**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-K**

**ANNUAL REPORT**

**PURSUANT TO SECTIONS 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**(Mark one)**

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

**For the fiscal year ended December 31, 2005**

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

**For the transition period from                       to                           **

**Commission file number: 0-15223**

**HEMACARE CORPORATION**

(Exact name of registrant as specified in its charter)

| **California**                  | ** ** | **95-3280412**                          |
|---------------------------------|------------|-----------------------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer Identification Number) |
| incorporation or organization)  |       |                                    |

 

| **21101 Oxnard Street**                                                     |   | ** **                                                               |
|-----------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|
| **Woodland Hills,  California**                                             |   | **91367**                                                                |
| (Address of  principal executive offices)                                   |   | (Zip code)                                                               |
| Registrant’s telephone number, including area code**: (818) 226-1968** |   |                                                                     |
| Securities registered pursuant to Section 12(b) of the  Act:      |   | **None**                                                                 |
| Securities registered pursuant to Section 12(g) of the  Act:      |   | **Common Stock (without par value)  Rights to purchase Preferred Stock** |

 

Indicate by check mark if the registrant is a well-known seasonedissuer, as defined in Rule 405 of the Securities Act. **o** YES     x NO

Indicate by check mark whether the registrant (1) has filedall reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. x** **YES     **o** NO

Indicate by check mark if disclosure of delinquent filers pursuantto Item 405 of Regulation S-K is not contained herein, and will not be contained,to the best of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K**. ****o**

Indicate by check mark whether the registrant is an acceleratedfiler (as defined in Rule12b-2 of the Act). **£** YES     x** **NO

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

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

 

The aggregate market value of the Common Stock held bynon-affiliates of the registrant as of June 30, 2005, the last businessday of the registrant’s most recently completed second fiscal quarter (basedupon the last sale price of the Common Stock as reported by the OTC BulletinBoard), was approximately $6,656,000.

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

As of February 20, 2006, 8,196,060 shares of Common Stock ofthe registrant were issued and outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the registrant’s definitiveproxy statement relating to its 2006 annual meeting of shareholders, which willbe filed with the Securities and Exchange Commission pursuant to Regulation 14Awithin 120 days of the close of the registrant’s last fiscal year, areincorporated by reference into Part III of this Report.

 

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**TABLE OF CONTENTS**

|            | ** ** | ** **                                                                                                                      | ** ** | **Page  Number** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
|       |       | **PART I**                                                                                                                 |       |             |
| Item 1.    |       | Business                                                                                                                        |       | 1                |
|       |       | General                                                                                                                         |       | 1                |
|       |       | Recent Developments                                                                                                             |       | 1                |
|       |       | Blood  Products Operations                                                                                                      |       | 2                |
|       |       | Blood  Services Operations                                                                                                      |       | 3                |
|       |       | Competition                                                                                                                     |       | 4                |
|       |       | Sales to Major Customers                                                                                                        |       | 5                |
|       |       | Marketing                                                                                                                       |       | 5                |
|       |       | Human Resources                                                                                                                 |       | 5                |
|       |       | Suppliers                                                                                                                       |       | 5                |
|       |       | Government Regulation                                                                                                           |       | 6                |
|       |       | Professional and Product Liability Insurance                                                                                    |       | 7                |
|       |       | Additional Information                                                                                                          |       | 7                |
| Item  1A.  |       | Risk  Factors                                                                                                                   |       | 7                |
| Item 1B.   |       | Unresolved Staff  Comments                                                                                                      |       | 14               |
| Item  2.   |       | Properties                                                                                                                      |       | 14               |
| Item  3.   |       | Legal  Proceedings                                                                                                              |       | 15               |
| Item 4.    |       | Submission of  Matters to a Vote of Security Holders                                                                            |       | 15               |
|       |       | **PART II**                                                                                                                |       |             |
| Item 5.    |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities             |       | 16               |
| Item 6.    |       | Selected Financial  Data                                                                                                        |       | 17               |
| Item 7.    |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       |       | 17               |
| Item 7A.   |       | Quantitative  and Qualitative Disclosures about Market Risk                                                                     |       | 27               |
| Item 8.    |       | Financial  Statements and Supplementary Data                                                                                    |       | 27               |
| Item 9.    |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                  |       | 27               |
| Item 9A.   |       | Controls and  Procedures                                                                                                        |       | 28               |
| Item  9B.  |       | Other  Information                                                                                                              |       | 28               |
| ** ** | ** ** | **PART III**                                                                                                               | ** ** | ** **       |
| Item 10.   |       | Directors and  Executive Officers of the Registrant                                                                             |       | 29               |
| Item 11.   |       | Executive  Compensation                                                                                                         |       | 29               |
| Item 12.   |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                 |       | 29               |
| Item 13.   |       | Certain  Relationships and Related Transactions                                                                                 |       | 29               |
| Item 14.   |       | Principal  Accountant Fees and Services                                                                                         |       | 29               |
| ** ** | ** ** | **PART IV**                                                                                                                | ** ** | ** **       |
| Item 15.   |       | Exhibits and  Financial Statement Schedules                                                                                     |       | 30               |
|       |       | Signatures                                                                                                                      |       | 32               |
|       |       | Index to Consolidated Financial Statements and  Schedules                                                                       |       | F-1              |

 

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**PART I**

**ITEM1.**                     BUSINESS

***This 2005 Annual Report on Form 10-K containsstatements which constitute forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. Those statements includestatements regarding the intent, belief or current expectations of the Companyand its management. Prospective investors are cautioned that any suchforward-looking statements are not guarantees of future performance and involverisks and uncertainties, and that actual results may differ materially fromthose projected in the forward-looking statements (See “Item 1A. Risk Factors”).The Company does not undertake to update its forward-looking statements toreflect actual events and outcomes or later events.***

**General**

HemaCareCorporation (“HemaCare” or the “Company”) collects, processes and distributesblood products to hospitals and other customers in the United States. TheCompany operates and manages donor centers and mobile donor vehicles to collectblood products from donors. Additionally, the Company provides blood relatedservices, principally therapeutic apheresis procedures, stem cell collectionand other blood treatments to patients with a variety of disorders. Bloodrelated services are usually provided under contract with hospitals as anoutside purchased service.

The Company hasoperated in Southern California since 1979. In 1998, the Company expandedoperations to include portions of the eastern U.S. In 2003, new managementreduced the number of geographic regions served as part of a restructuring planto return the Company to profitability. Since 2003, the Company’s earningsimproved as a result of the successful implementation of management’s plan. TheCompany’s current strategy is to continue to focus on increasing theutilization of existing capacity in those markets currently served by theCompany, expand the customer base for blood products to includebiopharmaceutical companies and other organizations involved in researchactivities, and expand the market potential for therapeutic apheresis servicesthrough physician education and other marketing efforts.

Although most blood suppliers are organized as not-for-profit,tax-exempt organizations, all suppliers charge fees for blood products to covertheir costs of operations. The Company believes that it is the onlyinvestor-owned and taxable organization operating as a blood supplier withsignificant operations in the U.S.

**Recent Developments**

***Continued Improvement in Overall Profitability***

The Company recordedincome before income taxes of $1,686,000 in 2005, representing the highestannual pretax earnings in the history of the Company, exceeding the priorrecord of $1,563,000 recorded in 2004. This represents a substantial changefrom the $1,695,000 loss before income taxes recorded in 2003. Thisaccomplishment was due to the successful implementation in late 2003 of a restructuring plandesigned to eliminate poorly performing operations, reduce overhead costs andimprove the product collection capabilities in the geographic areas served bythe Company. In addition, the Company has experienced increasing demand forblood products from existing customers, as well as from new customers, who areattracted by the Company’s customized blood products delivery system. Since theimplementation of the restructuring plan, the Company has recorded nineconsecutive profitable quarters.

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***Improvement in Revenue and Profitability for BloodProducts Business Segment***

The Company’s bloodproducts segment generated substantially higher revenue and profits in 2005compared with 2004. Revenue for this segment increased $5.2 million, or 27%,compared to 2004, which is mostly attributable to higher sales volumes of bloodproducts in the Company’s California and Maine operations. The Companysuccessfully increased the supply of blood products offered for sale throughincreased collections at Company operated donor centers and mobile operations,and through the purchase of products from other suppliers. In addition, thissegment recorded a $1.7 million, or 49%, increase in gross profit in 2005compared with 2004. This segment’s gross profit percentage improved to 20.6% in2005 compared with 17.5% for 2004, mostly attributable to increased operationalefficiencies realized from higher sales volumes.

***Declining Revenue and Profitability for Blood ServicesBusiness Segment***

The Company’s bloodservices segment generated lower revenue and profits in 2005 compared with 2004.This business segment recorded $800,000, or 10.9%, less revenue in 2005compared with 2004, which is mostly attributable to a decrease in the number oftherapeutic apheresis procedures performed. The revenues for the blood servicessegment fluctuate significantly with changes in the number of proceduresperformed. In addition, this segment recorded a $900,000, or 37%, decrease ingross profit in 2005 compared with 2004. This segment’s gross profit percentagedecreased to 22.9% in 2005 compared with 32.4% for 2004, mostly attributable toa decrease in revenue, higher staff compensation, and higher expenses to manageand market this segment.

***Infrastructure Investments***

The Company began toinvest the resources generated by recently improved profitability ininfrastructure projects to enhance regulatory compliance, management reportingand long-term profit potential for the Company’s blood products business. Someof these investments include a document management system, a new accounting andfinancial reporting system, and investments in new facilities, equipment andvehicles. In addition, a new blood bank information management system isplanned. These infrastructure enhancement projects are expected to costapproximately $2.5 million. Some of these projects are targeted for completion asearly as Spring of 2006, while others are expected to finish in 2008.

***Debt Reduction***

Over the past three years,the Company has reduced outstanding debt by $2.8 million. During this sameperiod, the Company’s cash balance increased by $1.6 million. As of December 31,2005, the Company’s remaining debt balance was only $88,000**.**The recent improvement in theCompany’s profitability, as well as improved management of the Company’s cashcollection activities, provided management with the cash to reduce debt.

**Business Segments**

HemaCare operates two primary business segments. The first is theblood products segment, which supplies customers with red blood cells,apheresis platelets and other blood products. The second is the blood servicessegment which includes therapeutic apheresis procedures, stem cell collectionand other blood therapies provided to patients typically in a hospital setting.

***Blood ProductsOperations***

The practice ofmedicine depends on a reliable, adequate and safe supply of blood products. Mostblood products collections consist of single units of whole blood. TheCompany contracts with local hospitals to serve as their whole blood collectioncontractor. The Company solicits sponsor organizations, 

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such as employers, schoolsor churches, to conduct blood drives on behalf of the hospital customer. TheCompany’s recruitment staff works with the staff of the sponsor organization toencourage individuals associated with the sponsor to donate blood at a blooddrive usually conducted at the sponsor’s facilities. The actual collection process issimple and safe for the donor. Whole blood collected at blood drives istested and processed into blood products, principally red blood cells andplasma, and then offered to the hospital customers for transfusion to patients.

The Company alsoperforms collections of blood components, principally platelets, utilizing acell separator. This process, known as apheresis, allows for the collection ofonly the desired components of a donor’s blood, returning the other componentsto the donor’s blood stream. Apheresis platelet collection is more complex andexpensive than whole blood collection. Apheresis equipment is costly andrequires longer donation times, which result in higher labor costs. Recruitingdonors for apheresis platelet donations is considerably more difficult thanrecruiting whole blood donorsbecause of the complexity of the donation process, and longer donationtimes. Recruiting andretaining donors is critical to the success of the Company’s blood productsoperations. Apheresis platelet donors are recruited from the most dedicated andcommitted subset of the whole blood donor population. The Company hasdemonstrated a consistent track record of donor recruitment for apheresisplatelet donors.

Blood products revenue depends on a number of factors,including the success of the Company’s donor recruitment efforts, the successof the Company’s marketing efforts to attract and retain new customers, and theability of the Company to properly process, store and transport blood productsto customers prior to the products’ expiration dates. All bloods products havea limited therapeutic life.

Product safety isof paramount concern when dealing with blood products. The U.S. Food and DrugAdministration (“FDA”) is the agency principally responsible for the regulationof the blood products industry in the U.S. The Company’s blood productsoperations are either licensed or registered with the FDA and are regularlyinspected by FDA personnel. Additionally, the Company’s operations arelicensed, regulated and inspected by various state agencies.

The AABB is theblood industry sponsored organization responsible for maintaining and improvingscience, safety, quality and education relating to blood. The Company is aninstitutional member, and the Company’s operations are accredited by the AABB.

The Company operates free standing blood collection centers andmobile blood collection operations in Southern California and Maine, and ahospital-based collection center in Massachusetts.

***Blood ServicesOperations***

Therapeuticapheresis is a technique for removing harmful components from a patient’s bloodand is used in the treatment of autoimmune diseases and other disorders.Therapeutic services are generally provided upon the request of a hospital,which has received an order from a patient’s physician. Therapeutic treatmentsare administered using mobile equipment operated at the patient’s bedside, ahospital outpatient setting or physician office. The mobile therapeuticequipment includes a blood cell separator and the disposables needed to performthe procedure. Treatments are administered by trained, nurse-specialists, underthe supervision of a specially trained physician, and acting in accordance withdocumented operating procedures and quality assurance protocols based onguidelines developed by the AABB and the Joint Commission on Accreditation ofHealthcare Organizations (“JCAHO”).

Since requests fortherapeutic apheresis treatments are often sporadic and unpredictable, manyhospitals choose not to equip, staff and maintain an apheresis unit. Theexisting nurse shortage in the U.S. has also hindered hospital efforts toadequately staff apheresis units. The Company’s services enable hospitals tooffer therapeutic apheresis services to their patients on an “as needed” basiswithout incurring 

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the costs associated with maintaining a full-time team ofapheresis specialists. In addition, the Company’s services can serve tosupplement a hospital’s existing apheresis capability when demand exceedscapacity.

Bloodservices revenue depends on a number of factors, including the occurrence ofdisease states that are appropriately treated by these services, and theperceived benefits of blood therapies compared to alternative courses oftreatment. The Company believes that physician education on the benefits of therapeutic apheresisresults in an increase in the application of such treatments in medicallyappropriate circumstances. The Company’s affiliated medical directors conducteducational seminars forphysicians to inform them of the benefits of therapeutic apheresis relative toother modes of patient treatment.

The Company provides therapeutic services using all currentlyrecognized treatment methods:  plasmaexchange and cell depletion; in-line immunoadsorbant columns; stem cellcollection; and photopheresis. Patients suffering from diseases such asmultiple myeloma, polyneuropathy, leukemia, systemic lupus erythematosus,scleroderma, hyperviscosity syndrome, thrombocytosis, thromboticthrombocytopenic purpura, myasthenia gravis and Guillain-Barre syndrome maybenefit from therapeutic apheresis treatments. The Company provides therapeuticapheresis services on a regional basis in several states. Major operations arein Southern California and the greater New York City area.

**Competition**

***General***

Most U.S. blood products suppliers are organized asnot-for-profit, tax-exempt entities. However, all blood suppliers charge feesto hospitals for the products utilized. These fees are generally set at levelsbased on the supply and demand for specific products, and are influenced by thecompetition amongst blood products suppliers and federal reimbursement rates tohospital customers. Many suppliers have greater financial, technical andpersonnel resources than the Company. In addition, since many of the Company’scompetitors are tax-exempt, they do not bear the tax burden the Company faces,and they have access to lower cost tax-exempt debt financing. Their status ascharitable institutions may also give them an advantage in recruiting volunteerdonors. The Company competes on the basis of responsiveness to customer needs,value-based pricing and the high quality of the services provided.

***Blood Products***

In the UnitedStates, approximately 50% of all blood products are supplied by the AmericanRed Cross (“ARC”) through its national collection network, and approximately40% are supplied by local and regional blood centers, including the Company. Theremainder is collected by hospitals directly.

The Company competes in the marketplace through a strategy ofoffering blood product supply programs tailored to the requirements ofindividual customers. The Company consistently reevaluates and revises itsproduct supply programs to respond to marketplace factors. Some competitorshave advantages over the Company as a result of established positions and relationshipswithin the communities they serve. In addition, the ARC’s size and marketdominance provides them with greater resources to sustain periods ofunprofitable sales, or to adopt aggressive pricing strategies for the purposeof defending or increasing market share.

***Blood Services***

The competition in the therapeutic blood services business isprimarily regional and community blood banks, dialysis companies that alsoprovide therapeutic blood services, and a wide range of small blood servicescompanies. In addition, since some diseases treatable with therapeuticapheresis are also treatable by other medical therapies, the competition forthe Company’s blood services business also includes companies that market orprovide many of these competing medical therapies. The Company believes that 

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it competes in this market by offeringhighly trained and experienced nurses and greater availability for customerswith immediate needs. In addition, the Company provides education to themedical community on the benefits of therapeutic apheresis as a treatmentsolution for various diseases.

**Sales to MajorCustomers**

The Company provides products and services to individualhospitals, hospital groups and hospital management companies, all of which arereferred to as “customers” for purposes of identifying concentration risk inthis section. During 2005 only two customers represented more than 10% of theCompany’s total revenue. One customer accounted for approximately 14.8% oftotal revenue, and the other accounted for approximately 10.1%. The nextlargest customer accounted for approximately 8.4% of total revenue. The Company’sten largest customers accounted for 62.2% of total revenues. The Company has norelationship with any of these customers other than as a provider of bloodproducts and services.

**Marketing**

The Company’s marketing programs include a combination of medicaleducation, advertising and promotional programs, in-person sales and othermarketing programs directed to selected physicians and hospitals. The Companymarkets its products and services in the form of supply programs that meet thespecific needs of individual customers. As a smaller company than the maincompetitors in the blood products marketplace, HemaCare offers more flexibilityin supply arrangements and pricing structure. This flexibility, a focus oncustomer service, and expertise, are the main messages communicated to potentialcustomers. The Company promotes and markets its blood services segment throughin-person sales, direct marketing, and physician education.

**Human Resources**

As of February 17,2006, the Company had 244 employees, including 61 part-time employees. Most ofthe Company’s professional and management personnel possess prior experience inhospitals, medical service companies or blood banks.

None of the Company’s employees is represented by a labor union. TheCompany considers its relations with its employees to be good.

**Suppliers**

The Companymaintains relationships with numerous suppliers who provide cell separatorequipment, disposable supplies, replacement fluids, testing services and bloodproducts. Generally, the Company has not experienced difficulty in obtainingmost of its equipment and supplies; however, if there were material adversechanges in the sources of its supplies, the Company’s operations could beadversely affected. In particular, in the event of a war or other internationalconflict or natural disaster, the availability of critical supplies could benegatively affected and the cost of procuring these supplies could increase.

During 2005, theCompany received goods and services from two major vendors that representedmore than 10% of the Company’s total costs. One vendor, that represents 18% oftotal costs, provides products that support the Company’s apheresis activities.The other vendor, that represents 15% of total costs, provides laboratoryservices**.**The Company has no relationship witheither vendor other than as a consumer of the goods and services provided byeach.

The Company utilizes blood donors to provide the platelets andwhole blood required to produce the blood products manufactured and sold by theCompany. The Company competes with the ARC and other blood suppliers inrecruiting its volunteer donors. The growth of the Company’s manufactured bloodproducts business is dependent on the Company’s ability to attract, screen andretain qualified donors.

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**GovernmentRegulation**

***Blood ProductOperations***

Blood productssuppliers are subject to extensive regulation by the FDA and various statelicensing authorities. FDA regulations are comprehensive, complex and extend tovirtually all aspects of the blood products industry, including: recruiting;screening blood donors; processing, testing, labeling, storing and shippingblood products; recordkeeping; and communications with hospital customers anddonors. FDA regulations also extend to the manufacturers of all criticalsupplies and equipment used in the blood supply industry.

The Company viewsblood product safety and compliance with governmental regulations as paramountconcerns at all times. The Company has developed extensive procedures andinternal quality control programs to increase compliance with all governmentalregulations and industry standards. Employees routinely participate in trainingclasses. Employees are tested at the conclusion of these classes to insure thatthe desired level of understanding of the Company’s compliance and safetyprocedures is achieved. Finally, HemaCare’s Regulatory Affairs and QualityAssurance Department conducts periodic audits of each operating unit toidentify the level of compliance with regulatory procedures.

During the pastyear, the FDA conducted inspections at selected HemaCare facilities. At theconclusion of each inspection, the FDA provided the Company with a list ofobservations of regulatory issues. The Company believes it has eitheradequately addressed the issues raised by the FDA, or is in the process ofaddressing these issues. As a result, the Company believes that it is incompliance with current FDA regulations.

Periodically, theDepartment of Health for the State of California conducts audits of the Company’sfacilities located in California. These audits focus on compliance withspecific California laws that cover HemaCare’s operations. At the conclusion ofthese audits, the Department of Health provides the Company with a list ofobservations to address. The Company believes that it is in compliance withCalifornia regulations governing the Company’s operations within the state.

Organizationswithin the blood supply industry are registered by the FDA to operate bloodcollection and/or blood processing facilities. All of the Company’s facilitiesoperate under an FDA registration, with the exception of a blood collectionfacility within a hospital that operates under the hospital’s FDA registration.

The FDA also issues licenses to organizations within the bloodsupply industry to ship blood products across state lines if the qualifyingorganization can demonstrate adequate employee training programs, proceduredocumentation and quality control systems to insure the quality of the productsshipped. HemaCare holds a license for its Sherman Oaks, California andScarborough, Maine facilities to ship selected blood products across statelines. The Company has submitted expanded license requests to the FDA foradditional blood products manufactured at Sherman Oaks, and for a license forblood products produced by the Company’s Bangor, Maine facility. These requestsare pending with the FDA.

***Other Matters***

State and federallaws set forth anti-kickback and self-referral prohibitions, and otherwiseregulate financial and referral relationships between blood suppliers,hospitals, physicians and others in the blood supply industry. The Companybelieves its present operations comply with all currently applicableregulations in this area.

Joshua Levy, M.D.,the national medical director of the Company and a shareholder, through hisprivate practice in Sherman Oaks, California, treats patients who requiretherapeutic services. Sales by the Company to hospital customers fortherapeutic services provided to Dr. Levy’s patients amounted to 

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approximately 2%, or less, of the Company’s total revenues in eachof the three years ended December 31, 2005. There are no agreementsbetween Dr. Levy and the Company’s hospital customers that require thehospitals to select HemaCare to provide therapeutic services to Dr. Levy’spatients.

New health care regulations are continuously under considerationby lawmakers at the federal level, and in many of the individual states inwhich the Company operates. New regulations could have a direct impact on theCompany and its operations. A regulatory agency recently released a draftproposal to lengthen the time between donations that could negatively impactthe Company’s collection efforts. Such a change may require costly complianceefforts, and may cause some of the Company’s operations to be prohibitivelyexpensive or impossible to continue. The Company is not aware of any otherspecific proposed regulation that would have a material adverse impact on theCompany; however, the Company is uncertain what changes may be made in the futureregarding health care policies, especially those regarding hospitalreimbursements, health insurance coverage, product testing, record keeping andmanaged care that may materially impact the Company’s operations.

**Professional and Product Liability Insurance**

The blood product and service business is inherently subject tosubstantial potential liabilities for personal injury claims. The Companymaintains medical professional liability insurance in the amount of $3,000,000for a single occurrence and $5,000,000 in the aggregate per year. There can beno assurance that potential insurance claims will not exceed present coverageor that continued or additional insurance coverage would be available ataffordable premium costs. If such insurance were ineffective or inadequate forany reason, the Company could be exposed to significant liabilities.

**AdditionalInformation**

The Company makes available free of charge through its website,www.hemacare.com, its Annual Report on Form 10-K, Quarterly Reportson Form 10-Q and Current Reports on Form 8-K andamendments to those reports filed or furnished pursuant to Section 13(a) ofthe Securities Exchange Act of 1934, as soon as practical after those reportsare filed with the Securities and Exchange Commission (the “SEC”). The Company’sfilings may also be read and copied at the SEC’s Public Reference Room at450 Fifth Street, NW, Washington D.C. 20549. Information on the operation ofthe Public Reference Room may be obtained by calling the SEC at 800-SEC-0330.The SEC also maintains an Internet site that contains reports, proxy andinformation statements, and other information regarding issuers that fileelectronically with the SEC. The address of that site is www.sec.gov.

**ITEM1A**                RISKFACTORS

*The Company’s short and long-term success is subjectto many factors that are beyond management’s control. Shareholders andprospective shareholders of the Company should consider carefully the followingrisk factors, in addition to other information contained in this report. Thematters discussed in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and elsewhere in this Annual Report on Form 10-Kthat are not historical are forward-looking statements. These statements mayalso be identified by the use of words such as “anticipate,” “believe,” “continue,”“estimate,” “expect,” “intend,” “may,” “project,” “will” and similarexpressions, as they relate to the Company, its management and its industry. Investorsand prospective investors are cautioned that these forward-looking statementsare not guarantees of future performance and involve risks and uncertainties,many of which will be beyond the control of the Company. Actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of various risks and uncertainties, including those in “Item 1A—RiskFactors” or in other filings by the Company with the Securities and ExchangeCommission. The Company does not undertake to update its forward-looking statementsto reflect later events and circumstances or actual outcomes.*

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***Changes in demand for blood products could affectprofitability***

The Company’s operationsare structured to produce particular blood products based on customers’existing demand, and perceived potential changes in demand, for these products.Sudden or unexpected changes in demand of these products could have an adverseimpact on the Company’s profitability. Increasing demand could harmrelationships with customers if the Company is unable to alter productioncapacity, or purchase products from other suppliers, adequately to fill orders.This could result in a net decrease in overall revenues and profits. Decreasesin demand may require the Company to make sizeable investments to restructure operationsaway from declining products to the production of new products. Lack of accessto sufficient capital, or lack of adequate time to properly respond to such achange in demand, could result in declining revenue and profits as customerstransfer to other suppliers.

***Declining blood donations could affect profitability***

The business depends onthe availability of donated blood. Only a small percentage of the populationdonates blood, and regulations intended to reduce the risk of introducinginfectious diseases in the blood supply have decreased the pool of potentialdonors. If the level of donor participation declines, the Company may not beable to reduce costs sufficiently to maintain profitability in blood products.

***Market prices may not rise as costs increase whichcould reduce profitability***

The costs of collecting,processing and testing blood have risen significantly in recent years and willlikely continue to increase. These cost increases are related to new andimproved testing procedures to assure that blood is free of infectious disease,increased regulatory requirements related to blood safety, and increased costsassociated with recruiting blood donors. New testing protocols have requiredthe Company to outsource much of the required testing. Competition and fixedprice contracts may limit the Company’s ability to pass these increased coststo customers. Some competitors have greater resources than the Company tosustain periods of unprofitable sales.  In this circumstance, the increased costs mayreduce profitability and may have a material adverse effect on the business andresults of operations.

***Competition may cause a loss of customers and anincrease in costs and impact profitability***

Competition within theblood services and blood products industries is constantly changing. Recentconsolidations of blood services providers has changed the competitiveenvironment for the Company’s blood services segment. Competition for customersand trained apheresis nurses is increasing. This has caused the Company toincur significant recruitment costs to replace nurses, dramatically increasenurses’ compensation and incur higher marketing related expenses in order toattract and retain customers. In addition, consolidations and affiliationswithin the hospital industry have changed the market for the blood productssegment. The newly consolidated or affiliated hospitals have started tonegotiate with the Company as a group, and therefore exert greater pricepressure on the Company. These changes may have a negative impact on theCompany’s future revenue, and may negatively impact future profitability.

***Operations depend on obtaining the services ofqualified professionals and competition for their services is strong***

The Company is highlydependent upon obtaining the services of qualified professionals. Inparticular, the Company’s operations depend on the services of registerednurses and other medical technologists, regulatory and quality assuranceprofessionals, and others with knowledge of the blood industry. Nationwide, thedemand for these professionals exceeds the supply and competition for theirservices is strong. If the Company is unable to attract and retain a staff ofqualified professionals, operations may be adversely affected.

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***Heavily regulated industry could increase operatingcosts***

The business of collecting, processing anddistributing blood products is subject to extensive and complex regulation bythe state and federal governments. The Company is required to obtain and maintainnumerous licenses in different legal jurisdictions regarding the safety ofproducts, facilities and procedures, and regarding the purity and quality ofblood products. In addition, state and federal laws include anti-kickback andself-referral prohibitions and other regulations that affect the shipping ofblood products and the relationships between blood banks, hospitals, physiciansand other persons who refer business to each other. Health insurers andgovernment payers, such as Medicare and Medicaid, also limit reimbursement forproducts and services, and require compliance with certain regulations beforereimbursement will be made.

The Company devotessubstantial resources to complying with laws and regulations, and believes itis currently in compliance; however, the possibility cannot be eliminated thatinterpretations of existing laws and regulations will result in a finding thatthe Company has not complied with significant existing regulations. Such afinding could materially harm the business. Moreover, healthcare reform iscontinually under consideration by regulators, and the Company does not knowhow laws and regulations will change in the future. A regulatory agencyrecently released a draft proposal to lengthen the time between donations thatcould negatively impact the Company’s collection efforts. Such changes in thelaws and regulations over blood product operations may require costlycompliance efforts which may cause some of the Company’s operations to beprohibitively expensive or impossible to continue.

***Decrease in reimbursement rates may affectprofitability***

Reimbursement rates forblood products and services provided to Medicaid and Medicare patients impactthe fees that the Company is able to negotiate with hospitals. In addition, tothe degree that the Company’s hospital customers receive lower reimbursementfor the products and services provided by the Company, these customers mayreduce their demand for these goods and services, and adversely affect theCompany’s revenue. If the Company is unable to increase prices for goods andservices, the Company’s profitability may be adversely affected.

***Lease for a major production facility has expired andif the Company needs to vacate it may be unable to locate an alternativefacility thereby disrupting business***

The long-term lease forthe Company’s Sherman Oaks production facility has expired. The Company hasbeen unable to negotiate a lease renewal. Presently, the Company continues tooccupy this facility with the possibility of receiving a 30-day notice tovacate at any time. The lack of a long-term lease agreement for this facilitycould have an adverse impact on profitability if the Company receives a 30-daynotice to vacate and is unable to locate an alternative facility. The Company’sability to produce platelet and whole blood products for Southern Californiacustomers may be severely impacted and result in a reduction of revenue andprofitability.

***Targeted partner blood drives involve highercollection costs***

Part of the Company’scurrent operations involves conducting blood drives in partnership withhospitals. Blood drives are conducted under the name of the hospital partnerand require that all promotional materials and other printed material includethe name of the hospital partner. This strategy lacks the efficienciesassociated with blood drives that are not targeted to benefit particularhospital partners. As a result, collection costs might be higher than thoseexperienced by the Company’s competition and may affect profitability andgrowth plans.

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***Not-For-Profit status gives advantages to competitorssince they are exempt from taxes***

HemaCare is the onlysignificant blood products supplier to hospitals in the U.S. that is operatedfor profit and investor owned. The not-for-profit competition is exempt fromfederal and state taxes, and has substantial community support and access totax-exempt financing. The Company may not be able to continue to competesuccessfully with not-for-profit organizations and the business and results ofoperations may suffer material adverse harm.

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

The Company currentlyrelies on a relatively small number of vendors to provide important suppliesand services. Disruptions in the ability of these vendors to provide productsand services may force the Company to find alternative vendors. Alternativevendors may not be available, or may not provide their products and services atthe same prices as the Company’s current vendors. In particular, the number ofvendors supplying albumin, which is a critical supply used by the Company’sblood services business segment, has declined. If the Company cannot obtain theproducts and services it currently uses, the Company’s ability to produceproducts and provide services to its customers may be severely impacted andresult in a reduction of revenue and profitability.

***Limited access to insurance could affect ability todefend against possible claims***

The Company currentlymaintains insurance coverage consistent with the industry; however, if theCompany experiences losses or the risks associated with the blood productsindustry increase in the future, insurance may become more expensive orunavailable. The Company also cannot give assurance that as the businessexpands, or the Company introduces new products and services, that additionalliability insurance on acceptable terms will be available, or that the existinginsurance will provide adequate coverage against any and all potential claims. Also,the limitations on liability contained in various agreements and contracts maynot be enforceable and may not otherwise protect the Company from liability fordamages. The successful assertion of one or more large claims against theCompany that exceed available insurance coverage, or changes in insurancepolicies, such as premium increases or the imposition of large deductibles orco-insurance requirements, may materially and adversely affect the business.

***Potential adverse effect from changes in thehealthcare industry, including consolidations, could affect access to customers***

Competition to gainpatients on the basis of price, quality and service is intensifying amonghealthcare providers who are under pressure to decrease the costs of healthcaredelivery. There has been significant consolidation among healthcare providersas providers seek to enhance efficiencies, and this consolidation is expectedto continue. As a result of these trends, the Company may be limited in itsability to increase prices for products in the future, even if costs increase. Further,customer attrition as a result of consolidation or closure of hospitalfacilities may adversely impact the Company.

***Future technological developments, including thedevelopment of synthetic substitutes for blood products, could jeopardizebusiness***

As a result of the risksposed by blood-borne diseases, many companies are currently seeking to developalternative treatments for blood product transfusions or synthetic substitutesfor human blood products. HemaCare’s business consists of collecting,processing and distributing human blood and blood products. The introductionand acceptance in the market of alternative treatments or synthetic bloodsubstitutes may cause material adverse harm to the business. In addition,recent technological developments to extend the shelf-life of productscurrently offered by the Company, could increase the 

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availablesupply in the market, and put downward pressure on the price for these products.This may cause a material adverse impact on the future profitability for theseproducts.

***Potential inability to meet future capital needs couldaffect plans to finance future expansion***

Currently, the Companybelieves it has sufficient cash available through its cash on hand, bank creditfacilities and funds from operations to finance its operations for the nextyear. The Company generated $1,655,000 in net income in 2005; however, there isno assurance this performance will be sustainable, and the Company may need toraise additional capital in the debt or equity markets. There can be noassurance that the Company will be able to obtain such financing on reasonableterms or at all. Additionally, there is no assurance that the Company will beable to obtain sufficient capital to finance future expansion.

***Ability to attract, retain and motivate management andother skilled employees***

The Company’s successdepends significantly on the continued services of key management and skilledpersonnel. Competition for qualified personnel is intense and there are alimited number of people with knowledge of, and experience in, the bloodproduct and blood service industries. The Company does not have employmentagreements with most key employees, nor maintain life insurance policies onthem. The loss of key personnel, especially without advance notice, or theCompany’s inability to hire or retain qualified personnel, could have amaterial adverse affect on revenue and on the Company’s ability to maintain acompetitive advantage. The Company cannot guarantee that it can retain keymanagement and skilled personnel, or that it will be able to attract,assimilate and retain other highly qualified personnel in the future.

***Product safety and product liability could provideexposure to claims and litigation***

Blood products carry therisk of transmitting infectious diseases, including but not limited tohepatitis, HIV and Creutzfeldt-Jakob disease. HemaCare screens donors, useshighly qualified testing service providers to test its blood products for knownpathogens in accordance with industry standards, and complies with allapplicable safety regulations. Nevertheless, the risk that screening andtesting processes might fail or that new pathogens may be undetected by themcannot be completely eliminated. There is currently no test to detect thepathogen responsible for Creutzfeldt-Jakob disease. If patients are infected byknown or unknown pathogens, claims may exceed insurance coverage and materiallyand adversely affect the Company’s financial condition.

***Environmental risks could cause the Company to incursubstantial costs to maintain compliance***

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

***Business interruption due to terrorism and increasedsecurity measures in response to terrorism***

HemaCare’s businessdepends on the free flow of products and services through the channels ofcommerce and freedom of movement for patients and donors. Delays or stoppages inthe transportation of perishable blood products and interruptions of mail,financial or other services could have a material adverse effect on the Company’sresults of operations and financial condition. Furthermore, the Company mayexperience an increase in operating costs, such as costs for transportation,insurance and security, as a 

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resultof the terrorist activities and potential activities, which may target healthcare facilities or medical products. The Company may also experience delays inreceiving payments from payers that have been affected by terrorist activitiesand potential activities. The U.S. economy in general is adversely affected byterrorist activities, and potential activities, and any economic downturn mayadversely impact the Company’s results of operations, impair its ability toraise capital or otherwise adversely affect its ability to grow its business.

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

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

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

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

The Company’squarterly revenue and operating results have fluctuated significantly in thepast, and are likely to continue to do so in the future due to a number offactors, many of which are not within the Company’s control. If quarterlyrevenue or operating results fall below the expectations of investors, theprice of the Company’s common stock could decline significantly. Factors thatmight cause quarterly fluctuations in revenue and operating results include thefollowing:

·       changesin demand for the Company’s products and services, and the ability to attainthe required resources to satisfy customer demand;

·       abilityto develop, introduce, market and gain market acceptance of new products orservices in a timely manner;

·       abilityto manage inventories, accounts receivable and cash flows;

·       abilityto control costs; and

·       abilityto attract qualified blood donors.

The amount of expensesincurred depends, in part, on expectation regarding future revenue. Inaddition, since many expenses are fixed in the short term, the Company cannotsignificantly reduce expenses if there is a decline in revenue to avoid losses.

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***Stocks traded on the OTC Bulletin Board are subject togreater market risks than those of exchange-traded and Nasdaq stocks since theyare less liquid***

HemaCare’s common stockwas delisted from the Nasdaq Small Cap Market on October 29, 1998 becauseof the failure to maintain Nasdaq’s requirement of a minimum bid price of $1.00.Since November 2, 1998 the common stock has traded on the OTC BulletinBoard, an electronic, screen-based trading system operated by the NationalAssociation of Securities Dealers, Inc. Securities traded on the OTCBulletin Board are, for the most part, thinly traded and generally are notsubject to the level of regulation imposed on securities listed or traded onthe Nasdaq Stock Market or on a national securities exchange. As a result, aninvestor may find it difficult to dispose of our common stock or to obtainaccurate quotations as to its price.

***Stock price could be volatile***

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

***Future sales of equity securities could dilute theCompany’s common stock***

The Company may seek newfinancing in the future through the sale of its securities. Future sales ofcommon stock or securities convertible into common stock could result indilution of the common stock currently outstanding. In addition, the perceivedrisk of dilution may cause some shareholders to sell their shares, which mayfurther reduce the market price of the common stock.

***Lack of dividend payments***

The Company intends toretain any future earnings for use in its business, and therefore does notanticipate declaring or paying any cash dividends in the foreseeable future.The declaration and payment of any cash dividends in the future will depend onthe Company’s earnings, financial condition, capital needs and other factorsdeemed relevant by the Board of Directors. In addition, the Company’s creditagreement prohibits the payment of dividends during the term of the agreement.

***Evaluation of internal control and remediation ofpotential problems will be costly and time consuming and could exposeweaknesses in financial reporting***

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

This process will be expensive and time consuming, andwill require significant attention of management. Management can give noassurance that material weaknesses in internal controls will not be discovered.Management also can give no assurance that the process of evaluation and theauditor’s attestation will be completed on time. If a material weakness isdiscovered, corrective action may be time 

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consuming, costly andfurther divert the attention of management. The disclosure of a materialweakness, even if quickly remedied, could reduce the market’s confidence in theCompany’s financial statements and harm the Company’s stock price, especiallyif a restatement of financial statements for past periods is required.

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

***Evaluation and consideration of strategic alternativesmay distract management from reacting appropriately to business challenges andlead to reduced profitability***

As a publicly tradedCompany, management must constantly evaluate and consider new strategicalternatives in an attempt to maximize shareholder value. The Company does notpossess a large management team that can both consider strategic alternativesand manage daily operations. Therefore, management distractions associated withthe evaluation and consideration of strategic alternatives, could preventmanagement from dedicating appropriate time to immediate business challenges orother significant business decisions. This may cause a material adverse impacton the future profitability for the Company.

**ITEM1B**               UNRESOLVEDSTAFF COMMENTS

**N**one.

**ITEM2**                        PROPERTIES

The Company’scorporate offices and part of its distribution center are located in an 11,250square foot facility in Woodland Hills, California. The rent for this facilityis fixed at $17,300 per month and the lease on this space expires October 31,2006. The Company has one five-year option to extend this lease at the thencurrent market price.

The Company alsooperates an apheresis donor center, a laboratory, a manufacturing facility forblood components and a distribution center in a 9,300 square foot facility inSherman Oaks, California. The Company currently rents this space on amonth-to-month basis for a monthly amount of approximately $22,500. Thus farthe Company has been unable to negotiate a long-term lease agreement regardingthis space, please see “Item 1A—Risk Factors—Lease for Major ProductionFacility has Expired and if the Company needs to vacate it may be unable tolocate an alternative facility thereby disrupting business.”

The Company leasesspace for offices, a laboratory, a manufacturing facility for blood componentsand a distribution center in a 3,600 square foot facility in Scarborough, Maine.The monthly rent is approximately $5,700 per month, with an escalation clausefor changes in the Consumer Price Index. The lease term expires October 31,2007.

The Company alsoleases space for a donor center in a 1,300 square foot facility in Scarborough,Maine. The monthly rent is approximately $1,700 per month. The lease termexpires October 21, 2008, and the Company has the option to extend thelease for two additional two-year terms at escalated rental rates that adjust3.5% annually.

The Company alsoleases space for a donor center in a 2,500 square foot facility in Bangor,Maine. The monthly rent is approximately $3,900 per month. The lease termexpires December 31, 2006, and the Company has the option to extend thelease for two additional five-year terms at rates adjusted for changes in theConsumer Price Index.

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In addition, theCompany leases a 1,278 square foot office space in Yonkers, New York whichexpires August 31, 2006, for a monthly amount of approximately $2,300 permonth.

The Companyoccupies space on the campuses of two of its client hospitals. While thearrangements vary, the Company’s use of these facilities are either subject tolease agreements with the sponsoring hospital for periods concurrent with bloodsupply agreements, or grant the Company the right to utilize space andfacilities on the hospital premises during the term of the blood supplyagreement at no cost.

On February 24, 2006,the Company entered into a lease under which the Company will leaseapproximately 20,000 square feet (the “Premises”) located in Van Nuys,California. The Premises will contain the Company’s corporate offices, alaboratory, a manufacturing facility for blood components and a distributioncenter, which facilities currently are contained in separate properties asdiscussed above. The Company will continue to operate an apheresis donor centerin Sherman Oaks, California. The Company will pay an average monthly base rent of$41,000, together with additional rent based on certain operating costs andtaxes. The lease expires 128 months after the commencement date. It isanticipated that the lease will commence on August 1, 2006.

**ITEM3**                        LEGALPROCEEDINGS

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

**ITEM4**                        SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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**PART II**

**ITEM 5**                        MARKET FOR REGISTRANT’S COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s Common Stock is quoted on the OTCBulletin Board under the symbol HEMA.

Thefollowing table sets forth the range of high and low closing bid prices of theCommon Stock, as reported by the OTC Bulletin Board, for the periods indicated.These prices reflect inter-dealer quotations, without retail markups, markdowns,or commissions, and do not necessarily represent actual transactions. Theprices appearing below were obtained from the National Quotation Bureau. Shareholdersare urged to obtain current market quotations for the Company’s Common Stock.

| ** **             | ** ** | **2005**   | ** ** | **2004** | ** ** |
|------------------------|------------|------------|------------|----------|------------|
| **Quarter ended** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| March 31          |       | $          | 1.96       |     | $          | 1.31 |   | $ | 0.80 |   | $ | 0.46 |   |
| June 30           |       | $          | 1.80       |     | $          | 1.20 |   | $ | 0.85 |   | $ | 0.70 |   |
| September 30      |       | $          | 1.76       |     | $          | 1.20 |   | $ | 1.68 |   | $ | 0.55 |   |
| December 31       |       | $          | 1.75       |     | $          | 1.35 |   | $ | 1.69 |   | $ | 1.10 |   |
|                        |            |            |            |          |            |  |  |  |  |  |  |  |  |  |  |

 

Shareholders are urged to obtain current marketquotations for the Company’s Common Stock.

The Company intends to retain any future earnings foruse in its business, and therefore, does not anticipate declaring or paying anycash dividends in the foreseeable future. Additionally, the Company’s line ofcredit prohibits the payment of dividends. The declaration and payment of anycash dividends in the future will depend upon the Company’s earnings, financialcondition, capital needs, line of credit requirements and other factors deemedrelevant by the Board of Directors.

On February 22, 2006,the approximate number of shareholders of record was 262 (excluding individualparticipants in nominee security position listings).

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**ITEM 6**                     SELECTED FINANCIAL DATA

Thefollowing selected financial data should be read in conjunction with the other informationand financial statements, including the notes thereto, appearing elsewhereherein:

|                                                                       | ** ** | **Years Ended December 31,**                        | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                            | ** ** | **(In Thousands, except Per Share Data)** | ** ** |
| Revenue                                                               |       | $                                                                  | 31,227     |   | $ | 26,836 |   | $ | 27,488 |   | $ | 27,817 |   | $ | 25,199 |   |
| Gross profit                                                          |       | 6,576                                                              |       | 5,816 |   | 2,251 |   | 3,745 |   | 4,409 |   |
| Income (loss) from  operations                                        |       | 1,686                                                              |       | 1,396 |   | (1,695 | ) | (329 | ) | 491 |   |
| Other income (expense)                                                |       | —                                                             |       | 167 |   | — |   | (51 | ) | 22 |   |
| Write off of impaired  goodwill                                       |       | —                                                             |       | — |   | — |   | (362 | ) | — |   |
| Provision (benefit) for income taxes                                  |       | 31                                                                 |       | 18 |   | 2,984 |   | (151 | ) | 190 |   |
| Net income (loss)                                                     |       | $                                                                  | 1,655      |   | $ | 1,545 |   | $ | (4,679 | ) | $ | (591 | ) | $ | 323 |   |
| *Basic  per share amounts:*                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss) from  operations                                        |       | $                                                                  | 0.21       |   | $ | 0.18 |   | $ | (0.22 | ) | $ | (0.04 | ) | $ | 0.07 |   |
| Net income (loss)                                                     |       | $                                                                  | 0.20       |   | $ | 0.20 |   | $ | (0.60 | ) | $ | (0.08 | ) | $ | 0.04 |   |
| *Diluted  per share amounts:*                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss)  from operations                                        |       | $                                                                  | 0.19       |   | $ | 0.17 |   | $ | (0.22 | ) | $ | (0.04 | ) | $ | 0.06 |   |
| Net income (loss)                                                     |       | $                                                                  | 0.19       |   | $ | 0.19 |   | $ | (0.60 | ) | $ | (0.08 | ) | $ | 0.04 |   |
| ** **                                                            | ** ** | **December 31,**                                              | ** ** |
| ** **                                                            | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                            | ** ** | **(In Thousands, except Per Share Data)**                          | ** ** |
| Total assets                                                          |       | $                                                                  | 10,546     |   | $ | 9,344 |   | $ | 8,286 |   | $ | 13,455 |   | $ | 13,082 |   |
| Long-term debt and capital lease obligations, net of  current portion |       | $                                                                  | 7          |   | $ | 703 |   | $ | 1,078 |   | $ | 1,353 |   | $ | 802 |   |
| Shareholders’ equity                                             |       | $                                                                  | 6,988      |   | $ | 5,167 |   | $ | 3,411 |   | $ | 8,087 |   | $ | 8,427 |   |

 

**ITEM 7**                        MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

**General**

HemaCare operates two primary business segments. Thefirst is the blood products segment which supplies hospitals and othercustomers with red blood cells, apheresis platelets and other blood products. TheCompany operates and manages donor centers and mobile donor vehicles to collectblood products from donors, and purchases blood products from othersuppliers. Additionally, the Company operates a blood services segment, whereinthe Company performs therapeutic apheresis procedures, stem cell collection andother blood treatments to patients with a variety of disorders. Blood servicesare usually provided under contract with hospitals as an outside purchasedservice.

The earnings generated by the blood products segmentimproved dramatically during the past year. This was primarily the result of increasingdemand for blood products from existing customers, as well as from newcustomers, who are attracted by the Company’s customized blood productsdelivery system. The Company successfully increased the supply of bloodproducts to offer for sale through increased collections 

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at Company operated donorcenters and mobile operations, and through the purchase of products from othersuppliers. As sales volumes increased, this segment experienced increasedoperational efficiencies that resulted in improved gross profit.

TheCompany’s blood services business segment recorded lower revenue and profits in2005 compared with 2004. The demand for this segment’s servicesfluctuates based on the occurrence rate of diseases treated with therapeuticapheresis, the degree hospitals have fully staffed apheresis units available,and the degree of success of the Company’s efforts at physician education aboutthe potential benefits of therapeutic apheresis as a treatment alternative. Overthe past year this business segment experienced a decline in the number ofprocedures performed, especially in Southern California. Gross profit for this segment declined in2005 as a result of the decrease in revenue, higher nurse compensation, andhigher expenses to manage and market this business unit.

**Results of Operations**

Thefollowing table sets forth, for the periods indicated, the percentage thatcertain items in the statement of operations were of net revenue and thepercentage dollar increase (decrease) of such items from period to period.

| ** **                           | ** ** | **Percent of Net Sales**     | ** ** | **Percentage Dollar  Increase (Decrease)** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **Years Ended December 31,** | ** ** | **Years Ended December 31,**          | ** ** |
| ** **                           | ** ** | **2005**                                    | ** ** | **2004**                                             | ** ** | **2003** | ** ** | **04 to ‘05** | ** ** | **‘03 to ‘04** | ** ** |
| Revenues                             |       | 100.0                                       | %          | 100.0                                                | %          | 100.0 | % |   | 16.4 | % |   |   | (2.4 | )% |   |
| Operating costs                      |       | 78.9                                        | %          | 78.3                                                 | %          | 91.8 | % |   | 17.3 | % |   |   | (16.7 | )% |   |
| Gross profit                         |       | 21.1                                        | %          | 21.7                                                 | %          | 8.2 | % |   | 13.1 | % |   |   | 158.4 | % |   |
| General and administrative expenses  |       | 15.7                                        | %          | 16.5                                                 | %          | 14.4 | % |   | 10.6 | % |   |   | 12.0 | % |   |
| Income (loss) from operations        |       | 5.4                                         | %          | 5.2                                                  | %          | (6.2 | )% |   | 20.8 | % |   |   | 182.4 | % |   |
| Other income (expense)               |       | —                                      |       | 0.6                                                  | %          | — |   |   | (100.0 | )% |   |   | 100.0 | % |   |
| Income (loss) before income taxes    |       | 5.4                                         | %          | 5.8                                                  | %          | (6.2 | )% |   | 7.9 | % |   |   | 192.2 | % |   |
| Provision (benefit) for income taxes |       | 0.1                                         | %          | 0.1                                                  | %          | 10.9 | % |   | 72.2 | % |   |   | (99.4 | )% |   |
| Net income (loss)                    |       | 5.3                                         | %          | 5.7                                                  | %          | (17.1 | )% |   | 7.1 | % |   |   | 133.0 | % |   |

 

***Year ended December 31, 2005 compared to the yearended December 31, 2004***

**Overview**

The Company generated net income of $1,655,000, or$.20 basic and $.19 fully diluted, earnings per share for 2005, compared to$1,545,000, or $.20 basic and $.19 fully diluted, earnings per share in 2004.

Revenues increased $4,391,000, or 16.4%, to$31,227,000 in 2005 from $26,836,000 for all of 2004. The increase isattributable to an increase in blood products revenue of 26.9%, which waspartially offset by a 10.9% decrease in blood services revenue.

Gross profit increased 13.1% to $6,576,000 in 2005from $5,816,000 in 2004 due to improved gross profit for the Company’s bloodproducts business segment. Increasing revenue, along with operationalefficiencies from an increase in sales volumes, produced most of theimprovement in blood products gross profit. This was partially offset by adecrease in gross profit for the Company’s blood services business segment as aresult of decreasing revenue, higher nursing compensation, and higher expensesto manage and market this business unit.

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General and administrative expenses increased$470,000, or 10.6%, in 2005 to $4,890,000 from $4,420,000 in 2004. This ismostly attributable to an increase in expenses for outside services, salaries,and liability insurance. However, general and administrative expenses decreasedas a percent of revenues from 16.5% in 2004 to 15.7% in 2005.

The Company recognized a$31,000 provision for income taxes for 2005, compared with $18,000 for 2004. The2005 provision reflects the impact of net operating loss carryforwards fromprevious years.

**Revenue and GrossProfit**

***Blood Products***

Blood products revenue for 2005 increased 26.9%, or$5,207,000, to $24,552,000 from $19,345,000 in 2004. This increase isattributable to an increase in the number of units of blood products sold,despite the closing of donor centers in Chapel Hill, North Carolina, Whittier,California, and Lebanon, New Hampshire. The Company recorded $850,000 ofrevenue from these donor centers in 2004.

Thefollowing table illustrates the components included in blood products resultsfor 2005 and 2004, and segregates that portion of blood products revenueassociated with closed operations:

| ** **              | ** ** | **For the twelve month period ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------------------------------|------------|
| ** **              | ** ** | **Ongoing Operations**                                                           | ** ** | **Closed Operations** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **    2005    **                              | ** ** | **    2004    ** | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** |
| ** **              | ** ** | **(Dollars in Thousands)**                                                  | ** ** |
| **Revenue***            |       | $                                                                                     | 24,552     |   | $ | 18,495 |   |   | $ | — |   |   |   | $ | 850 |   |   | $ | 24,552 |   | $ | 19,345 |   |
| **Gross  Profit**       |       | $                                                                                     | 5,049      |   | $ | 3,205 |   |   | $ | — |   |   |   | $ | 186 |   |   | $ | 5,049 |   | $ | 3,391 |   |
| **Gross Profit Margin** |       | 21                                                                                    | %          | 17 | % |   | N/A |   |   |   | 22 | % |   | 21 | % | 18 | % |

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*                    Includes bloodproduct sales, net of returns and credits

Revenue from ongoing operations increased $6,057,000,or 32.7%, in 2005 compared to 2004. This was primarily the result of increasedsales to existing and new customers attracted by the Company’s customized bloodproducts delivery system. The Company increased its supply of bloodproducts through increased collections at Company operated donor centers andmobile operations, and through the purchase of products from other suppliers. Closedoperations generated $850,000 of revenue in 2004.

Gross profit from ongoingoperations increased $1,844,000, or 57.5%, in 2005 to $5,049,000 from$3,205,000 in 2004. This is mostly due to increased blood products revenue andoperational efficiencies derived from an increase in sales volume. Gross profitfrom closed operations was $186,000 in 2004. Overall, the gross profitpercentage for this segment improved to 21% in 2005 compared with 17% for allof 2004.

***Blood Services***

Revenue for this businesssegment was $6,675,000 in 2005, which represents a $816,000, or 10.9%, decreasefrom the $7,491,000 recognized in 2004. The revenues for the blood servicessegment fluctuate significantly with changes in the number of proceduresperformed. The Company performed 10.1% fewer procedures in 2005 compared to2004, mostly as a result of reduced procedure volumes in the SouthernCalifornia and New England markets. The decrease occurred principally as aresult of competition in the Southern California market, and  ceasing in-patient services for a majorcustomer in Maine. The Company recognized a 37% decrease in gross profit forthis business segment from $2,425,000 in 2004 to $1,527,000 in 2005. The grossprofit percentage of this segment decreased to 22.9% for 2005, from 32.4% for 2004.The decline in gross profit is attributable to a decrease in revenue, andhigher expenses to staff, manage and market this business segment.

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**General andAdministrative Expenses**

General and administrativeexpenses increased $470,000, or 10.6%, to $4,890,000 in 2005 from $4,420,000 in2004. For all of 2005, general and administrative expenses represented 15.7% ofrevenue, which is a decrease from 16.5% reported for 2004. The increase ingeneral and administrative expenses was attributable to a $230,000 increase inexpenses for outside services, consultants and temporary personnel, a $265,000increase in compensation expense, and an $80,000 increase in liabilityinsurance. Theseincreases in general and administrative expenses were partially offset by a$66,000 decrease in interest expense, which is directly related to asubstantial reduction in outstanding debt during 2005.

**Income Taxes**

The Company has sufficient net operating losscarryforwards to avoid most federal income tax expense for 2005. However,management anticipates that the Company will be subject to federal alternativeminimum tax in 2005, as well as various state and local taxes which areunaffected by the net operating loss carryfowards. Management has calculated anestimated tax liability that includes the potential for federal alternativeminimum tax, and has calculated estimated tax liability for each state andlocal jurisdiction using the tax basis each jurisdiction uses to assess taxes. During2005, the Company recorded $31,000 to the provision for income taxes based onthese estimates, which represents an increase of $13,000 over the amountrecorded to the provision in 2004.

During 2005, the Companymaintained a 100% valuation reserve against deferred tax assets. Currentaccounting standards place significant weight on a history of recent cumulativelosses in determining whether it is more likely than not that the Company willrealize the tax benefits in the near future and accordingly whether a valuationallowance is necessary. Recent profitability, or forecasts of future taxableincome, are not considered sufficient positive evidence to outweigh a historyof losses. Accordingly, the assets remain fully reserved as of the end of 2005.The Company’s federal and state net operating loss carryforwards are notimpacted by this valuation allowance and therefore are still available forfuture use for up to 20 years. 

***Year ended December 31, 2004 compared to the yearended December 31, 2003***

**Overview**

The Company generated net income of $1,545,000, or$.20 basic and $.19 fully diluted, earnings per share for 2004, compared to anet loss of $4,679,000, or $.60 loss per share both basic and fully diluted, in2003. The main reasons for this material change in the earnings of the Companyare the reduction in costs realized by closing blood product operations as partof the successful implementation of management’s restructuring plan in late2003, and the lack of any increase in the deferred tax asset valuation reservein 2004, compared to the increase in 2003.

Gross profit increased 158.4% to $5,816,000 in 2004from $2,251,000 in 2003 due to reduced operating costs as a result of theclosure of underperforming donor centers as part of management’s restructuringplan, improved product sales volumes at the Company’s remaining operations andthe reclassification of professional liability insurance expense from operatingcosts to general and administrative expenses.

General and administrative expenses increased 12.0% in2004 to $4,420,000 from $3,946,000 in 2003. This is mostly attributable to areclassification of professional liability insurance expense to general andadministrative from operating costs, higher professional liability insurancepremiums, higher nurse recruitment costs and an increase in bonuses as a resultof achieving specific profitability targets.

The Company recognized $167,000 in other income in2004 as a result of the receipt of a refund of sales taxes previously paid toone of the Company’s major suppliers.

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The Company recognized an$18,000 provision for income taxes for 2004, compared with $2,984,000 for 2003.This change was the result of an increase in the deferred tax asset valuationreserve in 2003 to 100%. The Company recognized a relatively low provision for2004 because of net operating loss carryforwards from previous years.

**Revenue and GrossProfit**

***Blood Products***

Blood products revenue for 2004 decreased by 3.4%, or$685,000, to $19,345,000 from $20,030,000 in 2003. In late 2003, the Companyimplemented a restructuring plan that resulted in the closure of six donorcenters in the eastern United States, which contributed $3,028,000 of revenuesin 2003. In the first quarter of 2004, management closed the donor center inChapel Hill, North Carolina as the final step to complete the implementation ofthis plan. This donor center contributed $65,000 of revenue in 2004. In thesecond quarter of 2004, the donor center management contracts between theCompany and Presbyterian Intercommunity Hospital, located in Whittier,California, and between the Company and Dartmouth-Hitchcock Medical Center,located in Lebanon, New Hampshire, expired and were not renewed. The Companyrecorded revenues from the contract with Presbyterian Intercommunity Hospitalin 2003 of $555,000, and $302,000 in the first six months of 2004. The Companyrecorded revenues from the contract with Dartmouth-Hitchcock Medical Center in2003 of $897,000, and $483,000 in the first six months of 2004.

Gross profit for the blood products business segmentincreased $3,530,000 to $3,391,000 in 2004 from a loss of $139,000 in 2003. Thisis mostly attributable to the closure of underperforming donor centers in late2003 and higher levels of efficiency that result from higher volumes in ongoingoperations.

Thefollowing table illustrates the components included in blood products resultsfor 2004 and 2003, and segregates that portion of blood products revenueassociated with closed operations:

| ** **               | ** ** | **For the twelve month period ended December 31,** | ** ** |
|--------------------------|------------|---------------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **Ongoing Operations**                                                           | ** ** | **Closed Operations** | ** ** | **Total** | ** ** |
| ** **               | ** ** | **2004**                                                                              | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **               | ** ** | **($ in Thousands)**                                                        | ** ** |
| **Revenue***             |       | $                                                                                     | 18,495     |   | $ | 15,550 |   | $ | 850 |   | $ | 4,480 |   | $ | 19,345 |   | $ | 20,030 |   |
| **Gross  Profit**        |       | $                                                                                     | 3,205      |   | $ | 1,082 |   | $ | 186 |   | $ | (1,221 | ) | $ | 3,391 |   | $ | (139 | ) |
| **Gross  Profit Margin** |       | 17                                                                                    | %          | 7 | % | 22 | % | (27 | )% | 18 | % | (1 | )% |

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*                    Includes bloodproduct sales, net of returns and credits

Revenue from ongoing operations increased $2,945,000,or 18.9%, in 2004 compared to 2003. This is mostly attributable to increasedplatelet collections at the Company’s donor centers in California and Maine. Followingclosure of underperforming donor centers in 2003, management has focusedextensively on increasing collection volumes at the remaining facilities. Revenuefrom closed operations declined $3,630,000, or 81.0%, in 2004 compared to 2003.This is attributable to the fact that the Company closed five donor centers inlate 2003, and three donor centers in the first half of 2004. One of theclosures in early 2004 was the donor center in Chapel Hill, North Carolina thatwas closed as part of the restructuring plan implemented in late 2003. Theother two were the donorcenters at Presbyterian Intercommunity Hospital, located in Whittier,California, and at Dartmouth-Hitchcock Medical Center, located in Lebanon, NewHampshire. Both of these were closed when the management contracts between theCompany and these hospitals expired and were not renewed.

Gross profit from ongoingoperations increased $2,123,000, or 196%, to $3,205,000 from $1,082,000 in 2003.In addition, the gross profit margin for ongoing operations improved to 17% in2004, from 7% in 2003. This is mostly due to increased collection volume at theCompany’s remaining facilities. The increase 

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incollection volume does not require a corresponding increase in many of thecosts associated with the collection effort, such as facility costs, equipmentcosts and staffing costs. Gross profit for closed operations were $186,000 in2004 and a loss of $1,221,000 in 2003. The donor centers closed in 2004includedDartmouth-Hitchcock Medical Center and Presbyterian Intercommunity Hospital. These facilities were not part ofmanagement’s restructuring plan as they generally operated profitably. Thecontracts for these facilities were not renewed by the hospital customers. Thedonor centers closed in 2003 were generally underperforming operations.

***Blood Services***

Revenue for this businesssegment in 2004 was $7,491,000, which represents a 0.4% increase from the$7,458,000 recognized in 2003. The Company performed 13.0% fewer procedures in2004 compared to 2003, mostly as a result of reduced procedure volumes in theNew York and New England markets. The Company experienced difficultiesrecruiting trained apheresis nurses in these markets, which contributed to thedecline in procedures performed. The Company was able to recognize a smallincrease in revenue for this segment, despite the decline in procedure volume,mostly due to a change in procedure mix to higher average price procedures. TheCompany recognized a 1.5% improvement in gross profit for this business segmentfrom $2,390,000 in 2003 to $2,425,000 in 2004. This improvement is attributableto a change in procedure mix in 2004, the reduction in operating costs due tothe reclassification of professional liability insurance expense to general andadministrative expense from operating costs. In 2003, operating costs for theblood services business segment was charged $86,000 for liability insurance.

**General andAdministrative Expenses**

General and administrativeexpenses increased $474,000, or 12%, to $4,420,000 from $3,946,000 in 2003. Thisis mostly attributable to the reclassification of liability insurance in 2004,an increase in overall insurance expense, higher nurse recruitment costs and anincrease in management bonuses. Beginning in 2004, the Company charged generaland administrative expenses for professional liability insurance premiums whichhad previously been charged to operating costs, but which are not specificallyattributable to any specific operation or location. As a result of thisreclassification, insurance expense included in general and administrativeexpenses in 2004 increased $341,000 compared to 2003. In addition, the Companyexperienced an increase in the cost for all forms of insurance coverage in 2004of $151,000. Also in 2004, fees and other services related to nurse recruitmentincreased $298,000 compared to 2003. The 2004 bonus program for managementprovided for bonuses based on the Company’s achievement of specificprofitability targets. The Company achieved these targets and recognized anincrease of $155,000 in bonuses in 2004 compared to 2003. These increases ingeneral and administrative expenses were partially offset by a reduction in baddebt expense incurred in 2004. As a result of the closure of several donorcenters in late 2003, the Company recorded bad debt expense for certainhospital customers associated with these closed donor centers that would likelydelay or withhold payment of outstanding invoices. In 2004, the Company did notexperience any similar risk. As a result, bad debt expense recognized in 2004declined by $299,000 compared with 2003. In 2004, the Company changed its auditfirm and recognized a $74,000 reduction in audit fees associated with theexamination of the Company’s 2004 financial statements.

**Income Taxes**

During 2003, the Companyrecorded a valuation allowance of $2,984,000 against deferred tax assets. Thisnon-cash charge reduced the net value of the deferred tax assets on the balancesheet to zero. The assets were the result of income tax benefits that wererecorded due to operating losses in prior years. Current accounting standardsplace significant weight on a history of recent cumulative losses indetermining whether it is more likely than not that the Company will realizethe tax benefits in the near 

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futureand accordingly whether a valuation allowance is necessary. Forecasts of futuretaxable income are not considered sufficient positive evidence to outweigh ahistory of losses. Accordingly, the assets were reserved in full, and remainfully reserved as of the end of 2004. The Company’s federal and state netoperating loss carryforwards are not impacted by this change in valuationallowance and therefore are still available for future use for up to 20 years. In2004, the Company utilized these carryforwards to substantially reduce incometax expense. Other than state franchise tax, the Company incurred an estimated$18,000 in California alternative minimum tax for 2004.

**2005and 2004 Quarterly Financial Data**

The Company generated positive net income in everyquarter of 2005, and recognized the highest level of quarterly revenue andpretax earnings in the Company’s history in the fourth quarter of 2005. Most ofthis positive result was due to increasing blood products revenue and improvedblood products gross profit margins as a result of operational efficiencies.

The following tablepresents unaudited statement of operations data for each of the eight quartersended December 31, 2005. Management believes that all necessaryadjustments have been included to fairly present the quarterly information whenread in conjunction with the consolidated financial statements. The operatingresults for any quarter are not necessarily indicative of the results for anysubsequent quarter.

**UNAUDITED*(In Thousands, Except Per Share Data)***

| ** **                  | ** ** | **2004**               | ** ** | **2005**               | ** ** |
|-----------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **Quarter Ended** | ** ** | **Quarter Ended** | ** ** |
| ** **                  | ** ** | **March 31**      | ** ** | **June 30**       | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** | **March 31** | ** ** | **June 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| Revenues                    |       |                   | $          | 6,736                  |       |   | $ | 6,921 |   | $ | 6,318 |   | $ | 6,861 |   |   | $ | 7,083 |   |   | $ | 7,521 |   | $ | 7,768 |   | $ | 8,855 |   |
| Gross profit                |       |                   | 1,431      |                   |       | 1,503 |   | 1,370 |   | 1,512 |   |   | 1,465 |   |   | 1,766 |   | 1,446 |   | 1,899 |   |
| Income before  income taxes |       |                   | 246        |                   |       | 488 |   | 475 |   | 354 |   |   | 276 |   |   | 445 |   | 297 |   | 668 |   |
| Income tax  provision       |       |                   | —     |                   |       | — |   | — |   | 18 |   |   | — |   |   | 5 |   | 2 |   | 24 |   |
| Net income                  |       |                   | $          | 246                    |       |   | $ | 488 |   | $ | 475 |   | $ | 336 |   |   | $ | 276 |   |   | $ | 440 |   | $ | 295 |   | $ | 644 |   |
| Earnings per share          |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                       |       |                   | $          | 0.03                   |       |   | $ | 0.06 |   | $ | 0.06 |   | $ | 0.05 |   |   | $ | 0.03 |   |   | $ | 0.05 |   | $ | 0.04 |   | $ | 0.08 |   |
| Diluted                     |       |                   | $          | 0.03                   |       |   | $ | 0.06 |   | $ | 0.06 |   | $ | 0.04 |   |   | $ | 0.03 |   |   | $ | 0.05 |   | $ | 0.03 |   | $ | 0.08 |   |

 

The Company’squarterly revenue and operating results have fluctuated significantly in thepast, and are likely to continue to do so in the future due to a number offactors, many of which are not within the Company’s control. If quarterlyrevenue or operating results fall below the expectations of investors, theprice of the Company’s common stock could decline significantly. Factors thatmight cause quarterly fluctuations in revenue and operating results include thefollowing:

·       changesin demand for the Company’s products and services, and the ability to attainthe required resources to satisfy customer demand;

·       abilityto develop, introduce, market and gain market acceptance of new products orservices in a timely manner;

·       abilityto manage inventories, accounts receivable and cash flows;

·       abilityto control costs; and

·       abilityto attract qualified blood donors.

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The amount of expensesincurred depends, in part, on expectation regarding future revenue. Inaddition, since many expenses are fixed in the short term, the Company cannotsignificantly reduce expenses if there is a decline in revenue to avoid losses.

**CriticalAccounting Policies and Estimates**

***General***

Management’s discussion andanalysis of the Company’s financial condition and results of operations arebased on the Company’s consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires theCompany to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, the Company evaluatesits estimates, including those related to valuation reserves, income taxes andintangibles. The Company bases its estimates on historical experience and onvarious other assumptions that management believes are reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

***Allowance for Doubtful Accounts***

TheCompany makes ongoing estimates relating to the collectibility ofaccounts receivable and maintains a reserve for estimated losses resulting fromthe inability of customers to meet their financial obligations to the Company. Indetermining the amount of the reserve, management considers the historicallevel of credit losses and makes judgments about the creditworthiness ofsignificant customers based on ongoing credit evaluations. Since managementcannot predict future changes in the financial stability of customers, actualfuture losses from uncollectible accounts may differ from the estimates. If thefinancial condition of customers were to deteriorate, resulting in theirinability to make payments, a larger reserve may be required. In the event itis determined that a smaller or larger reserve is appropriate, the Companywould record a credit or a charge to general and administrative expense in theperiod in which such a determination is made.

***Income Taxes***

As part of the process of preparing the financialstatements, the Company is required to estimate income taxes in each of thejurisdictions that the Company operates. This process involves estimatingactual current tax exposure together with assessing temporary differencesresulting from differing treatment of items for tax and accounting purposes. Thesedifferences result in deferred tax assets and liabilities, which are includedin the balance sheet. Management must then assess the likelihood that thedeferred tax assets will be recovered from future taxable income, and to theextent management believes that recovery is not likely, must establish avaluation allowance. To the extent a valuation allowance is created or adjustedin a period, the Company must include an expense, or benefit, within the taxprovision in the statements of operations.

Significant managementjudgment is required in determining the provision for income taxes, deferredtax asset and liabilities and any valuation allowance recorded against net deferredtax assets. Management continually evaluates if the deferred tax asset islikely to be realized. If management determines that the deferred tax asset islikely to be realized, a write-up of that asset would be required and would bereflected as a benefit from income taxes in the accompanying period. If on theother hand management determines that a deferred tax asset is not likely to berealized, a write-down of that asset would be required and would be reflectedin the provision for taxes in the accompanying period.

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**Liquidity and Capital R**esources

At December 31, 2005, the Company had cash andcash equivalents of $2,612,000 and working capital of $4,158,000.

The Company, together with Coral Blood Services, Inc.,a subsidiary, has a working capital line of credit with Comerica Bank -California. This credit facility originally was scheduled to terminate as of June 30,2005; however, on July 1, 2005, the Company, Coral Blood Services, Inc.and Comerica Bank entered into an amendment to the credit facility to extendthe term of the facility to June 30, 2007. In addition, this amendmentaltered the interest rate calculation, established a $50,000 maximum limit forpurchasing or disposing of assets without Comerica Bank’s approval, and removedthe restriction in the agreement on the Company’s ability to purchase, acquire,repurchase, retire or redeem any of the Company’s capital stock. As of July 1,2005, the amount the Company may borrow is the lesser of: 75% of eligibleaccounts receivable or $2 million. Interest is payable monthly at a rate ofprime minus 0.25%; as of December 31, 2005 the rate associated with thisnote was 7.0%. In addition, the Company has the option to draw against thisfacility for thirty (30), sixty (60), or ninety (90) days using LIBOR as therelevant rate of interest. As of December 31, 2005, the Company had no netborrowing on this line of credit, and the Company had unused availability of$2,000,000. On January 31, 2006, the Company, Coral Blood Services, Inc.and Comerica Bank entered into an amendment to the credit facility whichprovides for the issuance of letters of credit by Comerica Bank on behalf ofthe Company in an amount not to exceed $1,000,000.

The Comerica line of credit is collateralized bysubstantially all of the Company’s assets and requires the maintenance ofcertain financial covenants that, among other things, require minimum levels ofprofitability and prohibits the payment of dividends. As of December 31,2005, the Company was in full compliance with all of the financial covenants. TheCompany did not incur any interest expense associated with the Comerica loan in2005.

The Company also has a capital equipment lease with GECapital used to finance the acquisition of vehicles. As of December 31,2005, the balance outstanding on this lease was $86,000,****of which approximately $79,000 is included in currentobligations. This lease is scheduled to terminate in January 2007, and hasa fixed interest rate of 8.0%.

The Company had another note payable to One SourceFinancial. During the third quarter of 2005, the Company paid all of theremaining unpaid balance on this capital lease, totaling $12,000. The note wasscheduled to terminate in January 2006, and had a fixed rate of 8.5%. Thisnote was secured by specific equipment.

The Company also had a capital equipment lease withGambro BCT to finance the acquisition of equipment used in the Company’sapheresis activities. During the third quarter of 2005, the Company paid all ofthe remaining unpaid balance on this capital lease, totaling $703,000. Thelease was scheduled to terminate in December 2008 and had a fixed interestof 7.5%. The lease was secured by all of the equipment purchased through thelease financing.

The Company had a capital equipment lease with DellFinancial Services associated with the acquisition of computer equipment. Duringthe third quarter of 2005, the Company paid all of the remaining unpaid balanceon this capital lease, totaling $2,000. This lease was scheduled to terminatein August 2005, and had a fixed interest rate of 12.6%.

Finally, the Company has a capital equipment leasewith Toshiba Financial Services associated with the acquisition of photocopierequipment. As of December 31, 2005, the balance outstanding on this leasewas $3,000, all of which is included in current obligations. This lease isscheduled to terminate in May 2006.

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Thefollowing table summarizes our contractual obligations by year (in thousands).

| ** **          | ** ** | **Payments due by year** | ** ** |
|---------------------|------------|-----------------------------------------|------------|
| ** **          | ** ** | **Total**                               | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Operating leases    |       | $                                       | 410        |   | $ | 298 |   |   | $ | 74 |   |   |   | $ | 25 |   |   |   | $ | 7 |   |   |   | $ | 6 |   |   |   | $ | — |   |   |
| Capitalized  elases |       | 88                                      |       | 81 |   |   | 7 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Notes payable       |       | —                                  |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Totals              |       | $                                       | 498        |   | $ | 379 |   |   | $ | 81 |   |   |   | $ | 25 |   |   |   | $ | 7 |   |   |   | $ | 6 |   |   |   | — |   |   |

 

Net cash provided by operating activities was$1,872,000 for 2005, and $2,325,000 for 2004, representing a decrease of$453,000. Most of the decrease was due to the fact that net accounts receivableincreased $548,000 in 2005, whereas net accounts receivable increased only$259,000 in 2004. This increase was due to an increase in revenue during 2005,particularly in the fourth quarter. Receivable collection efforts improvedduring 2005 as represented by the days sales outstanding statistic which stoodat 41 days as of December 31, 2005, compared with 45 days as of the end of2004. Also contributing to the decrease in cash generated by operatingactivities was an increase in inventories, supplies and prepaid expenses of$58,000, whereas the Company recorded a decrease of $103,000 for all of 2004. Achange in the termination date for the Company’s insurance policies resulted inan increase in the prepaid insurance balance as of December 31, 2005.

For 2005, net cash used in investing activities was$603,000, compared with $176,000 for 2004. The cash used in investingactivities in 2005 was primarily for the acquisition of cell separators,computers, software and vehicles. In 2004, the cash used in investingactivities was primarily for medical and computer equipment.

Cash used by financing activities in 2005 was$739,000, compared with $1,002,000 for 2004. Most of the cash utilized in bothyears was to reduce outstanding notes payable, capitalized leases and otherdebts.

The Company had previously decided to initiate a newinformation technology project to enhance the automation of its blood productoperations. The Company has identified a preferred blood bank informationsystem developer to provide this system, and is currently in contractnegotiations. This project is expected to take approximately two years tocomplete, and will involve considerable financial and managerial resources. Managementexpects approximately $2 million will be needed to complete this project.

Management anticipatesthat cash on hand, availability on the bank line of credit and cash generatedfrom operations will be sufficient to provide funding for the Company’s needsfor the upcoming year, including working capital requirements, equipmentpurchases and lease commitments.

**FactorsAffecting Forward-Looking Information**

The Private Securities Litigation Reform Act of 1995provides a “safe harbor” from liability for forward-looking statements. Certaininformation included in this Form 10-K and other materials filed orto be filed by the Company with the Securities and Exchange Commission (as wellas information included in oral statements or other written statements made orto be made by or on behalf of the Company) are forward-looking, such asstatements relating to operational and financing plans, competition, the impactof future price increases for blood products and demand for the Company’sproducts and services. These statements may also be identified by the use ofwords such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,”“may,” “project,” “will” and similar expressions, as they relate to theCompany, its management and its industry. Investors and prospective investorsare cautioned that these forward-looking statements are not guarantees offuture performance and involve risks and uncertainties, many of which will bebeyond the control of the Company. Actual results could differ materially fromthose anticipated in these forward-looking statements as a result of variousrisks and uncertainties, including 

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those above in “Item 1A—RiskFactors” or in other filings by the Company with the Securities and ExchangeCommission. The Company does not undertake to update its forward-lookingstatements to reflect later events and circumstances or actual outcomes.

Such forward-lookingstatements involve important risks and uncertainties, many of which will bebeyond the control of the Company. These risks and uncertainties couldsignificantly affect anticipated results in the future, both short-term andlong-term, and accordingly, such results may differ from those expressed inforward-looking statements made by or on behalf of the Company. These risks anduncertainties include, but are not limited to those listed above as “RiskFactors” or in other filings by the Company with the Securities and ExchangeCommission.

**ITEM 7A**                 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

In the normal course of business, the Company’soperations are exposed to risks associated with fluctuations in interest rates.The Company manages its risks based on management’s judgment of the appropriatetrade-off between risk, opportunity and costs. Management does not believe thatinterest rate risks are material to the results of operations or cash flows ofthe Company, and, accordingly, does not generally enter into interest ratehedge instruments.

At December 31, 2005, the Company had $88,000 ofdebt, all of which is from notes payable and capitalized leases with fixedinterest rates. The interest rate payable on the Company’s working capital lineof credit is based upon the prime interest rate. At December 31, 2005, noamount was outstanding on this line of credit.

In the normal course ofbusiness, the Company also faces risks that are either non-financial or notquantifiable, including those risks described earlier “Item 1A—Risk Factors.”

**ITEM 8**                        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Index to FinancialStatements and Schedules appears on page F-1. The Reports ofIndependent Public Accountants appears on F-2 and F-3, and theConsolidated Financial Statements and Notes to Consolidated FinancialStatements appear on pages F-4 to F-15.

**ITEM 9**                        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE

On April 5, 2004, the Company dismissed Ernst &Young LLP, an independent registered public accounting firm (“E&Y”), as theindependent accountants of the Company. On April 8, 2004, the Companyappointed Stonefield Josephson, Inc., an independent registered publicaccounting firm (“Stonefield”), as the independent accountants of the Company forthe fiscal year ended December 31, 2004. The determination to dismissE&Y and to appoint Stonefield was made by the Board of Directors of theCompany upon the recommendation of the Audit Committee.

The reports of E&Y on the financial statements ofthe Company for the fiscal year ended December 31, 2003 did not containany adverse opinion, disclaimer of opinion, or qualification or modification asto uncertainty, audit scope or accounting principles.

During the Company’s fiscal year ended December 31,2003, and the interim period from January 1, 2004 through April 8,2004, there were no disagreements with E&Y on any matter of accountingprinciples or practices, financial statement disclosure or auditing scope orprocedure, which disagreements, if not resolved to the satisfaction of E&Y,would have caused them to make reference to the subject matter of thedisagreement in connection with their reports on the Company’s financialstatements for such year.

27

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During the Company’s fiscal year ended December 31,2003, and the interim period from January 1, 2004 through April 8,2004, no reportable event (as defined in Item 304(a)(1)(v) of RegulationS-K) has occurred.

During the Company’s fiscal year ended December 31,2003, and the interim period from January 1, 2003 through April 8,2004, the Company did not consult with Stonefield on the application ofaccounting principles to a specified transaction, either completed or proposed,or the type of audit opinion that might be rendered on the Company’s financialstatements, or any matter which was the subject of any disagreement or anyreportable event (as defined in Items 304(a)(1)(iv) and 304(a)(1)(v),respectively, of Regulation S-K).

E&Y was provided witha copy of the disclosures contained herein. A letter from E&Y confirmingits agreement with the statements contained herein is attached as Exhibit 16.1to the Company’s Form 8-K filed on April 9, 2004.

**ITEM 9A**                CONTROLS AND PROCEDURES

The Chief Executive Officer and the Chief FinancialOfficer of the Company, with the participation of the Company’s management,carried out an evaluation of the effectiveness of the Company’s disclosurecontrols and procedures pursuant to Exchange Act Rule 13a-15(b). Basedon that evaluation, the Chief Executive Officer and the Chief Financial Officerbelieve that, as of the end of the period covered by this report, the Company’sdisclosure controls and procedures are effective at the reasonable assurancelevel described below in making known to them material information relating to theCompany (including its consolidated subsidiaries) required to be included inthis report.

Disclosure controls and procedures, no matter how welldesigned and implemented, can provide only reasonable assurance of achieving anentity’s disclosure objectives. The likelihood of achieving such objectives isaffected by limitations inherent in disclosure controls and procedures. Theseinclude the fact that human judgment in decision-making can be faulty and thatbreakdowns in internal control can occur because of human failures such assimple errors or mistakes or intentional circumvention of the establishedprocess.

There was no change in theCompany’s internal control over financial reporting known to the ChiefExecutive Officer or the Chief Financial Officer, that occurred during theCompany’s fiscal quarter ended December 31, 2005 that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

**ITEM 9B**                 OTHER INFORMATION

None.

28

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**PART III**

**ITEM 10**                 DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT

The information concerningthe directors and executive officers of the Company is incorporated herein byreference from the section entitled “Proposal 1—Election of Directors”contained in the definitive proxy statement of the Company to be filed pursuantto Regulation 14A within 120 days after the end of the Company’s last fiscalyear (the “Proxy Statement”).

**ITEM 11**                 EXECUTIVE COMPENSATION

The information concerningexecutive compensation is incorporated herein by reference from the sectionentitled “Proposal 1—Election of Directors” contained in the Proxy Statement.

**ITEM 12**                 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERSAND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information concerningthe security ownership of certain beneficial owners and management and relatedstockholder matters is incorporated herein by reference from the sectionentitled “General Information—Security Ownership of Principal Stockholders andManagement” and “Proposal 1—Election of Directors” contained in the ProxyStatement.

**ITEM 13**                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information concerningcertain relationships and related transactions is incorporated herein byreference from the section entitled “Proposal 1—Election of Directors—CertainRelationships and Related Transactions” contained in the Proxy Statement.

**ITEM 14**                 PRINCIPAL ACCOUNTANT FEES AND SERVICES 

The information concerning the Company’s principalaccountant’s fees and services is incorporated herein by reference from thesection entitled “Independent Registered Public Accounting Firm” in the ProxyStatement.

29

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**PART IV**

**ITEM 15**                 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The following arefiled as part of this Report:

1.                *Financial Statements*

An index to Financial Statements and Schedules appearson page F-1.

2.                *Financial Statement Schedules*

The schedules for which provision is made in theapplicable accounting regulations of the Securities and Exchange Commission arenot required under related instructions or are inapplicable, and therefore havebeen omitted.

3.                *Exhibits*

Thefollowing exhibits listed are filed or incorporated by reference as part ofthis Report.

| 3.1    |   | Restated Articles of Incorporation of the  Registrant—incorporated by reference to Exhibit 3.1 to Form 10-K  of the Registrant for the year ended December 31, 2002.                                                                                                     |   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 3.2    |   | Amended and  Restated Bylaws of the Registrant, as amended—incorporated by reference to  Exhibit 3.1 to Form 8-K of the Registrant dated  February 19, 2003.                                                                                                             |   |
| 4.1    |   | Warrant Agreement  between the Registrant and Alan C. Darlington, dated January 15, 2003—incorporated  by reference to Exhibit 4.4 to Form 10-K of the Registrant  for the year ended December 31, 2002.                                                            |   |
| 4.2    |   | Warrant Agreement  between the Registrant and Alan C. Darlington, dated January 15, 2003—incorporated  by reference to Exhibit 4.5 to Form 10-K of the Registrant  for the year ended December 31, 2002.                                                            |   |
| 4.3    |   | Rights Agreement  between the Registrant and U.S. Stock Transfer Corporation dated  March 3, 1998—incorporated by reference to Exhibit 4 to Form 8-K  of the Registrant dated March 5, 1998.                                                                        |   |
| 10.1*+ |   | 1996 Stock  Incentive Plan, as amended, of the Registrant.                                                                                                                                                                                                                                   |   |
| 10.2*  |   | 2004 Stock  Purchase Plan of the Registrant—incorporated by reference to  Exhibit 10.2 to Form 10-K of the Registrant for the year  ended December 31, 2004.                                                                                                             |   |
| 10.3   |   | Loan and Security  Agreement between the Registrant, Coral Blood Services, Inc. and  Comerica Bank dated November 19, 2002—incorporated by reference to  Exhibit 10.2 to Form 10-K of the Registrant for the year  ended December 31, 2002.                    |   |
| 10.4   |   | First  Modification to Loan and Security Agreement between the Registrant, Coral  Blood Services, Inc. and Comerica Bank dated March 22,  2004—incorporated by reference to Exhibit 10.1 of Form 10-Q  of the Registrant for the quarter-ended March 31, 2004. |   |
| 10.5   |   | Second  Modification to Loan and Security Agreement between the Registrant, Coral  Blood Services, Inc. and Comerica Bank dated July 1,  2005—incorporated by reference to Exhibit 10.1 of Form 8-K of  the Registrant dated July 1, 2005.                     |   |
| 10.6   |   | Third  Modification to Loan and Security Agreement between the Registrant, Coral  Blood Services, Inc. and Comerica Bank dated January 31, 2006—incorporated  by reference to Exhibit 99.1 of Form 8-K of the Registrant  filed on February 3, 2006.           |   |

30

----

 

| 10.7*  |   | Employment  Agreement between the Registrant and Joshua Levy dated March 22,  2000—incorporated by reference to Exhibit 10.12 of Form 10-K  of the Registrant for the year ended December 31, 2000.                                                       |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.8*  |   | Employment Letter  between the Registrant and Judi Irving, dated December 6,  2002—incorporated by reference to Exhibit 10.8 to Form 10-K  of the Registrant for the year ended December 31, 2002.                                                        |   |
| 10.9*  |   | Change of Control  Agreement between HemaCare Corporation and Judi Irving, President and Chief  Executive Officer dated June 6, 2005, incorporated by reference to  Exhibit 10.1 to Form 8-K of the Registrant filed on  June 10, 2005.                        |   |
| 10.10* |   | Change of Control  Agreement between HemaCare Corporation and Robert Chilton, Executive Vice  President and Chief Financial Officer, dated June 6, 2005—incorporated  by reference to Exhibit 10.2 to Form 8-K of the Registrant  filed on June 10, 2005. |   |
| 10.11  |   | Master Security  Lease Agreement between the Registrant and GE Capital Healthcare Financial  Services dated December 26, 2002—incorporated by reference to  Exhibit 10.10 to Form 10-K of the Registrant for the year  ended December 31, 2002.           |   |
| 10.12* |   | Employment Letter  between the Registrant and Robert S. Chilton, dated October 3, 2003—incorporated  by reference to Exhibit 10.1 to Form 10-Q of the Registrant  for the quarter ended September 30, 2003.                                               |   |
| 10.13  |   | Lease Agreement  between the Registrant and Gambro BCT, dated December 30, 2003—incorporated  by reference to Exhibit 10.12 to Form 10-K of the Registrant  for the year ended December 31, 2003.                                                         |   |
| 11.    |   | Computation of  earnings (loss) per common equivalent share.                                                                                                                                                                                                                       |   |
| 14.    |   | Code of  Ethics—incorporated by reference to Exhibit 14 to Form 10-K  of the Registrant for the year ended December 31, 2004.                                                                                                                                  |   |
| 16.    |   | Letter from  Ernst & Young LLP, Independent Registered Public Accounting Firm,  regarding change in independent accountants - incorporated by reference to  Exhibit 16.1 to Form 8-K of the Registrant filed  April 9, 2004.                               |   |
| 21.    |   | Subsidiaries of  the Registrant.                                                                                                                                                                                                                                                   |   |
| 23.1   |   | Consent of  Ernst & Young LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                             |   |
| 23.2   |   | Consent of  Stonefield Josephson, Inc., Independent Registered Public Accounting  Firm.                                                                                                                                                                                       |   |
| 31.1   |   | Certification  Pursuant to Rule 13a-14(a) of the Securities Exchange Act of  1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                               |   |
| 31.2   |   | Certification  Pursuant to Rule 13a-14(a) of the Securities Exchange Act of  1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                               |   |
| 32.1   |   | Certification  Pursuant to 18 U.S.C. 1350, Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                |   |

----

*                   Managementcontracts and compensatory plans and arrangements.

+               Filedherewith.

31

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Dated:  March 20,  2006 |   |   |   | **HEMACARE CORPORATION** |
|----------------------------------------|--------|--------|--------|--------------------------|
|                                   |   |   |   | By:                      |   | /s/ ROBERT S. CHILTON |
|                                   |   |   |   |                     |   | Robert S. Chilton, *Chief  Financial Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant in thecapacities indicated on the twentieth day of March, 2006.

|                                  | **Signature** | ** **                                            | ** ** |  | **Title** | ** ** |
|----------------------------------|---------------|-------------------------------------------------------|------------|--|-----------|------------|
| /s/ JULIAN  L. STEFFENHAGEN |          | Chairman of the  Board                                |
| Julian  L. Steffenhagen          |          |                                                  |
| /s/ JUDI  IRVING            |          | President and  Chief Executive Officer and Director   |
| Judi  Irving                     |          | (Principal Executive  Officer)                        |
| /s/ ROBERT  S. CHILTON      |          | Executive Vice  President and Chief Financial Officer |
| Robert  S. Chilton               |          | (Principal Financial and  Accounting Officer)         |
| /s/ STEVEN  GERBER          |          | Director                                              |
| Steven  Gerber                   |          |                                                  |
| /s/ ROBERT  L. JOHNSON      |          | Director                                              |
| Robert  L. Johnson               |          |                                                  |
| /s/ TERRY  VAN DER TUUK     |          | Director                                              |
| Terry Van Der  Tuuk              |          |                                                  |

 

32

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**Indexto Consolidated Financial Statements and Schedules**

| ** **                                                                                | ** ** | Page       | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                                | ** ** | **Number** | ** ** |
| Report of Stonefield Josephson, Inc., Independent  Registered Public Accounting Firm |       |       | F-2        |   |   |
| Report of Ernst & Young LLP, Independent  Registered Public Accounting Firm      |       |       | F-3        |   |   |
| Consolidated  balance sheets                                                              |       |       | F-4        |   |   |
| Consolidated statements of operations                                                     |       |       | F-5        |   |   |
| Consolidated statements of shareholders’ equity                                      |       |       | F-6        |   |   |
| Consolidated statements of cash flows                                                     |       |       | F-7        |   |   |
| Notes to consolidated financial statements                                                |       |       | F-8        |   |   |

 

All schedules are not submitted because either theyare not applicable, not required or because the information required isincluded in the Consolidated Financial Statements, including the notes thereto.

F-1

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**REPORTOF STONEFIELD JOSEPHSON, INC., INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Stockholders of HemaCare Corporation:

We have audited the accompanying consolidated balancesheet of HemaCare Corporation and subsidiaries, as of December 31, 2005 and2004, and the related consolidated statements of operations and shareholder’sequity and cash flows for the two years then ended. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonable assuranceabout whether the financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of HemaCare Corporation and subsidiaries as ofDecember 31, 2005 and 2004, and the results of its operations and its cashflows for the two years then ended in conformity with U.S. generally acceptedaccounting principles.

/s/ Stonefield Josephson, Inc.CERTIFIED PUBLIC ACCOUNTANTS

Los Angeles, CaliforniaFebruary 8, 2006

F-2

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**REPORTOF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Shareholders of HemaCare Corporation:

We have audited the accompanying consolidatedstatements of operations, shareholders’ equity, and cash flows of HemaCareCorporation (a California Corporation) and subsidiaries for the year ended December 31,2003. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged toperform an audit of the Company’s internal control over financial reporting. Ouraudit included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audit provides a reasonable basisfor our opinion.

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated results of its operations and its cash flows for theyear ended December 31, 2003, in conformity with U.S. generally acceptedaccounting principles.

/s/ ERNST & YOUNG LLP

Los Angeles, CaliforniaFebruary 17, 2004

F-3

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**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                    | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                    | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| **Assets**                                                                                                                    | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current assets:                                                                                                               |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                     |       | $                     | 2,612,000  |                  | $          | 2,082,000 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $85,000 in 2005  and $153,000 in 2004                         |       | 3,927,000             |       | 3,378,000             |       |
| Product inventories and supplies                                                                                              |       | 675,000               |       | 566,000               |       |
| Prepaid expenses                                                                                                              |       | 350,000               |       | 401,000               |       |
| Other receivables                                                                                                             |       | 145,000               |       | 110,000               |       |
| Total current assets                                                                                                          |       | 7,709,000             |       | 6,537,000             |       |
| Plant and equipment, net of accumulated depreciation  and amortization of $3,945,000 in 2005 and $3,470,000 in 2004           |       | 2,703,000             |       | 2,778,000             |       |
| Other assets                                                                                                                  |       | 134,000               |       | 29,000                |       |
|                                                                                                                          |       | $                     | 10,546,000 |                  | $          | 9,344,000 |   |
| **Liabilities and Shareholders’ Equity**                                                                                 | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                          |       |                  |       |                  |       |
| Accounts payable                                                                                                              |       | $                     | 1,791,000  |                  | $          | 1,730,000 |   |
| Accrued payroll and payroll taxes                                                                                             |       | 1,389,000             |       | 1,175,000             |       |
| Other accrued expenses                                                                                                        |       | 290,000               |       | 274,000               |       |
| Current obligations under capital leases                                                                                      |       | 81,000                |       | 253,000               |       |
| Current obligations under notes payable                                                                                       |       | —                |       | 37,000                |       |
| Total current liabilities                                                                                                     |       | 3,551,000             |       | 3,469,000             |       |
| Obligations under capital leases, net of current  portion                                                                     |       | 7,000                 |       | 701,000               |       |
| Notes payable,  net of current portion                                                                                        |       | —                |       | 2,000                 |       |
| Other long-term  liabilities                                                                                                  |       | —                |       | 5,000                 |       |
| Shareholders’ equity:                                                                                                    |       |                  |       |                  |       |
| Common stock, no par value—20,000,000 shares  authorized, 8,196,060 issued and outstanding in 2005 and 8,064,060 in 2004 |       | 13,696,000            |       | 13,530,000            |       |
| Accumulated deficit                                                                                                           |       | (6,708,000            | )          | (8,363,000            | )          |
| Total shareholders’ equity                                                                                               |       | 6,988,000             |       | 5,167,000             |       |
|                                                                                                                          |       | $                     | 10,546,000 |                  | $          | 9,344,000 |   |

 

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

F-4

----

**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONSFor the Years Ended December 31,**

| ** **                                        | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenues                                          |       |       |       |       |       |       |       |
| Blood products                                    |       | $          | 24,552,000 |       | $          | 19,345,000 |       | $ | 20,030,000 |   |
| Blood services                                    |       | 6,675,000  |       | 7,491,000  |       | 7,458,000  |       |
| Total revenue                                     |       | 31,227,000 |       | 26,836,000 |       | 27,488,000 |       |
| Operating costs  and expenses                     |       |       |       |       |       |       |       |
| Blood products                                    |       | 19,503,000 |       | 15,954,000 |       | 20,169,000 |       |
| Blood services                                    |       | 5,148,000  |       | 5,066,000  |       | 5,068,000  |       |
| Total operating costs and expenses                |       | 24,651,000 |       | 21,020,000 |       | 25,237,000 |       |
| Gross profit                                      |       | 6,576,000  |       | 5,816,000  |       | 2,251,000  |       |
| General and administrative expenses               |       | 4,890,000  |       | 4,420,000  |       | 3,946,000  |       |
| Income (loss) from operations                     |       | 1,686,000  |       | 1,396,000  |       | (1,695,000 | )          |
| Other income                                      |       | —     |       | 167,000    |       | —     |       |
| Income (loss)  before income taxes                |       | 1,686,000  |       | 1,563,000  |       | (1,695,000 | )          |
| Provision for  income taxes                       |       | 31,000     |       | 18,000     |       | 2,984,000  |       |
| Net income (loss)                                 |       | $          | 1,655,000  |       | $          | 1,545,000  |       | $ | (4,679,000 | ) |
| Income (loss) per  share                          |       |       |       |       |       |       |       |
| Basic                                             |       | $          | 0.20       |       | $          | 0.20       |       | $ | (0.60 | ) |
| Diluted                                           |       | $          | 0.19       |       | $          | 0.19       |       | $ | (0.60 | ) |
| Weighted average  shares outstanding—basic   |       | 8,121,000  |       | 7,831,000  |       | 7,753,000  |       |
| Weighted average  shares outstanding—diluted |       | 8,847,000  |       | 8,237,000  |       | 7,753,000  |       |

 

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

F-5

----

**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF SHAREHOLDERS’ EQUITYFor the Years Ended December 31, 2005, 2004, and 2003**

| ** **                                                     | ** ** | **Common Stock** | ** ** | **Accumulated** | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|
| ** **                                                     | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| Balance as of  December 31, 2002                          |       | 7,751,000             |       | $               | 13,316,000 |   | $ | (5,229,000 | ) | $ | 8,087,000 |   |
| Stock options exercised                                        |       | 5,000                 |       | 3,000           |       | — |   | 3,000 |   |
| Net Loss                                                       |       | —                |       | —          |       | (4,679,000 | ) | (4,679,000 | ) |
| Balance as of  December 31, 2003                          |       | 7,756,000             |       | $               | 13,319,000 |   | $ | (9,908,000 | ) | $ | 3,411,000 |   |
| Stock options exercised                                        |       | 153,000               |       | 81,000          |       | — |   | 81,000 |   |
| Issuance of  common stock through Employee Stock Purchase Plan |       | 155,000               |       | 130,000         |       |   |   | 130,000 |   |
| Net Income                                                     |       | —                |       | —          |       | 1,545,000 |   | 1,545,000 |   |
| Balance as of  December 31, 2004                          |       | 8,064,000             |       | $               | 13,530,000 |   | $ | (8,363,000 | ) | $ | 5,167,000 |   |
| Stock options exercised                                        |       | 52,000                |       | 34,000          |       | — |   | 34,000 |   |
| Issuance of  common stock through Employee Stock Purchase Plan |       | 80,000                |       | 132,000         |       |   |   | 132,000 |   |
| Net Income                                                     |       | —                |       | —          |       | 1,655,000 |   | 1,655,000 |   |
| Balance as of  December 31, 2005                          |       | 8,196,000             |       | $               | 13,696,000 |   | $ | (6,708,000 | ) | $ | 6,988,000 |   |

 

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

F-6

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**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF CASH FLOWSFor the Years Ended December 31,**

| ** **                                                                                   | ** ** | **2005**  | ** ** | **2004**   | ** ** | **2003**  | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|
| Cash flows from  operating activities:                                                       |       |      |       |       |       |      |       |
| Net income (loss)                                                                            |       | $         | 1,655,000  |       | $          | 1,545,000 |       | $ | (4,679,000 | ) |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |      |       |       |       |      |       |
| (Recovery) provision for bad debts                                                           |       | (1,000    | )          | 9,000      |       | 309,000   |       |
| Use of deferred tax assets                                                                   |       | —    |       | —     |       | 2,984,000 |       |
| Depreciation and amortization                                                                |       | 672,000   |       | 651,000    |       | 717,000   |       |
| Loss (gain) on disposal of assets                                                            |       | 6,000     |       | 25,000     |       | (11,000   | )          |
| Impairment of assets                                                                         |       | —    |       | —     |       | 446,000   |       |
| Changes in operating  assets and liabilities:                                                |       |      |       |       |       |      |       |
| (Increase) decrease in accounts receivable, net                                              |       | (548,000  | )          | (259,000   | )          | 1,495,000 |       |
| (Increase) decrease in inventories, supplies and  prepaid expenses                           |       | (58,000   | )          | 103,000    |       | 338,000   |       |
| (Increase) decrease in other assets                                                          |       | (140,000  | )          | (77,000    | )          | 31,000    |       |
| Increase (decrease) in accounts payable, accrued  expenses and other liabilities             |       | 286,000   |       | 328,000    |       | (869,000  | )          |
| Net cash provided by operating activities                                                    |       | 1,872,000 |       | 2,325,000  |       | 761,000   |       |
| Cash flows from  investing activities:                                                       |       |      |       |       |       |      |       |
| Proceeds from sale of plant and equipment                                                    |       | 13,000    |       | 17,000     |       | 79,000    |       |
| Proceeds from note receivable                                                                |       | —    |       | 20,000     |       | —    |       |
| Purchase of plant and equipment                                                              |       | (616,000  | )          | (213,000   | )          | (270,000  | )          |
| Net cash used in investing activities                                                        |       | (603,000  | )          | (176,000   | )          | (191,000  | )          |
| Cash flows from  financing activities:                                                       |       |      |       |       |       |      |       |
| Proceeds from exercise of stock options                                                      |       | 34,000    |       | 80,000     |       | 3,000     |       |
| Proceeds from sale of common stock                                                           |       | 132,000   |       | 130,000    |       | —    |       |
| Principal payments on debt and capitalized leases                                            |       | (905,000  | )          | (1,212,000 | )          | (686,000  | )          |
| Net cash used in financing activities                                                        |       | (739,000  | )          | (1,002,000 | )          | (683,000  | )          |
| Increase (decrease) in cash and cash equivalents                                             |       | 530,000   |       | 1,147,000  |       | (113,000  | )          |
| Cash and cash  equivalents at beginning of period                                            |       | 2,082,000 |       | 935,000    |       | 1,048,000 |       |
| Cash and cash  equivalents at end of period                                                  |       | $         | 2,612,000  |       | $          | 2,082,000 |       | $ | 935,000 |   |
| Supplemental  disclosure:                                                                    |       |      |       |       |       |      |       |
| Interest paid                                                                                |       | $         | 29,000     |       | $          | 95,000    |       | $ | 79,000 |   |
| Income taxes (refunded) paid                                                                 |       | $         | (100,000   | )          | $          | 117,000   |       | $ | 18,000 |   |
| Items not  impacting cash flows:                                                             |       |      |       |       |       |      |       |
| Purchase of equipment—Capital lease                                                     |       | $         | —     |       | $          | —    |       | $ | 932,000 |   |
| Insurance  premiums financed                                                                 |       | $         | —     |       | $          | 188,000   |       | $ | 130,000 |   |

 

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

F-7

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**HEMACARE CORPORATIONNOTES TO CONSOLIDATEDFINANCIAL STATEMENTSDECEMBER 31, 2005**

***Note 1—Organization***

HemaCare Corporation is inthe business of providing blood products and blood services to hospitals andmedical centers primarily in California and on the East Coast.

***Note 2—Summary of Accounting Policies***

*Principlesof Consolidation:*   The accompanying consolidatedfinancial statements include the accounts of the Company and its subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

*Useof Estimates:*   The preparation of financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements. Estimates also affectthe reported amounts of revenue and expenses during the reporting period. Actualresults could differ from those estimates.

*Cashand Cash Equivalents:*   The Company considers allhighly liquid investments with an original maturity of three months or less tobe cash equivalents.

*FinancialInstruments:**  *Cash andcash equivalents, accounts receivable and accounts payable are carried at cost,which approximates fair value. The interest rate applied to capital leases isbased upon the Company’s borrowing rate, and therefore their carrying valueapproximates fair value.

*Revenuesand Accounts Receivable:**  *Revenuesare recognized upon acceptance of the blood products or the performance ofblood services. Blood services revenues consist primarily of mobiletherapeutics sales, while blood products revenues consist primarily of sales ofsingle donor platelets and whole blood components that are manufactured orpurchased and distributed by the Company. Accounts receivable are reviewedperiodically for collectibility.

*Inventoriesand Supplies:*   Inventories consist ofCompany-manufactured platelets and whole blood components as well as componentblood products purchased for resale. Supplies consist primarily of medicalsupplies used to collect and manufacture products and to provide therapeutic services.Inventories are stated at the lower of cost or market and are accounted for ona first-in, first-out basis.

Inventoriesare comprised of the following as of December 31,

| ** **     | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| Blood products |       | $        | 154,000    |     | $          | 120,000 |   |
| Supplies       |       | 521,000  |       | 446,000  |       |
|           |       | $        | 675,000    |     | $          | 566,000 |   |

 

*Plantand Equipment:*   Plant and equipment are stated atoriginal cost. Furniture, fixtures, equipment and vehicles are depreciatedusing the straight-line method over two to ten years. Leasehold improvementsare amortized over the lesser of their useful life or the length of the lease,ranging from three to five years. The cost of normal repairs and maintenanceare expensed as incurred.

F-8

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*Long-livedAssets:**  *Alllong-lived assets are reviewed for impairment in value when changes incircumstances dictate, based upon undiscounted future operating cash flows, andappropriate losses are recognized and reflected in current earnings, to theextent the carrying amount of an asset exceeds its estimated fair valuedetermined by the use of appraisals, discounted cash flow analyses or comparablefair values of similar assets.

*OtherIncome:**  *In thirdquarter of 2004, the Company received a refund from Gambro BCT (“Gambro”), oneof the Company’s largest suppliers, as a result of an audit by the CaliforniaBoard of Equalization of Gambro’s sales tax records. Gambro communicated to theCompany that the results of this audit indicated that the Company over paidpreviously paid sales taxes. The amount of this refund is $167,000 and isincluded in the Consolidated Statement of Operations as Other Income.

*IncomeTaxes:*   Income taxes are computed under theprovisions of SFAS No. 109, “Accounting for Income Taxes.”  SFAS No. 109 provides for an asset andliability approach that requires the recognition of deferred tax assets andliabilities for the expected future tax consequences of events that have beenrecognized in the Company’s financial statements or tax returns. In estimatingfuture tax consequences, SFAS No. 109 generally considers all expectedfuture events other than enactments of changes in the tax law or rates. In2003, the Company determined that it was more likely than not that the deferredtax assets on the balance sheet would not be used against future possibleincome. Therefore, the Company recorded a valuation reserve equivalent to 100%of the value of the available deferred tax assets. This resulted in a charge tothe provision for income taxes of $2,984,000 in 2003. As of December 31,2005, the Company maintained a 100% valuation reserve on the available deferredtax assets.

*PerShare Data:*   Earnings per share-basic is computedby dividing net income by the weighted average shares outstanding. Earnings pershare-diluted is computed by dividing net income by the weighted average numberof shares outstanding including the diluted effect of options and warrants.

*InterestExpense:*   During the three years ended December 31,2005, 2004, and 2003, the Company incurred interest expense of $29,000,$95,000, and $79,000, respectively.

*Reclassification:*   Certainprior year amounts have been reclassified to conform to the current yearpresentation.

*EmployeeStock Option Plan:*   The Company accounts for its employee stock option planunder the recognition and measurement principles of Accounting Principles Board(“APB”) No. 25, “Accounting for Stock Issued to Employees,” and relatedInterpretations. Under APB No. 25, no stock-based compensation isreflected in net income, as all options granted under the plans had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant and the related number of shares granted is fixed at that point in time.

TheCompany has elected to adopt SFAS No. 123, “Accounting for Stock-BasedCompensation,” for disclosure purposes only and applies the provisions of APBOpinion No. 25. The Company did not recognize any compensation expenserelated to the issuance of stock options in 2005, 2004 or 2003. Hadcompensation expense or all options granted to employees been recognized inaccordance with SFAS No. 123, the Company’s net income and net income (loss)per share would have been as follows:

| ** **                                     | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)  as reported                 |       | $                                           | 1,655,000  |   | $ | 1,545,000 |   | $ | (4,679,000 | ) |
| Pro forma net  income (loss)                   |       | $                                           | 1,475,000  |   | $ | 1,497,000 |   | $ | (4,753,000 | ) |
| Basic income  (loss) per share as reported     |       | $                                           | 0.20       |   | $ | 0.20 |   | $ | (0.60 | ) |
| Diluted income  (loss) per share as reported   |       | $                                           | 0.19       |   | $ | 0.19 |   | $ | (0.60 | ) |
| Pro forma basic  net income (loss) per share   |       | $                                           | 0.18       |   | $ | 0.19 |   | $ | (0.61 | ) |
| Pro forma diluted net  income (loss) per share |       | $                                           | 0.17       |   | $ | 0.18 |   | $ | (0.61 | ) |

 

F-9

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Theabove pro forma amounts were calculated by estimating the fair value of eachoption or warrant granted on the date of grant using the Black-Scholesoption-pricing model as follows:

| ** **           | ** ** | **Years ended December 31,** | ** ** |
|----------------------|------------|---------------------------------------------|------------|
| ** **           | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected life        |       | 5.5 Years                                   |       | 6 Years |   | 4 Years |   |
| Expected  volatility |       | 94                                          | %          | 107 | % | 113 | % |
| Interest rate        |       | 4.0                                         | %          | 4.0 | % | 3.6 | % |
| Dividend yield       |       | 0                                           | %          | 0 | % | 0 | % |

 

*Recent AccountingPronouncements:*

In June 2005,the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Forcereached a consensus on Issue No. 05-6, Determining the AmortizationPeriod for Leasehold Improvements (“EITF 05-6”). The guidance requiresthat leasehold improvements acquired in a business combination or purchasedsubsequent to the inception of a lease be amortized over the lesser of theuseful life of the assets or a term that includes renewals that are reasonablyassured at the date of the business combination or purchases. The guidance iseffective for periods beginning after June 29, 2005. The Company’sadoption of EITF 05-6 did not have a significant effect on its financialstatements.

In May 2005, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 154, Accounting Changes andError Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3(“SFAS No.154”). SFAS No. 154 requires retrospective application to priorperiods’ financial statements for changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS No. 154 also requires that retrospectiveapplication of a change in accounting principle be limited to the directeffects of the change. Indirect effects of a change in accounting principle,such as a change in non-discretionary profit-sharing payments resulting from anaccounting change, should be recognized in the period of the accounting change.SFAS No. 154 also requires that a change in depreciation, amortization, ordepletion method for long-lived non-financial assets be accounted for as achange in accounting estimate affected by a change in accounting principle.SFAS No. 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005. Early adoption ispermitted for accounting changes and corrections of errors made in fiscal yearsbeginning after the date this statement was issued. The Company’s adoption ofSFAS No. 154 is not expected to have a material effect on the Company’sfinancial position or results of operations.

In December 2004, the FASB issued SFAS No. 153,Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29 (“SFASNo. 153”). The guidance in APB Opinion No. 29, Accounting forNonmonetary Transactions, is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of assetsexchanged. The guidance in that Opinion, however, included certain exceptionsto that principle. This Statement amends APB Opinion No. 29 to eliminatethe exception for nonmonetary exchanges of similar productive assets that donot have commercial substance. A nonmonetary exchange has commercial substanceif the future cash flows of the entity are expected to change significantly asa result of the exchange. SFAS No. 153 is effective for nonmonetaryexchanges occurring in fiscal periods beginning after June 15, 2005. TheCompany’s adoption of SFAS No. 153 is not expected to have a material impacton the Company’s financial position and results of operations.

In December 2004,the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”).SFAS No. 123(R) revises FASB Statement No. 123, Accounting forStock-Based Compensation (“SFAS No. 123”), and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and its related implementationguidance. The Statement focuses primarily on accounting for transactions inwhich an entity obtains employee or director services in share-based paymenttransactions. 

F-10

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TheStatement requires a public entity to measure the cost of employee or directorservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award (with limited exceptions). That cost will berecognized over the period during which an employee or director is required toprovide service in exchange for the award—the requisite service period (usuallythe vesting period). The cost of employee or director services received shallbe measured at its then current fair value and then remeasured at fair value ateach reporting date through the settlement date. Changes in fair value duringthe requisite service period will be recognized as compensation cost over thatperiod. The Statement is effective as of the beginning of the first interim orannual reporting period that begins after June 15, 2005. The Statementalso requires that, as of the required effective date, all public entities thatused the fair-value based method for either recognition or disclosure underSFAS No. 123 shall apply the modified prospective application transitionmethod. For periods before the required effective date, public entities mayelect to apply the modified retrospective application transition method. TheCompany anticipates adopting SFAS No. 123(R) beginning in the quarterending March 31, 2006 using the modified prospective applicationtransition method. Under that method, the provisions of the Statement apply tonew awards and to awards modified, repurchased or cancelled after the requiredeffective date. Additionally, compensation cost for the portion of awards forwhich the requisite service has not been rendered that are outstanding as ofthe required effective date shall be recognized as the requisite service isrendered on or after the required effective date.  In March 2005, the SEC issued StaffAccounting Bulletin Number 107 (“SAB 107”) that provided additional guidance topublic companies relating to share-based payment transactions and theimplementation of SFAS 123 (R), including guidance regarding valuation methodsand related assumptions, classification of compensation expense and income taxeffects of share-based payment arrangements. Based on unvested stock optiongrants outstanding at December 31, 2005, management estimates that theimpact from adopting SFAS No. 123 (R) together with the guidanceprovided by SAB 107 will reduce net income or increase net loss byapproximately $56,000 for the year ending December 31, 2006.

In November 2004, theFASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,Chapter 4 (“SFAS No. 151”). This statement amends the guidance in ARB No. 43,Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts ofidle facility expense, freight, handling costs, and wasted material (spoilage).Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “...undersome circumstances, items such as idle facility expense, excessive spoilage,double freight, and rehandling costs may be so abnormal as to require treatmentas current period charges...” SFAS No. 151 requires that those items berecognized as current-period charges regardless of whether they meet thecriterion of “so abnormal.” In addition, this statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. The provisions of SFAS No. 151shall be applied prospectively and are effective for inventory costs incurredduring fiscal years beginning after June 15, 2005, with earlierapplication permitted for inventory costs incurred during fiscal yearsbeginning after the date this statement is issued. The Company’s adoption ofSFAS No. 151 is not expected to have a material impact on the Company’sfinancial position and results of operations.

***Note 3—Allowance forDoubtful Accounts***

The Company periodically reviews the outstandingbalances owed by its customers. Generally, the Company recognizes an allowancefor doubtful accounts for any balances owed that are 90 days or more past due. Inaddition, balances less than 90 days past due are reserved based on the Company’srecent bad debt experience.

A decrease of $68,000 wasreflected in the allowance for doubtful accounts, improving from prior yearresults. Increases to the allowance for doubtful accounts totaled $10,000 and,$309,000 for the years ended December 31, 2004 and 2003 respectively.Write-offs against the allowance for doubtful accounts totaled $67,000,$208,000 and $165,000 for the years ended December 31, 2005, 2004 and2003, respectively.

F-11

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***Note 4—Plant and Equipment***

Plantand equipment consists of the following:

| ** **                                      | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Furniture,  fixtures and equipment              |       | $                                           | 6,122,000  |   | $ | 5,778,000 |   |
| Leasehold  improvements                         |       | 526,000                                     |       | 470,000 |   |
|                                            |       | 6,648,000                                   |       | 6,248,000 |   |
| Less accumulated  depreciation and amortization |       | (3,945,000                                  | )          | (3,470,000 | ) |
|                                            |       | $                                           | 2,703,000  |   | $ | 2,778,000 |   |

 

Depreciation expense for2005, 2004, and 2003 was $662,000, $651,000, and $717,000, respectively.

***Note 5—Line of Credit and Notes Payable***

The Company, together with Coral Blood Services, Inc.,a subsidiary, has a working capital line of credit with Comerica Bank—California.This credit facility originally was scheduled to terminate as of June 30,2005; however, on July 1, 2005, the Company, Coral Blood Services, Inc.and Comerica Bank entered into an amendment to the credit facility to extendthe term of the facility to June 30, 2007. In addition, this amendmentaltered the interest rate calculation, established a $50,000 maximum limit forpurchasing or disposing of assets without Comerica Bank’s approval, and removedthe restriction in the agreement on the Company’s ability to purchase, acquire,repurchase, retire or redeem any of the Company’s capital stock. As of July 1,2005, the amount the Company may borrow is the lesser of: 75% of eligibleaccounts receivable or $2 million. Interest is payable monthly at a rate ofprime minus 0.25%; as of December 31, 2005 the rate associated with thisnote was 7.0%. In addition, the Company has the option to draw against this facilityfor thirty (30), sixty (60), or ninety (90) days using LIBOR as the relevantrate of interest. As of December 31, 2005, the Company had no netborrowing on this line of credit, and the Company had unused availability of$2,000,000.

The Comerica loan is collateralized by substantiallyall of the Company’s assets and requires the maintenance of certain financialcovenants that among other things require minimum levels of profitability andprohibits the payment of dividends. As of December 31, 2005 the Companywas in full compliance with all of the financial covenants. During 2005, theCompany did not incur any interest expense associated with the Comerica loan.

In addition, the Companyhad a note payable with One Source Financial. During the fourth quarter of2005, the Company paid all of the remaining unpaid balance on this note,totaling $12,000. The note was due in full on January 25, 2006 and had afixed interest of 8.5%.

***Note 6—Leases***

TheCompany has entered into various capital leases for equipment, expiring onvarious dates through 2009.

| ** **                | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------|------------|---------------------------------------------|------------|
| ** **                | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
| Equipment                 |       | $                                           | 301,000    |   | $ | 1,317,000 |   |
| Accumulated  Depreciation |       | (106,000                                    | )          | (181,000 | ) |
|                      |       | $                                           | 195,000    |   | $ | 1,136,000 |   |

 

The Company had a capital equipment lease with GambroBCT to finance the acquisition of equipment used in the Company’s apheresisactivities. During the third quarter of 2005, the Company paid 

F-12

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all of the remainingunpaid balance on this capital lease, totaling $703,000. The lease wasscheduled to mature in December 2008 and had a fixed interest rate of 7.5%.The lease was secured by all of the equipment purchased through the leasefinancing.

The Company also has a capital equipment lease with GECapital Healthcare Financial Services used to finance the acquisition ofvehicles. As of December 31, 2005, the balance outstanding on this leasewas $86,000, of which approximately $79,000 is included in current obligations.This lease is secured by five mobile blood collection vehicles, and is scheduledto mature in January 2007, and has a fixed interest rate of 8.0%.

The Company had a capital equipment lease with DellFinancial Services associated with the acquisition of computer equipment. Duringthe third quarter of 2005, the Company paid all of the remaining unpaid balanceon this capital lease, totaling $2,000. This lease was scheduled to mature in August 2005,and had a fixed interest rate of 12.6%.

Finally, the Company has a capital equipment leasewith Toshiba Financial Services associated with the acquisition of photocopierequipment. As of December 31, 2005, the balance outstanding on this leasewas $3,000, all of which is included in current obligations. This lease isscheduled to terminate in May 2006.

TheCompany leases its facilities and certain equipment under operating leases thatexpire through the year 2007. Future minimum rentals under capitalized andoperating leases are as follows:

| **Years ending December 31,** | ** ** | ** ** | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|----------------------------------------------|------------|------------|------------|-------------|------------|---------------|------------|
| 2006                                         |       | $          | 85,000     |        | $          | 298,000       |       |
| 2007                                         |       | 7,000      |       | 74,000      |       |
| 2008                                         |       | 0          |       | 25,000      |       |
| 2009                                         |       | 0          |       | 7,000       |       |
| Thereafter                                   |       | 0          |       | 6,000       |       |
| Total:                                       |       | 92,000     |       | $           | 410,000    |          |
| Less: Interest                               |       | (4,000     | )          |        |       |
| Principal value  and taxes                   |       | 88,000     |       |        |       |
| Less: Current  portion                       |       | (81,000    | )          |        |       |
|                                         |       | $          | 7,000      |        |       |          |

 

Total rent expense under all operating leases was$693,000, $645,000, and $971,000, for the years ended December 31, 2005,2004, and 2003, respectively.

Most of the operating leases for facilities includeoptions to renew the lease at the then current fair market value for periods ofone to five years. Additionally, the Company’s facility in Sherman Oaks iscurrently operating on a month-to-month basis. In most cases, managementexpects that in the normal course of business, leases will be renewed orreplaced by other leases.

F-13

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***Note 7—Income Taxes***

Theprovision for income taxes for the years ended December 31, 2005, 2004,and 2003 are as follows:

| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**  | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Current taxes:              |       |     |       |     |       |      |       |
| Federal                     |       | $        | 21,000     |     | $          | 19,000    |       | $ | — |   |
| State                       |       | 10,000   |       | 9,000    |       | 2,000     |       |
|                        |       | $        | 31,000     |     | $          | 28,000    |       | $ | 2,000 |   |
| Deferred taxes:             |       |     |       |     |       |      |       |
| Federal                     |       | —   |       | —   |       | 2,647,000 |       |
| State                       |       | —   |       | (10,000  | )          | 335,000   |       |
|                        |       | —   |       | (10,000  | )          | 2,982,000 |       |
| Provision for income  taxes |       | $        | 31,000     |     | $          | 18,000    |       | $ | 2,984,000 |   |

 

Differencesbetween the provision for income taxes and income taxes at statutory federalincome tax rate for the years ended December 31, 2005, 2004, and 2003 areas follows:

| ** **                                    | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003**  | ** ** |
|-----------------------------------------------|------------|------------|------------|----------|------------|-----------|------------|
| Income tax  expense at federal statutory rate |       | $          | 573,000    |     | $          | 536,000   |       | $ | (576,000 | ) |
| State income  taxes, net of federal benefit   |       | 56,000     |       | 53,000   |       | (18,000   | )          |
| Change in  valuation allowance                |       | (1,127,000 | )          | (71,000  | )          | 3,540,000 |       |
| Permanent  differences                        |       | 8,000      |       | 7,000    |       | 9,000     |       |
| Change in  deferred tax asset and other       |       | 521,000    |       | (507,000 | )          | 29,000    |       |
| Income tax  expense                           |       | $          | 31,000     |     | $          | 18,000    |       | $ | 2,984,000 |   |

 

TheCompany has recorded no net deferred tax asset at December 31, 2005 and2004. The components of the net deferred tax asset at December 31, 2005,2004 and 2003 are as follows:

| ** **                                              | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------|------------|
| *Current:*                                              |       |       |       |       |       |
| Accounts  receivable reserve                            |       | $          | 33,000     |       | $          | 60,000 |   |
| Accrued expenses  and other                             |       | 276,000    |       | 276,000    |       |
| Total deferred  tax asset                               |       | 309,000    |       | 336,000    |       |
| *Noncurrent:*                                           |       |       |       |       |       |
| Net operating  loss carryforward                        |       | 1,688,000  |       | 2,513,000  |       |
| Depreciation and  amortization                          |       | 152,000    |       | 138,000    |       |
| Contribution  Carryover                                 |       | 16,000     |       | —     |       |
| Tax credit  carryforward                                |       | 703,000    |       | 1,332,000  |       |
| Other (Tax effect  of State Benefit ($348,000) in 2004) |       | (139,000   | )          | (308,000   | )          |
| Valuation  allowance                                    |       | (2,729,000 | )          | (4,011,000 | )          |
|                                                    |       | (309,000   | )          | (336,000   | )          |
|                                                    |       | $          | —     |       | $          | — |   |

 

A valuation allowance is recorded if the weight ofavailable evidence suggests it is more likely than not that some portion or theentire deferred tax asset will not be recognized. The Company determined at theend of 2005 that, based on recent historical and expected future operating results,it is more likely than not that the Company will not be able to realize asignificant portion of its deferred tax assets. Therefore, the Company recordeda 100% valuation reserve against all of the deferred tax assets.

F-14

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At December 31, 2005, the Company had netoperating loss carryforwards available for federal tax purposes totaling$5,000,000 which are not subject to expiration until 2012. At December 31,2005, the Company had federal and state income tax credit carryforwards ofapproximately $500,000 and $205,000, respectively, which are not subject toexpiration until 2010.

Acquisitions of commonstock, which result in changes in equity ownership in the Company, could resultin an “ownership change” within the meaning of Section 382 of the InternalRevenue Code of 1986, as amended (the “Code”), thereby imposing an annuallimitation (the “Section 382 Limitation”) on the Company’s ability toutilize its net operating loss carryforwards to reduce future taxable income. Inthe event of a Section 382 Limitation, the Company’s utilization of itsnet operating loss carryforwards would be restricted.

***Note 8—Shareholders’Equity***

**Stock Options**

In July 1996, the Company’s Board of Directorsapproved and adopted a stock incentive plan, which provides for grants of bothstock options and shares of restricted stock. A total of 2,500,000 shares maybe granted under the terms of the 1996 Plan. The term of the options granted isdetermined by the Company’s Board of Directors, but in no event may be longerthan ten years. The exercise price of options granted generally is required tobe not less than the fair market value of the common stock on the date ofgrant. Options granted to employees generally vest at a rate of at least 20%per year.

Thetable below summarizes stock option transactions.

| ** **                        | ** ** | **2005**   | ** ** | **2004**  | ** ** | **2003**   | ** ** |
|-----------------------------------|------------|------------|------------|-----------|------------|------------|------------|
| ** **                        | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of year |       | 1,216,000  |       | $         | 0.85       |       | 1,379,000  |   | $ | 0.91 |   | 1,264,000 |   | $ | 0.96 |   |
| Granted                           |       | 340,000    |       | $         | 1.41       |       | 200,000    |   | $ | 0.46 |   | 330,000 |   | $ | 0.74 |   |
| Exercised                         |       | (52,000    | )          | $         | (0.65      | )          | (153,000   | ) | $ | (0.53 | ) | (5,000 | ) | $ | (0.63 | ) |
| Canceled                          |       | (3,000     | )          | $         | (1.09      | )          | (210,000   | ) | $ | (0.96 | ) | (210,000 | ) | $ | (1.06 | ) |
| Outstanding at  end of year       |       | 1,501,000  |       | $         | 0.99       |       | 1,216,000  |   | $ | 0.85 |   | 1,379,000 |   | $ | 0.91 |   |
| Exercisable at end of  year       |       | 1,123,000  |       | $         | 1.01       |       | 896,000    |   | $ | 0.95 |   | 915,000 |   | $ | 0.95 |   |

 

Thefollowing table summarizes the range of exercise price, weighted averageremaining contractual life (“Life”) and weighted average exercise price (“Price”)for all stock options outstanding as of December 31, 2005:

| ** **                                 | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Exercise Price** | ** ** | ** **                   | ** ** | **Shares**                   | ** ** | **Life** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| $0.32 to $0.75                             |       | 691,000                      |       | 5.5 years                    |       | $ | 0.51 |   | 546,000 |   | $ | 0.53 |   |
| $0.76 to $1.50                             |       | 670,000                      |       | 5.5 years                    |       | $ | 1.22 |   | 446,000 |   | $ | 1.20 |   |
| $1.51 to $2.44                             |       | 140,000                      |       | 4 years                      |       | $ | 2.27 |   | 131,000 |   | $ | 2.31 |   |
|                                       |       | 1,501,000                    |       |                         |       | $ | 0.99 |   | 1,123,000 |   | $ | 1.01 |   |
|                                            |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |

 

**Warrants**

At December 31, 2005,2004, and 2003, the Company had a total of 270,000 warrants to purchase commonstock outstanding in each respective year, at weighted average exercise pricesof $0.64, respectively. All of the warrants outstanding for all periods wereexercisable. The weighted average lives for warrants outstanding at December 31,2005 are .74 years.

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***Note 9—Earnings per Share***

Thefollowing table provides the calculation methodology for the numerator anddenominator for earnings per share:

| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                             |       | $                                           | 1,655,000  |   | $ | 1,545,000 |   | $ | (4,679,000 | ) |
| Weighted average shares outstanding           |       | 8,121,000                                   |       | 7,831,000 |   | 7,753,000 |   |
| Net effect of  diluted options and warrants   |       | 726,000                                     |       | 406,000 |   | — |   |
| Weighted average  dilutive shares outstanding |       | 8,847,000                                   |       | 8,237,000 |   | 7,753,000 |   |
| Earnings (loss)  per share diluted            |       | $                                           | 0.19       |   | $ | 0.19 |   | $ | (0.60 | ) |

 

Warrants and options topurchase 1,649,000 shares of common stock were excluded from the 2003computation of diluted earnings per share because the Company incurred a lossin that year. They were anti-dilutive.

***Note 10—Concentration of Credit Risk***

The Company maintains cashbalances at various financial institutions. Deposits not exceeding $100,000 foreach institution are insured by the Federal Deposit Insurance Corporation. At December 31,2005 and December 31, 2004, the Company had uninsured cash and cashequivalents of $2,401,000 and $1,864,000, respectively.

***Note 11—401(k) Profit Sharing Plan***

HemaCare’s 401(k) ProfitSharing Plan (the “401(k) Plan”) qualifies, in form, under Section 401(k) ofthe Internal Revenue Code. The Company did not make any contributions to the401(k) Plan pertaining to the 2003 plan year. For the 2004 plan year, theCompany contributed cash in 2005 in the amount of $89,000 as matchingcontributions. In late 2005, the Board of Directors approved a matchingcontribution pertaining to the 2005 plan year of approximately $100,000.

***Note 12—Commitments and Contingencies***

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

Healthcare reform is continuously under considerationby lawmakers, and it is not certain as to what changes may be made in thefuture regarding health care policies. However, policies regardingreimbursement, universal health insurance and managed competition maymaterially impact the Company’s operations.

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

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***Note 13—SegmentInformation***

The Companyoperates in two business segments as follows:

·       BloodProducts: Collection, processing and distribution of blood products.

·       BloodServices: Therapeutic apheresis and stem cell collection procedures and othertherapeutic services provided to patients.

Managementuses more than one criterion to measure segment performance. However, thedominant measurements are consistent with the Company’s consolidated financialstatements which present revenue from external customers and operating profitincome for each segment. Supplemental data are as follows:

| ** **                     | ** ** | **Blood Products** | ** ** | **Blood Services** | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **2005**                       |       |                    |       |                    |       |   |   |   |   |
| Depreciation and  amortization |       |                    | $          | 513,000                 |       |   |   | $ | 34,000 |   |   |
| Expenditures for  fixed assets |       |                    | 427,000    |                    |       |   | 11,000 |   |   |
| **2004**                       |       |                    |       |                    |       |   |   |   |   |
| Depreciation and  amortization |       |                    | $          | 437,000                 |       |   |   | $ | 85,000 |   |   |
| Expenditures for  fixed assets |       |                    | 132,000    |                    |       |   | 28,000 |   |   |
| **2003**                       |       |                    |       |                    |       |   |   |   |   |
| Depreciation and  amortization |       |                    | $          | 918,000                 |       |   |   | $ | 51,000 |   |   |
| Expenditures for fixed  assets |       |                    | 828,000    |                    |       |   | 291,000 |   |   |

 

Management evaluatessegment performance based primarily on operating income. Other revenue andexpenses are not allocated to the segments. The accounting policies of thesegments are the same as those described in the significant accountingpolicies.

***Note 14—Exit and Disposal Activities***

As the result of an evaluation of the overall operationsof the Company, management implemented a plan to cease operations at severaldonor centers, including the mobile operations associated with these centersbeginning in the third quarter of 2003. The donor centers included in this planwere Albany, New York; Chicago, Illinois; three centers in North Carolina; andWilliston, Vermont. As of December 31, 2004, all of these donor centerswere closed. Costs associated with the closures that were completed as of December 31,2003 are reflected in the Company’s 2003 results in accordance with generallyaccepted accounting principles. Costs associated with the closures completed in2004 are reflected in the Company’s 2004 results in accordance with generallyaccepted accounting principles.

As a result of the implementation of management’s planto close certain locations as described above, the Company’s blood productssegment incurred certain expenses associated with closing these centers. Theseexpenses included the write-off of $214,000 of certain assets previously usedin the operations of the closed donor centers, severance payments of $77,000 to29 terminated employees, recognition of unexpired facility lease obligations of$253,000, and other associated costs of $54,000. Of all these costs, $27,000remained accrued as of December 31, 2003, and this accrual was fullyutilized in 2004.

All of these expenses wereincurred in 2003, of which $571,000 and were recorded as operating expenses and$27,000 were recorded as general and administrative expenses.

***Note 15—Concentration Risk***

The Companyprovides products and services to individual hospitals, hospital groups andhospital management companies, all of which are referred to as “customers” forpurposes of identifying 

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concentration risk in this section. During 2005 only two customersrepresented more than 10% of the Company’s total revenue. One customeraccounted for approximately 14.8% of total revenue, and as of December 31,2005, the gross accounts receivable balance for this customer was $428,000. Theother customer accounted for approximately 10.1% of the Company’s totalrevenue, and as of December 31, 2005, the gross accounts receivablebalance for this customer was $528,000. The next largest customer accounted forapproximately 8.4% of total revenue. The Company’s ten largest customersaccounted for 62.2% of total revenues. The Company has no relationship with anyof these customers other than as a provider of blood products and services.

In addition, consolidations and affiliations withinthe hospital industry have changed the environment for the blood productssegment. The newly consolidated or affiliated hospitals have started tonegotiate with the Company as a group, and therefore exert greater pressure onthe Company for price discounts. This may force the Company to offer pricediscounts to retain sales volume that previously would not have been granted ifthe hospitals were not negotiating as a group.

During 2005, the Company received goods and services from twomajor vendors that represented more than 10% of the Company’s total costs. Onevendor, that represents 18% of total costs, provides products that support theCompany’s apheresis activities. As of December 31, 2005, the Company owedthis vendor $387,000. The other vendor, that represents 15% of total costs,provides laboratory services. As of December 31, 2004, the Company owedthis vendor $183,000. The Company has no relationship with either vendor otherthan as a consumer of the goods and services provided by each.

***Note 16—Subsequent Events***

On January 31, 2006, the Company entered into thethird modification (the “Modification”) to the Loan and Security Agreement,dated November 19, 2002, as amended on March 22, 2004 and July 1,2005, among the Company, Coral Blood Services, Inc. and Comerica Bank. TheModification provides for letters of credit to be issued by Comerica Bank forthe account of the Company in an amount not to exceed one million dollars.

On February 24, 2006, the Company entered into alease agreement, between ECI Sherman Plaza LLC, as landlord, and theCompany, as tenant. Under the Lease, the Company will lease approximately20,000 square feet (the “Premises”) located in Van Nuys, California. ThePremises will contain the Company’s corporate offices, a laboratory, amanufacturing facility for whole blood components and a distribution center,which facilities currently are contained in separate properties. The Companywill continue to operate an apheresis donor center in Sherman Oaks, California.The Company will pay an average monthly base rent of $41,000, together withadditional rent based on certain operating costs and taxes. The lease expires128 months after the commencement date. It is anticipated that the lease willcommence on August 1, 2006.

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