**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





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


FOR
      THE
      QUARTERLY PERIOD ENDED **SEPTEMBER
      30, 2008**





p TRANSITION
      REPORT UNDER 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 small business issuer as specified in its charter)





**Delaware**
            
            **75-2242792**(State
                or other jurisdiction of
              incorporation
                or organization)
            
            (IRS
                Employer Identification Number)





**12121
      Wilshire Blvd., Suite 350, Los Angeles, California 90025**


(Address
      of principal executive offices)





**(310)
      923-9990**


(Issuer’s
      telephone number)





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 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 whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting
      company.




 ̈
                Large accelerated filer
            
             ̈
                Accelerated filer ̈
                Non-accelerated filer
            
            x
                Smaller reporting company





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





State
      the
      number of shares outstanding of each of the issuer’s classes of common equity,
      as of the latest practicable date.





**Class**
            
            **Outstanding
                as of November 17, 2008**Common
                Stock, $0.0001 par value
            
            14,704,687
                shares















**INDEX**


PART
                    I — FINANCIAL INFORMATION
                2Item
                    1. Interim Financial Statements
                2Balance
                    Sheets at September 30, 2008 (unaudited) and December 31,
                    2007
                2Statements
                    of Operations (unaudited) for the three and nine months ended
                    September
                    30, 2008 and September 30, 2007 and the period from inception
                    (May 4,
                    2001) to September 30, 2008
                3Statements
                    of Cash Flows (unaudited) for the nine months ended September
                    30, 2008 and
                    September 30, 2007 and the period from inception (May 4, 2001)
                    to
                    September 30, 2008
                4Statement
                    of Stockholders Equity (Deficit) for the nine months ended September
                    30,
                    2008 and the period from inception (May 4, 2001) to September
                    30, 2008
                    (unaudited)
                5Notes
                    to the Interim Financial Statements
                6Item
                    2. Management’s Discussion and Analysis of Financial Condition and Results
                    of Operations
                15Item
                    3. Quantitative and Qualitative Disclosures about Market
                    Risk
                19Item
                    4. Controls and Procedures
                19PART
                    II — OTHER INFORMATION
                21Item
                    1. Legal Proceedings
                21Item
                    1A. Risk Factors
                22Item
                    2. Unregistered Sales of Equity Securities ; Use of Proceeds
                    from
                    Registered Securities
                23Item
                    6. Exhibits
                24Signatures
                25


1





**PART
      I — FINANCIAL INFORMATION**





**ITEM
      1. Financial Statements**





**XCORPOREAL,
      INC.**


**(a
      Development Stage Company)**


**BALANCE
      SHEETS**


**(Unaudited)**





**September 30,**
            
            **December 31,****2008**
            
            **2007****ASSETS**CurrentCash
                and cash equivalents
            
            $
            253,042
            
            $
            106,495Marketable
                securities, at fair value
            
            
            5,756,685
            
            
            16,401,898Restricted
                cash
            
            
            67,788
            
            
            68,016Prepaid
                Expenses & Other Current Assets
            
            
            300,473
            
            
            408,303Total
                current assets
            
            
            6,377,988
            
            
            16,984,712Property
                and equipment, net
            
            
            304,749
            
            
            266,912Other
                assets
            
            
            877
            
            
            922Total
                Assets
            
            $
            6,683,614
            
            $
            17,252,546**LIABILITIES**CurrentAccounts
                payable
            
            $
            1,180,138
            
            $
            1,125,239Accrued
                professional fees
            
            
            3,049,015
            
            
            425,228Accrued
                royalties
            
            
            270,833
            
            
            83,333Accrued
                compensation
            
            
            139,564
            
            
            196,541Accrued
                other liabilities
            
            
            120,330
            
            
            68,946Payroll
                liabilities
            
            
            10,955
            
            
            11,926Deferred
                rent
            
            
            40,929
            
            
            -Other
                current liabilities
            
            
            115,400
            
            
            115,400Total
                Current Liabilities
            
            
            4,927,164
            
            
            2,026,613Shares
                issuable
            
            
            4,615,000
            
            
            -**COMMITMENTS
                & CONTINGENCIES****STOCKHOLDERS'
                EQUITY**Preferred
                Stock, $0.0001 par value, 10,000,000 shares authorized, none
                outstanding
            
            
            -
            
            
            -Common
                Stock, $0.0001 par value, 40,000,000 shares authorized, 14,704,687
                and
                14,372,472 outstanding on September 30, 2008 and December 31, 2007,
                respectively
            
            
            1,470
            
            
            1,437Additional
                paid-in capital
            
            
            41,526,283
            
            
            36,822,316Deficit
                accumulated during the development stage
            
            
            (44,386,303
            )
            
            (21,597,820
            )Total
                Stockholders' (Deficit) Equity
            
            
            (2,858,550
            )
            
            15,225,933Total
                Liabilities & Stockholders' (Deficit) Equity
            
            $
            6,683,614
            
            $
            17,252,546




See
      accompanying notes to interim financial statements.


2





**XCORPOREAL,
      INC.**


**(a
      Development Stage Company)**


**STATEMENTS
      OF OPERATIONS**


**(Unaudited)**





**May 4, 2001 (Date****Three Months Ended**
            
            **Nine Months Ended**
            
            **of Inception) to****September 30,**
            
            **September 30,**
            
            **September 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**
            
            **2008**Operating
                Expenses:Selling,
                general and administrative
            
            $
            2,111,578
            
            $
            2,664,405
            
            $
            7,756,230
            
            $
            8,254,693
            
            $
            22,158,922Research
                and development
            
            
            12,694,055
            
            
            2,087,753
            
            
            18,900,027
            
            
            4,775,887
            
            
            27,328,519Other
                expenses
            
            
            1,871,430
            
            
            -
            
            
            1,871,430
            
            
            -
            
            
            1,871,430Depreciation
                and amortization
            
            
            27,253
            
            
            9,243
            
            
            75,837
            
            
            14,626
            
            
            108,103Loss
                before other income, income taxes, and other expenses
            
            
            (16,704,316
            )
            
            (4,761,401
            )
            
            (28,603,524
            )
            
            (13,045,206
            )
            
            (51,466,974
            )Interest
                and other income
            
            
            44,871
            
            
            290,677
            
            
            278,941
            
            
            910,603
            
            
            1,546,171Change
                in fair value of shares issuable
            
            
            5,538,000
            
            
            -
            
            
            5,538,000
            
            
            -
            
            
            5,538,000Loss
                before income taxes and other expenses
            
            
            (11,121,445
            )
            
            (4,470,724
            )
            
            (22,786,583
            )
            
            (12,134,603
            )
            
            (44,382,803
            )Income
                taxes
            
            
            300
            
            
            -
            
            
            1,900
            
            
            -
            
            
            3,500Net
                Loss
            
            $
            (11,121,745
            )
            $
            (4,470,724
            )
            $
            (22,788,483
            )
            $
            (12,134,603
            )
            $
            (44,386,303
            )Basic
                and diluted loss per share
            
            $
            (0.76
            )
            $
            (0.32
            )
            $
            (1.57
            )
            $
            (0.86
            )Weighted
                average number of shares outstanding
            
            
            14,704,687
            
            
            14,089,180
            
            
            14,561,070
            
            
            14,162,687





See
      accompanying notes to interim financial statements.


3


**XCORPOREAL,
      INC.**


**(a
      Development Stage Company)**


**STATEMENTS
      OF CASH FLOWS**


**(Unaudited)**





**May 4, 2001 (Date****Nine Months Ended**
            
            **of Inception) to****September 30,**
            
            **September 30,****2008**
            
            **2007**
            
            **2008****Cash flows used in operating activities**Net
                Loss for the Period
            
            $
            (22,788,483
            )
            $
            (12,134,603
            )
            $
            (44,386,303
            )**Adjustments
                to reconcile net loss to net cash (used in) operating
                activities:**Stock
                Based Compensation
            
            
            3,813,158
            
            
            2,233,238
            
            
            7,798,894Non-employee
                Stock Based Compensation
            
            
            92,842
            
            
            2,923,344
            
            
            5,172,762Common
                Stock Issuance for consulting services rendered
            
            
            798,000
            
            
            -
            
            
            896,000Increase
                in shares issuable
            
            
            10,153,000
            
            
            -
            
            
            10,153,000Mark
                to market of shares issuable
            
            
            (5,538,000
            )
            
            -
            
            
            (5,538,000
            )Depreciation
            
            
            75,792
            
            
            14,562
            
            
            107,980Net
                Change in assets and liabilities:Decrease
                (increase) in Prepaid Expenses & Other Current Assets
            
            
            107,830
            
            
            (223,935
            )
            
            (300,473
            )Decrease
                (increase) in Other Assets
            
            
            45
            
            
            64
            
            
            (877
            )Increase
                in Accounts Payable and Accrued Liabilities
            
            
            2,859,622
            
            
            323,248
            
            
            4,733,464Increase
                in Deferred Rent
            
            
            40,929
            
            
            -
            
            
            40,929Increase
                in Other Current Liabilities
            
            
            -
            
            
            -
            
            
            115,400Net
                Cash Used in Operating Activities
            
            
            (10,385,265
            )
            
            (6,864,082
            )
            
            (21,207,224
            )**Cash
                Flows from Investing Activities**Capital
                Expenditures
            
            
            (113,629
            )
            
            (207,321
            )
            
            (412,729
            )Restricted
                Cash
            
            
            228
            
            
            (87,996
            )
            
            (67,788
            )Purchase
                of marketable securities
            
            
            (8,598,102
            )
            
            (21,932,739
            )
            
            (33,598,102
            )Sale
                of marketable securities
            
            
            19,243,315
            
            
            2,323,422
            
            
            27,841,417Net
                Cash Provided by (Used in) Investing Activities
            
            
            10,531,812
            
            
            (19,904,634
            )
            
            (6,237,202
            )**Cash
                Flows from Financing Activities**Capital
                Stock issued
            
            
            -
            
            
            -
            
            
            27,434,348Advances
                from related party
            
            
            -
            
            
            -
            
            
            64,620Additional
                Proceeds from the Sale of Common Stock in 2006
            
            
            -
            
            
            -
            
            
            198,500Net
                Cash Provided by Financing Activities
            
            
            -
            
            
            -
            
            
            27,697,468Increase/(decrease)
                in cash during the period
            
            
            146,547
            
            
            (26,768,716
            )
            
            253,042Cash,
                beginning of the period
            
            
            106,495
            
            
            27,440,987
            
            
            -Cash,
                end of the period
            
            $
            253,042
            
            $
            672,271
            
            $
            253,042Supplemental
                disclosure of cash flow information; cash paid for:Interest
            
            $
            -
            
            $
            -
            
            $
            -Income
                taxes
            
            $
            1,900
            
            $
            -
            
            $
            3,500





See
      accompanying notes to interim financial statements.


4




**XCORPOREAL,
      INC.**


**(a
      Development Stage Company)**


**STATEMENTS
      OF STOCKHOLDERS’ EQUITY (DEFICIT)**


**For
      the Period May 4, 2001 (Inception) to September 30, 2008**


**(Unaudited)**




**Deficit****Accumulated****Additional**
              
              **During****Common Stock**
              
              **Paid-in**
              
              **Development****Shares**
              
              **Amount**
              
              **Capital**
              
              **Stage**
              
              **Total**Common
                  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 a license rights at $0.0001 per share
              
              
              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 placement fees 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 in 2006
              
              
              
              
              
              
              
              
              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 consulting services at $3.61 per
                  share
              
              
              200,000
              
              
              20
              
              
              721,980
              
              
              
              
              
              722,000Warrants
                  granted for consulting services
              
              
              
              
              
              
              
              
              75,489
              
              
              
              
              
              75,489Stock-based
                  compensation expense
              
              
              
              
              
              
              
              
              1,121,118
              
              
              
              
              
              1,121,118Net
                  loss for the period
              
              
              
              
              
              
              
              
              
              
              
              (6,350,365
              )
              
              (6,350,365
              )Balance
                  as of March 31, 2008
              
              
              14,572,472
              
              
              1,457
              
              
              38,740,903
              
              
              (27,948,185
              )
              
              10,794,175Common
                  stock issued as compensation for consulting services at $3.80 per
                  share
              
              
              20,000
              
              
              2
              
              
              75,998
              
              
              
              
              
              76,000Cashless
                  exercise of warrants
              
              
              112,215
              
              
              11
              
              
              (11
              )
              
              
              
              
              0Warrants
                  granted for consulting services
              
              
              
              
              
              
              
              
              9,256
              
              
              
              
              
              9,256Stock-based
                  compensation expense
              
              
              
              
              
              
              
              
              960,840
              
              
              
              
              
              960,840Net
                  loss for the period
              
              
              
              
              
              
              
              
              
              
              
              (5,316,373
              )
              
              (5,316,373
              )Balance
                  as of June 30, 2008
              
              
              14,704,687
              
              
              1,470
              
              
              39,786,986
              
              
              (33,264,558
              )
              
              6,523,898Stock-based
                  compensation expense
              
              
              
              
              
              
              
              
              1,739,297
              
              
              
              
              
              1,739,297Net
                  loss for the period
              
              
              
              
              
              
              
              
              
              
              
              (11,121,745
              )
              
              (11,121,745
              )Balance
                  as of September 30, 2008
              
              
              14,704,687
              
              $
              1,470
              
              $
              41,526,283
              
              $
              (44,386,303
              )
              $
              (2,858,550
              )




See
      accompanying notes to interim financial statements.


5


**XCORPOREAL,
      INC.**


**(a
      Development Stage Company)**


**NOTES
      TO INTERIM FINANCIAL STATEMENTS**


**September
      30, 2008**


**(Unaudited)**





**Note
      1 — Interim Reporting**





While
      information presented in the accompanying interim financial statements is
      unaudited, it includes all adjustments, which are, in the opinion of management,
      necessary to present fairly the financial position, results of operations,
      and
      cash flows for the interim period presented.





The
      results of operations for the period ended September 30, 2008 are not
      necessarily indicative of the results that can be expected for the year ended
      December 31, 2008.





**Note
      2 — Nature of Operations**  **and
      Going Concern Uncertainty**





On
      October 12, 2007, pursuant to a merger agreement with Xcorporeal, Inc. (referred
      to hereinafter as Operations), our newly-formed wholly-owned merger 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 is 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, Operations is considered the accounting
      acquirer and the transaction is considered to be a recapitalization of
      Operations.





Historical
      financial statements prior to the merger were restated to be those of
      Operations. The merger is 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 is 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 are carried forward at their
      predecessor carrying amounts. Retained deficiency of Operations is carried
      forward after the merger. Operations prior to the merger are those of
      Operations. Earnings per share for periods prior to the merger are restated
      to
      reflect the number of equivalent shares received by Operations’s stockholders.
      The costs of the transaction will be 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 operating expenses and capital requirements before we
      achieve profitability. Accordingly, we may seek to raise additional funds
      through public or private placement of shares of preferred or common stock
      or
      through public or private 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 raising necessary funds on acceptable terms, or at all. As a
      result of these conditions, there is substantial doubt about our ability to
      continue as a going concern. The financial statements 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
      which closed in the fourth quarter of 2006, we strategically began our operating
      activities and research and development efforts which resulted in a net loss
      of
      $17.1 million in 2007, and $22.8 million in the nine months ended September
      30,
      2008 including a net $4.6 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 of which we sold $19.2 million of the investments, leaving a balance
      of $5.8 million as of September 30, 2008.




6




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. The platform leads 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 a License
      Agreement dated September 1, 2006, between Operations and National Quality
      Care,
      Inc. ("NQCI") pursuant to which we obtained the exclusive rights to the
      technology designated therein (the "License Agreement"). 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 the
      productive research and development efforts of the PAK, 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 by next year. 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. As we begin to shift out of the phase of
      development and build of the prototype equipment, reducing the related spending
      on research and development costs as well as consulting and material costs,
      see
      Note 16-Product Development Agreement, we expect that our monthly expenditures
      will remain somewhat constant. 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.




In
      addition, we have used some of our resources for the development of the WAK
      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
      additional 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.





**Note
      3 — 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.




**Note
      4 – Legal Proceedings**





On
      December 1, 2006, Operations initiated arbitration against National Quality
      Care, Inc. (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” (the “Technology
      Transaction”). The merger was not 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. Copies of the License Agreement and Merger Agreement are attached
      as exhibits to our amended current report on Form 8-K/A filed with the
      Securities and Exchange Commission on June 11, 2008.





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 November 17, 2008, there were 14,704,687 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.





7




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 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.





The
      Second Interim Award also 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. 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 professional fees” as of September
      30, 2008. The Licensor Expenses was accrued in the three months ended June
      30,
      2008 with the expenditure recorded as Licensing Expense within research and
      development operating expenses. To date, we have not received any supporting
      backup of these alleged Licensor Expenses.





On
      August
      15, 2008, the arbitrator awarded NQCI $1.87 million to settle over $4 million
      NQCI claimed in attorneys’ fees and costs, stating that NQCI’s lack of success
      and other factors warranted a substantial reduction in the sums claimed. The
      arbitrator stated in pertinent part: “National’s success in the arbitration has
      been only partial and this is directly relevant to the question of the quantum
      of attorneys’ fees which should be awarded. ... National sought eight or nine
      figure damages, but was awarded none. ... Further, National asserted claims for
      fraud, interference with contract, and other torts, all of which were rejected.
      This lack of success warrants a substantial reduction in the sums claimed.” NQCI
      asked for a total of $4.04 million in attorneys’ fees and costs. The arbitrator
      awarded NQCI a total of $1.87 million which have been accrued under “Accrued
      professional fees” as of September 30, 2008. The interim settlement of legal
      fees was accrued in the three and nine months ended September 30, 2008 with
      the
      expenditure recognized as “Other expenses” and payment pending to
      date.





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 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 Securities and Exchange Commission (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*, t he
      Technology Transaction will be measured based on the fair value of the shares
      surrendered on the date of issuance, 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 will expense the value of the intellectual property,
      determined in process research and development, at the date of
      acquisition.





Pursuant
      to the Second Interim Award, stating
      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 9.23 million shares of our common
      stock. As the Second Interim Award states that a registration statement for
      any
      issued shares must be declared effective within 90 days, and such contingency
      is
      not within our control, we have recorded the issuance as a liability, rather
      than as equity. The fair value of the 9.23 million 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 this interim
      reporting period, September 30, 2008. The fair value of the accrued shares
      on
      August 4, 2008, was $10,153,000 which was revalued at $4,615,000 as of September
      30, 2008, resulting in a $5,538,000 non-operating gain to the statement of
      operations for the three and nine months ended September 30, 2008. The net
      fair
      value of $4,615,000 was accrued under “Shares issuable” as of September 30,
      2008. Stockholders’ approval and issuance of the shares are pending to
      date.





Although
      we may seek stockholder approval for the issuance of the 9.23 million shares
      of
      our common stock to effectuate the Technology Transaction, we are uncertain
      whether the SEC will approve a form of proxy to solicit stockholder approval
      of
      the transaction, our stockholders will vote to approve the transaction, shares
      will be issued to NQCI, or the SEC will declare effective a 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 award, the above accrual may be adjusted and the accrual or the actual
      settlement will be recorded to coincide with the alternate award.





8




If
      the
      9.23 million shares contemplated by the Second Interim Award are issuable
      pursuant to a shareholder vote and the shares are issued pursuant to either
      a
      registration of such shares or the waiver of the registration proposal by the
      arbitrator, then the $4.6 million contingent liability record on our balance
      sheet becomes an addition of 9.23 million shares to our outstanding common
      shares and increases stockholders’ equity by the 9.23 million shares multiplied
      by the trading price of our shares on that day.





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.





The
      above
      legal proceedings are discussed in further detail below in Part II-Other
      Information, Item 1. Legal Proceedings.





**Note
      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 September 30, 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 bank credit card
      program.





**Note
      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
      sheet 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.
 
 ·
              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 he asset or liability
                  at the
                  measurement date.




9




The
      following tables summarize fair value measurements by level at September 30,
      2008 for assets and liabilities measured at fair value on a recurring
      basis:




**Level
                I**
            
            **Level
                II**
            
            **Level
                III**
            
            **Total**Cash
                and cash equivalents
            
            $
            253,042
            
            $
            -
            
            $
            -
            
            $
            253,042Marketable
                securities:Commercial
                paper
            
            
            3,708,821
            
            
            -
            
            
            -
            
            
            3,708,821Corporate
                securities fixed rate
            
            
            651,811
            
            
            -
            
            
            -
            
            
            651,811Money
                market fund
            
            
            1,396,053
            
            
            -
            
            
            -
            
            
            1,396,053Restricted
                cash
            
            
            67,788
            
            
            -
            
            
            -
            
            
            67,788Total
                assets
            
            $
            6,077,515
            
            $
            -
            
            $
            -
            
            $
            6,077,515




Short-term
      investments classified as available-for-sale were as follows:





**September 30, 2008****Aggregate Fair**
              **Value**
            
            **Gross Unrealized**
              **Gains / (Losses)**
            
            **Estimated Fair**
              **Value**Commercial
                paper
            
            $
            3,708,821
            
            $
            -
            
            $
            3,708,821Corporate
                securities fixed rate
            
            
            651,811
            
            
            -
            
            
            651,811Total
            
            $
            4,360,632
            
            $
            -
            
            $
            4,360,632





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 temporarily impaired as of
      September 30, 2008.





There
      were no gross unrealized gains or losses as of September 30, 2008.




**Note
      7 - Property and Equipment**





Property
      and equipment consist of the following at September 30, 2008:





Property
                and equipment
            
            $
            412,729Accumulated
                depreciation
            
            
            (107,980
            )Property
                and equipment, net
            
            $
            304,749





Depreciation
      expense for the three and nine months ended September 30, 2008 and 2007 was
      $27,238 and $75,792, and $9,229 and $14,562, respectively.





**Note
      8 – Shares Issuable**





Pursuant
      to the August 4, 2008, Second Interim Award, stating 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 a registration statement for any issued shares must be
      declared effective within 90 days, and such contingency is not within out
      control,we have recorded the issuance as a liability, rather than as equity.
      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
      gain or loss 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 9.23 million 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 $4,615,000 as of September
      30, 2008. The resulting non-operating gain of $5,538,000 to the statement of
      operations for the three and nine months ended September 30, 2008 was recognized
      as “Change in fair value of shares issuable”. Stockholder approval and issuance
      of the shares are pending to date.





Although
      we may seek stockholders’ approval for the issuance of 9.23 million shares of
      our common stock to effectuate the Technology Transaction, we are uncertain
      whether the SEC will approve the form of proxy to solicit stockholder approval
      of the transaction, our stockholders will vote to approve the transaction,
      shares will be issued to NQCI, or 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 award, the above accrual may be adjusted and the accrual
      or the actual settlement will be recorded to coincide with the alternate award.





10




**Note
      9 - 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 a 5 year period. As of September 30, 2008, our remaining
      total lease payments are $1,009,838.





The
      following is a schedule by years of future minimum lease payments required
      under
      the 5-year corporate office lease as of September 30, 2008:


Year
                  ending December 31:2008
              
              $
              52,224
              (
                  1 )2009
              
              
              215,8592010
              
              
              224,6502011
              
              
              233,5282012
              
              
              242,8422013
              
              
              40,735
              (
                  2 )Total
                  minimum payments required
              
              $
              1,009,838





(
                  1
                  )
                excludes
                    lease payments made through September 30,
                    2008
 (
                  2
                  )
                initial
                    term of the lease agreement ends February
                    2013




On
      May
      15, 2008, we executed the second amendment to the sublease agreement for office
      and warehouse space from Aubrey Group, Inc. (Aubrey). Pursuant to the amendment,
      we acquired additional office and warehouse space. In addition, our monthly
      sublease rent increased to $8,715 through December 31, 2008. As of September
      30,
      2008, our remaining total sublease payments are $17,429 for the remaining time
      we will occupy the subleased space from Aubrey which we have given notice to
      vacate by the end of November 2008.





**Note
      10 — Interest Income**





Interest
      income of $44,871 and $278,941, and $290,677 and $910,603 was reported for
      the
      three and nine months ended September 30, 2008 and 2007,
      respectively.





**Note
      11 – 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 professional fees” and
      captured the expenditure in “Other expenses” in the three and nine months ended
      September 30, 2008.





**Note
      12 — Related Party Transactions**





In
      connection with the contribution of the assets to our company, on August 31,
      2006 **** we
      issued
      to Consolidated National, LLC (CNL), of which Terren Peizer, who beneficially
      owns 42.4% 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.





The
      Chief
      Medical and Scientific Officer of our Company, Dr. Victor Gura, owns 15,497,250
      shares of common stock of NQCI (or approximately 20.9% of NQCI's common stock
      outstanding as of October 17, 2008 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, and 250,000 shares subject to warrants held
      by
      Dr. Gura which are currently exercisable.





Pursuant
      to a consulting agreement effective December 1, 2007, Daniel S. Goldberger,
      then
      a director, provided consulting services as 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 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 remains a strategic consultant to the Company thru the end of 2008.
      Mr. Goldberger will receive 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 September 30,
      2008, we reimbursed our Chief Medical and Scientific Officer $1,507 and $31,187
      for 50% of the monthly parking and rental, respectively.





11




**Note
      13 — License Agreement**





On
      August
      31, 2006, we entered into a Contribution Agreement with a company whose sole
      managing member, Terren Peizer, who beneficially owns 42.4% of our outstanding
      common stock. 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 National
      Quality Care, Inc. (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, 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.” 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. We recorded $520,833
      in royalty expenses covering the minimum royalties from commencement of the
      License Agreement through September 30, 2008. The License Agreement expires
      in
      2105. As of September 30, 2008, we had made one payment of the minimum annual
      royalty of $250,000 in November 2008.





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. As such, NQCI has made a claim for reimbursement of approximately
      $690,000 in alleged expenses under the License Agreement which were accrued
      under “Accrued professional fees” as of September 30, 2008. To
      date,
      we have not received any supporting backup of this alleged Licensor
      Expenses. See Note
      4-Legal Proceedings for further additional information related to this License
      Agreement.





**Note
      14 — 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 are substantially identical
      to the 2006 Incentive Compensation Plan 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. Effective February 28, 2007, there are 3,900,000
      shares of common stock reserved for issuance pursuant to the 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.





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





As
      of
      September 30, 2008, there were 129,500 optioned shares outstanding and 3,770,500
      shares available under the 2007 Incentive Compensation Plan.





***Stock
      Options to Employees, Officer 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.





In
      the
      three months ended September 30, 2008, an aggregate of 338,000 options were
      forfeited as a result of employee terminations and resignations. In addition,
      200,000 options were cancelled pursuant to a Director’s voluntary forfeiture
      with no other concurrent replacement award or other valuable consideration
      as
      his services as a Director remained and continued on the date of his voluntary
      forfeiture.





We
      reported $1,731,200 and $3,813,158 in stock-based compensation expense for
      employees, officers, and directors for the three and nine months ended September
      30, 2008, respectively. For the three and nine months ended September 30, 2007,
      we reported $749,774 and $2,233,238 in stock-based compensation expense for
      employees, officers, and directors, respectively.





12




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 nine months endedSeptember 30, 2008Expected dividend yields
            
            
            zeroExpected
                volatility
            
            
            136
            %Risk-free
                interest rate
            
            
            3.53-3.81
            %Expected
                terms in years
            
            
            3.12-8.88
                years




***Warrants
      and Stock Options to Non-Employees***





During
      the nine months ended September 30, 2008, there was no issuance of warrants.
      However, there were cashless exercises of warrants during the three months
      ended
      June 30, 2008.





We
      reported $8,097 and $92,842 in stock-based compensation expense for consultants
      for the three and nine months ended September 30, 2008, respectively. We
      reported $128,220 and $2,923,344 in stock-based compensation expense for
      consultants for the three and nine months ended September 30, 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:




For the nine months endedSeptember 30, 2008Expected
                dividend yields
            
            zeroExpected
                volatility
            
            
            136
            %Risk-free
                interest rate
            
            
            2.36-4.69
            %Expected
                terms in years
            
            
            1.14-4.05
                years




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 nine months ended September 30, 2008:


Stock Options and
                Warrants
                Outstanding
              
              Unamortized Compensation
                ExpenseJanuary
                  1, 2008
              
              
              4,674,221
              
              $
              18,228,742Granted
                  in the period
              
              
              55,000
              
              
              207,448Forfeited
                  & Cancelled in the period
              
              
              (823,000)
              (1)
              
              (2,386,795
              )Expensed
                  in the period
              
              
              -
              
              
              (5,353,382
              )Exercised
                  in the period
              
              
              (325,000)
              (2)
              
              -September
                  30, 2008
              
              
              3,581,221
              
              $
              10,696,013





(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.




13




(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.




Number of
              Options and
              Warrants
            
            Weighted
              Average
              Exercise
              PriceStock Options and WarrantsBalance
                at January 1, 2008
            
            
            4,674,221
            
            $
            6.01Granted
            
            
            55,000
            
            
            7.00Exercised
            
            
            (325,000
            )
            
            1.00Forfeited
                & Cancelled
            
            
            (823,000
            )
            
            6.51Balance
                at September 30, 2008
            
            
            3,581,221
            
            $
            6.37





**Note
      15 — Stockholders’ (Deficit) Equity**





In
      response to the NQCI arbitration interim award associated to the Technology
      Transaction, we are planning to seek stockholders 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 the accrual for 9.23 million shares, discussed further in Note 4-Legal
      Proceedings and Note 8-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
      September 30, 2008.





**Note
      16 — Product Development Agreement**





In
      July
      2007, we entered into an agreement with Aubrey Group, Inc., an FDA-registered
      third-party contract developer and manufacturer of medical devices for the
      design and development of a Portable Artificial Kidney ("PAK"). The PAK will
      be
      designed for use as an Intermittent as well as a Continuous Renal Replacement
      Therapy (CRRT) in the hospital with medical supervision. The development is
      expected to be completed by the end of 2008 and projected labor and material
      costs were estimated at approximately $5.1 million at the inception of the
      agreement and over the term. The agreement can be terminated at any time with
      30
      business days notice. From commencement through September 30, 2008, we incurred
      $3,063,798 in expense for the services rendered under this agreement and
      anticipate incurring approximately $200,000 for the remainder of
      2008.





**Note
      17 — Subsequent Events**





On
      October 2, 2008, Kelly J. McCrann was unanimously appointed Chairman of the
      Board of Directors and Chief Executive Officer. With his new role, Mr. McCrann
      resigned from the Audit Committee and Compensation Committee with Dr. Hans
      Polaschegg taking his place on the Compensation Committee. On October 6, 2008,
      effective October 2, 2008, we entered into an employment agreement with Mr.
      McCrann for a term of two years at an initial annual base salary of $325,000.
      He
      is eligible to receive discretionary bonuses based on achieving designated
      goals
      and milestones, and overall performance and profitability. Additionally, Mr.
      McCrann was granted 700,000 stock options at an exercise price of $1.50 per
      share under our 2007 Incentive Compensation Plan, which vest 25% on each of
      the
      first, second, third, and fourth anniversaries of the grant date, with
      anti-dilution protections. Further, if we issue shares to NQCI pursuant to
      the
      arbitration with NQCI, Mr. McCrann, shall, upon the date of such issuance to
      NQCI, be granted an additional option, number of shares to be determined, under
      the 2007 Incentive Compensation Plan to purchase such shares of our common
      stock, at an exercise price equal to the greater of (a) $1.50 per share or
      (b)
      the fair market value of a share of our common stock on the grant date,
      necessary to preserve Mr. McCrann’s ownership percentage of the company on a
      fully diluted basis, based upon the ownership percentage determined as of the
      date of initial grant. If Mr. McCrann is terminated without good cause or
      resigns for good reason, as defined in the employment agreement, we will
      obligated to pay Mr. McCrann twelve months' base salary. A copy of Mr. McCrann’s
      employment agreement is attached as an exhibit to our current report on Form
      8-K
      filed with the Securities and Exchange Commission on October 8,
      2008.





To
      comply
      with the American Stock Exchange rule requiring that a majority of our directors
      be independent, Daniel Goldberger and Dr. Victor Gura resigned as members of
      our
      board of directors on October 7, 2008.





In
      lieu
      of Mr. Goldberger’s resignation as our interim CEO on October 6, 2008, we
      amended his consulting agreement. Pursuant to the amendment, Mr. Goldberger
      will
      provide the company with his services through year end. As consideration for
      his
      services, he will be paid $12,500 for October 2008 and $5,000 per month for
      each
      of November and December.




14





On
      October 6, 2008, with modification to the lease agreement on October 23, 2008,
      we 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 in Lake Forest, CA. The monthly base rent will start at
      $23,540 per month and increase annually by approximately 3%. The total minimum
      lease, base rent, payments will be $1,515,120 over a 5 year period. As required
      by the agreement, we issued an 18 month, $300,000, letter of credit secured
      by a
      new CD account as collateral. Upon execution of the lease agreement, we notified
      Aubrey of our intent to vacate our current subleased space by the end of
      November 2008. A copy of the lease agreement is attached as Exhibit 10.1 to
      this
      quarterly report on Form 10-Q.





On
      August
      10, 2007, Terren S. Peizer entered into an Executive Chairman Agreement with
      Operations for an initial term of three years with automatic one-year renewals,
      which Executive Chairman Agreement was assumed by us. His base compensation
      is
      $450,000 per annum as of July 1, 2007, with a signing bonus of $225,000. Mr.
      Peizer will be entitled to receive an annual bonus at the discretion of the
      board based on performance goals and targeted at 100% of his base compensation.
      He is also eligible to participate in any equity incentive plans adopted by
      us.
      In the event Mr. Peizer’s position is terminated without good cause or he
      resigns for good reason, we will be obligated to pay Mr. Peizer in a lump sum
      an
      amount equal to three years’ base compensation bonus plus 100% of the targeted
      bonus. At the request of Mr. Peizer, we stopped making payments to him under
      the
      agreement in August 2008 and Mr. Peizer voluntarily relinquished his role as
      Executive Chairman in October 2008.





**ITEM
      2. Management’s Discussion and Analysis or Plan of
      Operation.**





*The
      following discussion of our financial condition and results of operations should
      be read in conjunction with our financial statements and the related notes,
      and
      the other financial information included in this report.*





**Forward-Looking
      Statements**





This
      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 stock of Xcorporeal, and other
      matters. Statements in this report that are not historical facts are
“forward-looking statements” for the purpose of the safe harbor provided by
      Section 21E of the Exchange Act and Section 27A of the Securities Act. Such
      forward-looking statements, including, without limitation, those relating to
      the
      future business prospects, revenues, and income of Xcorporeal, wherever they
      occur, are necessarily estimates reflecting the best judgment of the senior
      management of Xcorporeal on the date on which they were made, or if no date
      is
      stated, as of the date of this 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
      report could cause 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.





**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
                PAK for hospital Renal Replacement Therapy
                (RRT);




•
            A
                PAK for home hemodialysis; and




•
            A
                Wearable Artificial Kidney (WAK) for continuous ambulatory
                hemodialysis.




For
      the
      hospital market, we are developing a portable, multifunctional renal replacement
      device that will offer cost-effective therapy for those patients suffering
      from
      Acute Renal Failure (ARF) causing a rapid decline in kidney function. We have
      completed our functional prototype of the product, which is currently undergoing
      bench testing, and will submit a 510(k) filing with the FDA next year. We plan
      to commercialize the product after receiving clearance from the FDA. Timing
      of
      FDA clearance is uncertain at this time.




We
      also
      plan to commercialize a home hemodialysis device for the End Stage Renal Disease
      (ESRD) market, comprised of patients in whom the kidneys have ceased to
      function. We have also completed our functional prototype of the product, which
      is currently undergoing bench testing, and we will submit a 510(k) with the
      FDA
      during 2009. Clinical trials are anticipated to commence as soon as 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. Provided that the Technology Transaction
      described in Part II, Item 1 – Legal Proceedings below closes, we will evaluate
      the feasibility of furthering our development of this product over the next
      12
      months **.**


15




We
      are a
      development stage company, have been unprofitable since our inception, and
      will
      incur substantial additional operating losses for at least the next twelve
      months as we continue to implement commercial operations and allocate
      significant and increasing resources to research, development, clinical trials,
      and other activities. 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.





**Research
      and Development**





***R&D
      Team***





We
      have
      recruited and currently employ a talented interdisciplinary team of scientists
      and engineers who are developing our products. The team includes engineering
      leaders from within the dialysis field who provide state of the art as well
      as
      historical insights into dialysis equipment. The team also includes seasoned
      engineers from related medical fields providing us with cutting edge technology
      in the areas of fluidics, sensors, and electronics. In addition, we have
      retained a medical device consulting firm, The Aubrey Group, Inc., an
      FDA-registered third-party contract developer and manufacturer of medical
      devices, to provide engineering support in the development and build of the
      PAK
      thru the end of 2008. In 2009, we will transition into verification and
      validation of the PAK utilizing our scientists and engineers as well as outside
      consultants.





We
      incurred $12.7 million and $18.9 million in research and development costs
      in
      the three and nine months ended September 30, 2008, 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. Less the accrual for shares issuable, we incurred $2.5
      million and $8.7 million in research and development costs in the three and
      nine
      months ended September 30, 2008, respectively. This compares to $2.1 million
      and
      $4.8 million incurred in the three and nine months ended September 30,
      2007.





***Third-party
      Arrangements***





In
      July
      2007, we entered into an agreement with Aubrey for the design and development
      of
      subsystems of the PAK. The PAK will be designed for intermittent hemodialysis
      or
      CRRT in a clinical setting as well as for treatments in a home setting. The
      development is expected to be complete by the end of 2008. At the inception
      of
      the agreement, total labor and material costs over the term of the Aubrey
      agreement was budgeted at approximately $5.1 million which we anticipate to
      be
      under budget at completion. We can terminate the agreement at any time with
      30
      business days notice.





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.





**Management’s
      Discussion and Analysis**





***Results
      of Operations for the three and nine months ended September 30,
      2008.***





We
      have
      not generated any revenues since inception. We incurred a net loss of $11.1
      million and $22.8 million for the three and nine months ended September 30,
      2008, respectively, compared to a net loss of $4.5 million and $12.1 million
      for
      the three and nine months ended September 30, 2007, respectively. 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,
      officers, employees, and consultants, (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 September 30, 2008, we had positive working
      capital of $1.4 million compared to positive working capital of $15.0 million
      at
      the beginning of the year.





***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
      September 30, 2008, we had cash, cash equivalents and marketable securities
      of
      approximately $6.0 million. We are currently expending cash at a rate of
      approximately $1.1 million per month. In addition, we may become obligated
      to
      pay damages, costs or legal fees in connection with the ongoing arbitration
      described under Part II, Item 1-Legal Proceedings below, in an interim amount
      of
      $1.87 million. **** At
      present rates, we will have to raise additional funds during the next several
      months. We may not be successful in doing so on terms acceptable to us, and
      the
      inability to raise capital could require us to curtail our current plans in
      order to decrease spending, which could have a material adverse effect on our
      plan of operation. 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.


16





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 operating expenses and capital requirements before we
      achieve profitability. Accordingly, we may seek to raise additional funds
      through public or private placement of shares of preferred or common stock
      or
      through public or private 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 raising necessary funds on acceptable terms, or at all. As a
      result of these conditions, there is substantial doubt about our ability to
      continue as a going concern. The financial statements do not include any
      adjustments that might result from the outcome of this uncertainty.




Upon
      receipt of the approximate $27.3 million raised through private placement in
      the
      fourth quarter of 2006, we strategically began our operating activities and
      research and development efforts which resulted in a net loss of $17.1 million
      in 2007 and $18.2 million in the nine months ended September 30, 2008. In
      addition, we invested $25.0 million in high grade money market funds and
      marketable securities of which we sold $19.2 million of the investments, leaving
      a balance of $5.8 million as of September 30, 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 hospital and home PAKs that we plan to
      commercialize after 510(k) clearance from the Food and Drug Administration
      (FDA)
      which we plan 510(k) submission by next year. 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 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. Our rights to the WAK derive in part
      from a License Agreement dated September 1, 2006 between Operations and National
      Quality Care, Inc, pursuant to which we obtained the exclusive rights to the
      technology designated therein. Once the Technology Transaction has closed and
      the results of the arbitration proceeding are final, we will determine whether
      to devote additional resources to development of the WAK.




If
      we
      ever become obligated to pay all or a substantial portion of the $690,000 in
      alleged expenses related to the License Agreement and the interim award of
      $1.87
      million in attorneys’ fees pursuant to the NQCI arbitration, doing so 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**





We
      employ
      an interdisciplinary team of scientists and engineers who are developing the
      PAK
      and a separate, interdisciplinary team developing the WAK. In addition, we
      have
      retained Aubrey to assist with the engineering of the PAK. The PAK will be
      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. The
      final product design of the PAK will be completed shortly and units will undergo
      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.





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 8 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 wearable artificial kidney in man. Provided that
      the Technology Transaction closes, we will be making substantial improvements
      to
      the WAK. This work will result in a WAK Generation 2.0. Pending the FDA approval
      of an investigational Device Exemption (IDE), additional clinical studies will
      be conducted upon completion of the Generation 2.0 WAK prototype.





We
      incurred $12.7 million and $18.9 million in research and development costs
      in
      the three and nine months ended September 30, 2008, 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 such, less the accrual for the shares issuable, we
      incurred $2.5 million and $8.7 million in research and development costs in
      the
      three and nine months ended September 30, 2008, respectively. This compares
      to
      $2.1 million and $4.8 million incurred in the three and nine months ended
      September 30, 2007.


17





**Contractual
      Obligations and Commercial Commitments**




**Contractual
                Obligations:**
            
            **Total**
            
            **Less than 1**
              **year**
            
            **1 - 3 years**
            
            **3 - 5 years**
            
            **More than 5**
              **years****Capital
                Lease Obligations**
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -**Operating
                Lease Obligations (1)**
            
            
            1,176,889
            
            
            107,113
            
            
            786,199
            
            
            283,576
            
            
            -**Research
                & Development Contractual Commitments**
            
            
            77,996
            
            
            77,996
            
            
            -
            
            
            -
            
            
            -**Other
                Liabilities**
            
            
            12,167
            
            
            12,167
            
            
            -
            
            
            -
            
            
            -$
            1,267,051
            
            $
            197,276
            
            $
            786,199
            
            $
            283,576
            
            $
            -





(1)
      Operating lease commitments for our corporate office facility, product
      development facility, Dr. Gura’s office which is a related party transaction,
      and two corporate apartments as well as for copiers and T1 access.





The
      table
      excludes the agreement with Aubrey in relation to the PAK development which
      can
      be terminated at any time with 30 business days notice. Due to development
      efficiencies not anticipated at the inception of the Aubrey agreement, we will
      incur less actual costs and expenses than the $5.1 million budgeted amount.
      With
      the expected completion by end of 2008, we estimate we will incur a total cost
      of $3.3 million under this agreement.





**Off-Balance
      Sheet Arrangements**





As
      of
      September 30, 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.





***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:





*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.





Short-term
      investments classified as available-for-sale were as follows:





**September 30, 2008****Aggregate Fair**
              **Value**
            
            **Gross Unrealized**
              **Gains / (Losses)**
            
            **Estimated Fair**
              **Value**Commercial
                paper
            
            $
            3,708,821
            
            $
            -
            
            $
            3,708,821Corporate
                securities fixed rate
            
            
            651,811
            
            
            -
            
            
            651,811Total
            
            $
            4,360,632
            
            $
            -
            
            $
            4,360,632





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 September 30,
      2008.


18





There
      were no gross unrealized gains or losses as of September 30, 2008.





*Shares
      Issuable*





Pursuant
      to the Second Interim Award, stating 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
      9.23 million shares of our common stock. As the Second Interim Award states
      that
      a registration statement for any issued shares must be declared effective within
      90 days, and such contingency is not within our control, we have recorded the
      issuance as a liability, rather than as equity. The fair value of the 9.23
      million 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 this interim reporting period, September 30, 2008.
      The
      fair value of the accrued shares on August 4, 2008, was $10,153,000 which was
      revalued at $4,615,000 as of September 30, 2008, resulting in a $5,538,000
      non-operating gain to the statement of operations for the three and nine months
      ended September 30, 2008. The net fair value of $4,615,000 was accrued under
      “Shares issuable” as of September 30, 2008. Stockholders’ approval and issuance
      of the shares are pending to date. The
      shares issuable liability will be marked to market until a determination is
      made
      that the Technology Transaction will not be submitted to our stockholders,
      the
      stockholders vote not to approve the transaction, or they vote to approve the
      transaction and the shares are issued and registered. The price of our stock
      has
      declined since September 30, 2008, and as of November 18, 2008, the closing
      price was $0.27 per share, reducing the shares issuable liability from $4.6
      million to approximately $2.5 million as of that date. We anticipate that we
      will continue to incur losses, which will continue to increase the
      shareholder deficit.





Although
      we may seek stockholder approval for the issuance of the 9.23 million shares
      of
      our common stock to effectuate the Technology Transaction, we are uncertain
      whether the SEC will approve a form of proxy to solicit stockholder approval
      of
      the transaction, our stockholders will vote to approve the transaction, shares
      will be issued to NQCI, or the SEC will declare effective a 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 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
      Technology Transaction is approved and the shares are issued and registered
      or
      the registration requirement is eliminated or waived, that would eliminate
      the
      s hares
      issuable liability, and increase stockholders equity by the amount of the
      liability.




*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 our
      adoption of SFAS 123(R).





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.





**ITEM
      3. Quantitative and Qualitative Disclosures about Market
      Risk**





We
      invest
      our cash in short term high grade commercial paper, certificates of deposit,
      money market accounts, and marketable securities. We consider any liquid
      investment with an original maturity of three months or less when purchased
      to
      be cash equivalents. We classify investments with maturity dates greater than
      three months when purchased as marketable securities, which have readily
      determined fair values and are classified as available-for-sale securities.
      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.





Investments
      in both fixed rate and floating rate interest earning instruments carry a degree
      of interest rate risk arising from changes in the level or volatility of
      interest rates; however, interest rate movements do not materially affect the
      market value of our portfolio because of the short-term nature of these
      investments. A reduction in the overall level of interest rates may produce
      less interest income from our investment portfolio. The market risk associated
      with our investments in debt securities is substantially mitigated by the
      frequent turnover of our portfolio.





**ITEM
      4. Controls and Procedures**





***Disclosure
      Controls and Procedures***





Our
      management, with the participation of our Chief Executive Officer and our 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
      report (September 30, 2008), as is defined in Rule 13a-15(e) promulgated under
      the Securities Exchange Act of 1934, as amended. 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 Securities Exchange
      Act
      of 1934 is (i) recorded, processed, summarized and reported within the time
      periods specified in the Securities and Exchange Commission’s rules and forms
      and (ii) accumulated and communicated to our management, including the Chief
      Executive Officer and Chief Financial Officer, as the principal executive and
      financial officer, to allow timely decisions regarding required disclosures.


19





Based
      on
      that evaluation, our Chief Executive Officer and Chief Financial Officer
      concluded that, as of the end of the period covered by this report, our
      disclosure controls and procedures were effective. Our management has concluded
      that the financial statements included in this 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.





***Changes
      in Internal Control***





There
      have been no changes in our internal control over financial reporting, as
      defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, during
      our
      most recent fiscal quarter that have materially affected, or are reasonably
      likely to materially affect our internal control over financial
      reporting.


20





**PART
      II — OTHER INFORMATION**





**ITEM
      1. Legal Proceedings.**





On
      September 1, 2006, Operations entered into a Merger Agreement with NQCI which
      contemplated that we would acquire NQCI as a wholly owned subsidiary pursuant
      to
      a triangular merger, or we would issue shares of our common stock to NQCI
      stockholders in consideration of the assignment of the technology relating
      to
      our 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” (the “Technology Transaction”). The
      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 merger was not consummated. Copies of the License
      Agreement and the Merger Agreement are attached as Appendix B and Appendix
      C,
      respectively, to the preliminary proxy statement filed October 31, 2008, with
      the Securities and Exchange Commission.





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 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 between
      9,600,000 and 17,130,293 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. Although the first Interim Award stated that 48%
      of
      the outstanding shares should be issued, the Second Interim Award states that
      the number of shares issued should be 48% of 19,230,000 shares, the total number
      of shares necessary to put our 52% interest at 10,000,000 shares. As of October
      31, 2008, there were 14,704,687 shares of our common stock issued and
      outstanding. Accordingly, following Closing of the Technology Transaction,
      NQCI
      stockholders would own approximately 39% of our total outstanding shares, making
      NQCI our largest stockholder. The arbitrator found that, with the exception
      of
      shareholder approval, virtually all conditions to Closing the Technology
      Transaction have been waived, including virtually all of NQCI’s representations
      and warranties concerning the Technology. Upon Closing of the Technology
      Transaction, all of the Technology will be our sole and exclusive
      property.





The
      Second Interim Award also states 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, 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.


21


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 the 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, stating that NQCI’s lack of success and
      other factors warranted a substantial reduction in the sums claimed. The
      arbitrator stated in pertinent part: “National’s success in the arbitration has
      been only partial and this is directly relevant to the question of the quantum
      of attorneys’ fees which should be awarded. ... National sought eight or nine
      figure damages, but was awarded none. ... Further, National asserted claims for
      fraud, interference with contract, and other torts, all of which were rejected.
      His lack of success warrants a substantial reduction in the sums claimed.” NQCI
      asked for a total of $4.04 million in attorneys’ fees and costs. The arbitrator
      awarded NQCI a total of $1.87 million.





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 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 Securities and Exchange Commission, and no way
      to
      predict what further action, if any, the arbitrator may order if it is not
      declared effective.





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.





***Shares
      to be issued***





We
      intend
      to seek approval from our stockholders to issue 9,230,000 shares of our common
      stock to NQCI in order to close the Technology Transaction and obtain ownership
      of intellectual property rights described above. As of November 17, 2008, there
      were 14,704,687 shares of our common stock issued and outstanding. Accordingly,
      following Closing of the Technology Transaction, NQCI would own approximately
      39%of our total outstanding shares.





As
      a
      result, NQCI may have the ability to substantially influence the outcome of
      issues submitted to our stockholders. The interests of NQCI may not coincide
      with our interests or the interests of other stockholders, and it may act in
      a
      manner that advances its best interests and not necessarily those of other
      stockholders. One consequence to this substantial interest is that it may deter
      unsolicited takeovers, including transactions in which stockholders might
      otherwise receive a premium for their shares over then current market
      prices.





***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.





Under
      the
      License Agreement, NQCI grants to us an exclusive license for 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. We are required to "make commercially reasonable efforts to develop
      and commercially exploit the Technology to generate revenues" during the term
      of
      the License Agreement. The License Agreement does not provide for termination
      in
      the event the Merger Agreement is terminated; instead it provides for an
      adjustment of the royalty to 6.5%, 7.5%, or 8.5% depending on the grounds on
      which the Merger Agreement was terminated. Either party has the right to
      terminate the License Agreement in the event of a material breach by the other
      party which remains uncured for a period of 30 days after notice. In the event
      of a termination of the License Agreement, we are required to cease all use
      of
      the Technology and return all "Licensee Confidential Information" to NQCI.
      The
      Technology relates primarily to the WAK.





**ITEM
      1A. Risk Factors.**




*Investing
      in our common stock involves a high degree of risk. In addition to the
      information in this report, you should carefully consider the risks described
      under Risk Factors in Part I, Item 1 of our Annual Report on Form 10-KSB for
      the
      year ended December 31, 2007, and the revised risk factors noted below. If
      any
      of such risks actually occurs, our business, results of operations and financial
      condition will likely suffer. As a result the trading price of our common stock
      may decline, and you might lose part or all of your
      investment*


22


**An
      unfavorable result in the pending arbitration could have a material adverse
      effect on our capital structure, business and financial condition.**




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 the wearable artificial kidney
      (WAK) through a License Agreement with National Quality Care, Inc. (NQCI).
      On
      December 1, 2006, Operations initiated arbitration against NQCI for failure
      to
      fully perform its obligations under our License Agreement. NQCI filed
      counterclaims seeking to invalidate the License Agreement and claiming monetary
      damages against us. In interim awards, the arbitrator has found that the License
      Agreement will not survive if the Technology Transaction contemplated by the
      Merger Agreement entered into concurrently with the License Agreement fails
      to
      close. If this determination were upheld by a court of competent jurisdiction,
      we could be prevented from using the WAK technology we licensed from it. In
      addition, if it were found that our rights to the portable artificial kidney
      (PAK) are derived from the licensed technology, that could significantly impact
      our ability to develop, manufacture and sell our PAK, which would have a
      material adverse effect on our business and results of operations.




The
      interim awards state that NQCI is entitled to reimbursement for reasonable
      attorneys’ fees. NQCI has made a claim for approximately $3.9 million in such
      fees, which we have opposed and a lower amount of $1.87 million awarded by
      the
      arbitrator. The interim settlement of legal fees has been accrued in the three
      and nine months ending September 30, 2008. NQCI has also made a claim for
      reimbursement of approximately $690,000 in alleged expenses related to the
      License Agreement which has been accrued at June 30, 2008. If we ever become
      obligated to pay all or a substantial portion of such amounts, doing so could
      have a material adverse effect on our liquidity and financial ability to
      continue with ongoing operations as currently planned.





The
      interim awards also state that 9,230,000 shares of our common stock would have
      to be issued to effectuate the Technology Transaction, if Closing such a
      transaction were to be approved by our stockholders. The issuance of such shares
      would result in NQCI owning approximately 39% of our total outstanding shares,
      diluting current stockholders and giving it the ability to substantially
      influence the outcome of matters submitted to stockholders.





**We
      expect to incur negative cash flows and net losses for the foreseeable future
      and may not be able to continue as a going concern.**




As
      a
      result of our expectation of negative cash flows and net losses for the
      foreseeable future, based on our current plans, we believe our existing cash
      reserves will not be sufficient to meet our operating expenses and capital
      requirements before we achieve profitability. Our ability to meet our cash
      obligations as they become due will depend on our ability to secure financing
      on
      acceptable terms. Unless we are able to raise capital sufficient to support
      our operations there will be substantial doubt of our ability to continue as
      a
      going concern.





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





As
      of
      September 30, 2008, CNL, a limited liability company whose managing member
      is a
      member of our board of directors, directly owned 6,232,596 shares, which
      represent approximately 42.4% of our 14,704,687 shares of outstanding common
      stock. As a result, CNL presently and is expected to continue to have the
      ability to determine the outcome of issues submitted to our stockholders. The
      interests of this stockholder may not always coincide with our interests or
      the
      interests of other stockholders, and it may act in a manner that advances its
      best interests and not necessarily those of other stockholders. One consequence
      to this substantial stockholder’s interest is that it may be difficult for
      investors to remove management of the company. It could also deter unsolicited
      takeovers, including transactions in which stockholders might otherwise receive
      a premium for their shares over then current market prices.





**Sales
      of common stock by our existing 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 existing stockholders, including
      stockholders who recently purchased their shares from CNL. Most of our
      outstanding shares were registered on a Form S-4 registration statement in
      connection with our October 2007 merger, and are eligible for public resale.
      Approximately half of our shares of common stock are currently held by our
      affiliates and may be sold pursuant to an effective registration statement
      or in
      accordance with the volume and other limitations of Rule 144 under the
      Securities Act of 1933, as amended, or pursuant to other exempt transactions.
      Future sales of common stock by significant stockholders, including those who
      acquired their shares in private placements or who are affiliates, or the
      perception that such sales may occur, could depress the price of our common
      stock.





**ITEM
      2. Unregistered Sales of Equity Securities; Use of Proceeds from Registered
      Securities.**




For
      the
      three months ended September 30, 2008, we did not have unregistered sales of
      equity securities or use of proceeds from registered
      securities.


23


**ITEM
      6. Exhibits.**





**No.**
            
            **Description
                of Exhibit**10.1
            
            Lease
                for Operating Facility31.1
            
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200231.2
            
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200232.1
            
            Certification
                of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
                Act of 200232.2
            
            Certification
                of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002




24





**SIGNATURES**




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





Date:
                November 19, 2008
            By:
            /s/
                Robert WeinsteinRobert
              Weinstein
              Chief
                Financial Officer
              (Principal
                Financial Officer and Principal
              Accounting
                Officer)


25