**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, 2006**

**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)  |       |                                    |

 

| **15350 Sherman Way, Suite 350**                                            |   | ** **                                                               |
|-----------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|
| **Van Nuys,  California**                                                   |   | **91406**                                                                |
| (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 if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the 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 becontained, to the best of the registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.** ****o**

Indicate by check mark whether theregistrant is a large accelerated filer, and accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act.

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

 

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

The aggregate market value of the common stock held bynon-affiliates of the registrant as of June 30, 2006, 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 $10,328,000.

As of February 26, 2007, 8,495,954 shares of common stock ofthe registrant were issued and outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of the registrant’s definitiveproxy statement relating to its 2007 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**

**PART I**

|            | ** ** | ** **                                                                                                                      | ** ** | **Page  Number** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
|       |       | **PART I**                                                                                                                 |       |             |
| Item 1.    |       | Business                                                                                                                        |       | 1                |
|       |       | General                                                                                                                         |       | 1                |
|       |       | Recent Developments                                                                                                             |       | 1                |
|       |       | Business Segments                                                                                                               |       | 3                |
|       |       | Competition                                                                                                                     |       | 4                |
|       |       | Sales to Major Customers                                                                                                        |       | 5                |
|       |       | Marketing                                                                                                                       |       | 6                |
|       |       | Human Resources                                                                                                                 |       | 6                |
|       |       | Suppliers                                                                                                                       |       | 6                |
|       |       | Government Regulation                                                                                                           |       | 6                |
|       |       | Professional and Product Liability Insurance                                                                                    |       | 8                |
|       |       | Additional Information                                                                                                          |       | 8                |
| Item 1A.   |       | Risk Factors                                                                                                                    |       | 8                |
| Item 1B.   |       | Unresolved Staff Comments                                                                                                       |       | 16               |
| Item 2.    |       | Properties                                                                                                                      |       | 16               |
| Item 3.    |       | Legal Proceedings                                                                                                               |       | 17               |
| Item 4.    |       | Submission of Matters to a Vote of Security Holders                                                                             |       | 17               |
|       |       | **PART II**                                                                                                                |       |             |
| Item 5.    |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities              |       | 18               |
| Item  6.   |       | Selected  Financial Data                                                                                                        |       | 20               |
| Item 7.    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations       |       | 20               |
| Item 7A.   |       | Quantitative and Qualitative Disclosures about Market  Risk                                                                     |       | 30               |
| Item 8.    |       | Financial Statements and Supplementary Data                                                                                     |       | 31               |
| Item 9.    |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                  |       | 31               |
| Item  9A.  |       | Controls  and Procedures                                                                                                        |       | 31               |
| Item 9B.   |       | Other Information                                                                                                               |       | 31               |
| ** ** | ** ** | **PART III**                                                                                                               | ** ** | ** **       |
| Item 10.   |       | Directors, Executive Officers and Corporate Governance                                                                          |       | 32               |
| Item  11.  |       | Executive  Compensation                                                                                                         |       | 32               |
| Item 12.   |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                  |       | 32               |
| Item 13.   |       | Certain Relationships and Related Transactions and  Director Independence                                                       |       | 32               |
| Item 14.   |       | Principal Accountant Fees and Services                                                                                          |       | 32               |
| ** ** | ** ** | **PART IV**                                                                                                                | ** ** | ** **       |
| Item 15.   |       | Exhibits and Financial Statement Schedules                                                                                      |       | 33               |
|       |       | Signatures                                                                                                                      |       | 36               |
|       |       | Index to Consolidated Financial Statements and  Schedules                                                                       |       | F-1              |

 

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**PART I**

**ITEM 1.**                     BUSINESS

***This 2006 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”) provides the customized delivery ofblood products and services. The Company collects, processes and distributesblood products to hospitals and research related organizations. The Companyoperates and manages donor centers and mobile donor vehicles to collecttransfusable blood products from donors, and also collects human-derived bloodproducts which are utilized by health research related organizations. Additionally,the Company provides blood related services, principally therapeutic apheresisprocedures, stem cell collection and other blood treatments to patients with avariety of disorders. Blood related therapeutic services are usually providedunder contract as an outside 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 earnings haveimproved as a result of the successful implementation of management’s plan. In August 2006,the Company acquired Florida based Teragenix Corporation, subsequently renamedHemaCare BioScience, Inc., which sources, processes and distributes humanbiological specimens, manufactures quality control products and providesclinical trial management and support services.

The Company’scurrent strategy is to focus on increasing the utilization of existing bloodproducts capacity in those markets currently served, expand product andservice offerings for biotechnology, pharmaceutical and other research-focusedorganizations throughinvestment in expanded capacity and new marketing campaigns, and expand themarket potential for therapeutic apheresis services through physician educationand other marketing efforts.

Although mostsuppliers of transfusable blood products 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 transfusable bloodsupplier with significant operations in the U.S. The research specimen industryincludes many suppliers from small limited service providers to large fullyintegrated service organizations.

The Company was incorporated in the state of California in 1978.

**Recent Developments**

***Acquisition of Teragenix Corporation***

On August 29, 2006,the Company acquired privately-owned Teragenix Corporation, subsequentlyrenamed HemaCare BioScience, Inc. (“HemaBio”), which is located in FortLauderdale, Florida. HemaBio is a provider of human biological samples, qualitycontrol products and clinical trial management and support services for healthresearch organizations in the U. S.  HemaBio was acquired in exchange for (i) $1,372,203in cash, (ii) up to an additional $250,000 in cash, subject to the Company’sright to set-off, 

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(iii) 285,895shares of the Company’s Common Stock, (iv) secured, subordinatedpromissory notes issued by the Company in the aggregate principal amount of$200,000, (v) up to 248,000 additional shares of the Company’s CommonStock based on the “EBIT” (as defined) of HemaBio for the fiscal year ended March 31,2007, and (vi) up to an additional $1,300,000 in cash based on the EBIT ofHemaBio for the three fiscal years ended December 31, 2008, all as morefully described in the Company’s Current Reports on Form 8-K filedwith the SEC on September 5, 2006 and November 15, 2006. The formerowners of HemaBio are members of the management team and continue to operatethe business.

***Infrastructure Investments***

The Company has investedresources generated by recently improved profitability in infrastructureprojects to expand capacity, enhance regulatory compliance, improve managementreporting and generally improve the long-term profit potential for the Company.Some of these investments include a document management system, a newaccounting and financial reporting system, and investments in new facilities,equipment and vehicles. In addition, a new blood bank information managementsystem is planned. The Company’s single largest such investment in 2006 of $1.7million was for leasehold improvements at a new facility in Van Nuys,California housing corporate offices, mobile blood drive operations, a bloodcomponent manufacturing lab, a blood products distribution operation andtherapeutic apheresis activities. The Company occupied this new facility inNovember, 2006. On December 29, 2006, the Company entered into a licenseagreement with Information Data Management, Inc. (“IDM”), under which IDMwill license to the Company a blood donor information management system andprovide certain training, installation and maintenance services. The Companywill pay to IDM a fee of approximately $430,000, but also anticipates incurringexpenses of approximately $260,000 to purchase hardware and third partysoftware for use in connection with this information management system. TheCompany estimates the total cost for this system, once fully implemented, atapproximately $2 million, and that portions of this project are targeted forcompletion in Fall of 2007, while others are expected to finish in 2008.

***Growth in Mid-Atlantic Blood Services Business Segment***

The Company experiencedsubstantial growth in revenue and profits from its Mid-Atlantic blood servicesbusiness segment during 2006 compared with 2005. This improvement in performanceis principally the result of a 64% increase in the number of therapeuticapheresis procedures performed resulting from improved marketing efforts, and ageographic expansion of the market served by this business unit to includePennsylvania. The improvement in revenue resulted in substantial growth inprofit as operational efficiencies were achieved as revenue improved without acorresponding increase in operating costs.

***Declining Profitability for Maine Blood ProductsBusiness Unit***

The Company’s bloodproducts operation located in Bangor and Scarborough, Maine generated lowerprofits in 2006 compared with 2005. Net income generated by these operationsdeclined 67% in 2006 compared with 2005. Revenue decreased 4% as a result ofturnover in recruitment positions. The decrease in profits is primarily due toi) higher staffing costs for anticipated but unrealized growth, ii) costs tobuild infrastructure, iii) higher cost for supplies used in the collection andmanufacturing process, and iv) an increase in facility related expenses.

***Increase in Debt***

Since 2003, management hasestablished debt reduction as a priority for the use of the resources generatedby the Company’s improvement in profitability. This strategy resulted in asubstantial reduction in outstanding debt to only $88,000 as of December 31,2005**.**During2006, the Company invested substantial resources for the acquisition ofTeragenix, leasehold improvements and various systems 

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projects. Available cash and debt wasutilized to finance these investments. As of December 31, 2006, theCompany’s outstanding debt was approximately $2.7 million. On September 26,2006, the Company entered into an Amended and Restated Loan and SecurityAgreement with Comerica Bank to increase the amount available under this creditfacility from $2 million to $3 million and to extend the maturity date to June 30,2008. The amendment also granted the Comerica Bank a first priority securityinterest in HemaBio. Asof December 31, 2006, the Company had utilized $2,025,000 of this facility.Management anticipates that cash generated by operations, as well as theremaining portion of this credit facility, will be sufficient to satisfy theCompany’s capital requirements for the next year.

**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 Company’sblood products operations include blood products for transfusion in a hospitalsetting, and human-derived blood products utilized by health research relatedorganizations.

The Company contracts with hospitals to providetransfusable blood products. The Company conducts whole blood collection drivesat sponsor organizations, such as employers, schools or churches. The Company’srecruitment staff works with the staff of the sponsor organization to encourageindividuals associated with the sponsor to donate blood at a blood drive. 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.

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 bloodstream. 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 dedicatedsubset of the whole blood donor population. The Company has demonstrateda consistent track record of donor recruitment for apheresis platelet donors.

The Company also sources, processes and distributeshuman biological specimens, manufactures quality control products and providesclinical trial management and support services. Recruitment of physicianpractices to obtain such specimens is critical to the operation. The Companyhas relationships with physician practices throughout the world, selected basedon certain local population characteristics.

Blood products revenue depends on a number of factors,including the success of the Company’s recruitment efforts, the success of theCompany’s marketing efforts to attract and retain new customers, and theability of the Company to properly process, store and transport blood productsto customers. Blood products revenue contributed 79.5%, 78.6% and 72.1% of theCompany’s total revenue in 2006, 2005 and 2004, respectively.

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 

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FDA and are regularly inspected by FDA personnel. Additionally,the Company’s operations are licensed or registered, regulated and inspected byvarious 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 blood collection operations areaccredited 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. The Company’s researchbiological specimen facility is based in Southern Florida.

***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 primarily administered by trained,nurse-specialists, under the supervision of a specially trained physician, andacting in accordance with documented operating procedures and quality assuranceprotocols based on guidelines developed by the AABB and the Joint Commission onAccreditation of Healthcare 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 to adequatelystaff apheresis units. The Company’s services enable hospitals to offertherapeutic apheresis services to their patients on an “as needed” basiswithout incurring 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 conduct educational seminars forphysicians to inform them of the benefits of therapeutic apheresis relative toother modes of patient treatment. Blood services revenue contributed 20.5%,21.4% and 27.9% of the Company’s total revenue in 2006, 2005 and 2004,respectively.

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 in several Mid-Atlantic states, including New York.

**Competition**

***General***

The blood products and service industry has many participants fromsmall limited service providers to large full service organizations. There iscompetition for customers on the basis of many factors, including 

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reputation for reliable customized qualityperformance, expertise and experience in specific areas, scope of serviceofferings, price, and customer service. The Company believes it competesfavorably in these areas.

***Blood Products***

Most U.S. transfusableblood products suppliers are organized as not-for-profit, tax-exempt entities. However,all blood suppliers charge fees to hospitals for the products utilized. Thesefees are generally set at levels based on the supply and demand for specificproducts, and are influenced by the competition among blood products suppliersand federal reimbursement rates to hospital customers. Many suppliers havegreater financial, technical and personnel resources than the Company. Inaddition, since many of the Company’s competitors are tax-exempt, they do notbear the tax burden the Company faces, and they have access to lower costtax-exempt debt financing. Their status as charitable institutions may alsogive them an advantage in recruiting volunteer donors. The Company competes onthe basis of reputation for reliable customized quality performance, expertiseand experience in specific areas, scope of service offerings, price, andcustomer service.

Approximately 50%of U. S. transfusable blood products are supplied by the American Red Cross (“ARC”)through its national collection network, and approximately 40% are supplied bylocal and regional blood centers, including the Company. The remainder iscollected by hospitals directly.

The Companycompetes in the marketplace through a strategy of offering blood product supplyprograms tailored to the requirements of individual customers. The Companyconsistently reevaluates and revises its product supply programs to respond tomarketplace factors. Some competitors have advantages over the Company as aresult of establishedpositions and relationships within the communities they serve. In addition, theARC’s size and market dominance provides them with greater resources to sustainperiods of unprofitable sales, or to adopt aggressive pricing strategies forthe purpose of defending or increasing market share.

The research specimenmarket is served by several small to medium sized providers including selectedhospitals. The Company believes that its ability to offer normal and diseasestate samples, coupled with the ability to develop panels, supply materials forcontrols, and offer clinical trial management and support services on aninternational basis, provides a favorable position in the marketplace.

***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 itcompetes in this market by offering customized quality performance, expertiseand experience in specific areas, scope of service offerings, price, andcustomer service. In addition, the Company provides education to the medicalcommunity on the benefits of therapeutic apheresis as a treatment solution forvarious diseases.

**Sales to Major Customers**

The Company provides products and services to healthcare providersand hospitals, biotechnology, pharmacy and other research related companies,all of which are referred to as “customers” for purposes of identifyingconcentration risk in this section. During 2006, only two customers representedmore than 10% of the Company’s total revenue. One customer accounted forapproximately 12.6% of total revenue, and the other accounted for approximately11.5%. The next largest customer accounted for approximately 6.2% of totalrevenue. The Company’s ten largest customers accounted for 58.3% of totalrevenues. The 

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Company has no relationship with any ofthese customers other than as a provider of blood products 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 utilizers of blood products and services. TheCompany markets its products and services in the form of customized programsthat meet the specific needs of individual customers. As a smaller company thanthe main competitors in the blood products marketplace, HemaCare offers moreflexibility in supply arrangements and pricing structure. This flexibility, afocus on customer service, and expertise, are the main messages communicated topotential customers.

**Human Resources**

As of February 27,2007, the Company had 271 employees, including 83 part-time employees. Inaddition, the Company has a contract with an outside leasing company to provideemployees for HemaBio. As of February 27, 2007, 16 full-time employees,all of which working in the Company’s Fort Lauderdale, Florida facility, areprovided by the leasing company. Most of the Company’s professional andmanagement personnel possess prior experience in hospitals, medical servicecompanies 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 2006, theCompany received goods and services from two major vendors that representedmore than 10% of the Company’s total costs. One vendor, that represents 12.6%of total costs, provides products that support the Company’s apheresisactivities. The other vendor, that represents 11.1% of total costs, provideslaboratory services**.**The Companyhas no relationship with either vendor other than as a consumer of the goodsand services provided by each.

The Company’s blood products consist ofthose produced from donated platelets and whole blood, and blood products purchased fromother suppliers. TheCompany competes with the ARC and other blood suppliers in recruiting itsdonors. The growth of the Company’s manufactured blood products business isdependent on the Company’s ability to attract, screen and retain qualified donors.

**Government Regulation**

***Blood ProductOperations***

Blood productssuppliers are subject to extensive regulation and guidelines of the FDA, AABB,and various state licensing authorities. FDA regulations are comprehensive,complex and extend to virtually all aspects of the blood products industry,including: recruiting; screening blood donors; processing, testing, labeling,storing and shipping blood products; recordkeeping; and communications withhospital customers and donors. FDA regulations also extend to the manufacturersof all critical supplies and equipment used in the blood supply industry.

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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 evaluated at the conclusion of training 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. On May 5, 2006, the Companyreceived a warning letter from the FDA pertaining to specific observationsduring the inspection of the Company’s California operations. 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, thehealth departments of the states in which the Company operates conduct auditsof the Company’s facilities and operations. These audits focus on compliancewith specific state laws that cover HemaCare’s operations. At the conclusion ofthese audits, the Company is provided with a list of observations to address. TheCompany believes that it is in compliance with state regulations governing theCompany’s operations.

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,Scarborough, Maine and Bangor, Maine facilities to ship selected blood productsacross state lines.

***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 toapproximately 2%, or less, of the Company’s total revenues in each of the threeyears ended December 31, 2006. In 2006, this percentage was less than 1%. Thereare no agreements between Dr. Levy and the Company’s hospital customersthat require the hospitals to select HemaCare to provide therapeutic servicesto Dr. Levy’s patients.

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 

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proposed regulation that would have amaterial adverse impact on the Company; however, the Company is uncertain whatchanges may be made in the future regarding health care policies, especiallythose regarding hospital reimbursements, health insurance coverage, producttesting, record keeping and managed care that may materially impact the Company’soperations.

**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.

**Additional Information**

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 at100 F Street, N.E., Room 1580, Washington D.C. 20549. Information on theoperation of the Public Reference Room may be obtained by calling the SECat 800-SEC-0330. The SEC also maintains an Internet site thatcontains reports, proxy and information statements, and other informationregarding issuers that file electronically with the SEC. The address of thatsite is www.sec.gov.

**ITEM 1A**                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 above in “Item 1A- Risk Factors” or in other filings by the Company with the Securities andExchange Commission. The Company does not undertake to update itsforward-looking statements to reflect later events and circumstances or actualoutcomes.*

***Steady or declining market prices, and increasedcosts, could reduce profitability***

The cost of collecting,processing and testing blood products has risen significantly in recent yearsand will likely continue to increase. These cost increases are related to newand improved testing procedures, increased regulatory requirements related toblood safety, and higher staff and supply costs related to collecting andprocessing blood products. Competition and fixed price contracts may limit theCompany’s ability to maintain existing operating margins. Some competitors havegreater resources than the Company to sustain periods of marginally profitableor unprofitable sales. Steady or declining market prices, and increased costs,may reduce profitability and may have a material adverse effect on the businessand results of operations.

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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 for 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 decrease in overall revenues and profits. Decreases indemand may require the Company to make sizeable investments to restructureoperations away from declining products to the production of new products. Lackof access to sufficient capital, or lack of adequate time to properly respondto such a change in demand, could result in declining revenue and profits ascustomers transfer 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.

***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.Consolidations of blood services providers has changed the competitiveenvironment for the Company’s blood services segment. Competition for customersand trained clinical staff is increasing. This has caused the Company to incursignificant recruitment costs to hire staff, increase staff compensation andincur higher marketing related expenses to attract and retain customers. Inaddition, consolidations and affiliations within the hospital industry havechanged the market for the blood products segment. The newly consolidated oraffiliated hospitals have started to negotiate with the Company as a group, andtherefore exert greater price pressure on the Company. These changes may have anegative impact on the Company’s future revenue, and may negatively impactfuture profitability.

***Operations depend on services of qualifiedprofessionals 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, medical technologists, regulatory and quality assurance professionals,and others with knowledge of the blood industry. Nationwide, the demand forthese professionals exceeds the supply and competition for their services isstrong. If the Company is unable to attract and retain a staff of qualifiedprofessionals, operations may be adversely affected.

***Industry regulations and standards could increaseoperating costs***

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 andmaintain numerous licenses in different legal jurisdictions regarding thesafety of products, facilities and procedures, and regarding the purity andquality of blood products. In January 2006, the Food and DrugAdministration (“FDA”) performed an inspection of the Company’s California operations.On May 5, 2006, the Company received a warning letter from the FDApertaining to specific observations during the inspection. The Company hasresponded and implemented an action plan to address each issue.

On November 3, 2006, the AABB provided recommendationsto reduce the risk of transfusion-related acute lung injury (“TRALI”). Thisrecommendation, to be fully implemented for high-plasma volume 

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blood products andplatelets by November 2007 and 2008, respectively, may reduce the volumeof products available to customers, which may negatively impact the Company’soperations and profitability.

On December 14, 2006, the AABB providedrecommendations to reduce the risk to patients for contracting Chagas’ diseaseas a result of a receiving a transfusion of donated blood products. Therecommendations include the implementation of new blood tests to detect thepresence of the protozoan known to cause Chagas’ disease. The new test iscostly and the Company may not be able to raise prices to cover the cost ofthis new test, and therefore may negatively impact the Company’s profitability.

State and federal laws include anti-kickback andself-referral prohibitions and other regulations that affect the shipment 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; however, thepossibility cannot be eliminated that interpretations of existing laws andregulations will result in findings that the Company has not complied withsignificant existing regulations. Such a finding could materially harm thebusiness. Moreover, healthcare reform is continually under consideration byregulators, and the Company does not know how laws and regulations will changein the future.

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

Reimbursement rates forblood products and services provided to Medicaid, Medicare and commercialpatients, impact the fees that the Company is able to negotiate with customers.In addition, to the degree that the Company’s hospital customers receive lowerreimbursement for the products and services provided by the Company, thesecustomers may reduce their demand for these goods and services, and adverselyaffect the Company’s revenue. If the Company is unable to increase prices forgoods and services, the Company’s profitability may be adversely affected.

***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.

***Not-for-profit status gives advantages to competitors***

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 supply important supplies andservices. The Company receives many of its research related specimens fromforeign suppliers, who operate in countries with unstable business environments.Significant price increases, or disruptions in the 

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abilityto obtain products and services from existing vendors, may force the Company tofind alternative vendors. Alternative vendors may not be available, or may notprovide their products and services at favorable prices. If the Company cannotobtain the products and services it currently uses, or alternatives atreasonable prices, the Company’s ability to produce products and provideservices may be severely impacted and result in a reduction of revenue andprofitability.

***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 providersseeking to enhance efficiencies, and this consolidation is expected to continue.As a result of these trends, the Company may be limited in its ability toincrease 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 or alternativetreatments could jeopardize business***

As a result of the risksposed by blood-borne diseases, many companies and healthcare providers arecurrently seeking to develop alternative treatments for blood producttransfusions. HemaCare’s business consists of collecting, processing anddistributing human blood products and providing blood related therapeuticservices. The introduction and acceptance in the market of alternativetreatments may cause material adverse harm to the business. In addition, recenttechnological developments to extend the shelf-life of products currentlyoffered by the Company could increase the available supply in the market, and putdownward pressure on the price for these products. This may cause a materialadverse impact on the future profitability for these products.

***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 $1,334,000 in pre-tax income in 2006; however,there is no assurance this performance will be sustainable, and the Company mayneed to raise 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.

***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 industryincrease in the future, insurance may become more expensive or unavailable. TheCompany also cannot give assurance that as the business expands, or the Companyintroduces new products and services, that additional liability insurance onacceptable terms will be available, or that the existing insurance will provideadequate coverage against any and all potential claims. Also, the limitationson liability contained in various agreements and contracts may not beenforceable 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.

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***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, assimilateand 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 to, hepatitis,HIV and Creutzfeldt-Jakob disease. HemaCare screens donors, uses highlyqualified testing service providers, and conducts selective blood testing, totest blood products for known pathogens in accordance with industry standards,and complies with all applicable safety regulations. Nevertheless, the riskthat screening and testing processes might fail, or that new pathogens may beundetected by them, cannot be completely eliminated. There is currently no testto detect the pathogen responsible for Creutzfeldt-Jakob disease. If patientsare infected by known or unknown pathogens, claims may exceed insurancecoverage and materially and adversely affect the Company’s financial condition.In addition, improper handling of the Company’s disease state researchspecimens could expose the Company’s personnel, customers or third parties toinfection. Claims resulting from exposure could exceed the Company’s availableinsurance coverage and materially and adversely impact the Company’s financialcondition.

***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 donor center has expired. The Company has beenunable to negotiate a lease renewal. Presently, the Company continues to occupythis facility with the possibility of receiving a 30-day notice to vacateat any time. The lack of a long-term lease agreement for this facility couldhave an adverse impact on profitability if the Company receives a 30-daynotice to vacate and is unable to locate an alternative facility. The Companyis negotiating a potential lease agreement for alternative space, but there isno guarantee of a successful outcome. The loss of the donor center wouldadversely impact the Company’s ability to produce platelet products forSouthern California customers, and result in a reduction of revenue andprofitability.

***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 withenvironmental regulations as it develops and expands its business.

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***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 result of the terrorist activities and potentialactivities, which may target health care facilities or medical products. TheCompany may also experience delays in receiving payments from payers that havebeen affected by terrorist activities and potential activities. The U.S.economy in general is adversely affected by terrorist activities, and potentialactivities, and any economic downturn may adversely impact the Company’sresults of operations, impair its ability to raise capital or otherwiseadversely affect its ability to grow its business.

***Business interruption due to hurricanes or earthquakescould adversely impact profitability***

HemaCare’s principal bloodproducts and blood services operations, as well as the Company’s corporateheadquarters, are located in Southern California, which is an area known forpotentially destructive earthquakes. In addition, the Company’s principalresearch products operation is located in Southern Florida, an area known forpotentially destructive hurricanes. A severe event in either of these locationscould have substantial negative impact on the ability of the Company tocontinue to operate. Any significant delay in resuming operations in eitherregion following such an event could cause a material adverse impact on theprofitability of the Company.

***Evaluation and consideration of strategicalternatives, and other significant projects, may distract management fromreacting appropriately to business challenges and lead to reduced profitability***

As a publicly tradedCompany, management must constantly evaluate and consider new strategicalternatives, and other significant projects, in an attempt to maximizeshareholder value. The Company does not possess a large management team thatcan both consider strategic alternatives and manage daily operations. Therefore,management distractions associated with the evaluation and consideration ofstrategic alternatives, could prevent management from dedicating appropriatetime to immediate business challenges or other significant business decisions. Thismay cause a material adverse impact on the future profitability of the Company.

***Strategy to acquire companies may result in unsuitableacquisitions or failure to successfully integrate acquired companies, whichcould lead to reduced profitability***

The Company mayembark on a growth strategy through acquisitions of companies or operationsthat complement existing product lines, customers or other capabilities. TheCompany may be unsuccessful in identifying suitable acquisition candidates, ormay be unable to consummate a desired acquisition. To the extent any futureacquisitions are completed, the Company may be unsuccessful in integratingacquired companies or their operations, or if integration is more difficultthan anticipated, the Company may experience disruptions that could have amaterial adverse impact on future profitability. Some of the risks that mayaffect the Company’s ability to integrate, or realize any anticipated benefitsfrom, acquisitions include:

·       unexpectedlosses of key employees or customer of the acquired company;

·       difficultiesintegrating the acquired company’s standards, processes, procedures andcontrols;

·       difficultiescoordinating new product and process development;

·       difficultieshiring additional management and other critical personnel;

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·       difficultiesincreasing the scope, geographic diversity and complexity of the Company’soperations;

·       difficultiesconsolidating facilities, transferring processes and know-how;

·       difficultiesreducing costs of the acquired company’s business;

·       diversionof management’s attention from the management of the Company; and

·       adverse effects on existingbusiness relationships with customers.

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

HemaCare’s Articles of Incorporation empower the Boardof Directors to establish and issue a class of preferred stock, and todetermine the rights, preferences and privileges of the preferred stock. Thisgives the Board of Directors the ability to deter, discourage or make moredifficult for a change in control of HemaCare, even if such a change in controlwould be in the interest of a significant number of shareholders or if such achange in control would provide shareholders with a substantial premium fortheir shares over the then-prevailing market price for the Company’s commonstock.

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 the Company’s common stock or toobtain accurate 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 new financing in the futurethrough the sale of its securities. Future sales of common stock or securitiesconvertible into common stock could result in dilution of the common stockcurrently outstanding. In addition, the perceived risk of dilution may causesome shareholders to sell their shares, which may further reduce the marketprice 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 31,2008.

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.

On August 29, 2006, the Company acquiredprivately-owned Teragenix Corporation, subsequently renamed HemaCare BioScience, Inc.(“HemaBio”). Private companies generally may not have as formal orcomprehensive internal controls and compliance systems in place as publiccompanies. There is no assurance that we will be able to implement a formal andrigorous system of internal control at HemaBio and that we will be able toprovide a report that contains no significant deficiencies with respect toHemaBio.

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.

**ITEM 1B**               UNRESOLVEDSTAFF COMMENTS

**N**one.

**ITEM 2**                        PROPERTIES

On February 24, 2006, the Company entered into alease for approximately 19,600 square feet located in Van Nuys, Californiaintended to house corporate offices, a mobile blood drive operation, a bloodcomponent manufacturing lab and a blood products distribution operation. TheCompany occupied this facility in November 2006. The rent for thisfacility starts at $36,500 per month; however, the lease provides for 3% rentescalation upon the annual anniversary of the beginning of the lease term. Thelease on this space expires July 31, 2017; however, the Company has onefive-year option to extend this lease at the then current market price. Previously,the Company leased a 11,250 square foot facility in Woodland Hills, Californiafor corporate offices and mobile blood drive operations. The lease for thisspace expired on November 30, 2006. The Company also leased a 2,000 squarefoot facility in Sherman Oaks, California for a blood component manufacturinglab and a blood products distribution operation. The lease for this spaceexpired on January 31, 2007.

The Company continues to operate an apheresis donorcenter in approximately 6,900 square feet located in Sherman Oaks, California. TheCompany currently rents this space on a month-to-month basis for a monthlyamount of approximately $15,600. Please see “Item 1A-Risk Factor-Lease for amajor production facility has expired and if the Company needs to vacate it maybe unable to locate 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, and 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 $1,800. The lease term expires October 21,2008, and the Company has the option to extend the lease for two additionaltwo-year terms at escalated rental rates that adjust 3.5% annually.

The Company alsoleases space for a donor center in a 2,500 square foot facility in Bangor,Maine. The monthly rent is approximately $4,300. The lease term expires December 31,2011, and the Company has the option to extend the lease for one additionalfive-year term at rates adjusted for changes in the Consumer Price Index.

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In addition, theCompany leases space for offices, a laboratory and a storage and distributioncenter in a 8,900 square foot facility in Fort Lauderdale, Florida. The monthlyrent is approximately $8,200, but is scheduled to increase 4% annually each October 1st during the term of the lease. The lease expiresSeptember 30, 2009.

Finally, theCompany leases a 600 square foot office space in White Plains, New York for amonthly amount of approximately $1,400. The lease expires July 31, 2009.

The Companyoccupies space on the campuses of two of its client hospitals. While the arrangementsvary, the Company’s use of these facilities are either subject to leaseagreements 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.

We believe that our facilities are suitable, in good condition andadequate to meet our current and foreseeable needs.

**ITEM 3**                        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.

**ITEM 4**                        SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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**PART II**

**ITEM5**                        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.

| ** **             | ** ** | **2006**   | *** *** | **2005** | *** *** |
|------------------------|------------|------------|--------------|----------|--------------|
| **Quarter ended** | ** ** | ** ** | *** *** | **High** | ** **   | **Low** | ** ** | **High** | ** ** | **Low** | *** *** |
| March 31          |       | $          | 2.74         |     | $            | 1.50 |   | $ | 1.96 |   | $ | 1.31 |   |
| June 30           |       | $          | 3.53         |     | $            | 2.15 |   | $ | 1.80 |   | $ | 1.20 |   |
| September 30      |       | $          | 2.40         |     | $            | 1.90 |   | $ | 1.76 |   | $ | 1.20 |   |
| December 31       |       | $          | 2.90         |     | $            | 2.05 |   | $ | 1.75 |   | $ | 1.35 |   |
|                        |            |            |              |          |              |  |  |  |  |  |  |  |  |  |  |

 

On March 19, 2007, the closing bid price of theCompany’s common stock was $2.96. Shareholders are urged to obtain currentmarket quotations 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 during the term of the creditagreement. The declaration and payment of any cash dividends in the future willdepend upon the Company’s earnings, financial condition, capital needs, line ofcredit requirements and other factors deemed relevant by the Board ofDirectors.

On February 26, 2007, the approximate number ofshareholders of record was 264 (excluding individual participants in nomineesecurity position listings).

Set forth below is a graph comparing the yearlycumulative total shareholder return on the Company’s common stock, with theyearly cumulative total return on i) the Nasdaq Stock Market (U.S.Companies) Index ii), the Nasdaq Health Services Stock Index and iii) theNasdaq Biotechnology Stock Index. The graph assumes $100 was invested on December 31,2001 in each of the Company’s common stock, the Nasdaq Stock Market Index, theNasdaq Health Services Index and the Nasdaq Biotechnology Stock Index. Thecomparison assumes that all dividends are reinvested.

The comparisons in thegraph below are based on historical data and are not indicative of, or intendedto forecast, the possible future performance of the Company’s common stock.

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**COMPARISONOF 5 YEAR CUMULATIVE TOTAL RETURN***AmongHemacare Corporation, The NASDAQ Composite Index,The NASDAQ Health Services Index and The NASDAQ Biotechnology Index

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*                    $100invested on 12/31/01 in stock or index—including reinvestment of dividends.Fiscal year ending December 31.

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**ITEM6**                        SELECTED FINANCIAL DATA

Thefollowing selected financial data should be read in conjunction with the otherinformation and financial statements, including the notes thereto, appearingelsewhere herein.

| ** **                           | ** ** | **Years Ended December 31,**                        | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                           | ** ** | **(In Thousands, except Per Share Data)** | ** ** |
| Revenue                              |       | $                                                                  | 36,484     |   | $ | 31,227 |   | $ | 26,836 |   | $ | 27,488 |   | $ | 27,817 |   |
| Gross profit                         |       | 6,729                                                              |       | 6,576 |   | 5,816 |   | 2,251 |   | 3,745 |   |
| Income (loss) from operations        |       | 1,334                                                              |       | 1,686 |   | 1,396 |   | (1,695 | ) | (329 | ) |
| Other income (expense)               |       | —                                                             |       | — |   | 167 |   | — |   | (51 | ) |
| Write off of impaired goodwill       |       | —                                                             |       | — |   | — |   | — |   | (362 | ) |
| (Benefit) provision for income taxes |       | (517                                                               | )          | 31 |   | 18 |   | 2,984 |   | (151 | ) |
| Net income (loss)                    |       | $                                                                  | 1,851      |   | $ | 1,655 |   | $ | 1,545 |   | $ | (4,679 | ) | $ | (591 | ) |
| *Basic per share amounts:*           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss)  from operations       |       | $                                                                  | 0.16       |   | $ | 0.21 |   | $ | 0.18 |   | $ | (0.22 | ) | $ | (0.04 | ) |
| Net income (loss)                    |       | $                                                                  | 0.22       |   | $ | 0.20 |   | $ | 0.20 |   | $ | (0.60 | ) | $ | (0.08 | ) |
| *Diluted per share amounts:*         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income (loss)  from operations       |       | $                                                                  | 0.15       |   | $ | 0.19 |   | $ | 0.17 |   | $ | (0.22 | ) | $ | (0.04 | ) |
| Net income (loss)                    |       | $                                                                  | 0.20       |   | $ | 0.19 |   | $ | 0.19 |   | $ | (0.60 | ) | $ | (0.08 | ) |

 

| ** **                                                            | ** ** | **December 31,**                                              | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                            | ** ** | **(In Thousands, except Per Share Data)** | ** ** |
| Total assets                                                          |       | $                                                                  | 19,047     |   | $ | 10,546 |   | $ | 9,344 |   | $ | 8,286 |   | $ | 13,455 |   |
| Long-term debt  and capital lease obligations, net of current portion |       | $                                                                  | 525        |   | $ | 7 |   | $ | 703 |   | $ | 1,078 |   | $ | 1,353 |   |
| Shareholders’ equity                                             |       | $                                                                  | 9,853      |   | $ | 6,988 |   | $ | 5,167 |   | $ | 3,411 |   | $ | 8,087 |   |

 

**ITEM7**                        MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

**General**

HemaCare operates in two primary business segments. Thefirst is the blood products segment which supplies hospitals and healthresearch related organizations with red blood cells, apheresis platelets, andother blood products. The Company operates and manages donor centers and mobiledonor vehicles to collect blood products from donors, andpurchases blood products from other suppliers. Additionally, the Companyoperates a blood services segment, wherein the Company performs therapeuticapheresis procedures, stem cell collection and other blood treatments topatients with a variety of disorders. Blood services are usually provided undercontract with hospitals as an outside purchased service.

In August 2006, the Company acquired Florida based TeragenixCorporation, subsequently renamed HemaCare BioScience, Inc. (“HemaBio”),which sources, processes and distributes human biological specimens,manufactures quality control products and provides clinical trial managementand support services. Management considers the operations of HemaBio tobe similar to the Company’s existing blood products business segment. Therefore,the financial information for HemaBio is reported as part of the Company’sblood products business segment.

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**Results ofOperations**

Thefollowing table sets forth, for the periods indicated, the percentage thatcertain items in the statement of income were of net revenue and the percentagedollar 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,**          | ** ** |
| ** **                            | ** ** | **2006**                                    | ** ** | **2005**                                             | ** ** | **2004** | ** ** | **’05 to ’06** | ** ** | **’04 to ’05** | ** ** |
| Revenues                              |       | 100.0                                       | %          | 100.0                                                | %          | 100.0 | % | 16.8 | % | 16.4 | % |
| Operating costs                       |       | 81.6                                        | %          | 78.9                                                 | %          | 78.3 | % | 20.7 | % | 17.3 | % |
| Gross profit                          |       | 18.4                                        | %          | 21.1                                                 | %          | 21.7 | % | 2.3 | % | 13.1 | % |
| General and  administrative expenses  |       | 14.8                                        | %          | 15.7                                                 | %          | 16.5 | % | 10.3 | % | 10.6 | % |
| Income from  operations               |       | 3.6                                         | %          | 5.4                                                  | %          | 5.2 | % | (20.9 | )% | 20.8 | % |
| Other income                          |       | —                                      |       | —                                               |       | 0.6 | % | — |   | (100.0 | %) |
| Income before  income taxes           |       | 3.6                                         | %          | 5.4                                                  | %          | 5.8 | % | (20.9 | )% | 7.9 | % |
| (Benefit) provision  for income taxes |       | (1.5                                        | )%         | 0.1                                                  | %          | 0.1 | % | (1,767.7 | )% | 72.2 | % |
| Net income                            |       | 5.1                                         | %          | 5.3                                                  | %          | 5.7 | % | 11.8 | % | 7.1 | % |

 

***Year ended December 31, 2006 compared to the yearended December 31, 2005***

**Overview**

The Company generated net income of $1,851,000, or$.22 basic and $.20 fully diluted earnings per share, for 2006, compared to$1,655,000, or $.20 basic and $.19 fully diluted earnings per share, in 2005.

Revenues increased $5,257,000, or 16.8%, to$36,484,000 in 2006 from $31,227,000 for all of 2005. The increase isattributable to an increase in blood products and services revenue of 18.2%,and 12%, respectively.

Gross profit increased 2.3% to $6,729,000 in 2006 from$6,576,000 in 2005 due to improved gross profit for the Company’s bloodservices business segment. Higher revenue, along with operational efficienciesfrom an increase in procedure volumes, at the Company’s Mid-Atlanticoperations, improved blood services gross profit. Gross profit for the Company’sblood products business segment decreased due to higher operating costs,including staff compensation and facility expenses.

General and administrative expenses increased$505,000, or 10.3%, in 2006 to $5,395,000 from $4,890,000 in 2005. This changeis primarily attributable to an increase in non-cash stock based compensationexpense (“123R expenses”). These costs were partially offset by a substantialreduction in expenses for outside services. General and administrative expensesdecreased as a percent of revenues from 15.7% in 2005 to 14.8% in 2006.

The Company recognized a$517,000 benefit for income taxes for 2006, compared with $31,000 provision forincome taxes for 2005. The 2006 benefit reflects the expected application ofprevious years’ net operating loss carryforwards to future periods.

**Revenue and GrossProfit**

***Blood Products***

Blood products revenue for 2006 increased 18.2%, or$4,457,000, to $29,009,000 from $24,552,000 in 2005. This increase isattributable to an increase in sales of blood products to existing and new customers,primarily in Southern California. The Company increased its supply of bloodproducts through increased collections at Company operated donor centers andthrough the purchase of products from other 

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suppliers. In addition,blood products revenue includes four months of revenue from the Company’srecently acquired wholly owned subsidiary, HemaBio. HemaBio is a provider ofhuman biological samples, quality control products and clinical trialmanagement and support services for health research organizations.

Gross profit from thisbusiness segment decreased $141,000, or 2.8%, in 2006 to $4,908,000 from $5,049,000in 2005. This is mostly due to increased operating costs, including higherstaff compensation and higher facility related expenses, especially at theCompany’s Maine operations. The gross profit percentage for this segmentdeclined to 16.9% in 2006 compared with 20.6% for all of 2005.

***Blood Services***

Revenue for this businesssegment increased $800,000, or 12%, to $7.5 million from $6.7 millionrecognized in 2005. Blood services revenue fluctuates based on the number andtype of procedures performed. The Company performed 13% more procedures in2006, compared to 2005, primarily in the Mid-Atlantic region. The SouthernCalifornia region performed fewer procedures in 2006 principally as a result ofcompetition from other providers and a decrease in hospital utilization oftherapeutic apheresis as a treatment option due to unfavorable Medicarereimbursement. The Company recognized a 19.3% increase in gross profit for thisbusiness segment from $1,527,000 in 2005 to $1,821,000 in 2006. The grossprofit percentage of this segment increased to 24.4% for 2006, from 22.9% for2005. The improvement in gross profit is attributable primarily to operationalefficiencies from the Company’s Mid-Atlantic region associated with theincrease in revenue offset in part by higher albumin prices.

**General andAdministrative Expenses**

General and administrativeexpenses increased $505,000, or 10.3%, to $5,395,000 in 2006 from $4,890,000 in2005. This increase in expense is comprised of i) $402,000 for non-cashshared-based compensation, ii) $123,000 for facility relocation related costs,iii) $118,000 for insurance, iv) $84,000 in compensation and benefits, v) $44,000in bad debt, vi) $33,000 banking fees, vii) $25,000 in depreciation, and v)$21,000 in interest. These increases were partially offset by a $427,000reduction in the cost of outside services and temporary personnel. The increasein share-based compensation reflects the adoption of SFAS 123R in 2006associated with options issued under the Company’s 1996 Stock Incentive Plan. Theexpense for facility relocation occurred as part of the Company’s move of thecorporate offices, blood services administration offices, blood productmanufacturing lab, mobile drive operations and blood product distributionoperations to a new facility in Van Nuys, California. These expenses wereincurred primarily in the 4th quarter of 2006and included excess rent to maintain multiple locations simultaneously,temporary personnel and consultants, and losses associated with the abandonmentof certain furniture and equipment. Insurance expense increased as a result ofthe renewal of the Company’s liability insurance in May of 2006. Theincrease in employee compensation reflects higher salaries and health relatedbenefit expenses. Interest and banking expenses increased as a result of therecent utilization of the Company’s line of credit with Comerica Bank (“Comerica”),primarily to finance the acquisition of HemaBio. Bad debt expense increasedmostly due to an increase in the age of outstanding invoices for a singlecustomer. Depreciation expense increased as a result of the Company’sinvestment in several substantial assets in 2006. The reduction in outsideservices and temporary personnel is due to reduced reliance on outsideresources to assist management with various projects and from filling vacantpositions.

**Income Taxes**

The Company recognized a net income tax benefit for2006 of $517,000, compared to an income tax provision of $31,000 for 2005. TheCompany has sufficient net operating loss carryforwards to avoid most federalincome tax expense for 2006. However, management anticipates that the Companywill be subject to federal alternative minimum tax in 2006, as well as variousstate and local taxes which are unaffected by 

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any available netoperating loss carryfowards. Management has calculated an estimated taxliability that includes the potential for federal alternative minimum tax, andhas calculated estimated tax liability for each state and local jurisdictionusing the tax basis each jurisdiction uses to assess taxes. During 2006, theCompany recorded a $105,000 provision for income taxes based on theseestimates, which represents an increase of $74,000 over the amount recorded in2005. Much of the increase is Florida income tax associated with profits earnedby HemaBio during the last four months of 2006. The Company has no operatingloss carryforwards in Florida to avoid state income taxes.

Since the 3rd quarter of2003, the Company has recognized a 100% valuation reserve for deferred taxassets.  Current accountingstandards place 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 future and accordingly whether a valuationallowance is necessary. 2006represents the third consecutive profitable year for HemaCare Corporation, andtherefore represents evidence that it is more likely than not that the Companyis going to recognize a future benefit from net operating loss carryforwardsinto future years.

Management performed an extensive analysis of thefuture trends, risks and uncertainties associated with the business. Some ofthe factors considered included, i) possible changes in government regulation,ii) possible changes in Medicare reimbursement for the blood products orservices provided by the Company, iii) changes in strategies employed by theCompany’s competition, and iv) changes is medical technology that could alterthe utilization patterns for the Company’s products and services.

Based on this analysis,management estimated that it was more likely than not that only $622,000 of theavailable net operating loss carryforwards of $2.6 million would be utilized infuture periods. Therefore management reduced the deferred tax asset valuationreserve accordingly, which resulted in an income tax benefit for 2006. Thebalance of the deferred tax asset is not impacted by this valuation allowanceadjustment and therefore remains available for future use for up to 20 years. 

***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. Higher revenue, along with operational efficienciesfrom an increase in sales volumes, produced most of the improvement in bloodproducts gross profit. This was partially offset by a decrease in gross profitfor the Company’s blood services business segment as a result of lower revenue,higher nursing compensation, and higher expenses to manage and market thisbusiness unit.

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. General and administrative expenses decreased as apercent 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 little federal income tax as a result of theutilization of net operating loss carryforwards from previous years.

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**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 | % |

----

*                    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 20.6% in 2005 compared with 17.3% forall of 2004.

***Blood Services***

Revenue for this business segment was $6,675,000 in2005, which represents a $816,000, or 10.9%, decrease from the $7,491,000recognized in 2004. The revenues for the blood services segment fluctuate basedon the number and type of procedures performed. The Company performed 10.1%fewer procedures in 2005 compared to 2004, mostly as a result of reducedprocedure volumes in the Southern California and New England markets. Thedecrease occurred principally as a result of competition in the SouthernCalifornia market, and  ceasingin-patient services for a major customer in Maine. The Company recognized a 37%decrease in gross profit for this business segment from $2,425,000 in 2004 to$1,527,000 in 2005. The gross profit percentage of this segment decreased to22.9% for 2005, from 32.4% for 2004. The decline in gross profit isattributable to a decrease in revenue, and higher expenses to staff, manage andmarket 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 had sufficient net operating losscarryforwards to avoid most federal income tax expense for 2005. However,management anticipated that the Company would 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 calculated anestimated tax liability that included the potential for federal alternativeminimum tax, and calculated estimated tax liability for each state and localjurisdiction 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. Two years of profitability, or forecasts of futuretaxable income, are not considered sufficient positive evidence to outweigh ahistory of losses. Accordingly, the assets remained fully reserved as of theend of 2005. The Company’s federal and state net operating loss carryforwardswere not impacted by this valuation allowance and therefore were stillavailable for future use for up to 20 years. 

**2006 and 2005 QuarterlyFinancial Data**

The Company generated positive net income in everyquarter of 2006, and recognized the highest level of quarterly revenue and netincome in the fourth quarter of 2006 in more than six years. This positiveresult was due to higher blood products revenue, higher blood services revenueand improved blood services gross profit margins as a result of operationalefficiencies.

The following tablepresents unaudited statement of operations data for each of the eight quartersended December 31, 2006. 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.

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

| ** **                  | ** ** | **2005**               | ** ** | **2006**               | ** ** |
|-----------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **Quarter Ended** | ** ** | **Quarter Ended** | ** ** |
| ** **                  | ** ** | **March 31**      | ** ** | **June 30**       | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** | **March 31** | ** ** | **June 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| Revenues                    |       |                   | $          | 7,083                  |       |   | $ | 7,521 |   | $ | 7,768 |   | $ | 8,855 |   |   | $ | 8,187 |   |   | $ | 8,432 |   | $ | 9,177 |   | $ | 10,688 |   |
| Gross profit                |       |                   | 1,465      |                   |       | 1,766 |   | 1,446 |   | 1,899 |   |   | 1,648 |   |   | 1,490 |   | 1,731 |   | 1,860 |   |
| Income before  income taxes |       |                   | 276        |                   |       | 445 |   | 297 |   | 668 |   |   | 101 |   |   | 369 |   | 455 |   | 409 |   |
| Income tax  provision       |       |                   | —     |                   |       | 5 |   | 2 |   | 24 |   |   | 16 |   |   | 9 |   | 7 |   | (549 | ) |
| Net income                  |       |                   | $          | 276                    |       |   | $ | 440 |   | $ | 295 |   | $ | 644 |   |   | $ | 85 |   |   | $ | 360 |   | $ | 448 |   | $ | 958 |   |
| Earnings per  share         |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                       |       |                   | $          | 0.03                   |       |   | $ | 0.05 |   | $ | 0.04 |   | $ | 0.08 |   |   | $ | 0.01 |   |   | $ | 0.05 |   | $ | 0.05 |   | $ | 0.11 |   |
| Diluted                     |       |                   | $          | 0.03                   |       |   | $ | 0.05 |   | $ | 0.03 |   | $ | 0.08 |   |   | $ | 0.01 |   |   | $ | 0.04 |   | $ | 0.05 |   | $ | 0.10 |   |

 

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.

**Critical AccountingPolicies and Estimates**

***General***

Management’s discussionand analysis 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 the Companyto make estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, the Company evaluates its estimates, including those related tovaluation reserves, income taxes and intangibles. The Company bases itsestimates on historical experience and on various other assumptions thatmanagement believes are reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

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***Accounting for Share-Based Incentive Programs***

In accordance with SFAS 123R, the Company recognizedcompensation expense in 2006 related to stock options granted to employeesbased on: a) compensation cost for all share-based payments granted prior to,but not yet vested as of, December 31, 2005, based on the grant date fairvalue estimated in accordance with SFAS 123, adjusted for an estimated futureforfeiture rate, and b) compensation cost for all share-based payments grantedsubsequent to December 31, 2005, based on the grant date fair valueestimated in accordance with the provisions of SFAS 123R.

The Company’s assessment of the estimated fair valueof the stock options granted is affected by the price of the Company’s stock,as well as assumptions regarding a number of complex and subjective variablesand the related tax impact. Management utilized the Black-Scholes model toestimate the fair value of stock options granted. Generally, the calculation ofthe fair value for options granted under SFAS 123R is similar to thecalculation of fair value under SFAS 123, with the exception of the treatmentof forfeitures.

The Black-Scholesoption valuation model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable.This model also requires the input of highly subjective assumptions including:

(a)          The expected volatilityof the common stock price, which was determined based on historical volatilityof the Company’s common stock;

(b)         Expected dividends, whichare not anticipated; and

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

In the future, managementmay elect to use different assumptions under the Black-Scholes valuation modelor a different valuation model, which could result in a significantly differentimpact on net income or loss.

***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.

***Allowance for Obsolete Inventory***

HemaBio, the Company’ssubsidiary that focuses on providing human derived blood specimens to healthresearch organizations, maintains an extensive inventory of biological samples.This inventory is considered critical to providing customers with quick andeasy access to a variety of disease-state blood specimens. However, the demandfor these products fluctuates widely. As a result, HemaBio can store specimeninventory for extended periods of time and sell little of a particular specimentype. Management estimates the portion of this inventory that might not havefuture value for the Company by analyzing historical sales history data for thetwelve months prior to any balance sheet date. For each inventory type, 

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managementestablishes an obsolescence reserve equal to the value of inventory quantity inexcess of twelve months of historical sales quantity, using the first-in,first-out inventory valuation methodology. Therefore, the Company periodicallyadjusts the inventory reserve based on recent sales and inventory data, whichcan cause the net value of inventory to fluctuate dramatically from period toperiod.

***Goodwill***

In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwilland other Intangible Assets,” the Company periodically evaluates if anypreviously recognized goodwill is impaired and should be reduced in value bythe amount of the impairment. As a result of the acquisition of HemaBio, theCompany established a goodwill asset of $3,578,000 as of the end of 2006. Managementevaluated the four month performance of HemaBio after the acquisition byHemaCare on August 29, 2006, relative to the forecast utilized toestablish the original purchase price. As of December 31, 2006, managementconcluded that no impairment adjustment was required. Management will continueto evaluate the performance of HemaBio, along with other factors that mightindicate goodwill impairment, and will adjust the goodwill asset if impairmentis determined.

***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 netdeferred tax assets. Management continually evaluates if the deferred tax assetis likely to be realized. As of the end of 2006, management determined that$622,000 of deferred tax asset is likely to be realized, and recorded thedeferred tax asset, along with the corresponding benefit from income taxes inthe accompanying period. If on the other hand management determines that adeferred tax asset is not likely to be realized, a write-down of that assetwould be required and would be reflected in the provision for taxes in theaccompanying period.

**Liquidity andCapital R**esources

At December 31, 2006, the Company had cash andcash equivalents of $1,136,000 and working capital of $2,248,000.

On September 26, 2006, the Company, together withthe Company’s subsidiaries Coral Blood Services, Inc. and HemaCareBioScience, Inc., entered into an Amended and Restated Loan and SecurityAgreement (“Agreement”) with Comerica to provide a working capital line ofcredit. The Agreement restated the terms of the prior credit agreement withComerica, with the following revisions: i) the limits on the amount the Companymay borrow were changed to the lesser of 75% of eligible accounts receivable or$3 million, ii) HemaBio was added as an additional borrower, iii) Comerica wasgiven a security interest in all of the assets of HemaBio, and vi) the term ofthe Agreement was extended one year to June 30, 2008. The Agreementprovides that interest is payable monthly at a rate of prime minus 0.25%. As ofDecember 31, 2006, the rate associated with this credit facility was 8.00%.In addition, the Company has the option to draw against this facility forthirty, sixty or ninety days using LIBOR as the relevant rate of 

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interest. As of September 30,2006, the Company had borrowed $2,025,000 on this line of credit, and theCompany had unused availability of $975,000.

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 prohibit the payment of dividends. As of December 31,2006, the Company was in full compliance with all of the financial covenants. TheCompany incurred $42,000 in interest expense associated with the Comerica loanin 2006.

The Company also had a capital equipment lease with GECapital used to finance the acquisition of vehicles. As of December 31,2006, the balance outstanding on this lease was $7,000, all of which was included in currentobligations. This lease terminated in January 2007, and had a fixedinterest rate of 8.0%.

The Company had a capital equipment lease with ToshibaFinancial Services associated with the acquisition of photocopier equipment. During2006, the Company paid off the remaining outstanding balance of $3,000 on thisobligation.

As part of the consideration to acquire HemaBio, theCompany entered into two notes with each of the sellers. One note for $153,800for the benefit of Joseph Mauro, requires four equal annual installments of$38,450 each August 29 until paid. This note pays interest at 5% annually,and is secured through a security agreement, by all of the assets of HemaBio,although subordinate to Comerica. The second note for $46,200 for the benefitof Valentin Adia, requires four equal annual installments of $11,550 each August 29until paid. This note pays interest at 5% annually, and is also secured throughsecurity agreement, by all of the assets of HemaBio, although subordinate toComerica.

Finally,when the Company acquired HemaBio, HemaBio had two $250,000 notes outstandingto Dr. Lawrence Feldman and Dr. Karen Raben. Both of these notesrequire four equal annual installments of $62,500 each August 29 untilpaid, and pay interest at 7% annually. Each note is secured by all of theassets of HemaBio, but are subordinate to Comerica.

| ** **          | ** ** | **Payments due by year** | ** ** |
|---------------------|------------|-----------------------------------------|------------|
| ** **          | ** ** | **Total**                               | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Operating leases    |       | $                                       | 5,905,000  |   | $ | 592,000 |   | $ | 600,000 |   | $ | 606,000 |   | $ | 529,000 |   | $ | 538,000 |   | $ | 3,040,000 |   |
| Capitalized  leases |       | 7,000                                   |       | 7,000 |   | — |   | — |   | — |   | — |   | — |   |
| Notes payable       |       | 2,725,000                               |       | 2,200,000 |   | 175,000 |   | 175,000 |   | 175,000 |   | — |   | — |   |
| Totals              |       | $                                       | 8,637,000  |   | $ | 2,799,000 |   | $ | 775,000 |   | $ | 781,000 |   | $ | 704,000 |   | $ | 538,000 |   | $ | 3,040,000 |   |

 

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

Net cash provided by operating activities was$1,820,000 for 2006, and $1,872,000 for 2005, representing a decrease of $52,000.The decrease was due to a $2,902,000 increase in accounts receivable, and a$748,000 increase in inventories, supplies and prepaid expenses, partiallyoffset by a $2,992,000 increase in accounts payable, accrued expenses and otherliabilities, and net income for 2006 of $1,851,000. All of these categorieswere considerably smaller in size for 2005. Accounts receivable increased inpart as a result of the acquisition of HemaBio during 2006 and cash collectionsat the end of 2006 slowed due to the Company’s move of its corporate offices. HemaCare’sDSO stood at 58 days as of December 31, 2006, a level not seen by theCompany in over three years. Once the move related issues were resolved, cashcollections improved in early 2007 dropping DSO to 50 days as of January 31,2007 compared to 41 days as of December 31, 2005. The increase ininventories, supplies and prepaid expenses is the result of the HemaBioacquisition and an increase in albumin inventories compared to the end of 2005.The increase in accounts payable, accrued expenses and other liabilities, isthe result of the acquisition of HemaBio, and 

29

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the corporate office movedelayed some vendor payments, coupled with rent payable for the new facility inVan Nuys.

In 2006, net cash used in investing activitiesincreased to $5,753,000, compared with $603,000 for 2005 primarily due to $2.8million for the acquisition of HemaBio, $1.7 million investment in leaseholdimprovements and $500,000 for the acquisition and implementation of several newcomputer systems. In 2005, the cash used in investing activities was primarilyfor medical and computer equipment and new vehicles.

Cash provided by financing activities in 2006 was$2,457,000, compared with cash used of $739,000 for 2005. The Company utilized$2 million of the Comerica line of credit, and cash on hand, to finance assetinvestments in 2006. In addition, notes assumed in association with the HemaBioacquisition, provided the balance of the funds required by financing activities.For 2005, cash was used principally to pay off outstanding debt.

In December 2006, the Company signed a contractwith IDM, a subsidiary of Haemonetics, for a license agreement, support andimplementation services associated with a new information technology project toenhance the automation of the Company’s blood product operations. This projectis expected to take approximately two years to complete, and will involveconsiderable financial and managerial resources. Management expects the projectto costs a total of $2 million; portions of this project are scheduled forcompletion in late 2007 with full implementation in 2008.

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.

**Factors AffectingForward-Looking Information**

The Private SecuritiesLitigation Reform Act of 1995 provides a “safe harbor” from liability forforward-looking statements. Certain information included in this Form 10-Kand other materials filed or to be filed by the Company with the Securities andExchange Commission (as well as information included in oral statements orother written statements made or to be made by or on behalf of the Company) areforward-looking, such as statements relating to operational and financingplans, competition, the impact of future price increases for blood products anddemand for the Company’s products and services. These statements may also beidentified by the use of words such as “anticipate,” “believe,” “continue,” “estimate,”“expect,” “intend,” “may,” “project,” “will” and similar expressions, as theyrelate to the Company, its management and its industry. Investors and prospectiveinvestors are cautioned that these forward-looking statements are notguarantees of future performance and involve risks and uncertainties, many ofwhich will be beyond the control of the Company. Actual results could differmaterially from those anticipated in these forward-looking statements as aresult of various risks and uncertainties, including those above in “Item 1A -Risk Factors” or in other filings by the Company with the Securities andExchange Commission. The Company does not undertake to update itsforward-looking statements to reflect later events and circumstances or actualoutcomes.

**ITEM7A**                 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.

30

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At December 31, 2006, the Company had $2,732,000of debt, of which $707,000 is from notes payable and capitalized leases withfixed interest rates, and $2,025,000 on the Company’s working capital line ofcredit. The interest rate payable on this line of credit is based upon theprime interest rate. Accordingly, interest rate expense will fluctuate withrate changes in the U.S. If interest rates were to increase or decrease by 1%for the year, the Company’s interest expense would increase or decrease byapproximately $20,500.

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

**ITEM8***                       *FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Index to FinancialStatements and Schedules appears on page F-1. The Report ofIndependent Public Accountants appears on F-2 and the ConsolidatedFinancial Statements and Notes to Consolidated Financial Statements appear on pages F-3to F-21.

**ITEM9**                        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM9A***               *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 tothe Company (including its consolidated subsidiaries) required to be includedin this 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, 2006 that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

**ITEM9B**               OTHER INFORMATION

None.

31

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**PART III**

**ITEM10**                 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information concerningthe directors and executive officers of the Company and corporate governance isincorporated herein by reference from the section entitled “Proposal 1—Electionof Directors” contained in the definitive proxy statement of the Company to befiled pursuant to Regulation 14A within 120 days after the end of theCompany’s last fiscal year (the “Proxy Statement”).

**ITEM11**                 EXECUTIVE COMPENSATION

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

**ITEM12**                 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.

**ITEM13**                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,AND DIRECTOR INDEPENDENCE

The information concerningcertain relationships and related transactions and director independence isincorporated herein by reference from the section entitled “Proposal 1—Electionof Directors—Certain Relationships and Related Transactions” contained in theProxy Statement.

**ITEM14**                 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.

32

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**PART IV**

**ITEM15**                 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*

The following exhibits listed are filed or incorporatedby reference as part of this Report.
| 2.1   |   | Stock Purchase Agreement dated August 29, 2006,  among HemaCare Corporation, Joseph Mauro, Valentin Adia and Teragenix  Corporation, incorporated by reference to Exhibit 99.1 to Form 8-K  of the Registrant filed on September 5, 2006.                                                 |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.2   |   | Amendment to Stock  Purchase Agreement, dated as of November 14, 2006, among HemaCare  Corporation, Joseph Mauro, Valentin Adia and Teragenix Corporation,  incorporated by reference to Exhibit 99.12 to Amendment No. 1 to  Form 8-K of the Registrant filed on November 15, 2006. |
| 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   |   | 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.                                                                                             |
| 4.2   |   | Form of Common  Stock Certificate, incorporated by reference to Exhibit 4.4 to  Form S-8 of the Registrant dated July 10, 2006.                                                                                                                                                           |
| 10.1* |   | 1996 Stock Incentive  Plan, as amended, of the Registrant, incorporated by reference to Appendix to  the Proxy Statement of the Registrant filed on April 14, 2005.                                                                                                                                      |
| 10.2* |   | 2006 Equity Incentive  Plan of the Registrant, incorporated by reference to Annex A to the Proxy  Statement of the Registrant filed on April 21, 2006.                                                                                                                                                   |
| 10.3* |   | 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.                                                                                                                                  |
| 10.4  |   | 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.                                         |
| 10.5  |   | 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.                      |

33

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| 10.6   |   | 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.                                                         |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7   |   | 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.                                              |
| 10.8   |   | Lease agreement between  HemaCare Corporation, as tenant, and ECI Sherman Plaza LLC, as landlord  for approximately 20,000 square feet located in Van Nuys, California, dated  February 10, 2006, incorporated by reference to Exhibit 99.1 of  Form 8-K of the Registrant filed on March 1, 2006. |
| 10.9   |   | Amended and Restated  Loan and Security Agreement among HemaCare Corporation, Coral Blood  Services, Inc. and HemaCare BioScience, Inc. and Comerica Bank  dated September 26, 2006, incorporated by reference to Exhibit 99.1  to Form 8-K of the Registrant filed on September 29, 2006     |
| 10.10* |   | 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.                                                                                                    |
| 10.11* |   | 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.                                                                                                     |
| 10.12* |   | 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.                                                                 |
| 10.13* |   | 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.                                              |
| 10.14  |   | 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.                                                        |
| 10.15* |   | 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.                                                                                            |
| 10.16* |   | Indemnification  Agreement between HemaCare Corporation and Judi Irving, President and Chief  Executive Officer dated July 5, 2006, incorporated by reference to  Exhibit 99.1 to Form 8-K of the Registrant filed on  July 6, 2006.                                                                    |
| 10.17* |   | Indemnification  Agreement between HemaCare Corporation and Robert Chilton, Executive Vice  President and Chief Financial Officer dated July 5, 2006, incorporated  by reference to Exhibit 99.1 to Form 8-K of the Registrant  filed on July 6, 2006.                                                  |
| 10.18  |   | Escrow Agreement dated  as of August 29, 2006, among HemaCare Corporation, Joseph Mauro,  Valentin Adia and U.S. Bank, National Association, incorporated by reference  to Exhibit 99.2 to Registrant’s Current Report on Form 8-K  filed on September 5, 2006.                                    |

34

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| 10.19  |   | Promissory Note dated  August 29, 2006, in the principal amount of $153,800, of HemaCare  Corporation payable to Joseph Mauro, incorporated by reference to  Exhibit 99.3 to Registrant’s Current Report on Form 8-K filed  on September 5, 2006.                                    |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.20  |   | Promissory Note dated  August 29, 2006, in the principal amount of $46,200, of HemaCare  Corporation payable to Valentin Adia, incorporated by reference to  Exhibit 99.4 to Registrant’s Current Report on Form 8-K filed  on September 5, 2006.                                    |
| 10.21* |   | Employment Agreement  dated August 29, 2006, between HemaCare Corporation and Joseph Mauro,  incorporated by reference to Exhibit 99.5 to Registrant’s Current Report  on Form 8-K filed on September 5, 2006.                                                                       |
| 10.22* |   | Employment Agreement  dated August 29, 2006, between HemaCare Corporation and Valentin Adia,  incorporated by reference to Exhibit 99.6 to Registrant’s Current Report  on Form 8-K filed on September 5, 2006.                                                                      |
| 10.23  |   | Promissory Note dated  August 29, 2006, in the principal amount of $250,000, of Teragenix  Corporation, payable to Dr. Lawrence Feldman, incorporated by reference  to Exhibit 99.7 to Registrant’s Current Report on Form 8-K  filed on September 5, 2006.                     |
| 10.24  |   | Promissory Note dated  August 29, 2006, in the principal amount of $250,000, of Teragenix  Corporation, payable to Dr. Karen Raben, incorporated by reference to  Exhibit 99.8 to Registrant’s Current Report on Form 8-K filed  on September 5, 2006.                          |
| 10.25  |   | Letter agreement dated  August 29, 2006, among HemaCare Corporation, Teragenix Corporation,  Dr. Lawrence Feldman and Dr. Karen Raben, incorporated by reference  to Exhibit 99.9 to Registrant’s Current Report on Form 8-K  filed on September 5, 2006.                  |
| 10.26  |   | Select  Series License Agreement with Prelude Exhibit dated  December 29, 2006, between Information Data Management, Inc. and  HemaCare Corporation, incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed on January 5,  2007. |
| 10.27* |   | First Amendment to  Employment Agreement between HemaCare Corporation and Joshua Levy, M.D. dated  March 31, 2005.                                                                                                                                                                                       |
| 11     |   | Computation of earnings 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.                                                                                                                                                             |
| 21     |   | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                                              |
| 23.1   |   | Consent of Stonefield  Josephson, Inc., Independent Registered Public Accounting Firm.                                                                                                                                                                                                                   |
| 24     |   | Power of attorney (see  signature page).                                                                                                                                                                                                                                                                      |
| 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.

35

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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: | April 2, 2007 |   | **HEMACARE CORPORATION** |
|--------|--------------------|--------|--------------------------|
|   |               |   | By:                      | /s/ ROBERT S. CHILTON |
|   |               |   |                     | Robert S. Chilton, Chief Financial Officer |

 

KNOW ALL PERSONS BY THESE PRESENTS, that each personwhose signature appears below hereby constitutes and appoints Judi Irving,President and Chief Executive Officer, and Robert S. Chilton, Executive VicePresident, Chief Financial Officer and Corporate Secretary, his true and lawfulattorneys-in-fact and agents, with full power of substitution, to sign and executeon behalf of the undersigned any and all amendments to this report, and toperform any acts necessary in order to file the same, with all exhibits theretoand other documents in connection therewith with the Securities and ExchangeCommission, granting unto said attorneys-in-fact and agents full power andauthority to do and perform each and every act and thing requested andnecessary to be done in connection therewith, as fully to all intents andpurposes as he might or could do in person, hereby ratifying and confirming allthat said attorneys-in-fact and agents, or their or his or her substitutes,shall do or cause to be done by virtue hereof.

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 second day of April, 2007.
|                             | **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/ TERESA  SLIGH           |          | Director                                              |
| Teresa  Sligh               |          |                                                  |
| /s/  TERRY VAN DER TUUK     |          | Director                                              |
| Terry Van Der  Tuuk         |          |                                                  |

 

 

36

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**Indexto Consolidated Financial Statements and Schedules**

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

 

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 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Stockholders of HemaCare Corporation:

We have audited the accompanying consolidated balancesheets of HemaCare Corporation and subsidiaries, as of December 31, 2006 and2005, and the relatedconsolidated statements of income, shareholders’ equity and cash flows for eachof the three years in the period ended December 31, 2006. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged to perform an audit of the Company’s internalcontrol over financial reporting. Our audit included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of HemaCare Corporation and subsidiaries as of December 31, 2006and 2005, and the results of their operations and their cash flows for each ofthe three years in the period ended December 31, 2006 in conformity withaccounting principles generally accepted in the United States of America.

As discussed in Note 2 tothe consolidated financial statements, in 2006 the Company adopted Statement ofFinancial Accounting Standards No. 123 (Revised 2004), Share-BasedPayments.

/s/ Stonefield Josephson, Inc.

Los Angeles, CaliforniaMarch 30, 2007

F-2

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**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**
|                                                                                                                               | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                    | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Assets**                                                                                                                    | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current assets:                                                                                                               |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                     |       | $                     | 1,136,000  |                  | $          | 2,612,000 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $141,000 in 2006  and $85,000 in 2005                         |       | 6,766,000             |       | 3,927,000             |       |
| Product inventories and supplies                                                                                              |       | 1,261,000             |       | 675,000               |       |
| Prepaid expenses                                                                                                              |       | 512,000               |       | 350,000               |       |
| Deferred income taxes—current                                                                                            |       | 560,000               |       | —                |       |
| Other receivables                                                                                                             |       | 293,000               |       | 145,000               |       |
| Total current assets                                                                                                          |       | 10,528,000            |       | 7,709,000             |       |
| Plant and equipment, net of accumulated depreciation  and amortization of $4,376,000 in 2006 and $3,945,000 in 2005           |       | 4,778,000             |       | 2,703,000             |       |
| Deferred income  taxes—long-term                                                                                         |       | 62,000                |       | —                |       |
| Goodwill                                                                                                                      |       | 3,578,000             |       | —                |       |
| Other assets                                                                                                                  |       | 101,000               |       | 134,000               |       |
| ** **                                                                                                                    |       | $                     | 19,047,000 |                  | $          | 10,546,000 |   |
| **Liabilities and Shareholders’ Equity**                                                                                 | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                          |       |                  |       |                  |       |
| Accounts payable                                                                                                              |       | $                     | 3,414,000  |                  | $          | 1,791,000 |   |
| Accrued payroll and payroll taxes                                                                                             |       | 1,572,000             |       | 1,389,000             |       |
| Other accrued expenses                                                                                                        |       | 587,000               |       | 290,000               |       |
| Obligation under acquisition agreement                                                                                        |       | 500,000               |       | —                |       |
| Current obligations under capital leases                                                                                      |       | 7,000                 |       | 81,000                |       |
| Current obligation under line of credit                                                                                       |       | 2,025,000             |       | —                |       |
| Current obligations under notes payable                                                                                       |       | 175,000               |       | —                |       |
| Total current liabilities                                                                                                     |       | 8,280,000             |       | 3,551,000             |       |
| Obligations under capital leases, net of current  portion                                                                     |       | —                |       | 7,000                 |       |
| Notes payable,  net of current portion                                                                                        |       | 525,000               |       | —                |       |
| Other long-term  liabilities                                                                                                  |       | 389,000               |       | —                |       |
| Shareholders’ equity:                                                                                                    |       |                  |       |                  |       |
| Common stock, no par value—20,000,000 shares  authorized, 8,495,955 issued and outstanding in 2006 and 8,196,060 in 2005 |       | 14,710,000            |       | 13,696,000            |       |
| Accumulated deficit                                                                                                           |       | (4,857,000            | )          | (6,708,000            | )          |
| Total shareholders’ equity                                                                                               |       | 9,853,000             |       | 6,988,000             |       |
| ** **                                                                                                                    |       | $                     | 19,047,000 |                  | $          | 10,546,000 |   |

 

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

F-3

----

**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEFor the Years Ended December 31,**

| ** **                                        | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenues                                          |       |       |       |       |       |       |       |
| Blood products                                    |       | $          | 29,009,000 |       | $          | 24,552,000 |       | $ | 19,345,000 |   |
| Blood services                                    |       | 7,475,000  |       | 6,675,000  |       | 7,491,000  |       |
| Total revenue                                     |       | 36,484,000 |       | 31,227,000 |       | 26,836,000 |       |
| Operating costs  and expenses                     |       |       |       |       |       |       |       |
| Blood products                                    |       | 24,101,000 |       | 19,503,000 |       | 15,954,000 |       |
| Blood services                                    |       | 5,654,000  |       | 5,148,000  |       | 5,066,000  |       |
| Total operating costs and expenses                |       | 29,755,000 |       | 24,651,000 |       | 21,020,000 |       |
| Gross profit                                      |       | 6,729,000  |       | 6,576,000  |       | 5,816,000  |       |
| General and administrative expenses               |       | 5,395,000  |       | 4,890,000  |       | 4,420,000  |       |
| Income from operations                            |       | 1,334,000  |       | 1,686,000  |       | 1,396,000  |       |
| Other income                                      |       | —     |       | —     |       | 167,000    |       |
| Income before income taxes                        |       | 1,334,000  |       | 1,686,000  |       | 1,563,000  |       |
| (Benefit)  provision for income taxes             |       | (517,000   | )          | 31,000     |       | 18,000     |       |
| Net income                                        |       | $          | 1,851,000  |       | $          | 1,655,000  |       | $ | 1,545,000 |   |
| Income per share                                  |       |       |       |       |       |       |       |
| Basic                                             |       | $          | 0.22       |       | $          | 0.20       |       | $ | 0.20 |   |
| Diluted                                           |       | $          | 0.20       |       | $          | 0.19       |       | $ | 0.19 |   |
| Weighted average shares outstanding—basic    |       | 8,265,000  |       | 8,121,000  |       | 7,831,000  |       |
| Weighted average  shares outstanding—diluted |       | 9,095,000  |       | 8,847,000  |       | 8,237,000  |       |

 

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

F-4

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**HEMACARE CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITYFor the Years Ended December 31, 2006, 2005, and 2004**
|                                                                                               | ** ** | **Common Stock** | ** ** | **Accumulated** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|
| ** **                                                                                    | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| 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 |   |
| Stock options exercised                                                                       |       | 14,000                |       | 13,000          |       | — |   | 13,000 |   |
| Issuance of  common stock for Teragenix Acquisition        |       | 286,000               |       | 543,000         |       | — |   | 543,000 |   |
| Share-based  compensation expense                                                             |       | —                |       | 458,000         |       | — |   | 458,000 |   |
| Net income                                                                                    |       | —                |       | —          |       | 1,851,000 |   | 1,851,000 |   |
| Balance as of  December 31, 2006                                                         |       | 8,496,000             |       | $               | 14,710,000 |   | $ | (4,857,000 | ) | $ | 9,853,000 |   |

 

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

F-5

 

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

| ** **                                                                                   | ** ** | **2006**   | ** ** | **2005**  | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|-----------|------------|------------|------------|
| Cash flows from  operating activities:                                                       |       |       |       |      |       |       |       |
| Net income                                                                                   |       | $          | 1,851,000  |      | $          | 1,655,000  |       | $ | 1,545,000 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |       |       |      |       |       |       |
| Provision (recovery) for bad debts                                                           |       | 63,000     |       | (1,000    | )          | 9,000      |       |
| Benefit from deferred tax assets                                                             |       | (622,000   | )          | —    |       | —     |       |
| Depreciation and amortization                                                                |       | 815,000    |       | 672,000   |       | 651,000    |       |
| Loss on disposal of assets                                                                   |       | 28,000     |       | 6,000     |       | 25,000     |       |
| Share-based compensation expense                                                             |       | 458,000    |       | —    |       | —     |       |
| Changes in operating  assets and liabilities:                                                |       |       |       |      |       |       |       |
| Increase in accounts receivable, net                                                         |       | (2,902,000 | )          | (548,000  | )          | (259,000   | )          |
| (Increase) decrease in inventories, supplies and  prepaid expenses                           |       | (748,000   | )          | (58,000   | )          | 103,000    |       |
| Increase in other assets and other receivables                                               |       | (115,000   | )          | (140,000  | )          | (77,000    | )          |
| Increase in accounts payable, accrued expenses and  other liabilities                        |       | 2,992,000  |       | 286,000   |       | 328,000    |       |
| Net cash provided by operating activities                                                    |       | 1,820,000  |       | 1,872,000 |       | 2,325,000  |       |
| Cash flows from  investing activities:                                                       |       |       |       |      |       |       |       |
| Proceeds from sale of plant and equipment                                                    |       | 9,000      |       | 13,000    |       | 17,000     |       |
| Investment in HemaBio                                                                        |       | (2,836,000 | )          | —    |       | —     |       |
| Proceeds from notes receivable                                                               |       | —     |       | —    |       | 20,000     |       |
| Purchase of plant and equipment                                                              |       | (2,926,000 | )          | (616,000  | )          | (213,000   | )          |
| Net cash used in investing activities                                                        |       | (5,753,000 | )          | (603,000  | )          | (176,000   | )          |
| Cash flows from  financing activities:                                                       |       |       |       |      |       |       |       |
| Proceeds from exercise of stock options                                                      |       | 13,000     |       | 34,000    |       | 80,000     |       |
| Proceeds from sale of common stock                                                           |       | —     |       | 132,000   |       | 130,000    |       |
| Principal borrowings (payments) on debt and  capitalized leases                              |       | 2,444,000  |       | (905,000  | )          | (1,212,000 | )          |
| Net cash provided by (used in) financing activities                                          |       | 2,457,000  |       | (739,000  | )          | (1,002,000 | )          |
| (Decrease) increase in cash and cash equivalents                                             |       | (1,476,000 | )          | 530,000   |       | 1,147,000  |       |
| Cash and cash  equivalents at beginning of period                                            |       | 2,612,000  |       | 2,082,000 |       | 935,000    |       |
| Cash and cash  equivalents at end of period                                                  |       | $          | 1,136,000  |      | $          | 2,612,000  |       | $ | 2,082,000 |   |
| Supplemental  disclosure:                                                                    |       |       |       |      |       |       |       |
| Interest paid                                                                                |       | $          | 32,000     |      | $          | 29,000     |       | $ | 95,000 |   |
| Income taxes paid (refunded)                                                                 |       | $          | 58,000     |      | $          | (100,000   | )          | $ | 117,000 |   |
| Teragenix  acquisition:                                                                      |       |       |       |      |       |       |       |
| Notes issued to sellers                                                                      |       | $          | 200,000    |      |       |       |       |   |
| Common stock  issued to sellers                                                              |       | $          | 543,000    |      |       |       |       |   |

 

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

F-6

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**HemaCareCorporationNotes to Consolidated Financial StatementsDecember 31, 2006**

***Note 1—Organization***

HemaCare Corporation collects, processes and distributesblood products to hospitals and research related organizations and othercustomers in the United States, and has operations in Southern California,Mid-Atlantic United States and Southern Florida.

***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. Occasionally the Company receives advance payment againstfuture delivery of blood products or services. Until the related products orservices are delivered, the Company records advance payments as deferredrevenue, which is included as a current liability on the balance sheet. Bloodservices revenues consist primarily of mobile therapeutics sales, while bloodproducts revenues consist primarily of sales of single donor platelets, wholeblood components or other blood products that are manufactured or purchased anddistributed by the Company. Accounts receivable are reviewed periodically forcollectibility.

*Inventories and Supplies:*   Inventoriesconsist of Company-manufactured platelets, whole blood components and otherblood products, as well as component blood products purchased for resale. Suppliesconsist primarily of medical supplies used to collect and manufacture productsand to provide therapeutic services. Inventories are stated at the lower ofcost or market and are accounted for on a first-in, first-out basis. Management estimates the portion of inventorythat might not have future value by analyzing historical sales history for thetwelve months prior to any balance sheet date. For each inventory type,management establishes an obsolescence reserve equal to the value of inventoryquantity in excess of twelve months of historical sales quantity, using thefirst-in, first-out inventory valuation methodology. The Company recordedreserves for obsolete inventory of $736,000 and 0, as of December 31, 2006and 2005, respectively.

F-7

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**Inventoriesare comprised of the following as of December 31,**

| ** **     | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| Blood products |       | $        | 489,000    |     | $          | 154,000 |   |
| Supplies       |       | 772,000  |       | 521,000  |       |
|           |       | $        | 1,261,000  |     | $          | 675,000 |   |

 

*Plant and Equipment:*   Plantand equipment are stated at original cost. Furniture, fixtures, equipment andvehicles are depreciated using the straight-line method over five to ten years.Leasehold improvements are amortized over the lesser of their useful life or thelength of the lease, ranging from three to ten years. The cost of normalrepairs and maintenance are expensed as incurred.

*Long-lived Assets:**  *All long-lived assets are reviewed for impairment invalue when changes in circumstances dictate, based upon undiscounted futureoperating cash flows, and appropriate losses are recognized and reflected incurrent earnings, to the extent the carrying amount of an asset exceeds itsestimated fair value determined by the use of appraisals, discounted cash flowanalyses or comparable fair values of similar assets.

*Income Taxes:*   Theprocess of preparing the financial statements includes estimating income taxesin each of the jurisdictions that the Company operates. This process involvesestimating actual current tax exposure together with assessing temporarydifferences resulting from differing treatment of items for tax and accountingpurposes. These differences result in deferred tax assets and liabilities,which are included in the balance sheet. Under the provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 109, “Accounting for IncomeTaxes,” the Company must utilize an asset and liability approach that requiresthe recognition of deferred tax assets and liabilities for the expected futuretax consequences of events that have been recognized in the Company’s financialstatements or tax returns. Management must assess the likelihood that thedeferred tax assets or liabilities will be realized from future periods, and tothe extent management believes that realization 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 netdeferred tax assets. Management continually evaluates if the deferred tax assetis likely to be realized. As of the end of 2006, management determined that$622,000 of deferred tax asset was likely to be realized, and wrote-up thedeferred tax asset, along with the corresponding benefit from income taxes inthe accompanying period. If on the other hand management determines that adeferred tax asset is not likely to be realized, a write-down of that assetwould be required and would be reflected in the provision for taxes in theaccompanying period.

*Per Share Data:*   Earningsper share-basic is computed by dividing net income by the weighted averageshares outstanding. Earnings per share-diluted is computed by dividing netincome by the weighted average number of shares outstanding including thediluted effect of options and warrants.

*Interest Expense:*   Duringthe three years ended December 31, 2006, 2005, and 2004, the Companyincurred interest expense of $59,000, 29,000, and $95,000, respectively.

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

*Share-Based Compensation:**  *In accordance with SFAS No. 123R, “*Share-based Payment: An amendment of FASB Statements No. 123 and95”*(“SFAS 123R”), in the first quarter of fiscal year 2006, theCompany started to recognize compensation expense related to stock optionsgranted to employees based on: (a) compensation cost for all share-basedpayments granted prior to, but not yet vested as of December 31, 2005,based on the grant date fair value estimated in accordance with SFAS No 123, 

F-8

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“*Accounting for Stock-Based Compensation”* (“SFAS 123”), and (b) compensationcost for all share-based payments granted subsequent to December 31, 2005,based on the grant-date fair value estimated in accordance with the provisionsof SFAS 123R.

The Company’s assessmentof the estimated fair value of the stock options granted is affected by theprice of the Company’s stock, as well as assumptions regarding a number ofcomplex and subjective variables and the related tax impact. Managementutilized the Black-Scholes model to estimate the fair value of stock optionsgranted. Generally, the calculation of the fair value for options granted underSFAS 123R is similar to the calculation of fair value under SFAS 123, with theexception of the treatment of forfeitures.

TheBlack-Scholes option valuation model was developed for use in estimating thefair value of traded options that have no vesting restrictions and are fullytransferable. This model also requires the input of highly subjectiveassumptions including:

(a)          Theexpected volatility of the common stock price, which was determined based onhistorical volatility of the Company’s common stock;

(b)         Expecteddividends, which are not anticipated; and

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

In the future, managementmay elect to use different assumptions under the Black-Scholes valuation modelor a different valuation model, which could result in a significantly differentimpact on net income or loss.

*Employee Stock OptionPlan:*   Forthe years ended December 31, 2005 and 2004, the Company accountedfor its employee stock option plan under the recognition and measurementprinciples of Accounting Principles Board (“APB”) No. 25, “Accounting forStock Issued to Employees,” and related Interpretations. Under APB No. 25,no stock-based compensation is reflected in net income, as all options grantedunder the plans had an exercise price equal to the market value of theunderlying common stock on the date of grant and the related number of sharesgranted is fixed at that point in time.

*Recent Accounting Pronouncements:*

In September 2006,the Financial Accounting Standards Board (“FASB”) issued FAS No. 157, *“Fair Value Measurements”* (“FAS 157”). FAS 157 establishes acommon definition for fair value under GAAP, establishes a framework formeasuring fair value and expands disclosure requirements about such fair valuemeasurements. FAS 157 is effective for fiscal years beginning after November 15,2007. The Company is currently evaluating the impact of adopting FAS 157 on itsfinancial statements.

In June 2006, FASBissued FASB Interpretation (“FIN”) No. 48*, “Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”*(“FIN 48”), which clarifies the accounting for uncertainty in income taxpositions (“tax positions”). FIN 48 requires the Company to recognize in itsfinancial statements the impact of a tax position if that tax position is morelikely than not of being sustained on audit, based on the technical merits ofthe tax position. The provisions of FIN 48 are effective as of the beginning ofthe Company’s 2007 fiscal year, with the cumulative effect of the change inaccounting principle recorded as an adjustment to opening retained earnings.The Company estimates that there will be no material impact on the Company’sfinancial statements as a result of the implementation of FIN 48. This estimateis subject to revision as the Company completes its analysis.

In February 2007,FASB issued FAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities Including an Amendment of FASBStatement No. 115”* (“FAS 159”). FAS 159 permits entities tochoose to measure many financial instruments and certain other items at fairvalue. FAS 159 is effective for fiscal years beginning after November 15,2007. The Company is currently evaluating the impact of adopting FAS 159 on itsfinancial statements.

F-9

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***Note 3—Allowance for Doubtful Accounts***

The Company periodicallyreviews the outstanding balances owed by its customers. Generally, the Companyrecognizes an allowance for doubtful accounts for any balances owed that are 90days or more past due based on the invoice date, unless substantial evidenceexists that the receivable is collectable, such as subsequent cash collection. Inaddition, balances less than 90 days past due are reserved based on the Company’srecent bad debt experience.

An increase of $56,000 wasreflected in the allowance for doubtful accounts for 2006, mostly as a resultof delays in cash collections associated with the move of the corporate officesin November 2006. The allowance decreased $68,000 for 2005, and increased$10,000 for 2004. Write-offs against the allowance for doubtful accountstotaled $7,000, $67,000 and $208,000 for the years ended December 31,2006, 2005 and 2004, respectively. The Company will write-off a receivable whencollection efforts are terminated and the probability of collection is verylow.

***Note 4—Plant andEquipment***

Plantand equipment consists of the following:

| ** **                                      | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Furniture,  fixtures and equipment              |       | $                                           | 7,057,000  |   | $ | 6,122,000 |   |
| Leasehold  improvements                         |       | 2,097,000                                   |       | 526,000 |   |
|                                            |       | 9,154,000                                   |       | 6,648,000 |   |
| Less accumulated  depreciation and amortization |       | (4,376,000                                  | )          | (3,945,000 | ) |
|                                            |       | $                                           | 4,778,000  |   | $ | 2,703,000 |   |

 

Depreciation expense for2006, 2005, and 2004 was $815,000, $662,000, and $651,000, respectively.

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

On September 26, 2006, the Company, together withthe Company’s subsidiaries Coral Blood Services, Inc. and HemaCareBioScience, Inc. (“HemaBio”), entered into an Amended and Restated Loanand Security Agreement (“Agreement”) with Comerica Bank (“Comerica”) to providea working capital line of credit. The Agreement restated the terms of the priorcredit agreement with Comerica, except that: i) the limits on the amount theCompany may borrow were changed to the lesser of 75% of eligible accountsreceivable or $3 million, ii) HemaBio was added as an additional borrower, iii)Comerica was given a security interest in all of the assets of HemaBio, and vi)the term of the Agreement was extended one year to June 30, 2008. TheAgreement provides that interest is payable monthly at a rate of prime minus0.25%. As of December 31, 2006, the rate associated with this creditfacility was 8.00%. In addition, the Company has the option to draw againstthis facility for thirty, sixty or ninety days using LIBOR as the relevant rateof interest. As of December 31, 2006, the Company had borrowed $2,025,000on this line of credit, and the Company had unused availability of $975,000.

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 31,2006, the Company was in full compliance with all of the financial covenants. TheCompany incurred $42,000 in interest expense associated with the Comerica loanin 2006.

In addition, the Company had a note payable with OneSource Financial. During the fourth quarter of 2005, the Company paid all ofthe remaining unpaid balance on this note, totaling $12,000. The note was duein full on January 25, 2006 and had a fixed interest of 8.5%.

F-10

----

As part of the consideration to aquire HemaBio, theCompany entered into two notes with each of the sellers. One note for $153,800for the benefit of Joseph Mauro, requires four equal annual installments of$38,450 each August 29 until paid. This note pays interest at 5% annually,and is secured through a security agreement, by all of the assets of HemaBio,although subordinate to Comerica Bank. The second note for $46,200 for thebenefit of Valentin Adia, requires four equal annual installments of $11,550each August 29 until paid. This note pays interest at 5% annually, and isalso secured through security agreement, by all of the assets of HemaBio,although subordinate to Comerica Bank.

Finally, when the Companyacquired HemaBio, HemaBio had two $250,000 notes outstanding to Dr. KarenRaben and Dr. Lawrence Feldman. Both of these notes require four equalannual installments of $62,500 each August 29 until paid, and pay interestat 7% annually. Each note is secured by all of the assets of HemaBio, but aresubordinate to Comerica Bank.

Futureminimum payments under the line of credit and notes payable are as follows:

| **Years ending December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                         |       | $          | 2,200,000  |       |
| 2008                                         |       | 175,000    |       |
| 2009                                         |       | 175,000    |       |
| 2010                                         |       | 175,000    |       |
| Thereafter                                   |       | 0          |       |
| Total:                                       |       | 2,725,000  |       |
| Less: Current  portion                       |       | (2,200,000 | )          |
|                                         |       | $          | 525,000    |       |

 

***Note 6—Leases***

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

| ** **                     | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Equipment under  capital lease |       | $                                           | 286,000    |   | $ | 301,000 |   |
| Accumulated  Depreciation      |       | (119,000                                    | )          | (106,000 | ) |
|                           |       | $                                           | 167,000    |   | $ | 195,000 |   |

 

The Company has a capitalequipment lease with GE Capital Healthcare Financial Services used to finance theacquisition of vehicles. As of December 31, 2006, the balance outstandingon this lease was $7,000, all of which is included in current obligations. This lease is secured by five mobileblood collection vehicles, and is scheduled to mature in January 2007, andhas a fixed interest rate of 8.0%.

Finally, the Company had acapital equipment lease with Toshiba Financial Services associated with theacquisition of photocopier equipment. The outstanding balance on this lease of$3,000 was paid during 2006.

F-11

----

TheCompany leases its facilities and certain equipment under operating leases thatexpire through the year 2017. Future minimum rentals under capitalized andoperating leases are as follows:

| **Years ending December 31,** | ** ** | ** ** | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|----------------------------------------------|------------|------------|------------|-------------|------------|---------------|------------|
| 2007                                         |       | $          | 7,000      |        | $          | 592,000       |       |
| 2008                                         |       | 0          |       | 600,000     |       |
| 2009                                         |       | 0          |       | 606,000     |       |
| 2010                                         |       | 0          |       | 529,000     |       |
| Thereafter                                   |       | 0          |       | 3,578,000   |       |
| Total:                                       |       | 7,000      |       | $           | 5,905,000  |          |
| Less: Interest                               |       | 0          |       |        |       |
| Principal value  and taxes                   |       | 7,000      |       |        |       |
| Less: Current  portion                       |       | (7,000     | )          |        |       |
|                                         |       | $          | 0          |        |       |          |

 

Total rent expense under all operating leases was$734,000, $693,000, and $645,000, for the years ended December 31, 2006,2005, and 2004, 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.

On February 24, 2006, the Company entered into alease for approximately 19,600 square feet located in Van Nuys, Californiaintended to house corporate offices, a mobile blood drive operation, a bloodcomponent manufacturing lab and a blood products distribution operation. TheCompany occupied this facility in November 2006 and the lease on thisspace expires July 31, 2017. The rent for this facility starts atapproximately $36,500 per month, and the lease provides for 3% rent escalationon the anniversary of the beginning of the lease term. In addition, the leaseprovides the Company four months of rent abatement for the first, seventh,thirteenth and nineteenth months of the lease term. The Company has onefive-year option to extend this lease at the then current market price. Finally,the lease requires the landlord pay approximately $440,000 after completion ofthe tenant improvements, and approximately $105,000 on the fifth anniversary ofthe lease term to cover the cost of tenant improvements and facility upgrades.

The Company allocates on astraight-line basis the total lease payments, including rent escalation, abatedrent, and tenant improvement reimbursement, over the term of the lease. As aresult, the Company will recognize approximately $41,000 in monthly rentexpense over the term of the lease. As of December 31, 2006, the Companyrecognized $89,000 in deferred rent associated with this lease to be utilizedover the twelve month period ended December 31, 2007. This amount isincluded in other accrued expenses on the balance sheet. As of December 31,2006, the Company recognized $389,000 representing the balance of the deferredrent associated with this lease, included in other long-term liabilities on thebalance sheet.

***Note 7—Goodwill***

In accordance with SFAS No. 142,*“Goodwill and other Intangible Assets,”*the company periodically will evaluate if any previously recognized goodwill isimpaired and should be reduced in value by the amount of the impairment. As aresult of the acquisition of HemaBio, the Company established a goodwill assetof $3,578,000 as of the end of 2006. Management evaluated the four monthperformance of HemaBio after the acquisition by HemaCare on August 29,2006, relative to the forecast utilized to establish the original purchaseprice. As of December 31, 2006, management concluded that no impairmentadjustment 

F-12

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wasrequired. Management will continue to evaluate the performance of HemaBio,along with other factors that might indicate goodwill impairment, and willadjust the goodwill asset if impairment is determined.

***Note 8—Income Taxes***

Theprovision for income taxes for the years ended December 31, 2006, 2005,and 2004 are as follows:

| ** **                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current taxes:              |       |     |       |     |       |     |       |
| Federal                     |       | $        | 44,000     |     | $          | 21,000   |       | $ | 19,000 |   |
| State                       |       | 61,000   |       | 10,000   |       | 9,000    |       |
|                        |       | 105,000  |       | 31,000   |       | 28,000   |       |
| Deferred taxes:             |       |     |       |     |       |     |       |
| Federal                     |       | (622,000 | )          | —   |       | —   |       |
| State                       |       | —   |       | —   |       | (10,000  | )          |
|                        |       | (622,000 | )          | —   |       | (10,000  | )          |
| Provision for income  taxes |       | $        | (517,000   | )        | $          | 31,000   |       | $ | 18,000 |   |

 

Differencesbetween the provision for income taxes and income taxes at statutory federalincome tax rate for the years ended December 31, 2006, 2005, and 2004 areas follows:

| ** **                                    | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| Income tax  expense at federal statutory rate |       | $          | 436,000    |       | $          | 573,000  |       | $ | 536,000 |   |
| State income  taxes, net of federal benefit   |       | 67,000     |       | 56,000     |       | 53,000   |       |
| Change in  valuation allowance                |       | (1,039,000 | )          | (1,127,000 | )          | (71,000  | )          |
| Permanent  differences                        |       | 19,000     |       | 8,000      |       | 7,000    |       |
| Change in  deferred tax asset and other       |       | —     |       | 521,000    |       | (507,000 | )          |
| Income tax expense                            |       | $          | (517,000   | )          | $          | 31,000   |       | $ | 18,000 |   |

 

TheCompany recognized a $622,000 deferred tax asset as of December 31, 2006and no net deferred tax asset at December 31, 2005.   The components of the net deferred tax assetat December 31, 2006 and 2005 are as follows:

| ** **                       | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|
| *Current:*                       |       |       |       |       |       |
| Accounts  receivable reserve     |       | $          | 62,000     |       | $          | 33,000 |   |
| Accrued expenses  and other      |       | 498,000    |       | 276,000    |       |
| Total deferred  tax asset        |       | 560,000    |       | 309,000    |       |
| *Noncurrent:*                    | * *   | * *   | * *   | * *   | * *   |
| Net operating  loss carryforward |       | 952,000    |       | 1,688,000  |       |
| Depreciation and  amortization   |       | 275,000    |       | 152,000    |       |
| Contribution  Carryover          |       | —     |       | 16,000     |       |
| Tax credit  carryforward         |       | 596,000    |       | 703,000    |       |
| Other                            |       | (71,000    | )          | (139,000   | )          |
| Valuation  allowance             |       | (1,690,000 | )          | (2,729,000 | )          |
|                             |       | 62,000     |       | (309,000   | )          |
|                             |       | $          | 622,000    |       | $          | — |   |

 

F-13

----

A valuationallowance against the deferred tax asset is recorded if the weight of availableevidence suggests it is more likely than not that some portion or the entiredeferred tax asset will not be recognized. The Company determined at the end of2005 that, based on recent historical and expected future operating results, itwas more likely than not that the Company would not realize a significantportion of its deferred tax assets. Therefore, the Company recorded a 100%valuation reserve against all of the deferred tax assets.

2006 represents the third consecutive profitable yearfor HemaCare, and therefore represents evidence that it is more likely than notthat the Company is going to recognize a future benefit from net operating losscarryforwards into future years.

Management performed an extensive analysis of thefuture trends, risks and uncertainties associated with the business. Some ofthe factors considered included: i) possible changes in government regulation,ii) possible changes in Medicare reimbursement for the blood products orservices provided by the Company, iii) changes in strategies employed by theCompany’s competition, and iv) changes is medical technology that could alterthe utilization patterns for the Company’s products and services.

Based on this analysis,management estimated that it was more likely than not that only $622,000 of theavailable net operating loss carryforwards of $2.6 million would be utilized infuture periods. Therefore management reduced the deferred tax asset valuationreserve accordingly, which resulted in an income tax benefit for 2006. Thebalance of the deferred tax asset is not impacted by this valuation allowanceadjustment and therefore remains available for future use. The Company’savailable net operating loss carryforwards have various expiration datesranging from 2009 to 2023. 

***Note 9—Shareholders’ Equity***

**Stock Options**

In 1996, the Board of Directors, with shareholderapproval, adopted the Company’s 1996 Stock Incentive Plan (the “1996 Plan”). Thepurposes of the 1996 Plan are to (i) enable the Company to attract,motivate and retain top-quality directors, officers, employees, consultants andadvisors, (ii) provide substantial incentives for such persons to act inthe best interests of the shareholders of the Company, and (iii) rewardextraordinary effort by such persons on behalf of the Company. The 1996 Planprovides for awards in the form of stock options, which may be either “incentivestock options” within the meaning of Section 422 of the Internal RevenueCode of 1986, as amended (the “Code”), or non-qualified stock options, orrestricted stock. The total number of shares of common stock available fordistribution under the 1996 Plan is 2,500,000; provided, however, that no awardmay be made at any time if, after giving effect to such award, the total numberof shares of common stock issuable upon exercise of all outstanding options andwarrants of the Company (whether or not under the 1996 Plan) plus the totalnumber of shares of common stock called for under any stock bonus or similarplan of the Company (including shares of common stock underlying awards underthe 1996 Plan) would exceed 30% of the total number of shares of common stockoutstanding at the time of such award

Thetable below summarizes stock option transactions under the 1996 Plan.

| ** **                        | ** ** | **2006**   | ** ** | **2005**  | ** ** | **2004**   | ** ** |
|-----------------------------------|------------|------------|------------|-----------|------------|------------|------------|
| ** **                        | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of year |       | 1,501,000  |       | $         | 0.99       |       | 1,216,000  |   | $ | 0.85 |   | 1,379,000 |   | $ | 0.91 |   |
| Granted                           |       | 365,000    |       | $         | 2.41       |       | 340,000    |   | $ | 1.41 |   | 200,000 |   | $ | 0.46 |   |
| Exercised                         |       | (14,000    | )          | $         | (0.90      | )          | (52,000    | ) | $ | (0.65 | ) | (153,000 | ) | $ | (0.53 | ) |
| Canceled                          |       | (16,000    | )          | $         | (0.80      | )          | (3,000     | ) | $ | (1.09 | ) | (210,000 | ) | $ | (0.96 | ) |
| Outstanding at  end of year       |       | 1,836,000  |       | $         | 1.27       |       | 1,501,000  |   | $ | 0.99 |   | 1,216,000 |   | $ | 0.85 |   |
| Exercisable at end of  year       |       | 1,392,000  |       | $         | 1.14       |       | 1,123,000  |   | $ | 1.01 |   | 896,000 |   | $ | 0.95 |   |

 

F-14

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The following table summarizes the range of exerciseprice, weighted average remaining contractual life (“Life”) and weightedaverage exercise price (“Price”) for all stock options outstanding as of December 31,2006:

| ** **                                 | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Exercise Price** | ** ** | ** **                   | ** ** | **Shares**                   | ** ** | **Life** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| $0.32 to $0.75                             |       | 675,000                      |       | 5.0 years                    |       | $ | 0.50 |   | 610,000 |   | $ | 0 .51 |   |
| $0.76 to $1.50                             |       | 660,000                      |       | 7.0 years                    |       | $ | 1.22 |   | 497,000 |   | $ | 1.21 |   |
| $1.51 to $2.44                             |       | 501,000                      |       | 7.5 years                    |       | $ | 2.37 |   | 285,000 |   | $ | 2.37 |   |
|                                       |       | 1,836,000                    |       |                         |       | $ | 1.27 |   | 1,392,000 |   | $ | 1.14 |   |
|                                            |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |

 

As of December 31, 2006, the total aggregateintrinsic value of all fully vested stock options, and of all stock optionsoutstanding, is $2,310,000 and $2,805,000, respectively.

On May 24, 2006, the shareholders approved the2006 Equity Incentive Plan (“2006 Plan”) since the 1996 Plan expired in July 2006.The following is a summary of the 2006 Plan:

*Backgroundand Purpose.**  *Theprimary purpose of the 2006 Plan is to encourage ownership in the Company bykey personnel whose long-term service is considered essential to continuedprogress, thereby linking these employees directly to stockholder intereststhrough increased stock ownership.

*EligibleParticipants.**  *Awardsmay be granted under the 2006 Plan to any employee, director, or consultant or Companyaffiliates. An incentive stock option may be granted under the 2006 Plan onlyto a person who, at the time of the grant, is an employee of the Company or arelated corporation.

*Numberof Shares of Common Stock Available.**  *A total of 1,200,000 shares of commonstock have been reserved for issuance under the 2006 Plan. The maximumaggregate number of shares that may be issued under the 2006 Plan through theexercise of incentive stock options is 1,200,000. If an award is cancelled,terminates, expires, or lapses for any reason without having been fullyexercised or vested, or is settled for less than the full number of shares ofcommon stock represented by such award actually being issued, the unvested,cancelled, or unissued shares of common stock generally will be returned to theavailable pool of shares reserved for issuance under the 2006 Plan. Inaddition, if the Company experiences a stock dividend, reorganization, or otherchange in capital structure, the administrator may, in its discretion, adjustthe number of shares available for issuance under the 2006 Plan and anyoutstanding awards as appropriate to reflect the stock dividend or otherchange. The share number limitations included in the 2006 Plan will also adjustappropriately upon such event.

Through the end of fiscal 2005, the Company measuredcompensation expense for stock-based incentive programs utilizing the intrinsicvalue method prescribed by APB No. 25. Under this method, the Company didnot record compensation expense when stock options were granted to eligibleparticipants as long as the exercise price was not less than the fair marketvalue of the stock when the option was granted. In accordance with SFAS 123,the Company disclosed the pro forma net income per share as if the fairvalue-based method had been applied in measuring compensation expense forshare-based incentive awards. No share-based compensation cost was recognizedin the Condensed Consolidated Statement of Income for the twelve month periodsended December 31, 2005 and 2004 for options granted under the Company’s1996 Stock Incentive Plan, as all unvested options granted had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant.

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS 123R. This statement requires that thecost resulting from all share-based payment transactions be recognized in theCompany’s consolidated financial statements. In addition, in March 2005the Securities and Exchange Commission (“SEC”) released SEC Staff AccountingBulletin No. 107, “Share-Based Payment” (“SAB 107”). SAB 107 provides theSEC’s staff’s position regarding the application of SFAS 123R and certain 

F-15

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SEC rules andregulations, and also provides the staff’s views regarding the valuation ofshare-based payment arrangements for public companies. Generally, the approachin SFAS 123R is similar to the approach described in SFAS 123.However, SFAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the statementof income based on their fair values. Pro forma disclosure of fair valuerecognition, as prescribed under SFAS 123, is no longer an alternative.

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

TheBlack-Scholes option pricing model is used by the Company to determine theweighted average fair value of options. The fair value of options at date ofgrant and the assumptions utilized to determine such values are indicated inthe following table:

| ** **                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                          | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average  fair value at date of grant for options granted during the period |       | $                                           | 2.15       |   | $ | 1.25 |   | $ | 0.43 |   |
| Weighted average fair value for options exercised  during the period                |       | $                                           | 0.85       |   | $ | 0.57 |   | $ | 0.36 |   |
| Weighted average fair value for options vested  during the period                   |       | $                                           | 1.45       |   | $ | 1.00 |   | $ | 0.67 |   |
| Risk-free interest rates                                                            |       | 5.0                                         | %          | 5.0 | % | 4.0 | % |
| Expected stock price volatility                                                     |       | 95.3                                        | %          | 94.0 | % | 107.0 | % |
| Expected dividend yield                                                             |       | 0.0                                         | %          | 0.0 | % | 0.0 | % |
| Expected forfeitures                                                                |       | 0.0                                         | %          | 0.0 | % | 0.0 | % |
| Option Term                                                                         |       | 10 years                               |       | 10 years |   | 10 years |   |

 

For the twelve months ended December 31, 2006,the Company recognized non-cash share-based compensation costs of $458,000, asa result of the adoption of SFAS 123R, lowering income before taxes and netincome by this amount.

Thefollowing summarizes the activity of the Company’s stock options that have notvested for the year ended December 31, 2006.

| ** **                           | ** ** | **Shares** | ** ** | **Weighted  Average Fair  Value** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------------------|------------|
| Nonvested at  January 1, 2006   |       | 378,000    |       |                                   | $          | 0.93 |   |   |
| Granted                              |       | 365,000    |       |                                   | 2.15       |   |   |
| Vested                               |       | (299,000   | )          |                                   | 1.45       |   |   |
| Nonvested at  December 31, 2006 |       | 444,000    |       |                                   | $          | 1.51 |   |   |

 

F-16

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As of December 31, 2006, the compensation costrelated to nonvested awards not yet recognized is $670,000 with aweighted-average period over which the total compensation cost related tononvested awards not yet recognized is expected to be recognized of 8.5 years.

As of December 31, 2006, there are 1,392,000fully vested stock options outstanding with a weighted average fair value of$1.07 and an average contractual term of 5.4 years.

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

| ** **                                                                                                                                  | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income, as  reported                                                                                                                    |       | $                                           | 1,851,000  |   | $ | 1,655,000 |   | $ | 1,545,000 |   |
| Less: Total share-based employee compensation  expense determined under fair value-based method for all awards, net of  related tax effects |       | N/A                                         |       | 180,000 |   | 48,000 |   |
| Pro forma net  income                                                                                                                       |       | $                                           | 1,851,000  |   | $ | 1,475,000 |   | $ | 1,497,000 |   |
| Net income per  share - basic                                                                                                               |       |                                        |       |   |   |   |   |
| As reported                                                                                                                                 |       | $                                           | 0.22       |   | $ | 0.20 |   | $ | 0.20 |   |
| Pro forma                                                                                                                                   |       | $                                           | 0.22       |   | $ | 0.18 |   | $ | 0.19 |   |
| Net income per  share - diluted                                                                                                             |       |                                        |       |   |   |   |   |
| As reported                                                                                                                                 |       | $                                           | 0.20       |   | $ | 0.19 |   | $ | 0.19 |   |
| Pro forma                                                                                                                                   |       | $                                           | 0.20       |   | $ | 0.17 |   | $ | 0.18 |   |
| Shares used in  computing net income per share                                                                                              |       |                                        |       |   |   |   |   |
| Basic                                                                                                                                       |       | 8,265,000                                   |       | 8,121,000 |   | 7,831,000 |   |
| Diluted                                                                                                                                     |       | 9,095,000                                   |       | 8,847,000 |   | 8,237,000 |   |

 

***Note10—Earnings per Share***

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

| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                    |       | $                                           | 1,851,000  |   | $ | 1,655,000 |   | $ | 1,545,000 |   |
| Weighted average shares outstanding           |       | 8,265,000                                   |       | 8,121,000 |   | 7,831,000 |   |
| Net effect of  diluted options and warrants   |       | 830,000                                     |       | 726,000 |   | 406,000 |   |
| Weighted average  dilutive shares outstanding |       | 9,095,000                                   |       | 8,847,000 |   | 8,237,000 |   |
| Earnings per  share diluted                   |       | $                                           | 0.20       |   | $ | 0.19 |   | $ | 0.19 |   |

 

F-17

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***Note 11—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 31,2006 and December 31, 2005, the Company had uninsured cash and cashequivalents of $832,000 and $2,401,000, respectively.

***Note 12—401(k) Profit Sharing Plan***

The HemaCare Corporation401(k) Profit Sharing Plan (the “401(k) Plan”) qualifies, in form,under Section 401(k) of the Internal Revenue Code. For the 2004 planyear, the Company contributed cash in 2005 in the amount of $89,000 as matchingcontributions. The Company contributed in 2006, $92,000 in matchingcontributions for the 2005 plan year. In December 2006, the Board ofDirectors approved a matching contribution pertaining to the 2006 plan year ofapproximately $145,000.

***Note 13—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 oradversely impact 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.

***Note 14—Segment Information***

The Companyoperates in two business segments as follows:

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

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

F-18

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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** | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **2006**                       | ** ** |                    | ** ** | ** **              |       |   | ** ** | ** ** |   |
| Depreciation and  amortization |       |                    | $          | 520,000                 | ** ** |   |   | $ | 47,000 | ** ** |   |
| Expenditures for assets        |       |                    | 4,270,000  | ** **              |       |   | 126,000 | ** ** |   |
| Total assets                   |       |                    | $          | 10,574,000              | ** ** |   |   | $ | 2,655,000 | ** ** |   |
| **2005**                       | ** ** |                    | ** ** | ** **              |       |   | ** ** | ** ** |   |
| Depreciation and  amortization |       |                    | $          | 513,000                 | ** ** |   |   | $ | 34,000 | ** ** |   |
| Expenditures for assets        |       |                    | 427,000    | ** **              |       |   | 11,000 | ** ** |   |
| Total assets                   |       |                    | $          | 4,968,000               | ** ** |   |   | $ | 1,800,000 | ** ** |   |
| **2004**                       | ** ** |                    | ** ** | ** **              |       |   | ** ** | ** ** |   |
| Depreciation and  amortization |       |                    | $          | 437,000                 | ** ** |   |   | $ | 85,000 | ** ** |   |
| Expenditures for assets        |       |                    | 132,000    | ** **              |       |   | 28,000 | ** ** |   |
| Total assets                   |       |                    | $          | 4,603,000               | ** ** |   |   | $ | 1,785,000 | ** ** |   |

 

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 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 concentration risk in this section. During 2006 onlytwo customers represented more than 10% of the Company’s total revenue. Onecustomer accounted for approximately 12.6% of total revenue, and as of December 31,2006, the gross accounts receivable balance for this customer was $908,000. Theother customer accounted for approximately 11.5% of the Company’s totalrevenue, and as of December 31, 2006, the gross accounts receivablebalance for this customer was $812,000. The next largest customer accounted forapproximately 6.2% of total revenue. The Company’s ten largest customersaccounted for 58.3% 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 2006, the Company received goods and services from twomajor vendors that represented more than 10% of the Company’s total costs. Onevendor, that represents 12.6% of total costs, provides products that supportthe Company’s apheresis activities. As of December 31, 2006, the Companyowed this vendor $588,000. The other vendor, that represents 11.1% of totalcosts, provides laboratory services. As of December 31, 2006, the Companyowed this vendor $450,000. The Company has no relationship with either vendorother than as a consumer of the goods and services provided by each.

F-19

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***Note 16—Acquisition of Teragenix Corporation***

On August 29, 2006, the Company acquired all ofthe outstanding stock of Teragenix Corporation, subsequently renamed HemaCareBioScience, Inc. (“HemaBio”) for $4.8 million comprised of (i) $1,372,000in cash, (ii) up to an additional $250,000 in cash, subject to the Company’sright to set-off, (iii) 285,895 shares of the Company’s common stock, (iv) secured,subordinated promissory notes issued by the Company in the aggregate principalamount of $200,000, (v) up to 248,000 additional shares of the Company’scommon stock based on the “EBIT” (as defined) of HemaBio for the twelve month periodended March 31, 2007, and (vi) up to an additional $1,300,000 in cashbased on the EBIT of HemaBio for the three fiscal years ended December 31,2008, all as more fully described in the Company’s Current Reports on Form 8-Kfiled with the SEC on September 5, 2006 and November 15, 2006. Thiscontingent consideration will be added to the purchase price when determinable.The Company allocated the purchase price per SFAS 141 to the fair value of theassets acquired, net of liabilities assumed. The remaining portion of thepurchase price, or $3,078,000, was allocated to goodwill representing theamount of the purchase price in excess of the fair value of the assets, net ofliabilities acquired, subject to possible adjustment during the allocationperiod which will not to exceed one year. The Company elected to treat theacquisition as an asset purchase per Internal Revenue Code 338(h)(10). As aresult, the amortization of goodwill, over a 15 year period, will be deductiblefor tax purposes. This will create a deferred tax liability to the extent thebook basis of the goodwill exceeds the amortized tax basis. As ofDecember 31, 2006, the book basis of the goodwill exceeded the tax basisby approximately $80,000.

Thefollowing table summarizes the components of the consideration paid to acquireHemaBio:

| Cash paid to  sellers                         |   | $       | 1,372,000 |   |
|-----------------------------------------------|--------|---------|-----------|--------|
| Additional cash,  subject to right to set-off |   | 250,000 |      |
| Acquisition costs                             |   | 602,000 |      |
| Cash investment  in HemaBio:                  |   | $       | 2,224,000 |   |
| Notes issued to  sellers                      |   | 200,000 |      |
| HemaCare stock                                |   | 543,000 |      |
| Total  consideration:                         |   | $       | 2,967,000 |   |

 

Thefollowing table summarizes the allocation of the consideration to the assetsacquired, net of liabilities assumed:

| Cash and cash  equivalents            |   | $         | 248,000   |   |
|---------------------------------------|--------|-----------|-----------|--------|
| Accounts  receivable                  |   | 468,000   |      |
| Inventory                             |   | 257,000   |      |
| Other current  assets                 |   | 15,000    |      |
| Property,  plant & equipment |   | 160,000   |      |
| Other non-current  assets             |   | 16,000    |      |
| Goodwill                              |   | 3,078,000 |      |
| Total assets acquired:                |   | $         | 4,242,000 |   |
| Less: Liabilities  and debt assumed   |   | 1,275,000 |      |
| Total  consideration:                 |   | $         | 2,967,000 |   |

 

HemaCare’s primary reason for acquiring Teragenix isits focus on providing blood products and support services to research-focusedcustomers. HemaCare identified research support as a strategic growthopportunity, and believes the combination of the two companies will provideHemaCare with a market advantage by providing research customers with a widerange of biological samples and clinical research support services.

F-20

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As of December 31, 2006, the balance sheet ofHemaBio is consolidated with the Company’s balance sheet. The statement ofincome of HemaBio for the 123 day period from August 30, 2006 to December 31,2006 is consolidated with the Company’s statement of income for the year December 31,2006. The statement of cash flows for HemaBio for the period August 30,2006 to December 31, 2006 is included with the Company’s statement of cashflows for the year ended December 31, 2006.

If theoperating results of HemaBio had been included since the beginning of the yearsended December 31, 2005 and 2006, the pro forma revenues, net income andnet income per share would be as follows:

| ** **                                       | ** ** | **Years ended  December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| Revenues                                         |       | $                                       | 39,196,000 |   | $ | 36,412,000 |   |
| Net income                                       |       | 1,945,000                               |       | 2,529,000 |   |
| Net income per  share                            |       |                                    |       |   |   |
| Basic                                            |       | $                                       | 0.23       |   | $ | 0.30 |   |
| Diluted                                          |       | $                                       | 0.21       |   | $ | 0.28 |   |
| Shares used for  calculated net income per share |       |                                    |       |   |   |
| Basic                                            |       | 8,421,000                               |       | 8,407,000 |   |
| Diluted                                          |       | 9,251,000                               |       | 9,133,000 |   |

 

The acquisition agreement requires a cash payment of$500,000 as additional consideration to the sellers if the full annual 2006EBIT (as defined in the agreement) of HemaBio exceeded $427,500.  The Company has determined the required EBITtarget was achieved, and therefore the additional obligation was recognized asa current liability on the Company’s balance sheet. The recognition of thisadditional consideration increased goodwill by $500,000.

F-21

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