UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

(MARK ONE)
x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________________ TO _______________________

 

Commission file number 000-19031

 

NATIONAL QUALITY CARE, INC.

(Exact name of Registrant as Specified in its Charter)

 

Delaware (State or Other Jurisdiction of Incorporation or Organization)	84-1215959 (I.R.S. Employer Identification Number)
2431 Hill Drive Los Angeles, California 90041 (Address of Principal Executive Offices including Zip Code)
(323) 254-2014 (Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

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

 

Common Stock, $0.01 par value per share

 

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

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No x

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes o No o

 

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

 

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

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company x

 

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

 

The aggregate market value of voting and non-voting common stock held by non-affiliates of the Registrant as of June 30, 2010 is not determinable because there is no market for the Registrant’s common stock.

 

There were 80,221,807 shares of common stock outstanding as of December 31, 2010.

 

DOCUMENTS INCORPORATED BY REFERENCE: NONE.

 

 

TABLE OF CONTENTS TO ANNUAL REPORT
ON FORM 10-K
YEAR ENDED DECEMBER 31, 2010

 

		Page
FORWARD-LOOKING STATEMENTS		1
PART I		2
Item 1.	Description of Business	2
Item 1A.	Risk Factors	10
Item1B.	Unresolved Staff Comments	10
Item 2.	Description of Property	10
Item 3.	Legal Proceedings	10
Item 4.	Mine Safety Disclosures	10
PART II		11
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchaseof Equity Securities	11
Item 6.	Selected Financial Data	11
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	18
Item 8.	Financial Statements and Supplementary Data	18
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	18
Item 9A.	Controls and Procedures	18
Item 9B.	Other Information	20
PART III		20
Item 10.	Directors and Executive Officers	20
Item 11.	Executive Compensation	22
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	25
Item 13.	Certain Relationships, Related Transactions and Director Independence	26
Item 14.	Principal Accounting Fees and Services	26
PART IV		27
Item 15.	Exhibits and Financial Statement Schedules	27

 

 

FORWARD-LOOKING STATEMENTS

 

Certain statements in this Annual Report constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These include statements about anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products, anticipated market performance and similar matters. The words “budgeted,” “anticipate,” “project,” “estimate,” “expect,” “may,” “believe,” “potential” and similar statements are intended to be among the statements that are forward-looking statements. Because such statements reflect the risk and uncertainty that is inherent in our business, actual results may differ materially from those expressed or implied by such forward-looking statements. Some of these risks and uncertainties are related to our current business situation and include, but are not limited to, our lack of revenues, our history of operating losses, our need for additional financing, the uncertainty of our outstanding litigation with Xcorporeal, Inc. and the uncertainty about our ability to continue as a going concern, as well as those set forth in this Annual Report. Readers are cautioned not to place undue reliance on these forward-looking statements, which are made as of the date of this Report. Readers are advised that we undertake no obligation to release publicly any revisions to the forward-looking statements to reflect events or circumstances after the date hereof or to reflect unanticipated events or developments.

 

 

PART I

 

Item 1. Description of Business

 

Nature of Business

 

Prior to the sale of substantially all our assets as described later in this Report, we were a research and development company. Our platform technology was a wearable artificial kidney for dialysis and other medical applications (the “Wearable Kidney”). This device treats the blood of patients through a pulsating, dual-chambered pump. Continuous dialysis has always been possible for patients who are able to make several weekly visits to a dialysis clinic to be attached to a large machine for three to four hours at a time. With a wearable artificial kidney, patients would be able to have 24-hour dialysis, seven days a week, without having to spend long hours attached to a large machine at a clinic, allowing them to maintain a reasonable life style.

 

National Quality Care, Inc. was incorporated in Delaware in 1989 under the name “Emory Capital Corp.” The Company changed its name to Sargent, Inc. in 1991 and to National Quality Care, Inc. in 1996. Until May 31, 2006, the Company, through Los Angeles Community Dialysis, Inc., a California corporation (“LACD”), a wholly-owned subsidiary, provided dialysis services for patients suffering from chronic kidney failure and for patients suffering from acute kidney failure through a visiting nursing program contracted to several Los Angeles County hospitals. On May 31, 2006, LACD completed the sale of substantially all of its assets used in the chronic care dialysis clinic. On June 15, 2006, LACD completed the sale of the acute care dialysis unit. The Company decided to sell the dialysis units in order to focus principally on completion of the development and eventual commercial marketing of the Wearable Kidney.

 

The terms “NQCI,” “the Company,” “we,” “us” or “our” refer to National Quality Care, Inc., a Delaware corporation.

 

Our Wearable Artificial Kidney

 

The Wearable Kidney Solution

 

We developed a prototype device that can provide dialysis 24 hours a day, seven days a week, without requiring the patient to spend long hours attached to a large machine. We believed that this device would drastically improve the effectiveness of treatment and reduce mortality in the ESRD population and significantly reduce the costs associated with providing care to these patients.

 

The Wearable Kidney was designed to be worn on a patient’s belt or carried in a small backpack. We anticipated that the final version would weigh less than five pounds. We believed that the design of the Wearable Kidney addressed the three key challenges that have historically impeded the viability of a wearable artificial kidney, namely:

 

·

an efficient blood and dialysate circulation circuit that minimizes the amount of power consumption, allowing the use of batteries to power the system;

 

·

a lightweight dialysate regeneration system that minimizes the amount of dialysate required to cleanse the blood efficiently; and

 

·

an ergonomic design of components that should enable patients to wear the device continuously without discomfort.

  

Background of the Wearable Kidney

 

We began filing patent applications covering aspects of the Wearable Kidney technology in 2001. On November 15, 2004, we announced that we had developed a working prototype of the Wearable Kidney (the “Prototype”). The Prototype was designed to be powered by a battery and to operate substantially continuously 24 hours a day while in use. A version of the Prototype was successfully tested in bench studies and performed safely and effectively in animal testing studies conducted at the research facilities of Cedars Sinai Medical Center in Los Angles, California. The results of our testing and research were presented at the annual meeting of the American Society of Nephrology in November 2004. An abstract of the presentation was published in the Journal of the American Society of Nephrology. We demonstrated the feasibility of our Prototype by testing it on 12 pigs. We did not plan to do further animal studies because we believed that the testing and experiments performed constituted all the animal studies normally required prior to beginning clinical studies on human subjects.

 

 

In late 2006, we conducted research on new and enhanced techniques for removing blood impurities, such as urea and creatinine, using our Wearable Kidney technology. These enhanced techniques for removing blood impurities also provide an additional benefit of decreasing the power requirements of our Wearable Kidney without sacrificing its operational effectiveness. The findings from these lab studies were presented on November 18, 2006 at the annual meeting of the American Society of Nephrology. Small-scale, preliminary human studies under highly controlled circumstances were conducted with respect to the Wearable Kidney technology in Italy in 2006 and in England (carried out by Xcorporeal) in 2007.

 

We continued to evaluate our applications for initiating human clinical trials, which we began preparing in November 2005.

 

We had three issued U.S. patents covering various aspects of the Wearable Kidney. In addition we had ten pending U.S. patent applications directed to various aspects of both our Wearable Kidney and another device that we refer to as a Wearable Ultrafiltration Device. In April 2007, a Swedish patent was issued for the Wearable Kidney and in January 2008 a Mexican patent was issued for the Wearable Kidney. We also had nine additional patent applications pending in various countries including Japan, Mexico, the European Community, Brazil and China.

 

The Wearable Ultrafiltration Device removes excess fluid from patients with Congestive Heart Failure (CHF) and was intended to be worn as a belt and operated by batteries. The Wearable Ultrafiltration Device, like the Wearable Kidney, was intended to be substantially continuously operational 24 hours a day while in use. A prototype of our Wearable Ultrafiltration Device was successfully tested on animals in our research laboratory facility at Cedars Sinai Hospital in Los Angeles, California. The main benefit offered by this device was that it is intended to keep CHF patients free of salt and fluid overload, which is a major cause of hospitalizations and death for these patients. It was anticipated that the use of this device would result in significant improvements in patients’ quality of life and longevity while significantly reducing the enormous costs associated with treating the ever-growing CHF population.

 

Market and Marketing

 

We had targeted chronic kidney failure or ESRD as the first application of our new technology. At its most basic level, once the Wearable Kidney is connected to a patient’s blood supply, it can remove certain chemicals or toxins and excess fluids from the blood before returning the blood to the body, thus replacing many of the essential functions of a damaged kidney. At the same time, it can also be used to infuse the blood stream with drugs, hormones or nutritional components, as the clinical circumstances may require. While there are other devices to accomplish these tasks, only our device was actually wearable. Accordingly, the Wearable Kidney was anticipated to be able to provide patients with continuous, 24-hours operation, which would not only increase significantly the amount of treatment time but was also anticipated to enable patients to achieve a quality of life much closer to that of a healthy individual.

 

We intended to exploit the Wearable Kidney by generating revenue from sales and leases and from recurring sale of consumables associated with the Wearable Kidneys, such as pumps, sorbents, filters and rechargeable batteries. In the U.S., we intended to lease the Wearable Kidney mainly to existing dialysis centers.

 

Research and Development; Manufacturing

 

Pending resolution of the arbitration related to, among other things, the rights to use our Wearable Kidney technology, we suspended our research and development activities.

 

 

Patents and Proprietary Technology

 

We protected our proprietary rights from unauthorized use by third parties to the extent that our proprietary rights are covered by valid and enforceable patents or are effectively maintained as trade secrets. Patents and other proprietary rights are an essential element of our business. Our policy was to file patent applications and to protect our technology, inventions and improvements to inventions that are commercially important to the development of our business. We also rely on trade secret, employee and third-party nondisclosure agreements and other protective measures to protect our intellectual property rights pertaining to our products and technology.

 

In November 2005, we were issued our first U.S. patent covering the general design of the Wearable Kidney. Since then and recently in October 2007, we were issued a U.S. patent covering a new and useful sorbent cartridge design for use in the Wearable Kidney. Then in December 2007, we were issued our third U.S. patent, which covers additional novel aspects of the Wearable Kidney. In addition to the issued U.S. patents, we filed additional U.S. patent applications bringing our total number of pending patent applications in the U.S. to ten. With respect to our foreign patent filings, we had two issued patents covering basic design aspects of the Wearable Kidney in both Sweden (issued April 2007) and Mexico (issued January 2008). In addition to the two issued foreign patents, we had pending patent applications in the countries of, China, Brazil, the European Community, Japan and Mexico bringing the total of pending foreign patent applications to nine. These nine pending foreign patent applications, as well as the ten pending U.S. patent applications are directed generally to various overall features of the Wearable Kidney and the Wearable Ultrafiltration devices and systems. These additional patent applications, for example, are directed to specific novel aspects of the Wearable Kidney and Wearable Ultrafiltration devices as well as methods of using and servicing the devices, including, but not limited to, device size, power consumption, microprocessor control, fluid and chemical requirements, alarm systems, fluid pumping features, fluid flow volume and pressures, molecule removal clearances, as well as methods of servicing and maintaining the Wearable Kidney and Ultrafiltration devices.

 

Government Regulation

 

Due to the relatively early nature of our development efforts, we did not confirm with the FDA its view of the regulatory status of the Wearable Kidney or which center of the FDA might have primary responsibility for review of the regulatory submissions we intended to make. Depending on the claims made and the FDA’s ruling regarding the regulatory status of the Wearable Kidney, it could have been designated as a device, a biologic or as a combination product. However, we anticipated that regardless of regulatory designation, we would need to conduct pre-clinical and clinical studies on humans before being able to market the Wearable Kidney.

 

To support a regulatory submission, the FDA commonly requires clinical studies to show safety and effectiveness. While we could not state the nature of any such studies that the FDA may have required due to our early stage of product development, it is likely any product we attempted to develop would require extensive and time-consuming clinical studies in order to secure approval.

 

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

 

U.S. Regulation of Products. In the U.S., medical devices are classified into three different classes, Class I, II and III, on the basis of controls deemed reasonably necessary to ensure the safety and effectiveness of the device. Class I devices are subject to general controls (i.e. labeling, pre-market notification and adherence to the FDA’s Good Manufacturing Practices or GMP), Class II devices are subject to general and special controls (i.e. performance standards, post-market surveillance, patient registries and FDA guidelines). Class III devices are those which must receive pre-market approval by the FDA to ensure their safety and effectiveness, that is, life-sustaining, life-supporting and implantable devices, or new devices, which have been found not to be substantially equivalent to legally marketed devices. We believed that the Wearable Kidney for the treatment of ESRD would likely to be classified as a Class III device.

 

 

Clearance Procedure. Before a new medical device can be marketed, such as the Wearable Kidney for the treatment of ESRD, marketing clearance must be obtained through either the pre-market approval (“PMA”) process, or a shorter process under Section 510(k) of the Federal Food, Drug, and Cosmetic Act (“FDC Act”). Noncompliance with applicable requirements can result in fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal to authorize the marketing of new products or to allow us to enter into supply contracts and criminal prosecution. The PMA process is more formal and requires more panel time for trials, more information and a review period of 180 days (as compared to 90 days for 510(k)). The route required for a specific device depends on the class of the device and/or the similarity of the new decide to existing approved devices. The FDA has been requiring an increasingly rigorous demonstration of such similarity, which may include a requirement to submit human clinical trial data. Class III is the most stringent regulatory category for medical decides, since those devices support or sustain human life or prevent impairment to health. As such, these devices generally require PMA approval.

 

Human Clinical Trials. An investigational device exemption (“IDE”) allows an investigational device to be used in a clinical study in order to collect safety and effectiveness data required to support a PMA application to the FDA. Clinical studies are most often conducted to support a PMA. Investigational use also includes clinical evaluation of certain modifications or new intended uses of legally marketed devices. All clinical evaluations of investigational devices, unless exempt, must have an approved IDE before the study is initiated. An approved IDE permits a device to be shipped lawfully for the purpose of conducting investigations of the device without complying with other requirements of the FDC Act that would apply to devices in commercial distribution.

 

If human clinical trials of a device are required for a PMA application, or, in the opinion of the FDA, if the device presents a “significant risk,” the sponsor of the trial (usually the manufacturer or the distributor of the device) must file an IDE application prior to commencing human clinical trials. The IDE application must be supported by data, typically including the results of animal and laboratory testing. If the IDE application is approved by the FDA and one or more appropriate Institutional Review Boards (“IRBs”), human clinical trials may begin at a specific number of investigational sites with a specific number of patients, as approved by the FDA. If the device presents a “nonsignificant risk” to the patient, a sponsor may begin the clinical trial after obtaining approval for the study by one or more appropriate IRBs without the need for FDA approval.

 

International Product Regulation

 

International Organization for Standards (“ISO”) standards were developed by the European Community, or EC, as a tool for companies interested in increasing productivity, decreasing cost and increasing quality. The EC uses ISO standards to provide a universal framework for quality assurance and to ensure the good quality of products and services across borders. The ISO 9000 standards have facilitated trade throughout the EC, and businesses and governments throughout the world are recognizing the benefit of the globally accepted uniform standards. Any manufacturer utilized for purposes of manufacturing our products (including us, if we manufacture our own Wearable Kidney) will be required to obtain ISO certification to facilitate the highest quality products and the easiest market entry in cross-border marketing.

 

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

 

Employees

 

The Company has no employees and several consultants in administration as of December 31, 2010.

 

Available Information

 

We are a reporting company and file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (the “Commission”). You may inspect and copy these materials at the Public Reference Room maintained by the Commission at 100 F Street, N.E., Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for more information on the Public Reference Room. You can also find our Commission filings at the Commission’s website at www.sec.gov.

 

 

Events Prior to Sale of our Assets

 

On September 1, 2006, we entered into a merger agreement (the “Merger Agreement”) with Xcorporeal, Inc. (“Xcorporeal”) which contemplated that either (i) we would enter into a triangular merger in which we would become a wholly-owned subsidiary of Xcorporeal, or (ii) Xcorporeal would issue to us shares of its common stock in consideration of the assignment of the technology relating to our wearable artificial kidney and other medical devices (collectively sometimes referred to as the “Technology Transactions”). In connection with the Merger Agreement, also on September 1, 2006, we entered into a license agreement (the “License Agreement”) with Xcorporeal granting an exclusive license for ninety-nine years (or until the expiration of our proprietary rights in the technology, if earlier), to all technology relating to our wearable artificial kidney and other medical devices for a minimum royalty of $250,000.

 

Following execution of the Merger Agreement and the License Agreement, the parties attempted to close the transactions contemplated by the Merger Agreement, but disputes arose regarding satisfaction of the conditions to closing and with respect to certain provisions of the Merger Agreement. In addition, a dispute arose as to whether the License Agreement would survive a failure to consummate either of the two transactions contemplated by the Merger Agreement. The Company took the position that the License Agreement was revocable if the Merger Agreement and the transactions contemplated therein were terminated.

 

Effective as of December 29, 2006, we had terminated the Merger Agreement and License Agreement and all transactions contemplated thereby due to Xcorporeal’s continuing, uncured and incurable breaches of the Merger Agreement and wrongful conduct related to the Merger Agreement, the License Agreement and certain related matters. Xcorporeal did not dispute the termination of the Merger Agreement, but disputed our termination of the License Agreement, which Xcorporeal alleged to be in full force and effect.

 

On December 1, 2006, Xcorporeal filed a demand for arbitration against us, alleging an unspecified anticipatory breach of the License Agreement. On December 29, 2006, at the same time that we terminated the Merger Agreement and the License Agreement, we filed a lawsuit against Xcorporeal and against Victor Gura, former Chief Financial Officer and Chief Scientific Officer and a director of the Company. In the lawsuit, we alleged that Xcorporeal wrongfully induced Gura to become a member of Xcorporeal’s board of directors at the same time that he was an officer and director of the Company, and that both parties misappropriated our valuable rights and committed other wrongful acts in connection with the Merger Agreement, the License Agreement and transactions contemplated thereby. Xcorporeal and Gura stipulated to our filing of our claims against them as part of the arbitration proceedings related to the License Agreement, and we dismissed the lawsuit without prejudice.

 

On January 22, 2007, Xcorporeal filed a statement of claims in the arbitration proceeding. In this statement, Xcorporeal alleged that we breached several provisions of the Merger Agreement and engaged in interference with Xcorporeal’s contractual relations and prospective economic business advantage. In addition, Xcorporeal alleged that we improperly terminated the License Agreement and that it has retained the exclusive right to use our technology. On February 5, 2007 we filed a response to Xcorporeal’s statement of claims denying that we breached the Merger Agreement and asserting, among other things, that we properly terminated the License Agreement and that the License Agreement did not by its own terms and the meaning of the agreements survive the success or failure of the transactions contemplated by the Merger Agreement. In this response, the Company also asserted counterclaims against Xcorporeal for fraud, rescission, reformation, breach of contract, unjust enrichment and defamation. The Company amended its response on March 9, 2007 and on April 4, 2007 to add its claims against Terren S. Peizer, Xcorporeal’s Chairman of the Board and Gura. Xcorporeal, Peizer and Gura filed responses generally denying the Company’s allegations and asserting counter-claims.

 

The arbitration was held in February 2008. On June 9, 2008, the arbitrator issued an interim award in which he stated that “the core dispute is whether the Merger Agreement is dead and the License Agreement is prospectively enforceable.” The arbitrator concluded that the License Agreement was not to survive the failure of the transactions contemplated by the Merger Agreement, that Xcorporeal had waived and excused the Company’s obligations to perform under the Merger Agreement and that the appropriate remedy under the circumstances was to award the Company specific performance of the Technology Transaction. The arbitrator rejected the Company’s fraud, misappropriation and other claims, and rejected Gura’s claims against the Company and the Company’s claims against Gura. In addition, the arbitrator stated that the Company was the prevailing party in the arbitration and therefore entitled to recover its fees and costs.

 

 

Pursuant to the interim award, the Company applied for an award of fees and costs of approximately $3.9 million against Xcorporeal and of approximately $105,000 against Gura. Such amounts included fees and costs of the Company’s attorneys, experts and certain witnesses, as well as the costs and fees of the arbitration service, court reporters and litigation support services. Gura filed a separate application against the Company for approximately $617,000 in fees and costs. Because the Company had prevailed on some, but not all, of its claims, the arbitrator awarded the Company approximately $1.87 million in fees and costs. The arbitrator rejected the Company’s application against Gura and Gura’s application against the Company.

 

On August 4, 2008, the arbitrator issued a second interim award in which he established a schedule for completion of the Technology Transaction, as well as for the filing of a registration statement with respect to the resale of the shares of Xcorporeal to be issued to the Company at the closing (the “Registration Statement”). In the second interim award, the arbitrator clarified that the only conditions to the closing of the Technology Transaction were the filing and mailing of information statements by the parties as required by law, and the filing by Xcorporeal of the Registration Statement. On the basis of his interpretation of the parties’ intent as reflected by the provision in the Merger Agreement specifying that the Company was entitled, upon consummation of the Technology Transaction, to a 48% interest in Xcorporeal, as measured as of the date of the Merger Agreement and as adjusted for stock splits and certain other events, the arbitrator further confirmed that the Company was entitled to 9,230,000 shares of Xcorporeal, Inc. (AMEX: XCR) upon closing of the Technology Transaction.

 

Under the schedule established by the arbitrator, Xcorporeal was required to file an information statement or a proxy statement with respect to the Technology Transaction not later than August 22, 2008. Xcorporeal filed a proxy statement on August 22, 2008 seeking approval of its stockholders for the issuance of common stock in connection with the Technology Transaction. Xcorporeal was directed to close the Technology Transaction promptly following satisfaction of statutory requirements regarding information statements or proxy statements, as the case may be, and to file the Registration Statement within 30 days of closing. The Registration Statement was required to become effective within 90 days of filing. In the event that the Technology Transaction was not approved by Xcorporeal’s shareholders, the Company was to receive an alternate award in which all of the technology covered by the License Agreement would be decreed to be the sole and exclusive property of the Company. In such an event, the arbitrator would hold additional hearings to determine whether the portable artificial kidney technology currently under development by Xcorporeal was included in the technology under the License Agreement that would revert to the Company, and whether the Company would be entitled to compensatory damages.

 

The arbitrator further ordered in the second interim award that the License Agreement would remain in effect until the closing of the Technology Transaction, or until the arbitrator determined that no such closing will occur and that instead the alternate award described above will apply. By issuing “interim” awards, the arbitrator retained jurisdiction to oversee either the closing of the Technology Transaction or the implementation of the alternate award. The arbitrator stated that he would issue a single final, complete and self-contained award following the conclusion of his monitoring and supervision of the provisions of the second interim award.

 

On January 30, 2009, the arbitrator issued an order, in which the arbitrator modified the second interim award by reserving on what the final terms Xcorporeal's obligation to file the resale registration statement would be and stating that such registration obligation shall be in accordance with applicable laws, including applicable U.S. federal securities laws. While the arbitrator also retained jurisdiction to monitor Xcorporeal's compliance with such obligation, to award any appropriate relief to the Company if Xcorporeal failed to comply with such obligation and to render a decision on any other matters contested in the arbitration, the time periods set forth in the second interim award and summarized above were no longer applicable. The order also provided, among other things, that if Xcorporeal filed the proxy statement, obtained stockholder approval to issue to the Company 9,230,000 shares of Xcorporeal common stock as consideration for the closing of the Technology Transaction and issued such shares to the Company, the arbitrator anticipated confirming that all of the Technology covered by the License Agreement would be declared Xcorporeal's sole and exclusive property.

 

 

On April 13, 2009, the arbitrator in the arbitration proceeding issued a partial final award (“Partial Final Award”), which resolved the remaining issues that were pending for decision in the arbitration proceeding. The Partial Final Award reflected the arbitrator’s conclusions based on arguments by Xcorporeal that the 9,230,000 shares could not be issued to the Company in compliance with the federal securities laws because of the financial condition of the Company. The Partial Final Award provided that Xcorporeal would have a perpetual exclusive license (the “Perpetual License”) to the technology. Under the terms of the Partial Final Award, in consideration of the award of the Perpetual License to Xcorporeal, the Company was awarded a royalty of 39% of all net income, ordinary or extraordinary, to be received by Xcorporeal and the Company was to receive 39% of any shares received in any merger transaction to which Xcorporeal may become a party. In addition, the Partial Final Award provided that Xcorporeal was obligated to pay the Company $1,871,430 for its attorneys’ fees and costs previously awarded by the arbitrator in an order issued on August 13, 2008, that the Company’s application for interim royalties and expenses was denied and that the Company was not entitled to recover any additional attorneys’ fees.

 

Binding Memorandum of Understanding

 

On August 7, 2009, to clarify, resolve and settle disputes that had arisen between the Company and Xcorporeal with respect to the Partial Final Award, including with respect to the rights of the parties regarding certain technology and the application of the Partial Final Award in the case of a sale of the Technology, the Company and Xcorporeal entered into a Memorandum of Understanding (“Memorandum”).

 

In connection with the issuance of the Partial Final Award and the Memorandum, on August 7, 2009, the Company entered into a stipulation (the “Stipulation”) with Xcorporeal. Pursuant to the terms of the Stipulation, the Company and Xcorporeal agreed (i) not to challenge the terms of the Partial Final Award or any portion of such award, (ii) that any of the parties may, at any time, seek to confirm all but not part of the Partial Final Award through the filing of an appropriate petition or motion with the appropriate court and in response to such action to confirm the Partial Final Award, no party would oppose, object to or in any way seek to hinder or delay the court’s confirmation of the Partial Final Award, but would in fact support and stipulate to such confirmation, and (iii) to waive any and all right to appeal from, seek appellate review of, file or prosecute any lawsuit, action, motion or proceeding, in law, equity, or otherwise, challenging, opposing, seeking to modify or otherwise attacking the confirmed Partial Final Award or the judgment thereon.

 

Sale Negotiations

 

In late March 2009, Xcorporeal began a preliminary dialogue with Fresenius Medical Care Holdings, Inc. (Fresenius), to determine the interest of Fresenius to acquire certain or all of Xcorporeal assets. These discussions continued through June 2009. In June 2009 Fresenius commenced its due diligence review of Xcorporeal.

 

In September 2009, the Company and Xcorporeal reviewed the terms of a transaction proposed by FUSA, a wholly-owned subsidiary of Fresenius, in a draft non-binding term sheet for the acquisition of all of the Xcorporeal assets and the Company’s assets, which also included proposed provisions prohibiting Xcorporeal and the Company from soliciting other offers. The non-binding term sheet indicated that any further efforts by FUSA would be subject to its remaining due diligence and confirmation by FUSA and its counsel of certain approvals that would allow it to proceed with the transaction.

 

On September 21, 2009, the Company and Xcorporeal and FUSA executed an exclusivity letter (the “Exclusivity Letter’) pursuant to which the Company and Xcorporeal agreed to grant FUSA access to the respective books, records, personnel, properties, contracts and other data of Company and Xcorporeal. The Company and Xcorporeal also agreed that, until the later of (i) December 21, 2009 and (ii) the date on which any of the parties provided the others with written notice that negotiations to execute a definitive agreement were terminated (which any of the parties were entitled to do in their sole discretion), they would not directly or indirectly (i) solicit or take any other action to facilitate any offers from third parties with respect to the acquisition of the Company or a part or all of its assets, (ii) enter into an agreement to facilitate, approve or endorse such proposal or in connection with such proposal, abandon or terminate the proposed transaction between the Company and Xcorporeal and FUSA or (iii) enter into discussions, inquire or furnish information with respect to any such proposal.

  

The Company’s Board of Directors determined that the proposed asset sale would maximize stockholder value and that the Company’s best chance to receive any royalty payment(s) from the sale of its assets was to consummate the asset sale and thereby, indirectly partnering with FUSA, the world’s largest integrated provider of products and services for individuals undergoing dialysis because of chronic kidney failure.

 

 

The Company, Xcorporeal and FUSA executed an Asset Purchase Agreement on December 14, 2009 (“Asset Purchase Agreement”) and the Company publicly announced this transaction on December 18, 2009. On February 8, 2010, the Company, Xcorporeal and FUSA entered into an amendment , which extended from February 28, 2010 until March 31, 2010 the date upon which any party to the Asset Purchase Agreement could terminate the Asset Purchase Agreement if the closing of the transactions contemplated therein has not occurred.

 

Terms of the Asset Sale

 

The Asset Purchase Agreement provided for the sale of substantially all of each of the Company’s and Xcorporeal’s assets (the “Asset Sale”) to FUSA for an aggregate cash purchase price of $8,000,000 (the “Cash Purchase Price”) and certain other royalty payment rights (as more fully discussed below). Subject to the terms and conditions of the Asset Purchase Agreement, the Cash Purchase Price was to be paid to the Company and Xcorporeal as follows: (a) an exclusivity fee in the amount of $200,000 previously paid by FUSA to Xcorporeal, (b) $3,800,000 on the date of closing (the “Closing Date”) of the transactions contemplated under the Asset Purchase Agreement (the “Closing”), of which the Company and Xcorporeal received $2,150,000 and $1,650,000, respectively, (c) $2,000,000 on April 1, 2010, of which the Company and Xcorporeal received $1,625,000 and $375,000, respectively, and (d) $2,000,000 on April 1, 2011, of which the Company and Xcorporeal received $1,925,000 and $75,000, respectively.

 

In addition, during the life of the patents referred to as the HD WAK Technology (the “HD WAK Patents”), which expire between November 11, 2021 and September 9, 2024, the Company will be entitled to certain royalty payments from the sale of wearable hemodialysis (“HD WAK”) devices in each country where such sales infringe valid and issued claims of the Company’s and Xcorporeal’s HD WAK Patents issued in such country (“HD WAK Devices Royalty”) and the attendant disposables that incorporate the HD WAK Technology (as defined below) (“Attendant Disposables”), not to exceed a certain maximum amount per patient per week in a country where such sales infringe valid and issued claims of the HD WAK Patents issued in such country (the “Attendant Disposables Royalty”, and together with the HD WAK Devices Royalty, the “HD WAK Royalty”). Such payment for Attendant Disposables will not be payable with regard to Attendant Disposables that incorporate any technology for which a Supersorbent Royalty (as defined below) is paid by FUSA to the Company or Xcorporeal. The Company will be entitled to 40% of the HD WAK Royalty and Xcorporeal will be entitled to the remaining 60%.

 

Additionally, during the life of any patents referred to as the Supersorbent Technology (the “Supersorbent Patents”), the Company will be entitled to certain royalty payments on each supersorbent cartridge sold per patient in each country where such sales infringe valid and issued claims of the Supersorbent Patents issued in such country less any and all royalties payable to The Technion Research and Development Foundation Ltd. (“TRDF”) pursuant to a Research Agreement and Option for License, dated June 16, 2005 (the “Research Agreement”), or any subsequently executed license agreement between TRDF and FUSA. Such payment for supersorbent cartridges will not be payable with regard to supersorbent cartridges that incorporate any HD WAK Technology for which a HD WAK Royalty is paid by FUSA to the Company or Xcorporeal. During the life of any Supersorbent Patents, the Company will be entitled to 60% of the Supersorbent Royalty payments and Xcorporeal will be entitled to the remaining 40%. While several applications for patents are pending, no patent incorporating the Supersorbent Technology has yet been issued.

 

FUSA also granted to the Company and Xcorporeal an option to obtain a perpetual, worldwide license to the Supersorbent Technology for use in healthcare fields other than renal (the “Option”). The Option will be exercisable during the twelve-month period following FUSA’s receipt of regulatory approval for the sale of a supersorbent product in the United States or European Union, which the Company expects will require further development of the supersorbent technology with TRDF and successful completion of clinical trials by FUSA. In the event that the Option becomes exercisable and the Company and/or Xcorporeal exercises the Option, the consideration payable to FUSA by the Company or Xcorporeal for the exercise of the Option will consist of a payment in the amount of $7,500,000, payable in immediately available funds, and a payment of an ongoing royalty in an amount equal to the lesser of $0.75 per supersorbent cartridge and $1.50 per patient per week in each country where such sales infringe valid and issued claims of the Supersorbent Patents issued in such country.

 

 

Written Consent of the Company's Stockholders

 

On December 14, 2009, the holders of more than 50% of the issued and outstanding commons stock of the Company, considered and approved by written consent the Asset Sale. This written consent was sufficient to approve the Asset Sale and delivery of any and all documents necessary to the consummation of the Asset Sale.

 

Completion of the Asset Sale

 

On March 19, 2010, the Company and Xcorporeal completed the transactions contemplated by the Asset Purchase Agreement and the Company and Xcorporeal transferred substantially all of their respective assets to FUSA. The Company received $1,950,000 ($2,150,000 less $200,000 to resolve issues under the Asset Sale) at the Closing. On April 1, 2010 we received $1,625,000. On April 1, 2011 we received $1,675,000 ($1,925,000 less $250,000 to resolve issues under the Asset Sale). The closing of the Asset Sale also terminated the arbitration proceedings with Xcorporeal.

 

Item 1A. Risk Factors

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide this information.

 

Item1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Description of Property

 

As of December 31, 2010, we are operating out of 2431 Hill Drive, Los Angeles, California 90041.

 

Item 3. Legal Proceedings

 

On December 1, 2006, Xcorporeal filed a demand for arbitration at JAMS in Santa Monica, California against us, alleging an unspecified anticipatory breach of the License Agreement that we entered into with Xcorporeal on September 1, 2006. At the same time we entered into the License Agreement, we entered into an interrelated and inter-dependent Merger Agreement with Xcorporeal. Effective as of December 29, 2006, we terminated the merger and license agreements due to Xcorporeal’s continuing, uncured and incurable breaches of the Merger Agreement and its other wrongful conduct related to the merger and license agreements and certain related matters. At the same time we terminated the Merger Agreement and the License Agreement, we filed a lawsuit against Xcorporeal and against Victor Gura, a former officer and director of the Company. Xcorporeal and Gura stipulated to our filing of our claims against them as part of the arbitration proceedings related to the License Agreement, and we dismissed our lawsuit without prejudice. The arbitration was terminated with the closing of the Asset Sale in March 2010. A description of the arbitration proceedings is set forth at “Item 1. Description of Business—Events Prior to the Sale of Our Assets”.

 

On February 17, 2011, the Company commenced a binding arbitration with its former law firm regarding a fee dispute that arose as a result of claimed attorneys' fees incurred by the former law firm in connection with an arbitration between the Company and Xcorporeal and certain transactional and litigation matters handled by the law firm for the Company. The former law firm has asserted that approximately $2,729,000 million fees and costs are owed to it, plus interest. The binding arbitration is being heard in Los Angeles County by a panel of three arbitrators. The arbitrators have heard all of the testimony presented by the parties, and the parties submitted their final closing briefs on November 10, 2011. As of April 2, 2012 the arbitrators had not rendered their decision.

 

Item 4. Mine Safety Disclosures

 

Not Applicable.

 

 

PART II

 

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

 

During 2009 and 2010 there was no established trading market for our common stock. Our common stock trades only periodically on the so-called over-the-counter “pink sheets.” In 2009, we are only aware of one transaction in the Company’s common stock for a nominal amount of shares. In 2010, we are not aware of any transactions.

 

As of December 31, 2010, our authorized capital stock consisted of 125,000,000 shares of common stock, par value $0.01 per share and 5,000,000 shares of preferred stock, par value $0.01 per share. As of December 31, 2010, there were issued and outstanding 80,221,807 shares of common stock held by approximately 435 holders of record. There were no shares of preferred stock issued and outstanding.

 

Equity Compensation Plan Information

 

The following is a summary of all of our equity compensation plans and individual arrangements that provide for the issuance of equity securities as compensation, as of December 31, 2010:

 

		(A) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights				(B) Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights				(C) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column (A))
Equity compensation plans approved by security holders			900,000			$	0.24				10,000	(1)
Equity compensation plans not approved by security holders			4,980,000			$	0.46				N/A
Total			5,970,000			$	0.42				10,000	(1)

 

(1)	Represents shares available under the Company’s 1998 Stock Option Plan.

 

Dividend Policy

 

We have not declared or paid any dividends since inception on our common stock. We do not anticipate that any dividends will be declared or paid in the future on our common stock.

 

Our transfer agent is Colonial Stock Transfer, 66 Exchange Place, Salt Lake City, Utah 84111, telephone (801) 355-5740.

 

Recent Sales of Unregistered Securities

 

Not applicable.

 

Item 6. Selected Financial Data

 

Not applicable.

 

 

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

 

Overview

 

Prior to March 19, 2010, the Company’s platform technology was a wearable artificial kidney for dialysis and other medical applications. This device was being developed to treat the blood of patients through a pulsating, dual-chambered pump.

 

Until that date, the Company’s plan of operation was to complete the clinical studies in humans with the Wearable Artificial Kidney in order to apply to the FDA for permission to market the device. Pending resolution of the arbitration with Xcorporeal, Peizer and Gura, the Company suspended its research and development efforts with respect to the wearable artificial kidney and had no active business operations.

 

As of December 31, 2010, the Company did not have sufficient internal and external working capital resources to meet current and expected future obligations. Therefore, the Company will need to obtain future funding, in addition to the proceeds received from the sale of its technology rights in 2010. There can be no assurances that the Company will be successful in obtaining any additional capital on commercially reasonable terms or at all. The failure to obtain such capital would be expected to have a material adverse effect on the Company’s financial condition and operations.

 

Sale of Assets

 

On December 14, 2009, the Company, Xcorporeal and FUSA executed an Asset Purchase Agreement that provided for the sale of substantially all of each of the Company’s and Xcorporeal’s assets (the “Asset Sale”) to FUSA for an aggregate cash purchase price of $8,000,000 (the “Cash Purchase Price”) and certain other royalty payment rights. Subject to the terms and conditions of the Asset Purchase Agreement, the Cash Purchase Price was to be paid to the Company and Xcorporeal as follows: (a) an exclusivity fee in the amount of $200,000 previously paid by FUSA to Xcorporeal, (b) $3,800,000 on the date of closing (the “Closing Date”) of the transactions contemplated under the Asset Purchase Agreement (the “Closing”), of which the Company and Xcorporeal received $2,150,000 and $1,650,000, respectively, (c) $2,000,000 on April 1, 2010, of which the Company and Xcorporeal received $1,625,000 and $375,000, respectively, and (d) $2,000,000 on April 1, 2011, of which the Company and Xcorporeal received $1,925,000 and $75,000, respectively.

 

In addition, during the life of the patents referred to as the HD WAK Technology, which expire between November 11, 2021 and September 9, 2024, the Company is entitled to certain royalty payments from the sale of wearable hemodialysis devices and the attendant disposables that incorporate the HD WAK Technology. The Company is entitled to 40% of the HD WAK royalty and Xcorporeal is entitled to the remaining 60%.

 

Additionally, during the life of any patents referred to as the Supersorbent Technology, the Company is entitled to certain royalty payments on each supersorbent cartridge sold less any and all royalties payable to The Technion Research and Development Foundation Ltd. (“TRDF”) pursuant to a Research Agreement and Option for License, dated June 16, 2005, or any subsequently executed license agreement between TRDF and FUSA. The Company is entitled to 60% of the Supersorbent royalty payments and Xcorporeal is entitled to the remaining 40%. While several applications for patents are pending, no patent incorporating the Supersorbent Technology has yet been issued.

 

FUSA also granted to the Company and Xcorporeal an option to obtain a perpetual, worldwide license to the Supersorbent Technology for use in healthcare fields other than renal (the “Option”). The Option is exercisable during the twelve-month period following FUSA’s receipt of regulatory approval for the sale of a supersorbent product in the United States or European Union, which the Company expects will require further development of the supersorbent technology with TRDF and successful completion of clinical trials by FUSA. The consideration payable to FUSA by the Company or Xcorporeal for the exercise of the Option consists of a payment in the amount of $7,500,000, payable in immediately available funds, and a payment of an ongoing royalty in an amount equal to the lesser of $0.75 per supersorbent cartridge and $1.50 per patient per week in each country where such sales infringe valid and issued claims of the Supersorbent Patents issued in such country.

 

 

The Asset Purchase Agreement closed on March 19, 2010, with payments made to the Company by FUSA of $1,950,000, $1,625,000 and $1,675,000 on March 19, 2010, April 1, 2010 and April 1, 2011, respectively, for a total of $5,250,000. FUSA held back $200,000 and $250,000 from the March 19, 2010 and April 1, 2011 payments, respectively, for purposes of resolving a dispute between the Company and TRDF. The closing of the Asset Sale in March 2010 also terminated the arbitration proceeding with Xcorporeal.

 

Arbitration Proceeding

 

On February 17, 2011, the Company commenced a binding arbitration proceeding with its former law firm regarding a fee dispute that arose as a result of claimed attorneys’ fees incurred by the former law firm in connection with an arbitration proceeding between the Company and Xcorporeal, and certain transactional matters handled by the law firm for the Company. The former law firm has asserted that approximately $2,729,000 in fees and costs are owed to it by the Company for services rendered during 2008, 2009 and 2010, plus interest. The arbitrators have heard all of the testimony presented by the parties, and the parties submitted their final closing briefs on November 10, 2011. As of April 2, 2012, the arbitrators had not rendered their decision on this matter. The Company believes that it has adequately and appropriately provided for the fees incurred through December 31, 2010 in its consolidated financial statements. Given the Company’s limited liquidity and working capital resources, the Company may be unable to satisfy such obligation should a decision adverse to the Company be rendered.

 

Going Concern

 

The Company’s consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Prior to March 19, 2010, the Company was a research and development company in the business of developing a wearable artificial kidney for dialysis and other medical applications. On that date, the Company consummated a sale of its technology rights with respect to its developing wearable artificial kidney and, consequently, those activities have been accounted for as discontinued operations in the Company’s consolidated financial statements. Since June 15, 2006, the Company has not generated any revenues from operations, and does not expect to do so in the foreseeable future; however, the Company generated revenue from the sale of the Company’s technology rights during 2010.

 

For the past several years, except for 2010, the Company has experienced net operating losses and negative operating cash flows. As of December 31, 2010, the Company had an accumulated deficit of $13,509,581, had no revenues from operating activities, and did not have sufficient internal and external working capital resources to meet current and expected future obligations. Such deficiencies indicate the Company will be unable to continue to fund its operations and meet its obligations as they come due. In recent years, the Company has financed its working capital requirements through the sale of technology rights, loans and the recurring sales of its securities to related parties; however, there can be no assurances that such related party funding will be available to the Company in future periods on commercially reasonable terms or at all. As a result, the Company’s independent registered public accounting firm, in its report on the Company’s 2010 consolidated financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.

 

The Company’s ability to continue as a going concern is dependent upon its ability to raise additional debt and/or equity capital, and to acquire sufficient operating capital through the development of business activities, or otherwise. The Company’s consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

 

Recent Accounting Pronouncements

 

Management does not believe that any recently issued, but not yet effective, authoritative guidance, if currently adopted, would have a material impact on the Company's financial statement presentation or disclosures.

 

Significant Accounting Policies

 

The Company prepared its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.

 

 

The following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.

 

Research and Development

 

Research and development costs are expensed as incurred. Research and development expenses consist primarily of costs incurred with respect to the development of the Company’s wearable artificial kidney for dialysis and other medical applications, and are included in discontinued operations in the consolidated statement of operations.

 

Technology Rights

 

Technology rights relate to the Company’s wearable artificial kidney and were being amortized over an estimated useful life of approximately 20 years. Amortization is included in discontinued operations in the consolidated statement of operations.

 

Stock-Based Compensation

 

The Company periodically issues stock options and warrants to officers, directors and consultants for services rendered. Options vest and expire according to terms established at the grant date. The Company accounts for share-based payments to officers and directors by measuring the cost of services received in exchange for equity awards based on the grant date fair value of the awards, with the cost recognized as compensation expense in the Company’s consolidated financial statements over the vesting period of the awards. The Company accounts for share-based payments to consultants by determining the value of the stock compensation based upon the measurement date at either (a) the date at which a performance commitment is reached or (b) at the date at which the necessary performance to earn the equity instruments is complete.

 

Income Taxes

 

The Company accounts for income taxes under an asset and liability approach for financial accounting and reporting purposes. Accordingly, the Company recognizes deferred tax assets and liabilities for the expected impact of differences between the financial statements and the tax basis of assets and liabilities.

 

The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. In the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax assets would be credited to operations in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to operations in the period such determination was made.

 

Contingencies

 

The Company’s management assesses contingent liabilities, and such assessment inherently involves an exercise of judgment. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.

 

 

Results of Operations for the Years Ended December 31, 2010 and 2009

 

The Company had no revenues from operations for the years ended December 31, 2010 and 2009; however, the Company generated revenue from the sale of the Company’s technology rights during 2010.

 

General and administrative expenses for the year ended December 31, 2010 were $553,129, as compared to $993,287 for the year ended December 31, 2009, a decrease of $440,158 or 44%. Included in such costs was stock-based compensation of $22,296 and $37,813 in 2010 and 2009, respectively. The decrease in general and administrative expenses in 2010 as compared to 2009 was primarily a result of a decrease in legal fees of $460,725. Significant legal fees were incurred in 2009 as compared to 2010 due primarily to the arbitration with Xcorporeal.

 

Interest expense (all to a related party) was $197,030 for the year ended December 31, 2010, as compared to $336,883 for the year ended December 31, 2009. The decrease in 2010, as compared to 2009, was the result of the underlying debt being repaid in 2010 from the proceeds received in 2010 relating to the sale of the Company’s technology rights.

 

Other income was $156,145 for the year ended December 31, 2010, as compared to $95,228 for the year ended December 31, 2009. The increase was due primarily to forgiveness of payables by vendors in 2010.

 

Income tax expense related to continuing operations of $514,000 was recorded for the year ended December 31, 2010, and related primarily to the gain from legal settlement of $1,871,430 recognized during the year. Due to the Company’s determination that a gain would be recognized with respect to the sale of the Company’s technology rights in 2010, the Company recorded a federal income tax benefit of $1,500,000 for the year ended December 31, 2009, as a result of the reduction of a deferred tax valuation allowance that had been established in a prior year for uncertainty relating to the utilization of a net operating loss carryforward.

 

Income from continuing operations was $764,637 for the year ended December 31, 2010, as compared to income from continuing operations of $265,058 for the year ended December 31, 2009, due primarily to the gain from legal settlement, net of income taxes, in 2010.

 

Income from discontinued operations was $1,980,118 for the year ended December 31, 2010, as compared to a loss from discontinued operations of $109,209 for the year ended December 31, 2009, due primarily to the gain from the sale of assets, net of income taxes, in 2010.

 

Net income was $2,744,755 for the year ended December 31, 2010, as compared to net income of $155,849 for the year ended December 31, 2009.

 

The Company expects to report continuing losses from operations and negative operating cash flows in 2011 and subsequently, as the Company has no on-going revenue-generating activities, except for any ancillary revenues that may be derived in future periods from the sale of the Company’s technology rights.

 

At December 31, 2010, the Company had net operating loss carryforwards for federal income tax purposes of approximately $14,000,000, which, if not utilized, expire through 2029. In addition, the Company had net operating loss carryforwards of approximately $9,900,000 for state income tax purposes which expire through 2029.

 

Liquidity and Capital Resources

 

The Company had cash and money market funds of $1,522,374 at December 31, 2010, as compared to $22,281 at December 31, 2009, an increase of $1,500,093. However, the Company does not have sufficient internal and external working capital resources to meet current and expected future obligations. In recent years, the Company has financed its working capital requirements through the sale of technology rights, loans and the recurring sales of its securities to related parties; however, there can be no assurances that such related party funding will be available to the Company in future periods on commercially reasonable terms or at all. As a result, the Company’s independent registered public accounting firm, in its report on the Company’s 2010 consolidated financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.

 

 

The Company had a working capital surplus of $79,180 at December 31, 2010, as compared to a working capital deficit of $2,687,871 at December 31, 2009.

 

As of December 31, 2010, the Company had no note payable obligations. As of December 31, 2009, the Company had notes payable to related parties of $964,083, net of discount and including accrued interest.

 

Operating Activities

 

During the year ended December 31, 2010, the Company generated cash of $1,214,563 from continuing operating activities, as compared to using cash of $279,618 in continuing operating activities during the year ended December 31, 2009, a net increase of $1,494,181. Cash provided from continuing operations increased in 2010, as compared to 2009, due primarily to the proceeds received from the legal settlement, net of income taxes, during the year ended December 31, 2010.

 

During the year ended December 31, 2010, the Company used cash of $136,928 in discontinued operating activities, as compared to using cash of $129,901 in discontinued operating activities during the year ended December 31, 2009, a net increase of $7,027.

 

Investing Activities

 

During the year ended December 31, 2010, the Company generated $285,601 of cash from investing activities, consisting of the proceeds received from sale of assets of $1,703,570, less $1,417,969 transferred to the Company’s money market funds.

 

Financing Activities

 

During the year ended December 31, 2010, the Company used cash of $1,281,112 in financing activities, consisting primarily of principal and interest payments made on debt incurred in prior periods to finance the Company’s activities.

 

During the year ended December 31, 2009, the Company generated $315,000 of cash from financing activities, consisting of $87,500 in advances from a related party, $115,000 from the exercise of stock warrants, and $220,000 in proceeds from a note payable to a related party, less the repayment of advances and notes in the amount of $107,500.

 

The following significant financing transactions, primarily equity related, were completed in 2009 and 2010:

 

On May 13, 2009, a $700,000 promissory note dated December 26, 2007 payable to Robert M. Snukal, director and chief executive officer, and a $150,000 promissory note dated August 12, 2008 payable to Robert M. Snukal, plus accrued interest of $64,611, were rolled-over into a new uncollateralized non-convertible promissory note in the amount of $914,611, due on May 13, 2010, with interest at 6% per annum. In connection with this note, the Company issued warrants to purchase 16,937,240 shares of the Company’s common stock at an exercise price of $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the note. The warrants expire on the earlier of (i) May 13, 2016 or (ii) the closing of the Company’s sale of all or substantially all of its assets or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $377,667, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. In March 2010, the $914,611 note, with accrued interest of $42,398, was paid in full.

 

 

On April 21, 2009, the Company entered into a $20,000 uncollateralized convertible promissory note agreement with Robert M. Snukal, director and chief executive officer, with interest at 6% per annum, payable on August 31, 2009. Under the terms of the note, at the option of the holder through maturity, the principal amount plus any accrued interest thereon could be converted at any time into shares of the Company’s common stock at a conversion price of $0.03 per share, which was the approximate closing price of the Company’s common stock on the date the note was issued. In connection with this note, the Company issued warrants to purchase 333,333 shares of the Company’s common stock at an exercise price of $0.03 per share, which was the approximate closing price of the Company’s common stock on the date the warrants were issued. The warrants expire on the earlier of (i) April 21, 2016 or (ii) the closing of the Company’s sale of all or substantially all of its assets, or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $8,312, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. On April 28, 2009, the $20,000 note was paid in full.

 

On April 29, 2009, the Company issued 3,000,000 shares of its common stock to Robert M. Snukal, director and chief executive officer, upon the exercise of warrants at $0.02 per share. The Company received $60,000 of proceeds.

 

On May 11, 2009, the Company issued 2,000,000 shares of its common stock to Robert M. Snukal, director and chief executive officer, upon the exercise of warrants at $0.02 per share. The Company received $40,000 of proceeds.

 

On May 13, 2009, the Board approved the issuance of 500,000 shares of the Company’s common stock to Dr. Rambod, a consultant and former officer of the Company, as payment for services in connection with the completion and filing of a patent application regarding the Company’s rights in and to the polymer technology developed by the Company. The 500,000 shares of common stock were valued at $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the issuance, for a total of $13,500, which was charged to discontinued operations on May 13, 2009. On August 5, 2009, the Board approved an additional issuance of 250,000 shares of the Company’s common stock to Dr. Rambod as payment for additional services in connection with the patent application. The 250,000 shares of common stock were valued at $0.02 per share, which was the approximate closing price of the Company’s common stock on the date of the issuance, for a total of $5,000, which was charged to discontinued operations on August 5, 2009.

 

On May 13, 2009, the Company issued options to purchase 250,000 shares of common stock to a consultant for past services, which were fully vested on the date of grant. The options are exercisable at $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the issuance, and expire in ten years. The fair value of these options on the date of grant was $6,037, which was charged to operations on May 13, 2009.

 

On May 13, 2009, the Company issued options to purchase a total of 300,000 shares of common stock to two outside directors for past services, which were fully vested on the date of grant. The options are exercisable at $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the issuance, and expire in ten years. The fair value of these options on the date of grant was $7,244, which was charged to operations on May 13, 2009.

 

On July 7, 2009, the Company issued 555,555 shares of its common stock to Robert M. Snukal, director and chief executive officer, upon the exercise of warrants at $0.027 per share. The Company received $15,000 of proceeds.

 

During August and September 2009, Robert M. Snukal, director and chief executive officer, advanced $87,500 to the Company on a non-interest bearing basis for working capital purposes. On October 17, 2009, the advances were repaid in full.

 

On October 18, 2009, the Company entered into a $200,000 uncollateralized convertible promissory note agreement with Robert M. Snukal, director and chief executive officer, with interest at 6% per annum, and payable on April 30, 2010. Under the terms of the note, at the option of the holder through maturity, the principal amount plus any accrued interest thereon could be converted at any time into shares of the Company’s common stock at a conversion price of $0.022 per share, which was the approximate closing price of the Company’s common stock on or about the date the note was issued. In connection with this note, the Company issued warrants to purchase 4,545,455 shares of the Company’s common stock at an exercise price of $0.022 per share, which was the approximate closing price of the Company’s common stock on or about the date the warrants were issued. The warrants expire on the earlier of (i) October 18, 2016 or (ii) the closing of the Company’s sale of all or substantially all of its assets, or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $83,597, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. In March 2010, the $200,000 note, including accrued interest of $4,077, was paid in full.

 

 

On February 23, 2010, the Company entered into a $45,000 uncollateralized promissory note agreement with Robert M. Snukal, director and chief executive officer, with interest at 5% per annum, and payable on February 23, 2011. In March 2010, the $45,000 note, with accrued interest of $26, was paid in full.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

Item 8. Financial Statements and Supplementary Data

 

The financial statements required by this Item 8 are included elsewhere in this Annual Report and incorporated herein by this reference.

 

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

 

The Company’s Board of Directors dismissed PMB Helin Donovan, LLP (“PMB”) as the Company’s independent registered public accounting firm effective March 4, 2011.

 

Effective March 4, 2011, the Company engaged the accounting firm of Gumbiner Savett Inc. as the Company’s new independent registered public accounting firm. The retention of Gumbiner Savett Inc. was approved by the Company’s Board of Directors. During the two most recent fiscal years and the subsequent interim period to the date hereof, the Company did not consult with Gumbiner Savett Inc. regarding any of the matters or events set forth in Item 304(a)(2)(i) or (ii) of Regulation S-K.

 

Item 9A. Controls and Procedures

 

Disclosure Controls and Procedures

 

Regulations under the Securities Exchange Act of 1934 require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

We conducted an evaluation, with the participation of our Chief Executive Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the period covered by this Report. Based on that evaluation, our Chief Executive Officer has concluded that as of December 31, 2010, our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses.

 

A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 5) or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following three material weaknesses in our disclosure controls and procedures:

 

1.            We do not have written documentation of our internal control policies and procedures. Written documentation of key internal controls over financial reporting is a requirement of Section 404 of the Sarbanes-Oxley Act. Management evaluated the impact of our failure to have written documentation of our internal controls and procedures on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

 

 

2.          We do not have sufficient segregation of duties within accounting functions, which is a basic internal control. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties on our assessment of our disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.

 

3.          We do not have review and supervision procedures for financial reporting functions. The review and supervision function of internal control relates to the accuracy of financial information reported. The failure to review and supervise could allow the reporting of inaccurate or incomplete financial information. Due to our size and nature, review and supervision may not always be possible or economically possible. Management evaluated the impact of our significant number of audit adjustments and has concluded that the control deficiency that resulted represented a material weakness.

 

To address these material weaknesses, management performed additional analyses and other procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented. Management also retained outside consultants to assist it in the preparation of consolidated financial statements and footnotes.

 

Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that:

 

·

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

·

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

 

·

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of the inherent limitations of internal control, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

 

As of December 31, 2010, management assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and Securities and Exchange Commission guidance on conducting such assessments. Based on that evaluation, they concluded that, during the period covered by this report, such internal controls and procedures were not effective to detect the inappropriate application of US GAAP rules as more fully described below. This was due to deficiencies that existed in the design or operation of our internal controls over financial reporting that adversely affected our internal controls and that may be considered to be material weaknesses.

 

 

The matters involving internal controls and procedures that our management considered to be material weaknesses under the standards of the Public Company Accounting Oversight Board were: (1) lack of written documentation of internal control policies and procedures; (2) inadequate segregation of duties consistent with control objectives; and (3) lack of review and supervision over period end financial disclosure and reporting processes.

 

Management believes that the lack of documentation of internal controls did not have an effect on our financial results. However, management believes that the lack of segregation of duties, and a lack of review and supervision of reporting, could result in a material misstatement in our financial statements in future periods.

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting that occurred during the fourth quarter of the fiscal year ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B.   Other Information

 

None.

 

PART III

 

Item 10.   Directors and Executive Officers

 

Executive Officers and Directors

 

The directors of the Company currently have terms which will end at the next annual meeting of the stockholders of the Company or until their successors are elected and qualify, subject to their prior death, resignation or removal. Officers serve at the discretion of the Board of Directors. There are no family relationships among any of our directors and executive officers.

 

The following sets forth the names, ages and principal positions of our directors and executive officers as of December 31, 2010:

 

Name		Age		Position
Leonardo Berezovsky, M.D.		65		Chairman of the Board of Directors, Chief Financial Officer
Robert M. Snukal		66		Chief Executive Officer, President and Director
Ronald P. Lang, M.D.		59		Executive Vice-President, Secretary and Director
Edmond Rambod, Ph.D.		49		Chief Scientific Officer and Director
Jose Spiwak, M.D.		64		Director

  

Leonardo Berezovsky, M.D. has been a director since 2003, Chairman since 2005, and Chief Financial Officer since March 2007. Dr. Berezovsky is the Chairman and CEO of AssistMed, Inc., which utilizes proprietary technology to deliver integrated solutions for online clinical documentation and related business processes within the healthcare industry. In addition, Dr. Berezovsky was the Co-Founder, Chairman and CEO of AHI Healthcare Systems, Inc., a managing company for primary care physicians and comprehensive healthcare delivery networks. AHI completed a public offering and was later sold via merger to FPA Medical Management, Inc. in 1997. Dr. Berezovsky was also the co-founder, Chairman and CEO of Fiberspace, Inc., an optical networking concern that manufactured innovative fiber optic components for the telecommunications and oil and gas industries. Dr. Berezovsky completed his training in Internal Medicine and Cardiology at the Cleveland Clinic in Cleveland, Ohio, and practiced at Cedars Sinai Medical Center in Los Angeles, California. Dr. Berezovsky received his bachelor’s degree in 1960 and M.D. in 1968 from the Universidad de Rosario in Rosario, Argentina.

 

 

Robert M. Snukal has been a director since February 2003 and CEO and President since December 2005. From 1997 to 2002, he served as a member of the Board of Directors, Chief Executive Officer and President of Fountain View, Inc., a healthcare provider providing physical therapy, occupational therapy, speech therapy and pharmacy services as well as operating skilled nursing facilities and assisted living facilities. Mr. Snukal holds a Bachelors Degree and a Masters Degree in English Literature from the University of Manitoba. Mr. Snukal has been a lecturer and an assistant professor at several universities, including the University of British Columbia, the University of Sussex in England and the University of Calgary.

 

Ronald P. Lang, M.D. has been a director and the Secretary of the Company since May 1996. Dr. Lang is a medical doctor who is board certified in internal medicine/nephrology. He has been a physician with Medipace Medical Group, Inc. since 1983. Dr. Lang graduated from the Ohio State University College of Medicine in 1973, completed his residency at St. Luke’s Medical Center in Chicago, Illinois, and was a fellow in the nephrology department at UCLA-Center for the Health Sciences/Wadsworth Veterans Hospital. Dr. Lang also serves as a Clinical Assistant Professor of Medicine at UCLA School of Medicine. Dr. Lang also received M.A. and M.Ph. degrees in economics from Yale University and was an Economist — Program Analyst for the U.S. Department of Health, Education and Welfare (office of the Assistant Secretary for Planning and Education) from 1973 to 1974.

 

Edmond Rambod, Ph.D was appointed as a director and as the Company’s Chief Scientific Officer in August 2008. As the Company’s Chief Scientific Officer, Dr. Rambod is responsible for the Company’s scientific, technical and intellectual property related activities. Dr. Rambod is the inventor of the Company’s wearable devices and has provided the Company with scientific, technical and intellectual property consulting services since 2002. Dr. Rambod is the founder and Chief Executive Officer of BioQuantetics, Inc., a California-based corporation which has developed, among others, an ultrasound diagnostic technology with a variety of medical applications. Dr. Rambod received a Bachelors of Science degree in Chemical Engineering, a Masters of Science degree in Biomedical Engineering and a Doctorate of Philosophy degree in Medicine and Medical Sciences from the Technion - Israel Institute of Technology in Haifa, Israel. Currently, Dr. Rambod holds a Visiting Scholar appointment at the Department of Aeronautics and Bioengineering at the California Institute of Technology in Pasadena, California, where he also served as a Senior Scientist between 1993 and 2000. Prior to 1993, Dr. Rambod served as a Research Scientist in the Department of Cardiothoracic Surgery at Cedars-Sinai Medical Center and as an Associate Scientist in the Biomedical Engineering Program at the University of California at Los Angeles. Dr. Rambod is the recipient of the Achievements Award of the American Physical Society and is an active member of several professional, scientific and medical organizations such as the American Heart Association and the American Association for the Advancement of Science. Many of Dr. Rambod’s accomplishments and peer-reviewed reports relating to science, medicine and healthcare have been published in major medical and scientific journals. Between 1987 and 1989, Dr. Rambod actively served in the Israeli Defense Force.

 

Jose Spiwak M.D. has been a director since February 1998. Dr. Spiwak is a board certified thoracic and cardiovascular surgeon, and serves as Chairman of the Cardiovascular Thoracic Section of St. Francis Medical Center and Presbyterian Intercommunity Hospital in Los Angeles, California. He served as Vice-Chairman of American Health, Inc., a managing company of primary care physicians and comprehensive healthcare delivery networks, which was sold to FPA Medical Management, Inc. in April 1997. Dr. Spiwak graduated from the Universidad Javeriana Medical School (Bogotá, Columbia) in 1968 and performed his residency in Israel and the United States. Dr. Spiwak is a member of the Board of Directors of the American Cancer Society.

 

Audit Committee

 

The members of the Audit Committee of our Board of Directors are Ronald P. Lang, M.D. and Jose Spiwak M.D. The Audit Committee of our Board of Directors does not have a member that qualifies as an “audit committee financial expert” as that term is defined under applicable rules of the Securities and Exchange Commission.

 

 

Code of Ethics

 

We have adopted a code of ethics for directors, executive officers and other employees. We will provide to any person without charge, upon request, a copy of our code of ethics. Such copy may be obtained by writing to Secretary, National Quality Care, Inc., 2431 Hill Drive, Los Angeles, California 90041.

 

Compliance with Section 16(a) of the Securities Exchange Act of 1934

 

Section 16(a) of the Exchange Act requires its directors and executive officers and beneficial holders of more than 10% of our common stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of our equity securities. Based solely on a review of copies of such forms we have received and other information provided to us, Section 16(a) reports applicable to our officers, directors and greater-than-10% shareholders were timely filed during the year ended December 31, 2010.

 

Item 11.   Executive Compensation

 

Summary Compensation Table

 

The following table sets forth for the periods shown information as to the compensation of our principal executive officer, principal financial officer and our two other executive officers:

 

Name [and Principal Position]		Year				Salary ($)				Bonus ($)				Stock Awards ($)				Option Awards ($)(1)				Non-Equity Incentive Plan Compensation ($)				Nonqualified Deferred Compensation Earnings ($)				All Other Compensation ($)				Total ($)
Leonardo Berezovsky			2010				0				0				0				0				0				0				0				0
Chairman of the Board, CFO			2009				0				0				0				0				0				0				0				0
			2008				0				0				0				0				0				0				0				0
Robert M. Snukal			2010				0				0				0				0				0				0				0				0
CEO, President			2009				0				0				0				0				0				0				0				0
			2008				0				0				0				0				0				0				0				0
Ronald Lang, M.D.			2010				0				0				0				0				0				0				0				0
Executive Vice President			2009				0				0				0				3,622	(1)			0				0				0				3,622
			2008				0				0				0				0				0				0				0				0
Edmond Rambod			2010				0				0				0				0				0				0				0				0
Executive Vice President/			2009				0				0				18,500	(2)			0				0				0				0				18,500
Chief Science Officer			2008				0				0				0				10,414	(3)			0				0				0				10,414

_______________

(1)          The grant date value for options issued May 13, 2009 to purchase 150,000 shares of common stock.

 

(2)          The issuance of 500,000 shares of common stock at $0.027 per share on May 13, 2009 and the issuance of 250,000 shares of common stock at $0.02 per share on August 5, 2009 for services.

 

(3)          Includes options to purchase 1,000,000 shares of common stock at an exercise price of $0.12 per share, vested in eight equal semi-annual installments commencing on February 8, 2009 and continuing on each August 8 and February 8 thereafter, until the options become fully vested on the fourth anniversary of the date of grant (August 8, 2008).

 

We have no employment agreements with our current named executive officers.

 

  

The following table sets forth certain information concerning outstanding equity awards held by our named executive officers at December 31, 2010:

 

Outstanding Equity Awards at 2010 Fiscal Year-End

 

Option Awards																				Stock Awards
Name		Number of Securities Underlying Unexercised Options (#) Exercisable(1)				Number of Securities Underlying Unexercised Options (#) Unexercisable				Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned options (#)				Option Exercise Price ($)				Option| Expiration date		Number of Shares or Units of Stock That have Not Vested (#)				Market value of Shares or Units of Stock That Have Not Vested ($)				Equity Incentive Plan Awards: Number of Unearned shares, Units or Other Rights That Have Not Vested (#)				Equity Incentive Plan Awards: Market or Payout value of Unearned Shares, Units or Other Rights That Have Not Vested ($)
Leonardo Berezovsky
			200,000				0				0				0.52			3/4/2016			0				0				0				0
			1,000,000				0				0				0.65			4/19/2016			0				0				0				0
			5,000				0				0				0.62			1/2/2016			0				0				0				0
			5,000				0				0				0.62			4/3/2016			0				0				0				0
			5,000				0				0				0.62			7/1/2016			0				0				0				0
			5,000				0				0				0.62			10/1/2016			0				0				0				0
			250,000				0				0				0.25			5/3/2017			0				0				0				0
Robert M. Snukal
			400,000				0				0				0.52			3/4/2016			0				0				0				0
			2,000,000				0				0				0.65			4/19/2016			0				0				0				0
			5,000				0				0				0.62			1/2/2016			0				0				0				0
			5,000				0				0				0.62			4/3/2016			0				0				0				0
			5,000				0				0				0.62			7/1/2016			0				0				0				0
			5,000				0				0				0.62			10/1/2016			0				0				0				0
			500,000				0				0				0.25			5/3/2017			0				0				0				0
Ronald Lang
			150,000				0				0				0.027			5/13/2019			0				0				0				0
			250,000				0				0				0.65			4/19/2016			0				0				0				0
			5,000				0				0				0.62			1/2/2016			0				0				0				0
			5,000				0				0				0.62			4/3/2016			0				0				0				0
			5,000				0				0				0.62			7/1/2016			0				0				0				0
			5,000				0				0				0.62			10/1/2016			0				0				0				0
			50,000				0				0				0.25			5/3/2017			0				0				0				0
Edmond Rambod
			500,000				0				500,000				0.12			8/8/2018			0				0				0				0

 

 

Director Compensation

 

The following table sets forth certain information concerning compensation paid for services as our directors during the fiscal year December 31, 2010:

 

2010 Director Compensation

 

Name		Fees Earned or paid in Cash ($)				Stock Awards ($)				Option Awards ($)				All Other Compensation ($)				Total ($)
Leonard Berezovsky (1)			0				0				0				0				0
Robert M. Snukal (1)			0				0				0				0				0
Ronald Lang (1)			0				0				0				0				0
Jose Spiwak			0				0				0				0				0
Edmond Rambod			0				0				0				0				0

_____________________

(1)           See “Summary Compensation Table” for compensation paid to these executive officers named therein.

 

At December 31, 2010, the number of outstanding option awards held by the directors was as follows: L. Berezovsky — 1,470,000, R. Snukal — 2,920,000, R. Lang — 470,000, J. Spiwak — 220,000, Edmond Rambod — 2,500,000.

 

 

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

 

The following table reflects, as of December 31, 2010, based on 80,221,807 shares outstanding, the beneficial ownership of our common stock by: (a) each director of the Company, (b) each executive officer named in the Summary Compensation Table presented elsewhere in this document, (c) each person (or group of affiliated persons) known by us to be the beneficial owner of 5% or more of our common stock, and (d) all current executive officers and directors of the Company as a group:

 

Name and Address of Beneficial Owner		Number of Shares Beneficially Owned(1)				Percentage of Shares Beneficially Owned
Robert M. Snukal			47,207,331	(2)			54.7	%
Victor Gura			15,497,250	(3)			19.2	%
Leonard Berezovsky			6,107,258	(4)			7.5	%
Ronald P. Lang			3,808,449	(5)			4.7	%
Jose Spiwak			2,132,500	(6)			2.6	%
Edmond Rambod			3,050,000	(7)			3.7	%
Executive officers and directors as a group (5 persons)			62,305,538	(8)			68.8	%

_____________________

(1)          Such persons have sole voting and investment power with respect to all shares of Common Stock shown as being beneficially owned by them, subject to community property laws, where applicable, and the information contained in the footnotes to this table.

 

(2)          Includes 6,017,500 shares subject to options and warrants held by Mr. Snukal which are exercisable or become exercisable within 60 days after December 31, 2010.

 

(3)          Includes 800,000 shares held by Medipace Medical Group, Inc., an affiliate of Dr. Gura. Also includes 250,000 shares subject to warrants held by Dr. Gura which are currently exercisable.

 

(4)          Includes 2,926,841 shares held by various family and charitable trusts of which 2,879,966 shares are common stock and 46,875 shares are subject to warrants which are currently exercisable. Dr. Berezovsky has voting and investment power with respect to the shares held by the trusts. Also includes 1,470,000 shares subject to options held by Dr. Berezovsky which are exercisable or become exercisable within 60 days after December 31, 2010.

 

(5)          Includes 800,000 shares held by Medipace Medical Group, Inc., an affiliate of Dr. Lang. Also includes 470,000 shares subject to options held by Dr. Lang which are exercisable or become exercisable within 60 days after December 31, 2010.

 

(6)          Includes 220,000 shares subject to options held by Dr. Spiwak which are exercisable or become exercisable within 60 days after December 31, 2010.

 

(7)          Includes 2,000,000 shares subject to options which are exercisable or become exercisable within 60 days after December 31, 2010.

 

(8)          Includes 10,314,375 shares subject to options and warrants beneficially owned by current officers and directors as a group which are exercisable within 60 days after December 31, 2010.

 

 

Item 13. Certain Relationships, Related Transactions and Director Independence

 

On February 23, 2010, the Company entered into a $45,000 uncollateralized promissory note agreement with Robert M. Snukal, director and chief executive officer, with interest at 5% per annum, and payable on February 23, 2011. In March 2010, the $45,000 note, with accrued interest of $26, was paid in full.

 

Director Independence

 

Jose Spiwak qualifies as an independent director under the independence standards of the Nasdaq Stock Market (Rule 4200(a)(15)).

 

Item 14.   Principal Accounting Fees and Services

 

The Company did not pay or accrue principal accounting fees in 2009 or 2010.

 

The Board of Directors is responsible for approving every engagement of our independent registered public accounting firm.

 

 

PART IV

 

Item 15.   Exhibits and Financial Statement Schedules

 

A list of exhibits required to be filed as part of this report is set forth in the Index to Exhibits, which is presented elsewhere in this document, and is incorporated herein by reference.

 

 

NATIONAL QUALITY CARE, INC.
AND SUBSIDIARY

  

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(INCLUDING REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM)

 

Years Ended December 31, 2010 and 2009

 

Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets - December 31, 2010 and 2009		F-3
Consolidated Statements of Operations - Years Ended December 31, 2010 and 2009		F-4
Consolidated Statement of Stockholders’ Equity (Deficiency) - Years Ended December 31, 2010 and 2009		F-5
Consolidated Statements of Cash Flows - Years Ended December 31, 2010 and 2009		F-6
Notes to Consolidated Financial Statements – Years Ended December 31, 2010 and 2009		F-7

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

of National Quality Care, Inc.

 

We have audited the consolidated balance sheets of National Quality Care, Inc. and its wholly-owned subsidiary (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity (deficiency), and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Quality Care, Inc. and its wholly-owned subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with United States generally accepted accounting principles.

 

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

 

/s/ GUMBINER SAVETT INC.

Gumbiner Savett Inc.

Santa Monica, California

April 2, 2012

 

 

NATIONAL QUALITY CARE, INC.
AND SUBSIDIARY

 

CONSOLIDATED BALANCE SHEETS

 

		December 31,
		2010				2009
ASSETS
Current assets:
Cash		$	104,405			$	22,281
Money market funds			1,417,969				—
Receivable from sale of technology rights			1,675,000				—
Prepaid expenses and other current assets			68,965				—
Technology rights held for sale, net of accumulated amortization of $40,162 – discontinued operations			—				59,838
Deferred income taxes			—				1,500,000
Total current assets			3,266,339				1,582,119
Total assets		$	3,266,339			$	1,582,119
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable and accrued expenses		$	2,794,945			$	3,009,379
Accounts payable and accrued expenses – discontinued operations			15,214				176,528
Income taxes payable			231,000				—
Deferred income taxes			146,000				—
Notes payable to related party, including accrued interest of $37,497, net of discount of $188,025			—				964,083
Note payable to consultant – discontinued operations			—				120,000
Total current liabilities			3,187,159				4,269,990
Total liabilities			3,187,159				4,269,990
Commitments and contingencies
Stockholders’ equity (deficiency):
Preferred stock, $0.01 par value; authorized - 5,000,000 shares; issued – none			—				—
Common stock, $0.01 par value; authorized - 125,000,000 shares; issued and outstanding – 80,221,807 shares			802,219				802,219
Additional paid-in capital			12,786,542				12,764,246
Accumulated deficit			(13,509,581	)			(16,254,336	)
Total stockholders’ equity (deficiency)			79,180				(2,687,871	)
Total liabilities and stockholders’ equity (deficiency)		$	3,266,339			$	1,582,119

 

See accompanying notes to consolidated financial statements.

 

 

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Years Ended December 31,
		2010				2009
Revenues		$	—			$	—
General and administrative, including $22,296 and $37,813 of stock-based compensation costs for the years ended December 31, 2010 and 2009, respectively			553,129				993,287
Loss from operations			(553,129	)			(993,287	)
Interest expense – related party			(197,030	)			(336,883	)
Gain from legal settlement			1,871,430				—
Interest income			1,221				—
Other income			156,145				95,228
Income (loss) before income taxes			1,278,637				(1,234,942	)
Income tax benefit (expense)			(514,000	)			1,500,000
Income from continuing operations			764,637				265,058
Income (loss) from discontinued operations, including gain from sale of assets of $3,318,732, and net of income taxes of $1,363,000, for the year ended December 31, 2010			1,980,118				(109,209	)
Net income		$	2,744,755			$	155,849
Income (loss) per common share:
Continuing operations:
Basic		$	0.01			$	0.00
Diluted		$	0.01			$	0.00
Discontinued operations:
Basic		$	0.02			$	(0.00	)
Diluted		$	0.02			$	(0.00	)
Net income:
Basic		$	0.03			$	0.00
Diluted		$	0.03			$	0.00
Weighted average common shares outstanding:
Basic			80,221,807				77,917,165
Diluted			80,221,807				79,803,458

 

See accompanying notes to consolidated financial statements.

 

 

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

 

Years Ended December 31, 2010 and 2009

 

		Common Stock								Additional Paid-in				Accumulated				Total Stockholders’ Equity
		Shares				Amount				Capital				Deficit				(Deficiency)
Balance at December 31, 2008			73,916,252			$	739,163			$	12,186,413			$	(16,410,185	)		$	(3,484,609	)
Stock-based compensation costs			750,000				7,500				48,813				—				56,313
Exercise of stock warrants			5,555,555				55,556				59,444				—				115,000
Fair value of warrants issued in connection with debt			—				—				469,576				—				469,576
Net income			—				—				—				155,849				155,849
Balance at December 31, 2009			80,221,807				802,219				12,764,246				(16,254,336	)			(2,687,871	)
Stock-based compensation costs			—				—				22,296				—				22,296
Net income			—				—				—				2,744,755				2,744,755
Balance at December 31, 2010			80,221,807			$	802,219			$	12,786,542			$	(13,509,581	)		$	79,180

 

See accompanying notes to consolidated financial statements.

 

 

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Years Ended December 31,
		2010				2009
Cash flows from operating activities:
Continuing operations:
Income from continuing operations		$	764,637			$	265,058
Adjustments to reconcile income from continuing operations to net cash provided by (used in) continuing operating activities:
Amortization of discount on notes payable			188,025				281,551
Stock-based compensation costs			22,296				37,813
Forgiveness of payables			(156,145	)			(96,003	)
Deferred income taxes			432,000				(1,500,000	)
Changes in operating assets and liabilities:
(Increase) decrease in -
Prepaid expenses and other current assets			(68,965	)			13,291
Increase (decrease) in -
Accounts payable and accrued expenses			(58,289	)			663,340
Income taxes payable			82,000				—
Accrued interest due to related party			9,004				55,332
Net cash provided by (used in) continuing operating activities			1,214,563				(279,618	)
Discontinued operations:
Income (loss) from discontinued operations			1,980,118				(109,209	)
Adjustments to reconcile income (loss) from discontinued operations to net cash used in discontinued operating activities:
Stock-based compensation costs			—				18,500
Amortization of technology rights			—				4,860
Forgiveness of payables			(25,101	)			(51,977	)
Deferred income taxes			1,214,000				—
Gain from sale of assets			(3,318,732	)			—
Changes in discontinued operating assets and liabilities:
Increase (decrease) in -
Accounts payable and accrued expenses			(136,213	)			7,925
Income taxes payable			149,000				—
Net cash used in discontinued operating activities			(136,928	)			(129,901	)
Net cash provided by (used in) operating activities			1,077,635				(409,519	)
Cash flows from investing activities:
Proceeds from sale of assets			1,703,570				—
Increase in money market funds			(1,417,969	)			—
Net cash provided by investing activities			285,601				—
Cash flows from financing activities:
Proceeds from notes payable to related party			45,000				220,000
Advances from related party			—				87,500
Repayment of advances from related party			—				(87,500	)
Payment of note payable issued for services			(120,000	)			—
Exercise of stock warrants			—				115,000
Repayment of note payable to related party			(1,206,112	)			(20,000	)
Net cash provided by (used in) financing activities			(1,281,112	)			315,000
Net increase (decrease) in cash			82,124				(94,519	)
Cash balance at beginning of year			22,281				116,800
Cash balance at end of year		$	104,405			$	22,281
Supplemental disclosures of cash flow information:
Cash paid for -
Interest		$	116,043			$	—
Income taxes		$	1,600			$	1,600
Non-cash investing activities:
Notes payable to related party, including related accrued interest, rolled-over into a new note payable		$	—			$	914,611
Discount recorded for issuance of warrants in connection with convertible notes payable to related party		$	—			$	469,576
During 2010, the Company sold technology rights summarized as follows:
Total sales price		$	3,378,570
Less amount receivable as of December 31, 2010			(1,675,000	)
Cash received during 2010		$	1,703,570

 

See accompanying notes to consolidated financial statements.

 

 

NATIONAL QUALITY CARE, INC.

 

AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Years Ended December 31, 2010 and 2009

 

1.            Basis of Presentation

 

Organization and Nature of Business

 

National Quality Care, Inc. (“NQCI”), a publicly-traded Delaware corporation, was incorporated on January 1, 1996. Prior to March 19, 2010, NQCI was a research and development company in the business of developing a wearable artificial kidney for dialysis and other medical applications. On that date NQCI consummated a sale of its technology rights with respect to its developing wearable artificial kidney (see Note 11). Subsequent to March 19, 2010, NQCI has had no operations other than the maintenance of its corporate shell. Unless the context indicates otherwise, NQCI and its wholly-owned subsidiary, Los Angeles Community Dialysis, Inc. (“LACDI”), are hereinafter referred to as the “Company”.

 

The Company’s common stock is presently traded on the OTC Market (also referred to as the “Pink Sheets”) under the symbol “NQCI.PK”.

 

Going Concern

 

The Company’s consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Prior to March 19, 2010, the Company was a research and development company in the business of developing a wearable artificial kidney for dialysis and other medical applications. On that date, the Company consummated a sale of its technology rights with respect to its developing wearable artificial kidney (see Note 11) and, consequently, those activities have been accounted for as discontinued operations in the Company’s consolidated financial statements. Since June 15, 2006 (the date on which the Company sold its dialysis services business), the Company has not generated any revenues from operations, and does not expect to do so in the foreseeable future; however, the Company generated revenue from the sale of the Company’s technology rights during 2010.

 

For the past several years, except for 2010, the Company has experienced net operating losses and negative operating cash flows. As of December 31, 2010, the Company had an accumulated deficit of $13,509,581, had no revenue from operating activities, and did not have sufficient internal and external working capital resources to meet current and expected future obligations. Such deficiencies indicate the Company will be unable to continue to fund its operations and meet its obligations as they come due. In recent years, the Company has financed its working capital requirements through the sale of technology rights, loans and the recurring sales of its securities to related parties; however, there can be no assurances that such related party funding will be available to the Company in future periods on commercially reasonable terms or at all. As a result, the Company’s independent registered public accounting firm, in its report on the Company’s 2010 consolidated financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.

 

The Company’s ability to continue as a going concern is dependent upon its ability to raise additional debt and/or equity capital, and to acquire sufficient operating capital through the development of business activities, or otherwise. The Company’s consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

 

 

2.            Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the financial statements of NQCI and its wholly-owned subsidiary, LACDI. All intercompany balances and transactions have been eliminated in consolidation.

 

Concentrations

 

The Company’s cash and money market fund balances may periodically exceed federally insured limits and the limits of the Securities Investor Protection Corporation. The Company has not experienced a loss in such accounts to date. The Company maintains its accounts with financial institutions with high credit ratings.

 

Convertible Instruments

 

The Company issued convertible debt with non-detachable conversion features and detachable warrants. The non-detachable conversion feature and detachable warrants are recorded as a discount to the related debt either as additional paid-in capital or a derivative liability, depending on the guidance, using the intrinsic value method or relative fair value method, respectively. The debt discount associated with the warrants and embedded beneficial conversion feature, if any, is amortized to interest expense over the life of the debenture or upon earlier conversion of the debenture using either the effective yield method or the straight-line method, as appropriate.

 

Research and Development

 

Research and development costs were expensed as incurred.  Research and development expenses consist primarily of costs incurred with respect to the development of the Company’s wearable artificial kidney for dialysis and other medical applications, and are included in discontinued operations in the consolidated statement of operations.

 

Income Taxes

 

The Company accounts for income taxes under an asset and liability approach for financial accounting and reporting purposes. Accordingly, the Company recognizes deferred tax assets and liabilities for the expected impact of differences between the financial statements and the tax basis of assets and liabilities.

 

The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. In the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax assets would be credited to operations in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to operations in the period such determination was made.

 

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. As of December 31, 2010, no liability for unrecognized tax benefits was required to be recorded.

 

The Company files income tax returns in the U.S. federal jurisdiction and is subject to income tax examinations by federal tax authorities for the year 2008 and thereafter.  The Company’s policy is to record interest and penalties on uncertain tax positions as income tax expense. As of December 31, 2010, the Company had no accrued interest or penalties related to uncertain tax positions.

 

 

Contingencies

 

The Company’s management assesses contingent liabilities, and such assessment inherently involves an exercise of judgment. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.

 

Stock-Based Compensation

 

The Company periodically issues stock options and warrants to officers, directors and consultants for services rendered.  Options vest and expire according to terms established at the grant date. The Company accounts for share-based payments to officers and directors by measuring the cost of services received in exchange for equity awards based on the grant date fair value of the awards, with the cost recognized as compensation expense in the Company’s consolidated financial statements over the vesting period of the awards. The Company accounts for share-based payments to consultants by determining the value of the stock compensation based upon the measurement date at either (a) the date at which a performance commitment is reached or (b) at the date at which the necessary performance to earn the equity instruments is complete.

 

Earnings Per Share

 

The Company’s computation of earnings per share (“EPS”) includes basic and diluted EPS.  Basic EPS is measured as the income (loss) available to common shareholders divided by the weighted average common shares outstanding for the period.  Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., warrants and options) as if they had been converted at the beginning of the periods presented, or issuance date, if later.  Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

 

Fair Value of Financial Instruments

 

The carrying amounts of cash, money market funds, receivable from sale of technology rights, prepaid expenses and other current assets, accounts payable and accrued expenses, and income taxes payable approximate their respective fair values due to the short-term nature of these items. The amounts shown for notes payable also approximate fair value because current interest rates offered to the Company for debt of similar maturities are substantially the same.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. The Company evaluates its estimates on an on-going basis, including those related to valuation of warrants and options, analysis of deferred taxes and provision for income taxes, contingencies and litigation.

 

Segment Information

 

Prior to the discontinued operations discussed in Note 11, the Company’s reportable operating segments included dialysis services and development of a wearable artificial kidney.

 

Technology Rights

 

Technology rights for a wearable artificial kidney were being amortized over an estimated useful life of approximately 20 years. On December 14, 2009, the Company entered into an Asset Purchase Agreement for the sale of these rights, which was consummated on March 19, 2010 (see Note 11). Amortization is included in discontinued operations and amounted to $-0- and $4,860 for the years ended December 31, 2010 and 2009, respectively.

 

 

Recent Accounting Pronouncements

 

Management does not believe that any recently issued, but not yet effective, authoritative guidance, if currently adopted, would have a material impact on the Company's financial statement presentation or disclosures.

 

3.            Notes Payable

 

Notes Payable to Consultant

 

The Company was party to a contract dispute with a consultant claiming additional compensation relating to an agreement dated January 6, 2002, as amended. In August 2008, the Company and consultant reached an agreement whereby the Company executed and delivered a promissory note in the amount of $120,000, bearing interest at 2.54% per annum, and payable on August 7, 2010. In connection therewith, the Company and the consultant entered into a mutual general release agreement. As a result, compensation in the amount of $120,000 was charged to discontinued operations in August 2008. Additionally, on June 21, 2008, the Company granted the consultant options to purchase 1,500,000 shares of the Company’s common stock. In August 2008, the consultant was elected as a Director of the Company and was also appointed to serve as the Company’s Chief Scientific Officer. In connection with such election and appointment, the consultant received an additional 1,000,000 options to purchase shares of common stock. In March 2010, the note principal and related accrued interest were paid.

 

Note Payable to Related Party

 

On December 26, 2007, the Company entered into a $700,000 uncollateralized convertible promissory note agreement with Robert M. Snukal, a director and chief executive officer, bearing interest at 6% per annum, and payable on December 31, 2008. Under the terms of the note, at the option of the holder through maturity, the principal amount plus any accrued interest thereon could be converted into shares of the Company’s common stock at a conversion price of $0.07 per share, which was the approximate closing price of the Company’s common stock on or about the date of the note. In connection with this note, the Company issued warrants to purchase 5,000,000 shares of the Company’s common stock at an exercise price of $0.07 per share. The warrants were exercised in March 2008. The relative fair value of the warrants at the time of issuance was determined to be $179,163, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. The discount was fully amortized as of December 31, 2008.

 

On August 12, 2008, the Company entered into a $150,000 uncollateralized convertible promissory note agreement with Robert M. Snukal, a director and chief executive officer, bearing interest at 6% per annum, payable on December 31, 2008. Under the terms of the note, at the option of the holder through maturity, the principal amount plus any accrued interest thereon could be converted into shares of the Company’s common stock at a conversion price of $0.12 per share, which was the approximate closing price of the Company’s common stock on or about the date of the note. In connection with this note, the Company issued warrants to purchase 625,000 shares of the Company’s common stock at an exercise price of $0.12 per share. The warrants expire on the earlier of (i) August 12, 2015 or (ii) the closing of the Company’s sale of all or substantially all of its assets or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $45,478, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. The discount was fully amortized as of December 31, 2008. On March 19, 2010, the above described warrants to acquire 625,000 shares expired unexercised as a result of the Company’s sale of substantially all of its assets (see Note 11).

 

 

On May 13, 2009, the $700,000 promissory note payable to related party and the $150,000 promissory note payable to related party, plus accrued interest of $64,611, were rolled-over into a new uncollateralized non-convertible promissory note in the amount of $914,611, due on May 13, 2010, with interest at 6% per annum. In connection with this note, the Company issued warrants to purchase 16,937,240 shares of the Company’s common stock at an exercise price of $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the note. The warrants expire on the earlier of (i) May 13, 2016 or (ii) the closing of the Company’s sale of all or substantially all of its assets or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $377,667, using the Black-Scholes option-pricing model, and was recorded as discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. For the year ended December 31, 2010, the Company recorded interest expense of $136,581 relative to the amortized discount. The discount was fully amortized as of December 31, 2010. In March 2010, the $914,611 note, with accrued interest of $42,398, was paid in full. On July 7, 2009, warrants to acquire 555,555 shares were exercised. On March 19, 2010, warrants to acquire the remaining 16,381,685 shares expired unexercised as a result of the Company’s sale of substantially all of its assets (see Note 11).

 

On April 21, 2009, the Company entered into a $20,000 uncollateralized convertible promissory note agreement with Robert M. Snukal, a director and chief executive officer, bearing interest at 6% per annum, and payable on August 31, 2009. Under the terms of the note, at the option of the holder through maturity, the principal amount plus any accrued interest thereon could be converted into shares of the Company’s common stock at a conversion price of $0.03 per share, which was the approximate closing price of the Company’s common stock on the date of the note, at any time. In connection with this note, the Company issued warrants to purchase 333,333 shares of the Company’s common stock at an exercise price of $0.03 per share. The warrants expire on the earlier of (i) April 21, 2016 or (ii) the closing of the Company’s sale of all or substantially all of its assets or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $8,312, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was charged to interest expense over the period that the note was outstanding. The discount was fully amortized as of December 31, 2009. On April 28, 2009, the $20,000 note was paid in full. On March 19, 2010, the above described warrants to acquire 333,333 shares expired unexercised as a result of the Company’s sale of substantially all of its assets (see Note 11).

 

On October 18, 2009, the Company entered into a $200,000 uncollateralized convertible promissory note agreement with Robert M. Snukal, a director and chief executive officer, bearing interest at 6% per annum, and payable on April 30, 2010. Under the terms of the note, at the option of the holder through maturity, the principal amount plus any accrued interest thereon could be converted into shares of the Company’s common stock at a conversion price of $0.022 per share, which was the approximate closing price of the Company’s common stock on or about the date of the note, at any time. In connection with this note, the Company issued warrants to purchase 4,545,455 shares of the Company’s common stock at an exercise price of $0.022 per share. The warrants expire on the earlier of (i) October 18, 2016 or (ii) the closing of the Company’s sale of all or substantially all of its assets or the acquisition of the Company, as defined in the warrant. The relative fair value of the warrants at the time of issuance was determined to be $83,597, using the Black-Scholes option-pricing model, and was recorded as a discount to the note payable upon issuance. The relative fair value of the warrants was amortized to interest expense over the term of the note using the straight-line method. For the year ended December 31, 2010, the Company recorded interest expense of $51,444 relative to the amortized discount. The discount was fully amortized as of December 31, 2010. In March 2010, the $200,000 note, with accrued interest of $4,077, was paid in full. On March 19, 2010, the above described warrants to acquire 4,545,455 shares expired unexercised as a result of the Company’s sale of substantially all of its assets (see Note 11).

 

On February 23, 2010, the Company entered into a $45,000 uncollateralized promissory note agreement with an officer and director, bearing interest at 5% per annum, and payable on February 23, 2011. In March 2010, the $45,000 note, with accrued interest of $26, was paid in full.

 

During the years ended December 31, 2010 and 2009, the Company recorded total interest expense of $188,025 and $281,551, respectively, relative to the amortization of discounts.

 

 

 

4.

Income Taxes

 

The components of income tax expense (benefits) were as follows for the years ended December 31, 2010 and 2009:

 

		Federal				State				Total
December 31, 2010:
Continuing operations
Current		$	—			$	82,000			$	82,000
Deferred			432,000				—				432,000
		$	432,000			$	82,000			$	514,000
Discontinued operations
Current		$	—			$	149,000			$	149,000
Deferred			1,068,000				146,000				1,214,000
		$	1,068,000			$	295,000			$	1,363,000
Total
Current		$	—			$	231,000			$	231,000
Deferred			1,500,000				146,000				1,646,000
		$	1,500,000			$	377,000			$	1,877,000
December 31, 2009:
Continuing operations
Current		$	—			$	—			$	—
Deferred			(1,500,000	)			—				(1,500,000	)
		$	(1,500,000	)		$	—			$	(1,500,000	)
Discontinued operations
Current		$	—			$	—			$	—
Deferred			—				—				—
		$	—			$	—			$	—
Total
Current		$	—			$	—			$	—
Deferred			(1,500,000	)			—				(1,500,000	)
		$	(1,500,000	)		$	—			$	(1,500,000	)

 

Due to the gain to be recognized for the sale of its technology rights, during the year ended December 31, 2009, the Company recorded a federal income tax benefit of $1,500,000 as a result of the reduction of a deferred tax valuation allowance that had been established in a prior year for uncertainty relating to the utilization of a net operating loss carryforward.

 

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 2010 and 2009 are summarized below.

 

		December 31,
		2010				2009
Deferred tax assets:
Net operating loss carryforwards		$	5,351,000			$	6,241,000
Share-based compensation			707,000				698,000
Amortization of intangible assets			24,000				39,000
Accrued interest to related party			—				40,000
Accrued unpaid professional fees			1,093,000				1,267,000
State income taxes			80,000				2,000
Total deferred tax assets			7,255,000				8,287,000
Valuation allowance			(6,651,000	)			(6,787,000	)
Total deferred tax assets			604,000				1,500,000
Deferred tax liabilities:
State income taxes			146,000				—
Gain from installment sale			604,000				—
Total deferred tax liability			750,000				—
Net deferred tax asset (liability)		$	(146,000	)		$	1,500,000

 

In assessing the potential realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the Company attaining future taxable income during the periods in which those temporary differences become deductible. As of December 31, 2009, the Company determined that income resulting from the Asset Sale (see Note 11) provided the Company with assurance that a portion of its federal net operating loss carryforward would more likely than not be utilized in 2010 and 2011 and, as such, the accompanying consolidated balance sheets reflects a current deferred tax asset of $1,500,000 as of December 31, 2009.

 

Presented below is a reconciliation between the income tax rate computed by applying the U.S. federal statutory rate and the effective tax rate for the years ended December 31, 2010 and 2009.

 

		Years Ended December 31,
		2010				2009
U. S. federal statutory tax rate			34.0	%			(34.0	)%
State income tax, net of federal tax			5.8	%			(5.8	)%
Amortization of discount on notes payable			1.6	%			8.3	%
Change in valuation allowance			(2.9	)%			(90.6	)%
Other			2.1	%			10.4	%
Effective tax rate			40.6	%			(111.7	)%

 

At December 31, 2010, the Company had available net operating loss carryforwards for federal income tax purposes of approximately $14,000,000 which, if not utilized earlier, expire through 2029.

 

 

5.

Common Stock and Preferred Stock

 

The Company’s Certificate of Incorporation provides for authorized capital of 130,000,000 shares, of which 125,000,000 shares consist of common stock with a par value of $0.01 per share and 5,000,000 shares consist of preferred stock with a par value of $0.01 per share.

 

The Company is authorized to issue 5,000,000 shares of preferred stock with such designations, voting and other rights and preferences as may be determined from time to time by the Board of Directors.

 

Exercise of Options and Warrants

 

On April 29, 2009, the Company issued 3,000,000 shares of its common stock to Robert M. Snukal, a director and chief executive officer, upon the exercise of warrants at $0.02 per share. The Company received $60,000 of proceeds.

 

On May 11, 2009, the Company issued 2,000,000 shares of its common stock to Robert M. Snukal, a director and chief executive officer, upon the exercise of warrants at $0.02 per share. The Company received $40,000 of proceeds.

 

On July 7, 2009, the Company issued 555,555 shares of its common stock to Robert M. Snukal, a director and chief executive officer, upon the exercise of warrants at $0.027 per share. The Company received $15,000 of proceeds.

 

6.

Related Party Transactions

 

During August and September of 2009, Robert M. Snukal, a director and chief executive officer, advanced $87,500 to the Company on a non-interest bearing basis for working capital purposes. On October 17, 2009, the advances were repaid in full.

 

7.

Money Market Funds — Fair Value

 

Money market funds at December 31, 2010 consisted of an investment in shares of the UBS Select Prime Institutional Fund with a market value of $1,417,969. The stated objective of the UBS Select Prime Institutional Fund is to maximize current income consistent with liquidity and preservation of capital. The Fund invests in a diversified portfolio of high quality money market instruments of governmental and private issuers and may invest up to 5% of its net assets in investments exempt from federal income tax.

 

The authoritative guidance with respect to fair value established a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels, and requires that assets and liabilities carried at fair value be classified and disclosed in one of three categories, as presented below. Disclosure as to transfers in and out of Levels 1 and 2, and activity in Level 3 fair value measurements, is also required.

 

Level 1: quoted prices (unadjusted) in active markets for an identical asset or liability that the Company has the ability to access as of the measurement date. Financial assets and liabilities utilizing Level 1 inputs include active-exchange traded securities and exchange-based derivatives.

 

Level 2: inputs other than quoted prices included within Level 1 that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data. Financial assets and liabilities utilizing Level 2 inputs include fixed income securities, non-exchange based derivatives, mutual funds, and fair-value hedges.

 

Level 3: unobservable inputs for the asset or liability are only used when there is little, if any, market activity for the asset or liability at the measurement date. Financial assets and liabilities utilizing Level 3 inputs include infrequently-traded non-exchange-based derivatives and commingled investment funds, and are measured using present value pricing models.

 

 

The Company determines the level in the fair value hierarchy within which each fair value measurement falls in its entirety, based on the lowest level input that is significant to the fair value measurement in its entirety. In determining the appropriate levels, the Company performs an analysis of the assets and liabilities at each reporting period end.

 

Money market funds are the only financial instrument that is measured and recorded at fair value on the Company’s balance sheet on a recurring basis. The following table presents money market funds at their level within the fair value hierarchy at December 31, 2010.

 

		Total				Level 1				Level 2				Level 3
December 31, 2010:
Money market funds		$	1,417,969			$	1,417,969			$	—			$	—

 

8.

Stock Options and Warrants

 

A summary of the Company’s stock option activity and related information for the years ended December 31, 2010 and 2009 is as follows:

 

		2010								2009
						Weighted Average								Weighted Average
						Exercise								Exercise
		Options				Price				Options				Price
Outstanding — beginning of year			8,070,000			$	0.37				7,570,000			$	0.39
Granted			—			$	—				550,000			$	0.03
Exercised			—			$	—				—			$	—
Expired			—			$	—				(50,000	)		$	0.20
Outstanding — end of year			8,070,000			$	0.37				8,070,000			$	0.37

 

The following table summarizes the number of option shares, the weighted average exercise price, and weighted average life (by years) by price range for both total outstanding options and total exercisable options as of December 31, 2010:

 

				Total Outstanding												Total Exercisable
				Number				Weighted Average								Number				Weighted Average
Price Range				of Shares				Exercise Price				Life (Years)				of Shares				Exercise Price				Life (Years)
$0.03 - $0.35					4,090,000			$	0.12				7.38				3,590,000			$	0.12				7.35
$0.36 - $0.99					3,980,000			$	0.63				5.30				3,980,000			$	0.63				5.30
					8,070,000			$	0.37				6.35				7,570,000			$	0.39				6.27

 

See Note 9 for a description of the Company’s share-based compensation, including the stock option activity during the years ended December 31, 2010 and 2009.

 

 

Stock Warrants

 

A summary of the Company’s stock warrant activity and related information for the years ended December 31, 2010 and 2009 is as follows:

 

		2010								2009
						Weighted Average								Weighted Average
		Warrant				Exercise Price				Warrant				Exercise Price
Outstanding — beginning of year			26,351,098			$	0.05				10,090,625			$	0.10
Granted			—			$	—				21,816,028			$	0.03
Exercised			—			$	—				(5,555,555	)		$	0.02
Expired			(21,885,473	)		$	0.03				—			$	—
Outstanding — end of year			4,465,625			$	0.18				26,351,098			$	0.05

 

The following table summarizes the number of warrants, the weighted average exercise price, and weighted average life (by years) by price range for both total outstanding warrants and total exercisable warrants as of December 31, 2010:

  

				Total Outstanding												Total Exercisable
				Number				Weighted Average								Number				Weighted Average
Price Range				of Shares				Exercise Price				Life (Years)				of Shares				Exercise Price				Life (Years)
$0.02 - $0.35					4,315,625			$	0.15				3.15				4,315,625			$	0.15				3.15
$0.36 - $0.99					100,000			$	0.60				0.04				100,000			$	0.60				0.04
$1.00 - $1.25					50,000			$	1.25				0.04				50,000			$	1.25				0.04
					4,465,625			$	0.18				3.04				4,465,625			$	0.18				3.04

 

9.

Share-Based Compensation

 

As of December 31, 2010, the Company had adopted three stock option plans for the benefit of officers, directors, employees, independent contractors and consultants of the Company. These plans include: (i) the 1998 Stock Option Plan, (ii) the 1996 Stock Option Plan, and (iii) the 1996 Employee Compensatory Stock Option Plan. The 1998 Stock Option Plan was terminated with respect to future grants on April 8, 2008, the 1996 Stock Option Plan was terminated with respect to future grants on May 11, 2006 and the 1996 Employee Compensatory Stock Option Plan was terminated with respect to future grants on February 7, 2000. In addition to these plans, from time to time, the Company grants various other stock options and warrants directly to certain parties. The Company grants all such awards as incentive compensation to officers, directors, and employees, and as compensation for the services of independent contractors and consultants of the Company.

 

The fair value of each option and warrant awarded is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options and warrants have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options and warrants. The expected dividend yield assumption is based on the Company’s expectation of dividend payouts. Expected volatilities are based on historical volatility of the Company’s stock. The average risk-free interest rate is based on the U.S. treasury yield curve in effect as of the grant date. Expected life of the options and warrants is the average of the vesting term and the full contractual term of the options and warrants.

 

 

There were no transactions during the year ended December 31, 2010 requiring an assessment of value pursuant to the Black-Scholes option-pricing model. For the year ended December 31, 2009 the Black-Scholes option-pricing model has utilized the following assumptions: expected dividend yield – 0.00%; expected volatility – 142.57%; average risk-free interest rate – 1.98%; expected life – 5 years.

 

On August 5, 2009, the Board approved the issuance of 250,000 shares of the Company’s common stock to Dr. Rambod as payment for additional services in connection with the patent application. The common stock issued was valued at $0.02 per share, which was the approximate closing price of the Company’s common stock on the date of the issuance, for a total of $5,000, and was charged to discontinued operations on August 5, 2009.

 

On May 13, 2009, the Board approved the issuance of 500,000 shares of the Company’s common stock to Dr. Rambod, a consultant and former officer of the Company, as payment for services in connection with the completion and filing of a patent application regarding the Company’s rights in and to the polymer technology developed by the Company. The common stock issued was valued at $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the issuance, for a total of $13,500. On May 13, 2009, the Company charged discontinued operations for consultant compensation expense of $13,500 relating to these shares.

 

On May 13, 2009, the Company issued options to purchase 250,000 shares of common stock to a consultant for past services. The options became fully vested on May 13, 2009, the date of grant. The options have an exercise price of $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the issuance, and expire in ten years. The fair value of these options on the date of grant was $6,037, and was charged to operations on May 13, 2009.

 

On May 13, 2009, the Company issued options to purchase a total of 300,000 shares of common stock to two outside directors for past services. The options became fully vested on May 13, 2009, the date of grant. The options have an exercise price of $0.027 per share, which was the approximate closing price of the Company’s common stock on or about the date of the issuance, and expire in ten years. The fair value of these options on the date of grant was $7,244, and was charged to operations on May 13, 2009.

 

On August 8, 2008, the Company issued options to purchase 1,000,000 shares of common stock to a director pursuant to the 1998 Stock Option Plan. The options vest in eight equal semi-annual installments commencing on February 8, 2009 and continuing on each August 8 and February 8 thereafter until the becoming fully vested on the fourth anniversary of the date of grant, and expire in ten years. The fair value of these options on the date of grant was $83,621 and will be charged to operations on a straight-line basis over the requisite service period. During the year ended December 31, 2010 and 2009, the Company charged continuing operations for share-based compensation expense of $20,820 and $20,819, respectively, relating to these options.

 

On June 21, 2008, the Company issued options to purchase 100,000 shares of common stock to a consultant. The options vest over two years, have an exercise price of $0.08 per share, and expire in ten years. The fair value of these options on the date of grant was to $5,901 and is being charged to operations on a straight-line basis over the requisite service period. During the year ended December 31, 2010 and 2009, the Company charged continuing operations for share-based compensation expense of $1,476 and $2,952, respectively, relating to these options.

 

On February 12, 2007, the Company issued options to purchase 50,000 shares of common stock to a consultant pursuant to the 1998 Stock Option Plan. The options vest over two years, have an exercise price of $0.36 per share, and expire in ten years. The fair value of these options on the date of grant was $12,163 and is being charged to operations on a straight-line basis over the requisite service period. During the year ended December 31, 2009, the Company recorded consultant compensation expense of $761 relating to these options.

 

During the years ended December 31, 2010 and 2009, a total of $22,296 and $56,313, respectively, was charged to continuing and discontinued operations for share-based compensation costs relating to common stock, stock options and warrants.

 

 

As of December 31, 2010, there was approximately $31,300 of total unrecognized compensation cost related to share-based compensation arrangements, which is expected to be recognized over the ensuing 19 months.

 

There were no unexercised in-the-money stock options and warrants at December 31, 2010. Accordingly, they had no intrinsic value on that date, based on a fair market value of $0.01 on December 31, 2010. The intrinsic value of exercisable but unexercised in-the-money stock options and warrants at December 31, 2009 was approximately $87,000, based on a fair market value of $0.03 per share on December 31, 2009.

 

10.

Commitments and Contingencies

 

Arbitration Proceeding with Xcorporeal

 

On September 1, 2006, the Company entered into a merger agreement (the “Merger Agreement”) with Xcorporeal, Inc. (“Xcorporeal”) which contemplated that either (i) the Company would enter into a triangular merger in which the Company would become a wholly-owned subsidiary of Xcorporeal, or (ii) Xcorporeal would issue to the Company shares of its common stock in consideration of the assignment of the technology relating to the Company’s wearable artificial kidney and other medical devices (collectively sometimes referred to as the “Technology Transactions”). In connection with the Merger Agreement, also on September 1, 2006, the Company entered into a license agreement (the “License Agreement”) with Xcorporeal granting an exclusive license for ninety-nine years (or until the expiration of the Company’s proprietary rights in the technology, if earlier), to all technology relating to the Company’s wearable artificial kidney and other medical devices for a minimum royalty of $250,000.

 

Following execution of the Merger Agreement and the License Agreement, the parties attempted to close the transactions contemplated by the Merger Agreement, but disputes arose regarding satisfaction of the conditions to closing and with respect to certain provisions of the Merger Agreement. In addition, a dispute arose as to whether the License Agreement would survive a failure to consummate either of the two transactions contemplated by the Merger Agreement.

 

Effective as of December 29, 2006, the Company terminated the Merger Agreement and License Agreement and all transactions contemplated thereby due to Xcorporeal’s continuing, uncured and incurable breaches of the Merger Agreement, the License Agreement and certain related matters. Xcorporeal did not dispute the termination of the Merger Agreement, but had disputed the Company’s termination of the License Agreement, which Xcorporeal alleged to be in full force and effect.

 

On December 1, 2006, Xcorporeal filed a demand for arbitration against the Company, alleging an unspecified anticipatory breach of the License Agreement. On December 29, 2006, at the same time that the Company terminated the Merger Agreement and the License Agreement, the Company filed a lawsuit against Xcorporeal and against Victor Gura, former Chief Financial Officer and Chief Scientific Officer and a director of the Company.

 

The arbitration was held in February 2008. On June 9, 2008, the arbitrator issued an interim award. The arbitrator concluded that the License Agreement was not to survive the failure of the transactions contemplated by the Merger Agreement, that Xcorporeal had waived and excused the Company’s obligations to perform under the Merger Agreement and that the appropriate remedy under the circumstances was to award the Company specific performance of the Technology Transaction. The arbitrator rejected the Company’s fraud, misappropriation and other claims, and rejected Gura’s claims against the Company and the Company’s claims against Gura. In addition, the arbitrator stated that the Company was the prevailing party in the arbitration and therefore entitled to recover its fees and costs. Because the Company had prevailed on some, but not all, of its claims, the arbitrator awarded the Company approximately $1,870,000 in fees and costs.

 

 

On April 13, 2009, the arbitrator in the arbitration proceeding issued a partial final award (“Partial Final Award”), which resolved the remaining issues that were pending for decision in the arbitration proceeding. The Partial Final Award reflected the arbitrator’s conclusions based on arguments by Xcorporeal that the 9,230,000 shares could not be issued to the Company in compliance with the federal securities laws because of the financial condition of the Company. The Partial Final Award provided that Xcorporeal would have a perpetual exclusive license (the “Perpetual License”) to the technology. Under the terms of the Partial Final Award, in consideration of the award of the Perpetual License to Xcorporeal, the Company was awarded a royalty of 39% of all net income, ordinary or extraordinary, to be received by Xcorporeal and the Company was to receive 39% of any shares received in any merger transaction to which Xcorporeal may become a party. In addition, the Partial Final Award provided that Xcorporeal was obligated to pay the Company $1,871,430 for its attorneys’ fees and costs previously awarded by the arbitrator in an order issued on August 13, 2008, that the Company’s application for interim royalties and expenses was denied and that the Company was not entitled to recover any additional attorneys’ fees.

 

On August 7, 2009, to clarify, resolve and settle disputes that had arisen between the Company and Xcorporeal with respect to the Partial Final Award, including with respect to the rights of the parties regarding certain technology and the application of the Partial Final Award in the case of a sale of the Technology, the Company and Xcorporeal entered into a Memorandum of Understanding (“Memorandum”).

 

In connection with the issuance of the Partial Final Award and the Memorandum, on August 7, 2009, the Company entered into a stipulation (the “Stipulation”) with Xcorporeal. Pursuant to the terms of the Stipulation, the Company and Xcorporeal agreed (i) not to challenge the terms of the Partial Final Award or any portion of such award, (ii) that any of the parties may, at any time, seek to confirm all but not part of the Partial Final Award through the filing of an appropriate petition or motion with the appropriate court and in response to such action to confirm the Partial Final Award, no party would oppose, object to or in any way seek to hinder or delay the court’s confirmation of the Partial Final Award, but would in fact support and stipulate to such confirmation, and (iii) to waive any and all right to appeal from, seek appellate review of, file or prosecute any lawsuit, action, motion or proceeding, in law, equity, or otherwise, challenging, opposing, seeking to modify or otherwise attacking the confirmed Partial Final Award or the judgment thereon.

 

In late March 2009, Xcorporeal began a preliminary dialogue with Fresenius Medical Care Holdings, Inc. (“Fresenius”), to determine the interest of Fresenius to acquire certain or all of Xcorporeal assets. These discussions continued through June 2009. In June 2009, Fresenius commenced its due diligence review of Xcorporeal.

 

In September 2009, the Company and Xcorporeal reviewed the terms of a transaction proposed by Fresenius USA, Inc. (“FUSA”), a wholly-owned subsidiary of Fresenius, in a draft non-binding term sheet for the acquisition of all of the Xcorporeal assets and the Company’s assets.

 

The Company, Xcorporeal and FUSA executed an Asset Purchase Agreement on December 14, 2009 (“Asset Purchase Agreement”) and the Company publicly announced this transaction on December 18, 2009. The arbitration was terminated with the closing of the Asset Sale in March 2010 (see Note 11).

 

Arbitration Proceeding with Former Legal Counsel

 

On February 17, 2011, the Company commenced a binding arbitration proceeding with its former law firm regarding a fee dispute that arose as a result of claimed attorneys' fees incurred by the former law firm in connection with an arbitration proceeding between the Company and Xcorporeal, and certain transactional matters handled by the law firm for the Company. The former law firm has asserted that approximately $2,729,000 in fees and costs are owed to it by the Company for services rendered during 2008, 2009 and 2010, plus interest. The arbitrators have heard all of the testimony presented by the parties, and the parties submitted their final closing briefs on November 10, 2011. As of April 2, 2012, the arbitrators had not rendered their decision on this matter. Management reviews available information and determines the need for recording an estimate of the potential expense when the amount is probable, reasonable and estimable. The Company believes that it has adequately and appropriately provided for the fees incurred through December 31, 2010 in the accompanying consolidated financial statements. Given the Company’s limited liquidity and working capital resources, it is uncertain whether the Company would be able to satisfy such obligation should a decision adverse to the Company be rendered.

 

 

11.

Discontinued Operations

 

Asset Purchase Agreement

 

On December 14, 2009, the Company, Xcorporeal and FUSA executed an Asset Purchase Agreement that provided for the sale of substantially all of each of the Company’s and Xcorporeal’s assets (the “Asset Sale”) to FUSA for an aggregate cash purchase price of $8,000,000 (the “Cash Purchase Price”) and certain other royalty payment rights. Subject to the terms and conditions of the Asset Purchase Agreement, the Cash Purchase Price was to be paid to the Company and Xcorporeal as follows: (a) an exclusivity fee in the amount of $200,000 previously paid by FUSA to Xcorporeal, (b) $3,800,000 on the date of closing (the “Closing Date”) of the transactions contemplated under the Asset Purchase Agreement (the “Closing”), of which the Company and Xcorporeal received $2,150,000 and $1,650,000, respectively, (c) $2,000,000 on April 1, 2010, of which the Company and Xcorporeal received $1,625,000 and $375,000, respectively, and (d) $2,000,000 on April 1, 2011, of which the Company and Xcorporeal received $1,925,000 and $75,000, respectively.

 

In addition, during the life of the patents referred to as the HD WAK Technology, which expire between November 11, 2021 and September 9, 2024, the Company is entitled to certain royalty payments from the sale of wearable hemodialysis devices and the attendant disposables that incorporate the HD WAK Technology. The Company is entitled to 40% of the HD WAK royalty and Xcorporeal is entitled to the remaining 60%.

 

Additionally, during the life of any patents referred to as the Supersorbent Technology, the Company is entitled to certain royalty payments on each supersorbent cartridge sold less any and all royalties payable to The Technion Research and Development Foundation Ltd. (“TRDF”) pursuant to a Research Agreement and Option for License, dated June 16, 2005, or any subsequently executed license agreement between TRDF and FUSA. The Company is entitled to 60% of the Supersorbent royalty payments and Xcorporeal is entitled to the remaining 40%. While several applications for patents are pending, no patent incorporating the Supersorbent Technology has yet been issued.

 

FUSA also granted to the Company and Xcorporeal an option to obtain a perpetual, worldwide license to the Supersorbent Technology for use in healthcare fields other than renal (the “Option”). The Option is exercisable during the twelve-month period following FUSA’s receipt of regulatory approval for the sale of a supersorbent product in the United States or European Union, which the Company expects will require further development of the supersorbent technology with TRDF and successful completion of clinical trials by FUSA. The consideration payable to FUSA by the Company or Xcorporeal for the exercise of the Option consists of a payment in the amount of $7,500,000, payable in immediately available funds, and a payment of an ongoing royalty in an amount equal to the lesser of $0.75 per supersorbent cartridge and $1.50 per patient per week in each country where such sales infringe valid and issued claims of the Supersorbent Patents issued in such country.

 

The Asset Purchase Agreement closed on March 19, 2010, with payments made to the Company by FUSA of $1,950,000, $1,625,000 and $1,675,000 on March 19, 2010, April 1, 2010 and April 1, 2011, respectively, for a total of $5,250,000. FUSA held back $200,000 and $250,000 from the March 19, 2010 and April 1, 2011 payments, respectively, for purposes of resolving a dispute between the Company and TRDF. The closing of the Asset Sale in March 2010 also terminated the arbitration proceeding with Xcorporeal (see Note 10).

 

As a result of the Asset Sale, the Company has accounted for its previous research and development activities as a discontinued operation for all periods presented. During the years ended December 31, 2010 and 2009, the Company had income (loss) from its discontinued research and development operation of $24,386 and $(109,209), respectively.

 

Additionally, upon the closing of the Asset Sale on March 19, 2010, the Company recorded a gain from debt settlement of $1,871,430 (see Note 10), which is included in continuing operations, and a gain from the Asset Sale of $3,318,732, before income taxes of approximately $1,363,000, which is included in discontinued operations, in the accompanying consolidated statement of operations.

 

12.

Income (Loss) Per Share

 

Basic and diluted income per common share amounts for the year ended December 31, 2010 are the same because all warrants, stock options and convertible notes payable outstanding were anti-dilutive.

 

 

The following table illustrates the computation of basic and diluted income (loss) per common share for the year ended December 31, 2009:

 

		Income (Numerator)				Shares (Denominator)				Per- Share Amount
Income per common share from continuing operations
Basic
Income from continuing operations available to common stockholders		$	265,058				77,917,165			$	0.00
Effect of dilutive securities:
Warrants							20,479
Convertible notes payable			34,619				1,865,814
Diluted		$	299,677				79,803,458			$	0.00
Loss per common share from discontinued operations
Basic
Loss from discontinued operations available to common stockholders		$	(109,209	)			77,917,165			$	(0.00	)
Effect of dilutive securities			34,619				1,886,293
Diluted		$	(74,590	)			79,803,458			$	(0.00	)
Net income per common share
Basic
Net income available to common stockholders		$	155,849				77,917,165			$	0.00
Effect of dilutive securities			34,619				1,886,293
Diluted		$	190,468				79,803,458			$	0.00

 

At December 31, 2010 and 2009, the Company excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock, from its calculation of earnings per share, as their effect would have been anti-dilutive.

 

		2010				2009
Warrants			4,465,625				21,805,643
Stock options			8,070,000				8,070,000
Total			12,535,625				29,875,643

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	NATIONAL QUALITY CARE, INC.
Date:  April 2, 2012	By:	/s/ROBERT M. SNUKAL
		Robert M. Snukal
		Chief Executive Officer and President

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed as of April 2, 2012 by the following persons on behalf of the registrant and in the capacities indicated.

 

Signature		Capacity in Which Signed
/s/ LEONARDO BEREZOVSKY, MD.		Chairman of the Board of Directors and
Leonardo Berezovsky M.D.		Chief Financial Officer
		(principal financial officer)
/s/ ROBERT M. SNUKAL		Chief Executive Officer, President and Director
Robert M. Snukal		(principal executive officer)
/s/ RONALD LANG, M.D.		Executive Vice-President and Director
Ronald Lang, M.D.
/s/ JOSE SPIWAK		Director
Jose Spiwak, M.D.
		Chief Scientific Officer and Director
Edmond Rambod, Ph.D.

 

 

Index to Exhibits

 

Exhibit No.		Description
2.1		Agreement for Exchange of Stock dated May 11, 1996, by and among the Company, Los Angeles Community Dialysis, Inc., Victor Gura, M.D., Avraham H. Uncyk, M.D. and Ronald P. Lang, M.D. (1)
3.1		Restated Certificate of Incorporation (2)
3.2		Bylaws (2)
10.1		1996 Employee Compensation Stock Option Plan (3)
10.2		1996 Stock Option Plan (4)
10.3		1998 Stock Option Plan (5)
10.4		Technology Purchase Agreement, dated as of December 18, 2001, between the Company and Victor Gura, M.D. (6)
10.5		Purchase and Sale Agreement, dated May 31, 2006, between Los Angeles Community Dialysis, Inc., a California corporation, Ronald Lang, M.D. and Victor Gura, M.D., on the one hand, and Los Angeles Kidney Dialysis Center, LLC. on the other hand. (7)
10.6		License Agreement, dated as of September 1, 2006, between the Company and Xcorporeal, Inc. (8)
10.7		Merger Agreement, dated as of September 1, 2006, among the Company, NQCI Acquisition Corporation and Xcorporeal, Inc. (8)
10.8		Form of Subscription Agreement (9)
10.9		Form of Promissory Note (9)
10.10		Form of Warrant (9)
10.11		Deferred Compensation Plan (10)
10.12		Convertible Promissory Note dated December 26, 2007 issued to Robert M. Snukal (11)
10.13		Warrant dated December 26, 2007 issued to Robert M. Snukal (11)
10.14		Subscription Agreement dated October 16, 2008 between the Company and Robert M. Snukal (12)
10.15		Warrant dated October 16, 2008 issued to Robert M. Snukal (12)
10.16		Promissory Note dated October 16, 2008 issued by Robert M. Snukal to Company (12)
10.17		Warrant dated March 25, 2008 issued to Robert M. Snukal (13)
10.18		Convertible Promissory Note dated August 12, 2008 issued to Robert M. Snukal (14)
10.19		Warrant dated August 12, 2008 issued to Robert M. Snukal (14)
10.20		Asset Purchase Agreement dated December 14, 2009 among the Company, Xcorporeal, Inc., Xcorporeal Operations, Inc. and Fresenius USA, Inc. (15)
10.21		Amendment No. 1 to Asset Purchase Agreement dated February 8, 2010 among the Company, Xcorporeal, Inc., Xcorporeal Operations, Inc. and Fresenius USA, Inc. (16)
14.1		Code of Ethics. (17)
16.1		Letter from PMB Helin Donovan dated March 4, 2011 (18)
31.1		Certification of CEO pursuant to Securities Exchange Act rules 13a-15 and 15d-15(c) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of CFO pursuant to Securities Exchange Act rules 13a-15 and 15d-15(c) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

 

Exhibit No.		Description
32.1		Certification of CEO and CFO pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002.

 

 

1.		Incorporated by reference herein to its Current Report on Form 8-K dated May 24, 1996.
2.		Incorporated by reference herein to its Quarterly Report on Form 10-QSB for the quarterly period ended April 30, 1996.
3.		Incorporated by reference herein to its Registration Statement on Form S-8 dated April 6, 1996.
4.		Incorporated by reference herein to its Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 1996.
5.		Incorporated by reference herein to its Registration Statement on Form S-8 dated March 5, 1999.
6.		Incorporated by reference herein to its Annual Report on Form 10-KSB for the year ended December 31, 2001.
7.		Incorporated by reference herein to its Current Report on Form 8-K dated June 5, 2006.
8.		Incorporated by reference herein to its Annual Report on Form 10-KSB for the year ended December 31, 2006.
9.		Incorporated by reference herein to its Current Report on Form 8-K dated June 22, 2007.
10.		Incorporated by reference herein to its Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 2007.
11.		Incorporated by reference herein to its Current Report on Form 8-K dated December 26, 2007.
12.		Incorporated by reference herein to its Current Report on Form 8-K dated October 16, 2008.
13.		Incorporated by reference herein to its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2008.
14.		Incorporated by reference herein to its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2008.
15.		Incorporated by reference herein to its Current Report on Form 8-K dated December 14, 2009.
16.		Incorporated by reference herein to its Current Report on Form 8-K dated February 8, 2010.
17.		Incorporated by reference herein to its Annual Report on Form 10-KSB for the year ended December 31, 2003.
18.		Incorporated by reference herein to its Current Report on Form 8-K dated March 4, 2011.