member of
our Board of Directors on October 7, 2008, and remained a strategic consultant
to the Company through December 31, 2008.





Dr. Gura
maintains an office located in Beverly Hills, California. Pursuant to a
reimbursement agreement effective January 29, 2008, we reimburse 50% of the
rental and 50% of his monthly parking. The term of the agreement commenced on
April 23, 2007, the date of the office lease agreement, and continues until the
date on which he ceases to use the remote office to perform his duties as our
Chief Medical and Scientific Officer. From commencement through December 31,
2008, we reimbursed Dr. Gura $1,710 and $37,988 for 50% of the monthly parking
and rental, respectively.





16.
            LICENSE
      AGREEMENT





On August
31, 2006, we entered into a Contribution Agreement with CNL. We issued 9,600,000
shares of common stock in exchange for (a) the right, title, and interest to the
name “Xcorporeal” and related trademarks and domain names, and (b) the right to
enter into a License Agreement with NQCI, dated September 1, 2006, pursuant to
which we obtained the exclusive rights to the technology relating to our kidney
failure treatment and other medical devices which, as listed under “Technology”
on the License Agreement, are “all existing and hereafter developed Intellectual
Property, Know-How, Licensor Patents, Licensor Patent Applications, Derivative
Works and any other technology, invented, improved or developed by Licensor, or
as to which Licensor owns or holds any rights, arising out of or relating to the
research, development, design, manufacture or use of (a) any medical device,
treatment or method as of the date of this Agreement, (b) any portable or
continuous dialysis methods or devices, specifically including any Wearable
Artificial Kidney and related devices, (c) any device, methods or treatments for
congestive heart failure, and (d) any artificial heart or coronary device.”
Operations was a shell corporation prior to the transaction. We valued the
License Agreement at the carry-over basis of $1,000. As consideration for being
granted the License, we agreed to pay to NQCI a minimum annual royalty of
$250,000, or 7% of net sales. Although we have asserted that NQCI’s breaches of
the License Agreement excused our obligation to make the minimum royalty
payments, we recorded $583,333 in royalty expenses covering the minimum
royalties from commencement of the License Agreement through December 31, 2008.
The License Agreement expires in 2105.





The
License Agreement also stipulates the reimbursement of reasonable and necessary
expenses incurred in the ordinary course of business consistent with past
practices (“Licensor Expenses”) until the closing or the termination of the
Merger Agreement. The Second Interim Award from the arbitration with NQCI states
that the License Agreement will remain in full force and effect until the
Technology Transaction closes or the arbitrator determines that it will never
close. Although we have contested its right to any further payments, NQCI has
made a claim for reimbursement of approximately $690,000 in alleged expenses
under the License Agreement which were accrued under “Accrued legal fees &
licensing expense” as of December 31, 2008. See Note 4, “Legal Proceedings”
above, for further additional information related to this License
Agreement.




45




17.
            STOCK OPTIONS AND
      WARRANTS





Incentive
Compensation Plan





On
October 12, 2007, we adopted the Xcorporeal, Inc. 2007 Incentive Compensation
Plan and the related form of option agreement that is substantially identical to
the 2006 Incentive Compensation Plan that was in effect at Operations
immediately prior to the merger.




The plan
authorizes the grant of stock options, restricted stock, restricted stock units,
and stock appreciation rights. There are 3,900,000 shares of common stock
authorized for issuance under to the 2007 Incentive Compensation Plan (subject
to adjustment in accordance with the provisions of the plan). The plan will
continue in effect for a term of up to ten years. As of December 31, 2008, there
were options to purchase 977,500 shares outstanding and 2,922,500 shares
available for issuance under the 2007 Incentive Compensation Plan.





On
October 12, 2007, we also assumed options to purchase up to 3,880,000 shares of
common stock that were granted by Operations under its 2006 Incentive
Compensation Plan, of which 980,000 have since been forfeited, canceled, or
expired, and therefore, options to purchase 2,900,000 shares remain
outstanding.





Stock
Options to Employees, Officers and Directors





The
Compensation Committee of our Board of Directors determines the terms of the
options granted, including the exercise price, the number of shares subject to
option, and the vesting period. Options generally vest over five years and have
a maximum life of ten years.





We
reported $4,704,039 and $3,721,485 in stock-based compensation expense for
employees, officers, and directors for the years ended December 31, 2008 and
2007, respectively.





All
compensation expense for stock options granted has been determined under the
fair value method using the Black-Scholes option-pricing model with the
following assumptions:





For
      the years ended December 31,2008
                          
                          
                          2007Expected
      dividend yields
                          
                          zero
                          
                          
                          zeroExpected
      volatility
                          
                          
                          130-136
                          %
                          
                          
                          110-136
                          %Risk-free
      interest rate
                          
                          
                          3.53-3.81
                          %
                          
                          
                          4.18-4.68
                          %Expected
      terms in years
                          
                          2.87-8.96
      years
                          
                          
                          6.25-10
      years




Warrants
and Stock Options to Non-Employees





During
the year ended December 31, 2008, there was no issuance of
warrants.





We reported $91,306 and $2,917,309 in
stock-based compensation expenses for consultants for the years ended December
31, 2008 and 2007, respectively.





Compensation
for options granted to non-employees has been determined in accordance with SFAS
No. 123R, EITF 96-18, and EITF 00-18, “Accounting for Equity Instruments that
are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services.” Accordingly, compensation is determined using the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured.





For
options and warrants issued as compensation to non-employees for services that
are fully vested and non-forfeitable at the time of issuance, the estimated
value is recorded in equity and expensed when the services are performed and
benefit is received as provided by Financial Accounting and Standards Board
(“FASB”) Emerging Issues Task Force No. 96-18 “Accounting For Equity Instruments
That Are Issued To Other Than Employees For Acquiring or In Conjunction With
Selling Goods Or Services.”





All
charges for warrants granted have been determined under the fair value method
using the Black-Scholes option-pricing model with the following
assumptions:




46




For
      the years ended December 31,2008
                    
                    
                    2007Expected
      dividend yields
                    
                    zero
                    
                    
                    zeroExpected
      volatility
                    
                    
                    130-136
                    %
                    
                    
                    117-136
                    %Risk-free
      interest rate
                    
                    
                    1.00-4.69
                    %
                    
                    
                    3.45-4.65
                    %Expected
      terms in years
                    
                    0.88-8.63
      years
                    
                    
                    4.80-9.62
      years





The
following tables summarize information concerning outstanding options at
December 31, 2008 and 2007:





WeightedAverageStock
      Options
                            
                            
                            Exercise PriceOutstanding
      at December 31, 2005
                            
                            
                            -
                            
                            
                            $
                            -Granted
                            
                            
                            1,600,000
                            
                            
                            
                            5.00Exercised
                            
                            
                            -
                            
                            
                            
                            -Cancelled
      or forfeited
                            
                            
                            -
                            
                            
                            
                            -Outstanding
      at December 31, 2006
                            
                            
                            1,600,000
                            
                            
                            
                            5.00Granted
                            
                            
                            2,872,500
                            
                            
                            
                            7.00Exercised
                            
                            
                            -
                            
                            
                            
                            -Cancelled
      or forfeited
                            
                            
                            (675,000
                            )
                            
                            
                            6.41Outstanding
      at December 31, 2007
                            
                            
                            3,797,500
                            
                            
                            
                            6.26Granted
                            
                            
                            905,000
                            
                            
                            
                            2.75Exercised
                            
                            
                            -
                            
                            
                            
                            -Cancelled
      or forfeited
                            
                            
                            (825,000
                            )
                            
                            
                            6.52Outstanding
      at December 31, 2008
                            
                            
                            3,877,500
                            
                            
                            
                            5.39Exercisable
      at December 31, 2006
                            
                            
                            -
                            
                            
                            
                            -Exercisable
      at December 31, 2007
                            
                            
                            440,000
                            
                            
                            
                            5.61Exercisable
      at December 31, 2008
                            
                            
                            1,000,500
                            
                            
                            $
                            5.94




The
following tables summarize information concerning outstanding warrants at
December 31, 2008 and 2007:





WeightedAverageWarrants
                          
                          
                          Exercise PriceOutstanding
      at December 31, 2005
                          
                          
                          -
                          
                          
                          $
                          -Granted
                          
                          
                          454,221
                          
                          
                          
                          2.72Exercised
                          
                          
                          -
                          
                          
                          
                          -Cancelled
      or forfeited
                          
                          
                          -
                          
                          
                          
                          -Outstanding
      at December 31, 2006
                          
                          
                          454,221
                          
                          
                          
                          2.72Granted
                          
                          
                          422,500
                          
                          
                          
                          7.29Exercised
                          
                          
                          -
                          
                          
                          
                          -Cancelled
      or forfeited
                          
                          
                          -
                          
                          
                          
                          -Outstanding
      at December 31, 2007
                          
                          
                          876,721
                          
                          
                          
                          4.92Granted
                          
                          
                          -
                          
                          
                          
                          -Exercised
                          
                          
                          (325,000
                          )
                          
                          
                          1.00Cancelled
      or forfeited
                          
                          
                          -
                          
                          
                          
                          -Outstanding
      at December 31, 2008
                          
                          
                          551,721
                          
                          
                          
                          7.24Exercisable
      at December 31, 2006
                          
                          
                          454,221
                          
                          
                          
                          2.72Exercisable
      at December 31, 2007
                          
                          
                          754,221
                          
                          
                          
                          4.42Exercisable
      at December 31, 2008
                          
                          
                          544,221
                          
                          
                          $
                          7.22




The
weighted average remaining contractual life of the stock options that are
exercisable as of December 31, 2008, is approximately 8.24 years. The weighted
average remaining contractual life of the warrants that are exercisable as of
December 31, 2008, is approximately 2.52 years.





47




The
weighted average grant-date estimated fair value of stock options granted in
2008 and 2007 is approximately $0.5 million and $12.7 million or $0.60 and $5.79
per share, respectively. There were no warrants granted in 2008. The weighted
average grant-date estimated fair value of warrants granted in 2007 is
approximately $2.4 million or $5.63 per share. At December 31, 2008 and 2007,
the unamortized compensation charges related to outstanding stock options were
$10,091,802 and $17,818,693, respectively. At December 31, 2008 and 2007, the
unamortized compensation charges related to outstanding warrants were $224 and
$410,049, respectively. In 2008, we issued an aggregate of 112,215 shares of our
common stock pursuant to cashless exercise of warrants by three warrant
holders.


The
following table shows the change in unamortized compensation expense for stock
options and warrants issued to employees, officers, directors and non-employees
during the year ended December 31, 2008:





Stock
      Options andWarrants
                            
                            
                            Unamortized
      CompensationOutstanding
                            
                            
                            ExpenseJanuary
      1, 2008
                            
                            
                            4,674,221
                            
                            
                            $
                            18,228,742Granted
      in the period
                            
                            
                            905,000
                            
                            
                            
                            542,827Forfeited
      & Cancelled in the period
                            
                            
                            (825,000
                            )(1)
                            
                            
                            (2,392,494
                            )Expensed
      in the period
                            
                            
                            -
                            
                            
                            
                            (6,287,049
                            )Exercised
      in the period
                            
                            
                            (325,000
                            )(2)
                            
                            
                            -December
      31, 2008
                            
                            
                            4,429,221
                            
                            
                            $
                            10,092,026




(1) One
of our directors voluntarily forfeited his 200,000 options on September 8, 2008.
Due to his continued services as a director on the date of his voluntary
forfeiture, this was treated as a cancellation and all unamortized expense of
$924,021 was fully recognized in the period. Subsequently, on October 7, 2008
the director resigned from our Board of Directors.




(2) The
cashless exercises of the granted 325,000 warrant shares resulted in the
issuance of an aggregate of 112,215 shares of our common stock.




WeightedNumber
      of
                      
                      
                      AverageOptions
      and
                      
                      
                      ExerciseWarrants
                      
                      
                      PriceStock Options and WarrantsBalance
      at January 1, 2008
                      
                      
                      4,674,221
                      
                      
                      $
                      6.01Granted
                      
                      
                      905,000
                      
                      
                      
                      2.75Exercised
                      
                      
                      (325,000
                      )
                      
                      
                      1.00Forfeited
      & Cancelled
                      
                      
                      (825,000
                      )
                      
                      
                      6.52Balance
      at December 31, 2008
                      
                      
                      4,429,221
                      
                      
                      $
                      5.62




18.
            STOCKHOLDERS’ (DEFICIT)
      EQUITY





Pursuant
to the terms of the arbitration interim award associated to the Technology
Transaction, we are planning to seek stockholder approval to issue 9,230,000
shares of our common stock directly to NQCI to effectuate the transaction. Upon
issuance and delivery of the proposed shares, NQCI will be our largest
stockholder, owning approximately 39% of our total outstanding
shares.





As a
result of our continued operating losses and the accrual for 9,230,000 shares,
discussed further in Note 4, “Legal Proceedings” and Note 10, “Shares Issuable”
above, “Total Stockholders’ (Deficit) Equity” has a negative balance with our
deficit accumulated during the development stage being greater than our
additional paid in capital as of December 31, 2008.





During
the year ended December 31, 2008, we issued an aggregate of 270,000 shares of
our common stock as compensation for consulting services rendered to us.
Pursuant to cashless exercises of warrants by three warrant holders, we issued
an aggregate of 112,215 shares of our common stock.





During
the year ended December 31, 2007, 200,000 shares of common stock were cancelled
pursuant to a settlement agreement with one of our stockholders. Immediately
prior to the effectiveness of the merger, we caused a reverse split of our
common stock, whereby each 8.27 issued and outstanding shares of our common
stock were converted into one share of common stock. Pursuant to a consulting
agreement, we issued 20,000 shares of our common stock.


48





19.
            PRODUCT
      DEVELOPMENT AGREEMENT





In July
2007, we entered into the Aubrey Agreement. The PAK will be designed for
intermittent hemodialysis or Continuous Renal Replacement Therapy (CRRT) in an
attended care setting as well as for treatments in a home setting. As of
December 31, 2008, Aubrey substantially completed its work and we intend to
terminate this agreement. At the inception of the Aubrey Agreement, total labor
and material costs over the term of the agreement were budgeted to amount to
approximately $5.1 million and as of December 31, 2008, the agreement was
substantially completed under the budgeted amount at a cost of $3.2
million.




20.
              SUBSEQUENT EVENTS
(UNAUDITED)


Corporate Restructuring





The continuing delay in consummating
the Technology Transaction has significantly adversely affected our Company.
Accordingly, we have had to modify our activities and business. We have
instituted a variety of measures in an attempt to conserve cash and reduce our
operating expenses. Our actions included:





·
            Reductions
      in our labor force – On March 13, 2009, we gave notice of employment
      termination to 19 employees. This represents a total work-force reduction
      of approximately 73%. We paid accrued vacation benefits of approximately
      $70,000 to terminated employees. The layoffs and our other efforts focused
      on streamlining our operations designed to reduce our annual expenses by
      approximately $3.5 million to a current operating burn rate of
      approximately $200,000 per month.


·
            Refocusing
      our available assets and employee resources on the development of the
      PAK.


·
            Continuing
      vigorous efforts to minimize or defer our operating
    expenses.


·
            Exploring
      various strategic alternatives, which may include the license of certain
      of our intellectual property rights, as a means to further develop our
      technologies, among other possible transactions and
      alternatives.


·
            Intensifying
      our search to obtain additional financing to support our operations and to
      satisfy our ongoing capital requirements in order to improve our liquidity
      position.


·
            Continuing
      to prosecute our patents and take other steps to perfect our intellectual
      property rights.





In light of the unprecedented economic
slow down, lack of access to capital markets and prolonged arbitration
proceeding with NQCI, we were compelled to undertake the efforts outlined above
in order to remain in the position to continue our operations. We hope to be
able to obtain additional financing to meet our cash obligations as they become
due and otherwise proceed with our business plan. Our ability to execute on our
current business plan is dependent upon our ability to obtain equity or debt
financing, develop and market our products, and, ultimately, to generate
revenue. Unless we are able to raise financing sufficient to support our
operations and to satisfy our ongoing financing requirements, we will not be
able to develop any of our products, submit 510(k) notifications to the FDA,
conduct clinical trials or otherwise commercialize any of our products. We will
make every effort however, to continue the development of the PAK. As a result
of these conditions, there is substantial doubt about our ability to continue as
a going concern. Our ability to continue as a going concern is substantially
dependent on the successful execution of many of the actions referred to above,
on the timeline contemplated by our plans and our ability to obtain additional
financing. We cannot assure you that we will be successful now or in the future
in obtaining any additional financing on terms favorable to us, if at all. The
failure to obtain financing will have a material adverse effect on our financial
condition and operations.





We will continue to analyze the effects
of the events described above to determine if any subsequent changes are
required to the accounting treatment of such events.





Other
Considerations – Royalty and Other Payments Under the License
Agreement





As consideration for entering into the
License Agreement, we agreed to pay to NQCI a minimum annual royalty of
$250,000, or 7% of net sales. As a result of the transfer of the Technology to
us, we may be able to realize additional savings of not having to compensate
NQCI for any royalty payments accrued and not yet paid. Although we have
asserted that NQCI’s breaches of the License Agreement excused our obligation to
make the minimum royalty payments, we recorded $583,333 in royalty expenses,
covering the minimum royalties, from commencement of the License Agreement
through December 31, 2008. The License Agreement expires in 2105. The License
Agreement also requires us to reimburse NQCI’s reasonable and necessary expenses
incurred in the ordinary course of business consistent with past practices, or
the “Licensor Expenses”, until the closing or the termination of the Merger
Agreement. The Second Interim Award states that the License Agreement will
remain in full force and effect until the Technology Transaction closes or the
arbitrator determines that it will never close. Although we have contested its
right to any further payments, NQCI has made a claim for reimbursement of
approximately $690,000 in alleged expenses under the License Agreement as of
December 31, 2008. If we are able to acquire the Technology from NQCI, the
arbitrator has indicated that the License Agreement would be terminated
simultaneously with such acquisition. As a result of the Technology becoming our
sole and exclusive property, among other benefits, we would be able to
discontinue these royalty payments to NQCI, realize corresponding savings and we
should be able to realize additional savings of not having to reimburse NQCI for
any Licensor Expenses accrued and not yet paid.





49


Item
9.                 Changes in and Disagreements With
Accountants on Accounting and Financial
Disclosure.





None.





Item
9A(T).Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures





Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
Annual Report (December 31, 2008), as is defined in Rule 13a-15(e) promulgated
under the Exchange Act. Our disclosure controls and procedures are intended to
ensure that the information we are required to disclose in the reports that we
file or submit under the Exchange Act is (i) recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms and (ii)
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as the principal executive and financial
officers, respectively, to allow timely decisions regarding required
disclosures.




Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this Annual Report, our
disclosure controls and procedures were effective.




Our
management has concluded that the financial statements included in this Annual
Report present fairly, in all material respects our financial position, results
of operations and cash flows for the periods presented in conformity with
generally accepted accounting principles.




It should
be noted that any system of controls, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the
system will be met. In addition, the design of any control system is based in
part upon certain assumptions about the likelihood of future events. Because of
these and other inherent limitations of control systems, there can be
no


assurance
that any design will succeed in achieving its stated goals under all potential
future conditions.




Management’s
Report on Internal Control Over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal control over
our financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the
Exchange Act). Internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of
America.




Our
internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of our assets,
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America, and that our
receipts and expenditures are being made only in accordance with authorizations
of our management and directors, and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or
disposition of our assets that could have a material effect on the financial
statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate. Our management, with the
participation of our Chief Executive Officer and Chief Financial Officer,
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
Annual Report, our internal control over financial reporting was
effective.




50


This Annual Report does not include an
audit report of our independent registered public accounting firm regarding our
internal control over financial reporting. In addition, our management’s report
on our internal control over financial reporting is not subject to attestation
by our registered public accounting firm pursuant to temporary rules of the SEC
that permit us to provide only our management’s report in this Annual
Report.





Changes
in Internal Control Over Financial Reporting





In
connection with the evaluation of our internal controls during our last fiscal
quarter, our Chief Executive Officer and Chief Financial Officer concluded that
there has been no change in our internal control over financial reporting during
the fourth quarter ended December 31, 2008, that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.





Item
9B.                      Other
Information.





None.





51





PART
III





Item 10.                      Directors,Executive Officersand Corporate
Governance





The
names, ages and positions of our executive officers and directors, as of
December 31, 2008, are set forth below. Biographical information for each
of these persons who currently serves as our officer and/or director, as
provided to us by each respective individual also, is presented
below:


Name
                        
                        Age
                        
                        Position
                        
                        Director
                          SinceKelly
      J. McCrann
                        
                        53
                        
                        Chairman
      of the Board and Chief Executive Officer
                        
                        2007Robert
      Weinstein
                        
                        48
                        
                        Chief
      Financial Officer and Secretary
                        
                        n/aVictor Gura, M.D.
                        
                        66
                        
                        Chief
      Medical and Scientific Officer
                        
                        n/aTerren
      S. Peizer
                        
                        49
                        
                        Director
                        
                        2007Hans-Dietrich
      Polaschegg, Ph.D.
                        
                        66
                        
                        Director
                        
                        2007Jay
      A. Wolf
                        
                        36
                        
                        Director
                        
                        2007Marc
      G. Cummins (1)
                        
                        49
                        
                        Director
                        
                        2007





(1) Mr.
Cummins resigned as a member of our Board of Directors effective March 6,
2009.





Kelly J. McCrann was appointed
as a member of Operations’ board of directors in August 2007. In October 2008,
Mr. McCrann was appointed our Chairman of the Board and Chief Executive Officer.
Mr. McCrann is a senior healthcare executive with extensive experience in board
governance, strategic leadership, profit and loss management and strategic
transactions. He was most recently Senior Vice President of DaVita Inc., where
he was responsible for all home based renal replacement therapies for the United
States’ second largest kidney dialysis provider. Prior to that, Mr. McCrann was
the Chief Executive Officer and President of PacifiCare Dental and Vision, Inc.
Mr. McCrann has held positions of increasing responsibility at Professional
Dental Associates, Inc., Coram Healthcare Corporation, HMSS, Inc. and American
Medical International. He is a graduate of the Harvard Business School and began
his career as a consultant for KPMG and McKinsey & Company.





Robert Weinstein was appointed
our Chief Financial Officer in October 2007. He also serves on the board of
directors of Operations. He was appointed as Chief Financial Officer of
Operations in August 2007. Prior to joining us, Mr. Weinstein served as Vice
President, Director of Quality Control & Compliance of Citi Private Equity
Services (formerly BISYS Private Equity Services) New York, NY, a worldwide
private equity fund administrator and accounting service provider. In 2005, Mr.
Weinstein was the Founder, Finance & Accounting Consultant for EB
Associates, LLC, Irvington, NY, an entrepreneurial service organization. From
December 2002 to November 2004, Mr. Weinstein served as the Chief Financial
Officer for Able Laboratories, Inc., which filed Chapter 11 bankruptcy in July
2005. In 2002, he served as Acting Chief Financial Officer of Eutotech, Ltd.,
Fairfax, VA, a distressed, publicly traded early-stage technology transfer and
development company. Mr. Weinstein received his M.B.A., Finance &
International Business from the University of Chicago, Graduate School of
Business, and a B.S. in Accounting from the State University of New York at
Albany. Mr. Weinstein is a Certified Public Accountant (inactive) in the State
of New York.





Victor Gura, M.D. became
Operations’ Chief Medical and Scientific Officer in December 2006, and became a
member of the Board in October 2006. He resigned as a director in October 2008.
Dr. Gura continues to serve as a member of our Board of Advisors. He served as
Chief Scientific Officer of National Quality Care, Inc. from 2005 to November
2006. He was formerly its Chairman of the Board, President and Chief Executive
Officer. Dr. Gura is board certified in internal medicine/nephrology. He has
been a director and principal stockholder of Medipace Medical Group, Inc. in Los
Angeles, California, since 1980. Dr. Gura has been an attending physician at
Cedars-Sinai Medical Center since 1984 and the medical director of Los Angeles
Community Dialysis since 1985. He also serves as a Clinical Assistant Professor
at UCLA School of Medicine. He was a fellow at the nephrology departments at Tel
Aviv University Medical School and USC Medical Center. Dr. Gura received his
M.D. from School of Medicine, Buenos Aires University.





Terren S. Peizer served as our
Executive Chairman until October 2008. He became the Chairman of Operations’
board of directors in August 2006 and our Executive Chairman in August 2007.
From April 1999 to October 2003, Mr. Peizer served as Chief Executive Officer of
Clearant, Inc., which he founded to develop and commercialize a universal
pathogen inactivation technology. He served as Chairman of its board of
directors from April 1999 to October 2004 and a Director until February 2005.
From February 1997 to February 1999, Mr. Peizer served as President and Vice
Chairman of Hollis-Eden Pharmaceuticals, Inc. In addition, from June 1999
through May 2003 he was a Director, and from June 1999 through December 2000 he
was Chairman of the Board, of supercomputer designer and builder Cray Inc., and
remains its largest beneficial stockholder. Mr. Peizer has been the largest
beneficial stockholder and held various senior executive positions with several
technology and biotech companies. In these capacities he has assisted the
companies with assembling management teams, boards of directors and scientific
advisory boards, formulating business and financial strategies, investor and
public relations, and capital formation. Mr. Peizer has been a Director,
Chairman of the Board and Chief Executive Officer of Hythiam, Inc., a healthcare
services management company focused on delivering solutions for those suffering
from alcoholism and other substance dependencies, since September 2003. Mr.
Peizer has a background in venture capital, investing, mergers and acquisitions,
corporate finance, and previously held senior executive positions with the
investment banking firms Goldman Sachs, First Boston and Drexel Burnham Lambert.
He received his B.S.E. in Finance from The Wharton School of Finance and
Commerce.





52


Hans-Dietrich Polaschegg, PhD.
serves as a consultant to the medical device industry. From 1979 to 1994, Dr.
Polaschegg held positions of increasing responsibility at Fresenius AG, a global
leader in the manufacture of dialysis products. As Head of Research and
Development of the medical systems division of Fresenius, he designed three
hemodialysis machines. Dr. Polaschegg holds 88 medical technology patents and is
credited with inventing electrolyte balancing, thermal energy balancing, safe
dialysate filtering, blood volume monitoring by ultrasound density, and safe
on-line hemodiafiltration. He is a member of several international American and
European standard committees including Chairman of the Extracorporeal
Circulation and Infusion and Technology Committee. Dr. Polaschegg received his
PhD in Nuclear Physics from Technical University of Vienna in
Austria.





Jay A. Wolf became a member of
Operations’ Board of Directors in November 2006. He has over a decade of
investment and operations experience in a broad range of industries. His
investment experience includes: senior and subordinated debt, private equity
(including leveraged transactions), mergers & acquisitions and public equity
investments. Since 2003, Mr. Wolf has served as a Managing Director of Trinad
Capital. From 1999 to 2003, he served as the Executive Vice President of
Corporate Development for Wolf Group Integrated Communications Ltd. where he was
responsible for our acquisition program. From 1996 to 1999, Mr. Wolf worked at
Canadian Corporate Funding, Ltd., a Toronto-based merchant bank in the senior
debt department and subsequently for Trillium Growth, the firm’s venture capital
Fund. He sits on the boards of Shells Seafood Restaurants, Prolink Holdings
Corporation, Optio Software, Inc. and Starvox Communications, Inc. Mr. Wolf
received a Bachelor of Arts from Dalhousie University.





There are no family relationships, as
defined in Item 401 of Regulation S-K, between any of the officers and/or
directors named above, and there is no arrangement or understanding between any
of the directors named above and any other person pursuant to which he or she
was elected as a director.





No executive officer or director has
been involved, directly or indirectly, in any bankruptcy or insolvency
proceeding of any kind.





No executive officer or
director is currently involved in any litigation nor has such person been
involved in any litigation that would have a bearing on any such person's
fitness or other ability to act and serve as our director or
officer.





Term
of Office





Each of our directors serve for a term
of one year or until their respective successors are elected and qualified or
until removed from office in accordance with our bylaws. Our executive
officers are elected annually by the Board of Directors and serve at the
discretion of the Board of Directors.





Information
Regarding Committees





Our Board of Directors has established
three committees: an Audit Committee, a Compensation Committee and
a


Nominating
Committee. The Board of Directors has also adopted written corporate
governance guidelines for the Board and a written committee charter for each of
the Board’s committees, describing the authority and responsibilities delegated
to each committee by the Board. A copy of our Audit Committee Charter,
Compensation Committee Charter and Nominating Committee Charter can be found on
our website at http://www.xcorporeal.com.





Audit Committee – As of
December 31, 2008, the Audit Committee consisted of Messrs. Cummins and Wolf,
with Mr. Wolf serving as the chairman; however, effective March 6, 2009, Mr.
Cummins resigned from his positions of a member of our Board of Directors and
our Audit Committee. The Board has determined that each of the members of the
Audit Committee is independent as defined under the applicable NYSE Amex
standards, meet the applicable requirements for audit committee members,
including Rule 10A-3(b) under the Securities and Exchange Act of 1934, as
amended, and, that Mr. Wolf qualifies as an “audit committee financial expert”
as such term is defined in Item 407(d)(5) of SEC Regulation S-K. In order
to fill the vacancy in the Audit Committee created by Mr. Cummins’ resignation,
effective March 26, 2009, Hans-Dietrich Polaschegg, a member of our Board of
Directors, was appointed to the Audit Committee.





As a result of Mr. Cummins’ resignation
from his position of a member of our Board of Directors, we are no longer in
compliance with Section 803(A)(1) of the Amex Company Guide because a majority
of the members of our Board of Directors are not independent
directors.





Compensation Committee–
The Compensation Committee currently consists of Dr. Polaschegg and Mr. Wolf,
with Dr. Polaschegg serving as the chairman, each of whom is independent as
defined under the applicable NYSE Amex standards. The Compensation Committee
reviews and recommends to the Board of Directors for approval the compensation
of our executive officers.





Nominating Committee–
As of December 31, 2008, the Nominating Committee currently consisted of Messrs.
Cummins and Polaschegg, with Mr. Cummins serving as the chairman; however, Mr.
Cummins resigned as a member of our Board of Directors effective March 6, 2009.
The Board has determined that each of the members of the Audit Committee is
independent as defined under the applicable NYSE Amex standards. The nominating
committee nominates new directors and oversees corporate governance
matters.





53


Changes
in Nominating Procedures





There
have not been any material changes to the procedures by which our stockholders
may recommend nominees to our Board of Directors since the end of our 2007
fiscal year.





Section
16(a) Beneficial Ownership reporting Compliance





Section 16(a) of the Exchange
Act requires any person who is our director or executive officer or
who beneficially holds more than 10% of any class of our securities which
have been registered with the SEC, to file reports of initial ownership and
changes in ownership with the SEC. These persons are also required under
the regulations of the SEC to furnish us with copies of all Section 16(a)
reports they file.





To our knowledge, based solely on our
review of the copies of the Section 16(a) reports furnished to us, all Section
16(a) filing requirements
applicable to our directors, executive officers and holders of more than 10% of
any class of our registered securities were timely complied with during the
year ended December 31, 2008.





Code
of Ethics





Upon
effectiveness of the merger between our company and pre-merger Xcorporeal, we
adopted a Code of Ethics that applies to all of our officers, directors and
employees, including our principal executive officer, principal financial
officer, principal accounting officer and controller, and others performing
similar functions. A copy of our Code of Ethics can be found under the
“Company”, sub-category “Corporate Governance”, section of our website at
www.xcorporeal.com, and any waiver from the Code of Ethics will be timely
disclosed on our website as will any amendments to the Code of
Ethics.





Item 11.Executive
Compensation





COMPENSATION
DISCUSSION AND ANALYSIS





The
following discussion and analysis contains statements regarding future
individual and company performance targets and goals. These targets and goals
are disclosed in the limited context of our compensation programs and should not
be understood to be statements of management's expectations or estimates of
results or other guidance. We specifically caution investors not to apply these
statements to other contexts.





We
believe our long term success is dependent on a leadership team with the
integrity, skills, and dedication necessary to oversee a growing organization on
a day-to-day basis. In addition, the leadership must have the vision to
anticipate and respond to future market and regulatory developments. Our
executive compensation program is designed to enable us to attract, motivate and
retain a senior management team with the collective and individual abilities to
meet these challenges. The program's primary objective is to align executives'
efforts with the long term interests of stockholders by enhancing our
reputation, financial success and capabilities.





General
Executive Compensation Philosophy





We
compensate our executives, including our named executive officers who are
identified in the Summary Compensation Table, through a combination of base
salary, cash bonus incentives, long-term equity incentive compensation, and
related benefits. These components are designed, in aggregate, to be competitive
with comparable organizations and to align the financial incentives for the
executives with the short and long term interests of stockholders.





Our
Compensation Committee receives our management’s recommendations and then
discusses, reviews and considers management's recommendations with respect to
the compensation of those members of senior management whose compensation the
committee considers. The committee then makes its recommendation to the Board of
Directors which discusses and then decides raises, bonuses and
options. Although their advice may be sought and they may be questioned by
the committee, executive members of the Board of Directors do not participate in
the committee’s or the Board of Directors' discussion and vote. Prior to
the committee making its recommendations, the members of the Compensation
Committee have several discussions among themselves and meet to discuss, among
other things, the performance and contributions of each of the members of senior
management whose compensation they are considering as well as expectations (of
the individual for the year and the future and those of our company), results,
responsibilities, and desire to retain such executive. In addition, the
Compensation Committee may have conversations with certain others before making
its recommendations.





Our
philosophy is to provide a compensation package that attracts, motivates and
retains executive talent, and delivers rewards for superior performance as well
as consequences for underperformance. Specifically, our executive
compensation program is designed to:




54




·
            provide
      a competitive total compensation package that is competitive within the
      medical device industry in which we compete for executive talent, and will
      assist in the retention of our executives and motivate them to perform at
      a superior level;




·
            link
      a substantial part of each of our executive’s compensation to the
      achievement of our financial and operating objectives and to the
      individual's performance;




·
            provide
      long-term incentive compensation that focuses our executives' efforts on
      building stockholder value by aligning their interests with our
      stockholders; and




·
            provide
      incentives that promote executive
retention.





Each
year, our management and the Board of Directors approve financial and
non-financial objectives for our company and our executive officers, which may
be reflected in our executive employment agreements and incentive compensation
plans. We design our incentive compensation plans to reward company-wide
performance. In addition, we also consider the individual performance of each
executive officer and other relevant criteria, such as the accomplishments of
the management team as a whole. In designing and administering our executive
compensation programs, we attempt to strike an appropriate balance among these
elements.





The major
compensation elements for our named executive officers are base salary,
performance-based bonuses, stock options, insurance benefits and perquisites.
Each of these elements is an integral part of and supports our overall
compensation objectives. Base salaries (other than increases), insurance
benefits and perquisites form stable parts of our executive officers’
compensation packages that are not dependent on our performance during a
particular year. We set these compensation elements at competitive levels so
that we are able to attract, motivate and retain highly qualified executive
officers. Consistent with our performance-based philosophy, we reserve the
largest potential compensation awards for performance- and incentive-based
programs. These programs include awards that are based on our financial
performance and provide compensation in the form of both cash and equity to
provide incentives that are tied to both our short-term and long-term
performance. Our performance-based bonus program rewards short-term and
long-term performance, while our equity awards, in the form of stock options,
reward long-term performance and align the interests of management with our
stockholders.





Board of Directors Determination of
Compensation Awards





Our
Compensation Committee recommends and the Board of Directors determines the
compensation awards to be made to our executive officers. Our Compensation
Committee recommends and the Board of Directors determines the total
compensation levels for our executive officers by considering several factors,
including each executive officer's role and responsibilities, how the executive
officer is performing against those responsibilities, our performance, and the
competitive market data applicable to the executive officers’
positions.





In
arriving at specific levels of compensation for executive officers, the Board of
Directors has relied on:





·
            the
      recommendations of our management;




·
            benchmarks
      provided by generally available compensation surveys;
  and




·
            the
      experience of the members of our Board of Directors and their knowledge of
      compensation paid by comparable companies or companies of similar size or
      generally engaged in the healthcare services
  business.





We seek
an appropriate relationship between executive pay and our corporate performance.
Our executive officers are entitled to customary benefits generally available to
all of our employees, including group medical, dental and life insurance and a
401(k) plan. We have employment agreements (which include severance
arrangements) with three of our key executive officers to provide them with the
employment security and severance deemed necessary to retain them.




Components
of Executive Compensation





Base salary. Base salaries
provide our executive officers with a degree of financial certainty and
stability. We seek to provide base salaries sufficient to attract and retain
highly qualified executives. Whenever management proposes to enter into a new
employment agreement or to renew an existing employment agreement, the
Compensation Committee reviews and recommends, and the Board of Directors
determines, the base salaries for such persons, including our chief
executive officer and our other executive officers. Salaries are also reviewed
in the case of executive promotions or other significant changes in
responsibilities. In each case, the Compensation Committee and the Board of
Directors each take into account competitive salary practices, scope of
responsibilities, the results previously achieved by the executive and his or
her development potential.





On an
individual basis, a base salary increase, where appropriate and as contemplated
by the individual's employment agreement, is designed to reward performance
consistent with our overall financial performance in the context of competitive
practice. Performance reviews, including changes in an executive officer's scope
of responsibilities, in combination with general market trends determine
individual salary increases. Aside from contractually provided minimum cost of
living adjustments, no formulaic base salary increases are provided to the named
executive officers.





55


In
addition to complying with the executive compensation policy and to the
requirements of applicable employment agreements, compensation for each of the
our executive officers for 2008 was based on the executive's performance of his
or her duties and responsibilities, our performance, both financial and
otherwise, and the success of the executive in managing, developing and
executing our business development, sales and marketing, financing and strategic
plans, as appropriate. No merit raises or bonuses were approved or recommended
for our executive officers for 2008.





Bonus. Executive officers are
eligible to receive cash bonuses based on the degree of our achievement of
financial and other objectives and the degree of achievement by each such
officer of his or her individual objectives. Within such guidelines the amount
of any bonus is discretionary.





The
primary purpose of our performance incentive awards is to motivate our
executives to meet or exceed our company-wide short-term performance objectives.
Our cash bonuses are designed to reward management-level employees for their
contributions to individual and corporate objectives. Regardless of our
performance, the Board of Directors retains the discretion to adjust the amount
of our executives’ bonus based upon individual performance or
circumstances.





At the
beginning of 2008, the management and the Board of Directors established
performance objectives for the payment of incentive awards to each of our named
executive officers and other senior management employees. Performance objectives
were based on corporate objectives established as part of the annual operating
plan process. Year end bonus awards were based on attainment of these
performance objectives as adjusted to reflect changes in our business and
industry throughout the year. Our Compensation Committee recommended and the
Board of Directors determined that bonuses in the amounts set forth in the
Summary Compensation Table below were appropriate. Each individual's bonus
was determined based upon the individual’s attainment of performance objectives
pre-established for that participant by the Board of Directors, senior
management, or the executive's supervisor. Our management and the Board of
Directors established our chief executive officer's performance
objectives.





In
general, each participant set for himself or herself (subject to his or her
supervisor’s review and approval or modification) a number of objectives for
2008 and then received a performance evaluation against those objectives as a
part of the year-end compensation review process. The individual objectives
varied considerably in detail and subject matter depending on the executive's
position. By accounting for individual performance, we were able to
differentiate among executives and emphasize the link between individual
performance and compensation.





Stock options. Equity
participation is a key component of our executive compensation program. Under
the incentive compensation plan, we are permitted to grant stock options to our
officers, directors, employees and consultants. To date, stock options have been
the sole means of providing equity participation to executive officers. Stock
options are granted to our executive officers primarily based on the officer's
actual and expected contribution to our development. Options are designed to
retain our executive officers and motivate them to enhance our stockholder value
by aligning their financial interests with those of the our stockholders. Stock
options are intended to enable us to attract and retain key personnel and
provide an effective incentive for management to create stockholder value over
the long term since the option value depends on appreciation in the price of our
common stock.





Our
employees, including our executive officers, are eligible to participate in the
award of stock options under our 2007 Incentive Compensation Plan, as
amended. Option grant dates for newly hired or promoted officers and other
eligible employees have typically been approved on the first Board of Directors
meeting date following the date of employment or in the new position. Employees
who have demonstrated outstanding performance during the year may be awarded
options during or following the year. Such grants provide an incentive for
our executives and other employees to increase our market value, as represented
by our market price, as well as serving as a method for motivating and retaining
our executives.





In
determining to provide long-term incentive awards in the form of stock options,
the Board of Directors considered cost and dilution impact, market trends
relating to long-term incentive compensation and other relevant factors. The
Board of Directors determined that an award of stock options more closely aligns
the interests of the recipient with those of our stockholders because the
recipient will only realize a return on the option if our stock price increases
over the term of the option.





Perquisites and Other
Benefits.We also provide other benefits to our executive
officers that are not tied to any formal individual or our performance criteria
and are intended to be part of a competitive overall compensation program. For
2008, these benefits were solely comprised of an automobile allowance paid to
Dr. Gura. We also offer 401(k) retirement plans and medical plans, for which our
executives are generally charged the same rates as all other of our
employees.





Chief
Executive Officer Compensation





Our
Compensation Committee, at least annually, reviews and recommends to the Board
of Directors the compensation of Kelly McCrann, our Chairman of the Board of
Directors and Chief Executive Officer, in accordance with the terms of his
employment agreement, as well as any variations in his compensation the
committee feels are warranted. Mr. McCrann, as a member of the Board of
Directors, does not participate in and abstains from all discussions and
decisions of the Board of Directors with regard to his compensation. The Board
of Directors believes that in the highly competitive healthcare industry in
which we operate, it is important that Mr. McCrann receive compensation
consistent with compensation received by chief executive officers of competitors
and companies in similar stages of development. Mr. McCrann was a Board of
Directors member and did not receive a bonus in 2008. His base salary for
2008 is currently $325,000, prorated for his October 2, 2008 start date. See
section captioned “Employment Agreements and Termination of Employment and
Change-in-Control Arrangements” below for a description of the material terms
and conditions of Mr. McCrann's employment agreement.





56


Severance
and Change of Control Arrangements





We have
entered into change of control employment agreements with certain of our named
executive officers, as described in “Employment Agreements.” These agreements
provide for severance payments to be made to our named executive officers if
their employment is terminated under specified circumstances following a change
of control. We also provide benefits to these executive officers upon qualifying
terminations. The agreements are designed to retain our named executive officers
and provide continuity of management in the event of an actual or threatened
change of control and to ensure that our named executive officers’ compensation
and benefits expectations would be satisfied in such event.





Internal
Revenue Code Limits on Deductibility of Compensation





Section 162(m)
generally disallows a Federal income tax deduction to public companies for
certain compensation in excess of $1 million paid to a corporation’s chief
executive officer or any of its four other most highly compensated executive
officers. Qualifying performance-based compensation will not be subject to the
deduction limit if certain requirements are met. The Board of Directors is of
the opinion that our incentive compensation plan has been structured to qualify
the compensation income deemed to be received upon the exercise of stock options
granted under the plans as performance-based compensation. The Board of
Directors will review with appropriate experts or consultants as necessary the
potential effects of Section 162(m) periodically and in the future may decide to
structure additional portions of compensation programs in a manner designed to
permit unlimited deductibility for federal income tax purposes.





We are not currently
subject to the limitations of Section 162(m) because no executive officers
received cash payments during 2008 in excess of $1 million. To the extent that
we may be subject to the Section 162(m) limitation in the future, the effect of
this limitation on earnings may be mitigated by net operating losses, although
the amount of any deduction disallowed under Section 162(m) could increase
alternative minimum tax by a portion of such disallowed amount. For information
relating to our net operating losses, see the consolidated financial statements
included in this Annual Report.




All
members of our Compensation Committee qualify as outside directors. The Board of
Directors considers the anticipated tax treatment to our company and our
executive officers when reviewing executive compensation and our compensation
programs. The deductibility of some types of compensation payments can depend
upon the timing of an executive's vesting or exercise of previously granted
rights. Interpretations of and changes in applicable tax laws and regulations,
as well as other factors beyond the Board of Directors’ control, also can affect
the deductibility of compensation.





While the
tax impact of any compensation arrangement is one factor to be considered, such
impact is evaluated in light of our overall compensation philosophy. The Board
of Directors will consider ways to maximize the deductibility of executive
compensation, while retaining the discretion it deems necessary to compensate
officers in a manner commensurate with performance and the competitive
environment for executive talent. From time to time, the Board of Directors may
award compensation to our executive officers which is not fully deductible if it
determines that such award is consistent with its philosophy and is in our and
our stockholders’ best interests, or as part of initial employment offers, such
as grants of nonqualified stock options.





Sections 280G
and 4999 of the Code impose certain adverse tax consequences on compensation
treated as excess parachute payments. An executive is treated as having received
excess parachute payments for purposes of Sections 280G and 4999 if he or
she receives compensatory payments or benefits that are contingent on a change
in the ownership or control of a corporation, and the aggregate amount of such
contingent compensatory payments and benefits equal or exceeds three times the
executive's base amount. If the executive's aggregate contingent compensatory
payments and benefits equal or exceed three times the executive's base amount,
the portion of the payments and benefits in excess of one times the base amount
are treated as excess parachute payments. Treasury Regulations define the events
that constitute a change in ownership or control of a corporation for purposes
of Sections 280G and 4999 and the executives subject to Sections 280G
and 4999.





An
executive's base amount generally is determined by averaging the executive's
Form W-2 taxable compensation from the corporation and its subsidiaries for
the five calendar years preceding the calendar year in which the change in
ownership or control occurs. An executive's excess parachute payments are
subject to a 20% excise tax under Section 4999, in addition to any
applicable federal income and employment taxes. Also, the corporation's
compensation deduction in respect of the executive's excess parachute payments
is disallowed under Section 280G. If we were to be subject to a change of
control, certain amounts received by our executives (for example, amounts
attributable to the accelerated vesting of stock options) could be excess
parachute payments under Sections 280G and 4999. We provide our chief
executive officer with tax gross up payments in event of a change of
control.





57


Section 409A
of the Code imposes distribution requirements on nonqualified deferred
compensation plans and arrangements. If a nonqualified deferred compensation
plan or arrangement fails to comply with Section 409A of the Code, an
executive participating in such plan or arrangement will be subject to adverse
tax consequences (including an additional 20% income tax on amounts deferred
under the plan or arrangement). Our nonqualified deferred compensation plans and
arrangements for our executive officers are intended to comply with
Section 409A of the Code, or to be exempt from the requirements of
Section 409A of the Code.





SUMMARY
COMPENSATION TABLE





The
following table sets forth the total compensation received by our named
executive officers during the fiscal years ended December 31, 2008 and
2007:





Name and Principal
                          Position
                        
                        Year
                        
                        Salary
                          ($)
                        
                        
                        Bonus
                          ($)
                        
                        
                        Stock
                          Awards
                          ($)
                        
                        
                        Option
                          Awards
                          ($)(1)
                        
                        
                        Non-Equity
                          Incentive Plan
                          Compensation
                          ($)
                        
                        
                        Change in
                          Pension
                          Value and
                          Nonqualified
                          Deferred
                          Compensation
                          Earnings
                          ($)
                        
                        
                        All Other
                          Compensation
                          ($)
                        
                        
                        Total
                          ($)Kelly
      J. McCrann,
                        
                        2008
                        
                        
                        80,000
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        17,411
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        97,411Chairman
      & CEO (2)Robert
      Weinstein,
                        
                        2008
                        
                        
                        286,500
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        449,346
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        735,846CFO
      & Secretary
                        
                        2007
                        
                        
                        100,128
                        
                        
                        
                        21,400
                        
                        
                        
                        —
                        
                        
                        
                        175,564
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        297,092Victor
    Gura,
                        
                        2008
                        
                        
                        437,600
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        858,246
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        18,000
                        (3)
                        
                        
                        1,313,846Chief
      Medical &
                        
                        2007
                        
                        
                        455,000
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        855,901
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        19,500
                        (3)
                        
                        
                        1,330,401Scientific
      OfficerDaniel S.
      Goldberger,
                        
                        2008
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        152,500
                        (5)
                        
                        
                        152,500Former
      President,
                        
                        2007
                        
                        
                        219,898
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        238,457
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        458,355COO
      & Interim CEO (4)




(1)
            Represents
      the dollar amount recognized for financial statement reporting purposes
      with respect to fiscal years 2008 and 2007 in accordance with
      SFAS 123(R), and includes amounts from awards granted in and prior to
      2008 and 2007. Additional information concerning the Company’s
      accounting for stock awards may be found in Note 17, “Stock Options and
      Warrants” to our financial statements filed as part of this Annual
      Report.


(2)
            Mr.
      McCrann was appointed as the Chairman of the Board of Directors and our
      CEO on October 2, 2008.


(3)
            Represents
      auto allowance that Dr. Gura received in the respective fiscal year
      pursuant to his employment agreement
..


(4)
            Mr.
      Goldberger resigned as our President and COO on August 10, 2007. Mr.
      Goldberger also served as our interim CEO from January to October 2008 and
      was paid as an independent
consultant.


(5)
            Represents
      compensation that Mr. Goldberger received pursuant to his consulting
      agreement as an independent consultant while serving as our interim CEO
      from January to October 2008 and providing consulting services thereafter
      until December 31, 2008.





GRANTS
OF PLAN-BASED AWARDS FOR FISCAL YEAR 2008





The
following table presents information regarding grants of plan-based awards to
our named executive officers during the fiscal year ended December 31,
2008.




Estimated Possible Payouts
                        Under
                        Non-Equity Incentive Plan
                        Awards(1)
                      
                      
                      Estimated Future Payouts
                        Under
                        Equity Incentive Plan Awards(2)
                      
                      
                      All
                        Other
                        Stock
                        Awards:
                        Number
                      
                      
                      All
                        Other
                        Option
                        Awards
                        Number
                        of
                      
                      
                      Exercise
                      
                      
                      Grant
                        Date
                        Fair
                        Value ofName
                      
                      Grant Date
                      
                      Threshold
                        ($)
                      
                      
                      Target
                        ($)
                      
                      
                      Maximum
                        ($)
                      
                      
                      Threshold
                        ($)
                      
                      
                      Target
                        ($)
                      
                      
                      Maximum
                        ($)
                      
                      
                      of
                        Shares of
                        Stock
                        or Units
                        (#)
                      
                      
                      Securities
                        Under-
                        lying
                        Option
                        (#)
                      
                      
                      or Base
                        Price of
                        Option
                        Awards
                        ($/Sh)
                      
                      
                      Stock
                        and
                        Option
                        Awards
                        ($)(1)Kelly J.
      McCrann,Chairman
      & CEO
                      
                      10/02/08
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      700,000
                      
                      
                      
                      1.50
                      
                      
                      
                      282,646




(1)
            Represents
      the total grant date fair value determined for financial statement
      reporting purposes in accordance with SFAS 123(R) for awards granted in
      2008.





58


OUTSTANDING
EQUITY AWARDS AT LAST FISCAL YEAR-END





The
following table sets forth all outstanding equity awards held by our named
executive officers as of December 31, 2008:




OPTION AWARDSName
                                                                                                  
                                                                                                  
                                                                                                  Number of
                                                                                                    Securities
                                                                                                    Underlying
                                                                                                    Unexercised
                                                                                                    Options (#)
                                                                                                    Exercisable
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  Number of
                                                                                                      Securities
                                                                                                      Underlying
                                                                                                      Unexercised
                                                                                                      Options (#)
                                                                                                      Unexercisable
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  Equity
                                                                                                    Incentive Plan
                                                                                                    Awards:
                                                                                                    Number of
                                                                                                    Securities
                                                                                                    Underlying
                                                                                                    Unexercised
                                                                                                    Unearned
                                                                                                    Options (#)
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  Option
                                                                                                    Exercise
                                                                                                    Price ($)
                                                                                                  
                                                                                                  
                                                                                                  Option
                                                                                                    Expiration
                                                                                                    DateKelly
      J. McCrann,
                                                                                                    Chairman
      of the
                                                                                                    Board
      & CEO
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  700,000
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  1.50
                                                                                                  
                                                                                                  
                                                                                                  10/02/18Robert
      Weinstein,
                                                                                                    CFO
      & Secretary
                                                                                                  
                                                                                                  
                                                                                                  75,000
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  225,000
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  7.00
                                                                                                  
                                                                                                  
                                                                                                  08/10/17Victor
Gura,
                                                                                                    Chief
      Medical &
                                                                                                    Scientific
      Officer
                                                                                                  
                                                                                                  
                                                                                                  250,000
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  250,000
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  5.00
                                                                                                  
                                                                                                  
                                                                                                  11/14/16Daniel S.
      Goldberger,
                                                                                                    Former
      President, COO & Interim CEO (1)
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —
                                                                                                  
                                                                                                  
                                                                                                  
                                                                                                  —




(1)
            Mr.
      Goldberger resigned as our President and COO on August 10, 2007. From
      January to October 2008, Mr. Goldberger served as our interim CEO. Mr.
      Goldberger also resigned from his position as a member of the Board of
      Directors in October 2008. On September 8, 2008, Mr. Goldberger
      voluntarily forfeited his remaining 200,000
  options.





OPTIONS EXERCISES AND STOCK VESTED IN
2008




No
options were exercised during the fiscal year ended December 31, 2008. During
the fiscal year ended December 31, 2008, an aggregate of 1,544,721 shares of our
common stock underlying our outstanding options, warrants, stock awards,
restricted stock unit awards and similar instruments vested. We granted options
to purchase an aggregate of 905,000 shares of our common stock and options to
purchase an aggregate of 825,000 shares of our common stock were forfeited by
the departed employees and consultants whose services were terminated during the
fiscal year ended December 31, 2008.





PENSION
BENEFITS





We did
not have a defined benefit pension plan or a defined contribution plan and the
named executive officers received no benefits under any retirement plan during
the year ended December 31, 2008.





NON-QUALIFIED
DEFERRED COMPENSATION





We had no
deferred compensation plans during the year ended December 31,
2008.





Employment
Agreements and Termination of Employment and Change-in-Control
Arrangements




The
employment agreements for Dr. Victor Gura, Kelly McCrann, and Robert Weinstein
were in effect during the year ended December 31, 2008, with only Dr. Gura’s and
Mr. Weinstein’s employment agreements in effect during the year ended December
31, 2007.





Chief
Executive Officer -On
October 6, 2008, we entered into an employment agreement with Kelly J. McCrann,
effective October 2, 2008, for a term of two years at an initial annual base
salary of $325,000. Mr. McCrann is eligible to receive discretionary bonuses
based on achieving designated individual goals and milestones, overall
performance and profitability. Additionally, Mr. McCrann was granted 700,000
stock options as an exercise price of $1.50 per share under our 2007 Incentive
Compensation Plan, which vests 25% on each of the first, second, third and
fourth anniversaries of the grant date, with anti-dilution protections. He will
be included in our medical, dental, disability and life insurance, pensions and
retirement plans, and other benefit plans and programs. If Mr. McCrann is
terminated without good reason or resigns for good reason, as defined in his
employment agreement, we will be obligated to pay Mr. McCrann twelve month's
base salary (at the rate in effect at the time of termination).




59


Chief
Financial Officer - On August 10, 2007, Robert Weinstein entered into an
employment agreement with Operations with an initial term of three years, with
automatic one year renewals, which agreement has been assumed by us. His initial
base salary was $275,000. Mr. Weinstein will be entitled to receive an annual
bonus at the discretion of the Board of Directors based on performance goals and
targeted at 50% of his annual salary. In addition to any perquisites and other
fringe benefits provided to other executives, Mr. Weinstein received options to
purchase 300,000 shares of common stock under the Operations 2006 Incentive
Compensation Plan at an exercise price of $7.00 per share and vesting at a rate
of 25% per year, which options have been assumed under our 2007 Incentive
Compensation Plan. In the event Mr. Weinstein is terminated by us without good
cause or he resigns for good reason, as such terms are defined in his employment
agreement, we will be obligated to pay Mr. Weinstein in a lump sum an amount
equal to 12 months salary (at the rate in effect at the time of termination) and
benefits.




Chief
Medical and Scientific Officer - On November 30, 2006, Victor Gura, M.D. entered
into an employment agreement with Operations for a term of four years, which
agreement has been assumed by us. In October 2007, Dr. Gura became our Chief
Medical and Scientific Officer, which position he has held with Operations since
December 2006. Dr. Gura was a member of our Board of Directors from
October 2007 and until October 2008, and was appointed as a member of the board
of directors of Operations in October 2006. His initial annual base
salary was $420,000. Dr. Gura is eligible to receive discretionary bonuses
on an annual basis targeted at 50% of his annual salary. Additionally, Dr. Gura
was granted 500,000 stock options at an exercise price of $5 per share under the
Operations 2006 Incentive Compensation Plan. These options, which were assumed
under our 2007 Incentive Compensation Plan, will vest 25% on each of the first,
second, third, and fourth anniversaries of the original grant date and expire
November 14, 2011. He will also be granted options to purchase an additional
500,000 shares of our common stock upon FDA approval of our first product. Dr.
Gura is eligible to receive reimbursement of reasonable and customary relocation
expenses as well as health, medical, dental insurance coverage and insurance for
accidental death and disability. In the event he is terminated by us without
good cause or if he resigns for good reason, as such terms as are defined in his
employment agreement, we will be obligated to pay Dr. Gura in a lump sum an
amount equal to two year’s salary (at the rate in effect at the time of
termination) plus 200% of the targeted bonus for the year in which termination
occurs. In addition all stock options granted to Dr. Gura will vest
immediately.





Dr.
Gura’s agreement provides for medical insurance and disability benefits,
severance pay if his employment is terminated by us without cause or due to
change in our control before the expiration of the agreement, and allows for
bonus compensation and stock option grants as determined by our Board of
Directors. Dr. Gura’s employment agreement also contains a restrictive covenant
preventing competition with us and the use of confidential business information,
except in connection with the performance of his duties for us, for a period of
two years following the termination of his employment with us.




Confidentiality
Agreements




Each of
our employees is required to enter into a confidentiality agreement. These
agreements provide that for so long as the employee works for us, and after the
employee’s termination for any reason, the employee may not disclose in any way
any of our proprietary confidential information.





Limitation
on Liability and Indemnification Matters





Our
certificate of incorporation and amended and restated bylaws limit the liability
of directors and executive officers to the maximum extent permitted by Delaware
law. The limitation on our directors’ and executive officers’ liability may not
apply to liabilities arising under the federal securities laws. Our certificate
of incorporation and amended and restated bylaws provide that we shall indemnify
our directors and executive officers and may indemnify our other officers and
employees and other agents to the fullest extent permitted by law. Insofar as
indemnification for liabilities arising under the Securities Act may be
permitted to our directors and executive officers pursuant to our certificate of
incorporation and amended and restated bylaws, we have been informed that in the
opinion of the SEC such indemnification is against public policy as expressed in
the Securities Act and is therefore unenforceable.





At
present, there is no pending litigation or proceeding involving any of our
directors, officers, employees or agents where indemnification will be required
or permitted. We are not aware of any threatened litigation or proceeding that
might result in a claim for such indemnification.





COMPENSATION
OF DIRECTORS





Compensation. Some of our
directors have been granted stock options to purchase shares of our common
stock. Our directors also receive cash compensation for their services as
directors. All members of the Board of Directors receive reimbursement for
actual travel-related expenses incurred in connection with their attendance at
meetings of the Board of Directors or its committees.





Options. Directors are
eligible to receive options under our 2007 Incentive Compensation
Plan.





60


The
following table provides information regarding compensation that was paid to the
individuals who served as our directors during the year ended December 31, 2008.
Except as set forth in the table, directors did not earn nor receive cash
compensation or compensation in the form of stock awards, stock option awards or
any other form.





The
following table reflects the compensation of our directors for our fiscal year
ended December 31, 2008:





Name
                  
                  Fees Earned
                    or Paid in
                    Cash ($)
                  
                  
                  Stock
                    Awards ($)
                  
                  
                  Option
                    Awards
                    ($) (1)(7)
                  
                  
                  Non-Equity
                    Incentive
                    Plan
                    Compensation
                    ($)
                  
                  
                  Change in
                    Pension Value and
                    Nonqualified
                    Deferred
                    Compensation
                    Earnings ($)
                  
                  
                  All Other
                    Compensation ($)
                  
                  
                  Total ($)Terren
      S. Peizer
                  
                  
                  281,250
                  (2)
                  
                  
                  —
                  
                  
                  
                  822,582
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,103,832Kelly
      J. McCrann
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  120,960
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  120,960Hans-Dietrich
      Polaschegg
                  
                  
                  60,000
                  (3)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  60,000Jay
      A. Wolf
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  120,818
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  120,818Daniel
      Goldberger (4)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Dr.
      Victor Gura (5)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Marc
      G. Cummins (6)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —





(1)
            Represents
      the dollar amount recognized for financial statement reporting purposes
      with respect to fiscal year 2008 in accordance with SFAS 123(R), and
      includes amounts from awards granted in and prior to
  2008.




(2)
            Represents
      compensation that Mr. Peizer received for his services as Executive
      Chairman. Mr. Peizer was paid pursuant to his Executive Chairman Agreement
      and as an independent consultant. Mr. Peizer served as our Executive
      Chairman until October 2008.




(3)
            Represents
      compensation that Dr. Polaschegg received for his research and development
      consulting services. Dr. Polaschegg was compensated in accordance with his
      month to month consulting agreement and paid as an independent
      consultant.




(4)
            On
      October 6, 2008, Mr. Goldberger resigned as our interim CEO, and on
      October 7, 2008, Mr. Goldberger resigned as a member of the Board. Other
      than the options granted to him, which he voluntarily forfeited on
      September 8, 2008, Mr. Goldberger did not receive any other compensation
      for his services as director.




(5)
            On
      October 7, 2008, Dr. Gura resigned as a member of our Board of
      Directors. Dr. Gura did not receive any compensation or options for his
      services as a director.


(6)
              Mr.
      Cummins resigned as a member of our Board of Directors effective March 6,
      2009.


(7)
              The
      aggregate number of option awards outstanding as of December 31, 2008 for
      each of our directors serving in such capacity on such date are as
      follows: Mr. Peizer’s - 280,000 stock options which were vested and
      exercisable within 60 days of March 23, 2009 and 420,000 stock options
      which were unvested and unexercisable of such date, Mr. McCrann - 20,000
      stock options which were vested and exercisable within 60 days of March
      23, 2009 and 780,000 stock options which were unvested and unexercisable
      of such date, Dr. Polaschegg - 0, Mr. Wolf - 40,000 stock options which
      were vested and exercisable within 60 days of March 23, 2009 and 60,000
      stock options which were unvested and unexercisable of such date, Mr.
      Goldberger - 0, Dr. Gura - 250,000 stock options which were vested and
      exercisable within 60 days of March 23, 2009 and 250,000 stock options
      which were unvested and unexercisable of such date, and Mr. Cummins -
      0.





Compensation
Committee Interlocks and Insider Participation





Not required for smaller reporting
companies.





Compensation
Committee Report





Not required for smaller reporting
companies.


61


Item 12.                 Security Ownership and Certain
Beneficial Owners and Management and Related Stockholder
Matters





Security Ownership of
Certain Beneficial
Owners and Management





The
following table sets forth certain information regarding the shares of common
stock beneficially owned as of March 23, 2009 by: (i) each person known to
us to be the beneficial owner of more than 5% of our common stock,
(ii) each of our directors, (iii) our chief executive officer and the
two most highly compensated executive officers other than the chief executive
officer, who were serving as executive officers at the end of our last fiscal
year (collectively, the “named executive officers”) and other executive officers
named in the Summary Compensation Table set forth in the “Executive
Compensation” section, and (iv) all such directors and executive officers
as a group.





Name and Address
                      of Beneficial Owner (1)
                    
                    Title of Class of Shares
                      Owned
                    
                    Amount and Nature of
                      Beneficial Ownership
                    
                    
                    Percent of
                      ClassTerren
      S. Peizer (2)
                    
                    common
      stock
                    
                    
                    6,512,596
                    
                    
                    
                    43.3
                    %Jay
      A. Wolf (3)
                    
                    common
      stock
                    
                    
                    397,143
                    
                    
                    
                    2.7
                    %Victor
      Gura (4)
                    
                    common
      stock
                    
                    
                    250,000
                    
                    
                    
                    1.7
                    %Kelly
      J. McCrann (5)
                    
                    common
      stock
                    
                    
                    120,000
                    
                    
                    
                    *Robert
      Weinstein (6)
                    
                    common
      stock
                    
                    
                    95,000
                    
                    
                    
                    *Hans-Dietrich
      Polaschegg
                    
                    common
      stock
                    
                    
                    —
                    
                    
                    
                    —Marc
      G. Cummins (7)(8)
                    
                    common
      stock
                    
                    
                    1,557,158
                    
                    
                    
                    10.6
                    %All
      directors and named executive officers
                      as
      a group (7 persons)
                    
                    common
      stock
                    
                    
                    8,931,897
                    
                    
                    
                    58.9
                    %





*
            Represents
      beneficial ownership of less than
1%.




(1)
            Unless
      otherwise indicated, the address of all of the above named persons is c/o
      Xcorporeal, Inc., 12121 Wilshire Blvd., Suite 350, Los Angeles, California
      90025.




(2)
            Includes
      6,232,596 shares held of record by Consolidated National, LLC, of which
      Mr. Peizer is the sole managing member and beneficial owner. As of
      December 31, 2008, shares of our common stock underlying 280,000 stock
      options granted to Mr. Peizer’s were vested and exercisable within 60 days
      of March 23, 2009.




(3)
            Includes
      357,143 shares held of record by Trinad Capital Master Fund Ltd. (the
      “Master Fund”), that may be deemed to be beneficially owned by Trinad
      Management, LLC, the investment manager of the Master Fund and Trinad
      Capital LP; a controlling stockholder of the Master Fund; Trinad Advisors
      GP, LLC, the general partner of Trinad Capital LP; and Jay Wolf a director
      of the issuer and a managing director of Trinad Management, LLC and a
      managing director of Trinad Advisors GP, LLC. Mr. Wolf disclaims
      beneficial ownership of the reported securities except to the extent of
      his pecuniary interest therein. Also includes 40,000 shares of our common
      stock underlying stock options issued to Mr. Wolf’s which were vested and
      exercisable within 60 days of March 23,
2009.




(4)
            Represents
      shares of our common stock underlying 250,000 stock option granted to Dr.
      Gura which were vested and exercisable within 60 days of March 23,
      2009.




(5)
            Includes
      shares of our common stock underlying 20,000 stock options granted to Mr.
      McCrann which were vested and exercisable within 60 days of March 23,
      2009.




(6)
            Includes
      shares of our common stock underlying 75,000 stock options granted to Mr.
      Weinstein which were vested and exercisable within 60 days of March 23,
      2009.




(7)
            Mr.
      Cummins resigned as a member of our Board of Directors effective March 6,
      2009.




(8)
            Represents
      shares held of record by Prime Logic Capital, LLC, CPS Opportunities, and
      GPC LXI, LLC. Mr. Cummins is a Managing Partner of Prime Capital, LLC. He
      disclaims beneficial ownership of the reported securities except to the
      extent of his pecuniary interest therein. Excludes warrants to purchase
      150,000 shares held by OGT, LLC, an affiliate of Prime Logic, over which
      Mr. Cummins disclaims beneficial ownership except to the extent of his
      pecuniary interest therein.





Unless
otherwise indicated, we believe that all persons named in the above table have
sole voting and investment power with respect to all shares of our common stock
beneficially owned by them. A person is deemed to be the beneficial owner of
securities which may be acquired by such person within 60 days from the date on
which beneficial ownership is to be determined, upon the exercise of options,
warrants or convertible securities. Each beneficial owner’s percentage ownership
is determined by assuming that options, warrants and convertible securities that
are held by such person (but not those held by any other person) and which are
exercisable, convertible or exchangeable within such 60 day period, have been so
exercised, converted or exchanged.




62


Item 13.                      CertainRelationshipsandRelated Transactionsand Director
Independence.





Certain
Relationships and Related Transactions




Related-party
transactions have the potential to create actual or perceived conflicts of
interest between our company and our directors and executive officers or their
immediate family members. The Board reviews such matters as they pertain to
related-party transactions as defined by Item 404(b) of the SEC’s
Regulation S-K. In deciding whether to continue to allow these
related-party transactions involving a director, executive officer, or their
immediate family members, the Board considered, among other
factors:





·
            information
      about the services proposed to be or being provided by or to the related
      party or the nature of the
transactions;




·
            the
      nature of the transactions and the costs to be incurred by our company or
      payments to us;




·
            an
      analysis of the costs and benefits associated with the transaction and a
      comparison of comparable or alternative services that are available to us
      from unrelated parties;




·
            the
      business advantage that we would gain by engaging in the
      transaction; and




·
            an
      analysis of the significance of the transaction to our company and to the
      related party.





The Board
determined that the related party transactions disclosed herein are on terms
that are fair and reasonable to us, and which are as favorable to our company as
would be available from non-related entities in comparable transactions. The
Board believes that there is a business interest to our company in supporting
the transactions and the transactions meet the same standards that we apply to
comparable transactions with unaffiliated entities. Although the aforementioned
controls are not written, each determination was made by the Board and reflected
in its minutes.




Below are
the transactions that occurred since the beginning of the fiscal year 2008, or
any currently proposed transactions, in which, to our knowledge, we were or are
a party, in which the amount involved exceeded $120,000, and in which any of our
directors, director nominees, executive officers, holders of more than 5% of any
class of our common stock, or any member of the immediate family of any of the
foregoing persons had or will have a direct or indirect material
interest.





In
connection with the contribution of the assets to our company, on August 31,
2006we issued to
CNL, of which Terren Peizer, our former Executive Chairman and current member of
the Board, who beneficially owns 43.3% of our outstanding common stock, is the
sole managing member and beneficial owner, an aggregate of 9,600,000 shares of
common stock of which 6,232,596 shares are still held by CNL.  Mr.
Peizer served until October 2008 as our Executive Chairman pursuant to his
Executive Chairman Agreement dated August 10, 2007. In consideration of his
services, commencing July 1, 2007, we paid Mr. Peizer base compensation of
$450,000 per annum with a signing bonus of $225,000. From January 1, 2008
through October 2008, Mr. Peizer received $281,250 for his services under the
agreement. Mr. Peizer voluntarily resigned from his position as Executive
Chairman in October 2008 and remains a member of our Board of
Directors.





Dr. Gura,
our Chief Medical and Scientific Officer, owns 15,497,250 shares of common stock
of NQCI (or approximately 20.9% of NQCI’s common stock outstanding as of January
31, 2009) with whom we entered into the License Agreement. Such shares include
800,000 shares owned by Medipace Medical Group, Inc., an affiliate of Dr. Gura
(or approximately 1.1% of NQCI’s common stock outstanding as of January 31,
2009), and 250,000 shares subject to warrants held by Dr. Gura which are
currently exercisable (or approximately 0.3% of NQCI’s common stock outstanding
as of January 31, 2009).





Pursuant
to a consulting agreement effective December 1, 2007, Daniel S. Goldberger, a
former member of our Board of Directors, provided consulting services as our
interim Chief Executive Officer. In consideration of the services, we paid Mr.
Goldberger $15,000 per month during the first two months and $12,500 per month
thereafter during the term of the consulting agreement. From the date of his
consulting agreement through September 30, 2008, Mr. Goldberger was compensated
$130,000 for his services. Mr. Goldberger resigned as interim Chief Executive
Officer on October 6, 2008, and as a director on October 7, 2008, and remained
as a strategic consultant to our company through the end of 2008. Mr. Goldberger
received an additional $22,500 in compensation for such services.





Dr. Gura
maintains an office located in Beverly Hills, California. Pursuant to a
reimbursement agreement effective January 29, 2008, we reimburse 50% of the
rental and 50% of his monthly parking. The term of the agreement commenced on
April 23, 2007, the date of the office lease agreement, and continue until the
date on which he ceases to use the remote office to perform his duties as our
Chief Medical and Scientific Officer. From commencement through December 31,
2008, we reimbursed our Chief Medical and Scientific Officer $1,710 and $37,988
for 50% of the monthly parking and rental, respectively.





Director
Independence





After review of all of the relevant
transactions or relationships of each director and his family members, our
Board of Directors has determined that Messrs. Cummins, Polaschegg and Wolf are
“independent” as that term is defined under the applicable NYSE Amex standards,
including that each such director is free of any relationship that would
interfere with his individual exercise of independent judgment. Each of the
members of our Audit Committee, Compensation Committee and Nominating Committee
were determined by the Board of Directors to be independent under applicable
NYSE Amex standards.




63


As a result of Mr. Cummins’ resignation
from his position of a member of our Board of Directors effective March 6, 2009,
we are no longer in compliance with Section 803(A)(1) of the Amex Company Guide
because a majority of the members of our Board of Directors are not independent
directors.





Item 14.                      PrincipalAccountingFees and
Services.





BDO
Seidman served as the independent registered public accounting firm for
Operations, and as of the effective date of the merger between us and
pre-merger Xcorporeal, Inc., BDO Seidman has served as our independent
registered public accounting firm.





Audit
Fees




Total
fees for professional services rendered by our principal accountant for the
audit and review of our financial statements included in our Form 10-Q/10-QSBs
and Form 10-K/10-KSBs, and services provided in connection with our other SEC
filings for the years ended December 31, 2007 and 2008 were $303,155 and
$202,174, respectively.





Audit-Related
Fees




Audit-related
fees are for accounting technical consultations and totaled $0 in 2008 and
$24,000 in 2007.




Tax
Fees




We paid
no fees for professional services with respect to tax compliance, tax advice, or
tax planning to our auditor in 2007 or 2008.





All
Other Fees




Our
principal accountant did not bill us any other fees during 2007 or
2008.




Audit
committee’s pre-approval policies and procedures




Our Audit
Committee has responsibility for the approval of all audit and non-audit
services before we engage an accountant. All of the services rendered to us by
BDO Seidman, LLP are pre-approved by our Audit Committee before the engagement
of the auditors for such services. Our pre-approval policy expressly provides
for the annual pre-approval of all audits, audit-related and all non-audit
services proposed to be rendered by the independent auditor for the fiscal year,
as specifically described in the auditor's engagement letter, such annual
pre-approval to be performed by our Audit Committee.





64


PART
IV








Item
15. Exhibits and
Financial Statement Schedules.





(a)
            
            The
      Following documents are filed as a part of this
  report:




1.
            
            Financial
      Statements





Our financial statements are as set
forth under Item 8 of this Annual Report on Form 10-K.





2.
            
            Financial
      Statement Schedules




The
auditors’ report with respect to the above-listed financial statement schedule
appears on page 30 of this Annual Report. All other financial statements and
schedules not listed are omitted either because they are not applicable, not
required or the required information is included in the financial
statements.





3.
            
            Exhibits
      required by Item 601 of Regulation
S-K







The
exhibits listed in the Exhibit Index, which appears immediately following the
signature page of this report and is incorporated herein by reference, are filed
as part of this Annual Report.




65


SIGNATURES





Pursuant
to the requirements of Section 13 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, on the date indicated.





XCORPOREAL, INC.








Date: March
31,
2009                                                                                By:  /s/Kelly J.
McCrann


Kelly J. McCrann


Chief Executive Officer


(Principal Executive
Officer)





Date: March
31,
2009                                                                                By:  /s/Robert
Weinstein


Robert Weinstein


Chief Financial Officer


(Principal Financial Officer and
Principal Accounting Officer)





KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Kelly J. McCrann and Robert Weinstein, or either of
them, his or her attorneys-in-fact, for such  person in any and all
capacities, to sign any amendments to this report and to file the same, with
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
either of said attorneys-in-fact, or substitute or substitutes, may do or cause
to be done by virtue hereof.





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the date indicated.





Signature
                                          
                                          Title(s)
                                          
                                          Date/s/Kelly J.
      McCrann
                                          
                                          Chairman
      of the Board of Directors
                                          
                                          March
      31, 2009Kelly
      J. McCrann/s/
      Terren S.
      Peizer
                                          
                                          Director
                                          
                                          March
      31, 2009Terren
      S. Peizer/s/Hans-Dietrich Polaschegg,
      Ph.D.
                                          
                                          Director
                                          
                                          March
      31, 2009Hans-Dietrich
      Polaschegg, Ph.D./s/Jay A.
    Wolf
                                          
                                          Director
                                          
                                          March
      31, 2009Jay
      A. Wolf




66




EXHIBIT
INDEX





No.
                                                                                                                
                                                                                                                Description2.1
                                                                                                                
                                                                                                                Merger
      Agreement, dated as of September 1, 2006, by and among Xcorporeal,
      Inc., NQCI Acquisition Corporation and National Quality Care,
      Inc.(1)3.1
                                                                                                                
                                                                                                                Amended
      and Restated Certificate of Incorporation of Xcorporeal, Inc.
      (1)3.2
                                                                                                                
                                                                                                                Amended
      and Restated Bylaws of Xcorporeal, Inc. (1)4.1
                                                                                                                
                                                                                                                Specimen
      of Common Stock certificate (1)10.1†
                                                                                                                
                                                                                                                Form
      of Indemnification Agreement for directors (1)10.2†
                                                                                                                
                                                                                                                Xcorporeal,
      Inc. 2007 Incentive Compensation Plan (1)10.3
                                                                                                                
                                                                                                                License
      Agreement, dated as of September 1, 2006 (1)10.4†
                                                                                                                
                                                                                                                Contribution
      Agreement, dated as of August 31, 2006 (1)10.5†
                                                                                                                
                                                                                                                Employment
      Agreement, dated as of November 30, 2006, between Xcorporeal, Inc. and
      Victor Gura, M.D. (1)10.6
                                                                                                                
                                                                                                                Form
      of Innovation, Proprietary Information and Confidentiality Agreement
      (1)10.7†
                                                                                                                
                                                                                                                Executive
      Chairman Agreement, dated as of August 10, 2007, between Xcorporeal, Inc.
      and Terren S. Peizer (1)10.8†
                                                                                                                
                                                                                                                Employment
      Agreement of Robert Weinstein (1)10.9†
                                                                                                                
                                                                                                                Consulting
      Agreement, dated as of October 1, 2007, between Xcorporeal, Inc. and
      Hans-Dietrich Polaschegg (1)10.10
                                                                                                                
                                                                                                                Services
      Agreement, dated as of March 22, 2007, between Xcorporeal, Inc. and Aubrey
      Group, Inc. (1)10.11†
                                                                                                                
                                                                                                                Employment
      Agreement, dated as of November 30, 2006, between Xcorporeal, Inc. and
      Kelly J. McCrann. (2)10.12†
                                                                                                                
                                                                                                                Services
      Agreement, dated as of January 24, 2008, between Xcorporeal, Inc. and
      Daniel  S. Goldberger (3)10.13
                                                                                                                
                                                                                                                Lease
      for Operating Facility, dated as of October 6, 2008, between Xcorporeal,
      Inc. and
                                                                                                                  Olen
      Commercial Realty Corp. (4)14.1
                                                                                                                
                                                                                                                Code
      of Ethics (1)21.1
                                                                                                                
                                                                                                                Subsidiaries
      of Xcorporeal, Inc.*23.1
                                                                                                                
                                                                                                                Consent
      of Independent Registered Public Accounting Firm *31.1
                                                                                                                
                                                                                                                Rule
      13a-14(a) Certification of Chief Executive Officer *31.2
                                                                                                                
                                                                                                                Rule
      13a-14(a) Certification of Chief Financial Officer *32.1
                                                                                                                
                                                                                                                Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  *32.2
                                                                                                                
                                                                                                                Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  *


____________





*   Filed
      herewith.


†   Management
      contracts, compensatory plans or
arrangements.





(1)
Incorporated by reference to exhibit of the same number to our Quarterly Report
on Form 10-Q filed November 13, 2007.





(2)
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K
filed October 8, 2008.





(3) Incorporated
by reference to Exhibit 10.1 to our Current Report on Form 8-K filed January 25,
2008.





(4)
Incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q
filed November 19, 2008.





67