NATIONAL QUALITY CARE INC - FORM 10-Q

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EX-31.1 - EXHIBIT 31.1 - NATIONAL QUALITY CARE INC	v313459_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - NATIONAL QUALITY CARE INC	v313459_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - NATIONAL QUALITY CARE INC	v313459_ex31-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

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	84-1215959
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	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)

N/A

(Former address and telephone number, if changed since last report)

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

Indicate by check mark whether each registrant has submitted electronically and posted on its corporate Website, 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 ¨ No ¨

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 80,221,807 shares of common stock as of March 31, 2011.

Documents incorporated by reference: None

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

TABLE OF CONTENTS

	Page
	Number
PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements	4

Condensed Consolidated Balance Sheets – March 31, 2011 (Unaudited) and December 31, 2010	4

Condensed Consolidated Statements of Operations (Unaudited) – Three Months Ended March 31, 2011 and 2010	5

Condensed Consolidated Statement of Stockholders’ Equity (Deficiency) – Year ended December 31, 2010 and Three Months Ended March 31, 2011 (Unaudited)	6

Condensed Consolidated Statements of Cash Flows (Unaudited) – Three Months Ended March 31, 2011 and 2010	7

Notes to Condensed Consolidated Financial Statements (Unaudited) – Three Months ended March 31, 2011 and 2010	8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3. Quantitative and Qualitative Disclosures About Market Risk	24

Item 4. Controls and Procedures	24

PART II - OTHER INFORMATION

Item 1. Legal Proceedings	25

Item 1A. Risk Factors	25

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	25

Item 3. Defaults Upon Senior Securities	25

Item 4. Mine Safety Disclosures	25

Item 5. Other Information	26

Item 6. Exhibits	26

SIGNATURES	26

Forward-Looking Statements

Certain statements in this Quarterly 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 pending arbitration with our former legal counsel, and the uncertainty about our ability to continue as a going concern, as well as those set forth in this Quarterly Report. Readers are cautioned not to place undue reliance on these forward-looking statements, which are made as of March 31, 2011. 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 – FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Financial Statements

NATIONAL QUALITY CARE, INC.
AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

	March 31,			December 31,
	2011			2010
	(Unaudited)

ASSETS
Current assets:
Cash	$	14,408		$	104,405
Money market funds		39,750			1,417,969
Funds on deposit with law firms		967,663			—
Receivable from sale of technology rights		1,675,000			1,675,000
Prepaid expenses and other current assets		383,939			68,965
Total current assets		3,080,760			3,266,339
Total assets	$	3,080,760		$	3,266,339

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable and accrued expenses	$	2,743,522		$	2,794,945
Accounts payable and accrued expenses – discontinued operations		15,214			15,214
Income taxes payable		377,000			231,000
Deferred income taxes		—			146,000
Total current liabilities		3,135,736			3,187,159
Total liabilities		3,135,736			3,187,159

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		12,791,747			12,786,542
Accumulated deficit		(13,648,942	)		(13,509,581	)
Total stockholders’ equity (deficiency)		(54,976	)		79,180
Total liabilities and stockholders’ equity (deficiency)	$	3,080,760		$	3,266,339

See accompanying notes to condensed consolidated financial statements.

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	Three Months Ended March 31,
	2011			2010
Revenues	$	—		$	—

General and administrative expense, including $5,205 and $5,943 of stock-based compensation costs for the three months ended March 31, 2011 and 2010, respectively		139,642			131,350
Loss from operations		(139,642	)		(131,350	)
Interest expense – related party		—			(197,030	)
Gain from legal settlement		—			1,871,430
Interest income		281			—
Other income		—			156,145
Income (loss) before income taxes		(139,361	)		1,699,195
Income tax expense		—			(683,000	)
Income (loss) from continuing operations		(139,361	)		1,016,195
Income from discontinued operations, including gain from sale of assets of $3,318,732, net of income taxes of $1,363,000		—			1,980,118
Net income (loss)	$	(139,361	)	$	2,996,313

Income (loss) per common share – basic and diluted:
Continuing operations	$	(0.00	)	$	0.01
Discontinued operations		—			0.03
Total net income (loss) per common share	$	(0.00	)	$	0.04

Weighted average common shares outstanding – basic and diluted		80,221,807			80,221,807

See accompanying notes to condensed consolidated financial statements.

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIENCY)

Year Ended December 31, 2010

And Three Months Ended March 31, 2011

	Common Stock				Additional Paid-in		Accumulated			Total Stockholders’ Equity
	Shares		Amount		Capital		Deficit			(Deficiency)
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
Stock-based compensation costs		—		—		5,205		—			5,205
Net loss		—		—		—		(139,361	)		(139,361	)
Balance at March 31, 2011 (Unaudited)		80,221,807	$	802,219	$	12,791,747	$	(13,648,942	)	$	(54,976	)

See accompanying notes to condensed consolidated financial statements.

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended March 31,
	2011			2010
Cash flows from operating activities:
Continuing operations:
Income (loss) from continuing operations	$	(139,361	)	$	1,016,195
Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) continuing operating activities:
Amortization of discount on notes payable		—			188,025
Stock-based compensation costs		5,205			5,943
Forgiveness of payables		—			(156,145	)
Deferred income taxes		(146,000	)		574,000
Changes in operating assets and liabilities:
Increase in -
Funds on deposit with law firms		(967,663	)		—
Prepaid expenses and other current assets		(314,974	)		(48,794	)
Increase (decrease) in -
Accounts payable and accrued expenses		(51,423	)		(124,111	)
Income taxes payable		146,000			109,000
Accrued interest due to related party		—			9,004
Net cash provided by (used in) continuing operating activities		(1,468,216	)		1,573,117
Discontinued operations:
Income from discontinued operations		—			1,980,118
Adjustments to reconcile income from discontinued operations to net cash used in discontinued operating activities:
Forgiveness of payables		—			(25,101	)
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		—			(134,215	)
Income taxes payable		—			149,000
Net cash used in discontinued operating activities		—			(134,930	)
Net cash provided by (used in) operating activities		(1,468,216	)		1,438,187

Cash flows from investing activities:
Proceeds from sale of assets		—			78,570
(Increase) decrease in money market funds		1,378,219			(175,838	)
Net cash provided by (used in) investing activities		1,378,219			(97,268	)

Cash flows from financing activities:
Proceeds from notes payable to related party		—			45,000
Payment of note payable issued for services		—			(120,000	)
Repayment of note payable to related party		—			(1,206,112	)
Net cash used in financing activities		—			(1,281,112	)

Net increase (decrease) in cash		(89,997	)		59,807
Cash balance at beginning of period		104,405			22,281
Cash balance at end of period	$	14,408		$	82,088

Supplemental disclosures of cash flow information:
Cash paid for -
Interest	$	—		$	116,043
Income taxes	$	—		$	750

Non-cash investing activities:
During the three months ended March 31, 2010, the Company sold technology rights summarized as follows:
Total sales price				$	3,378,570
Less amount receivable as of March 31, 2010					(3,300,000	)
Proceeds from sale of assets during the three months ended March 31, 2010				$	78,570

See accompanying notes to condensed consolidated financial statements.

NATIONAL QUALITY CARE, INC.

AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Three Months Ended March 31, 2011 and 2010

1. Basis of Presentation

The condensed consolidated financial statements of National Quality Care, Inc. (“NQCI”) and its wholly-owned subsidiary, Los Angeles Community Dialysis, Inc. (“LACDI”) (collectively, the “Company”) at March 31, 2011, and for the three months ended March 31, 2011 and 2010, are unaudited. In the opinion of management, all adjustments (including normal recurring adjustments) have been made that are necessary to present fairly the financial position of the Company as of March 31, 2011, the results of its operations for the three months ended March 31, 2011 and 2010, and its cash flows for the three months ended March 31, 2011 and 2010. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for a full fiscal year. The condensed balance sheet at December 31, 2010 has been derived from the Company’s audited financial statements.

The statements and related notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and other information included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, as filed with the SEC.

Organization and Business Operations

Organization and Nature of Business

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 a wearable artificial kidney (see Note 10). 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 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 condensed 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 a wearable artificial kidney (see Note 10) and, consequently, those activities have been accounted for as discontinued operations in the Company’s condensed 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 March 31, 2011, the Company had an accumulated deficit of $13,648,942, 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 condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

3. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying condensed 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.

Funds on Deposit with Law Firms

Funds on deposit with law firms represent amounts held by law firms for the benefit of the Company.

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 condensed 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 March 31, 2011, 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 March 31, 2011, 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 condensed 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 condensed 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.

Income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the respective periods. Basic and diluted income (loss) per common share is the same for all periods presented because all warrants, stock options and convertible notes payable outstanding were anti-dilutive.

At March 31, 2011 and 2010, 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.

	2011		2010

Warrants		4,315,625		4,465,625
Stock options		8,070,000		8,070,000
Total		12,385,625		12,535,625

Fair Value of Financial Instruments

The carrying amounts of cash, money market funds, funds on deposit with law firms, 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.

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.

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.

4. Notes Payable

Note 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.

Notes 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 10).

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 three months ended March 31, 2010, the Company recorded interest expense of $136,581 relative to the amortized discount. The discount was fully amortized as of March 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 10).

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 10).

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 three months ended March 31, 2010, the Company recorded interest expense of $51,444 relative to the amortized discount. The discount was fully amortized as of March 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 10).

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 three months ended March 31, 2010, the Company recorded total interest expense of $188,025 relative to the amortization of discounts. There was no amortization of discounts during the three months ended March 31, 2011.

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.

6. Money Market Funds — Fair Value

Money market funds at March 31, 2011 and December 31, 2010 consisted of an investment in shares of the UBS Select Prime Institutional Fund with a market value of $39,750 and $1,417,969, respectively. 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 March 31, 2011 and December 31, 2010.

	Total		Level 1		Level 2		Level 3

March 31, 2011:
Money market funds	$	39,750	$	39,750	$	—	$	—

December 31, 2010:
Money market funds	$	1,417,969	$	1,417,969	$	—	$	—

7. Stock Options and Warrants

A summary of the Company’s stock option activity and related information for the three months ended March 31, 2011 and 2010 is as follows:

	2011				2010
			Weighted Average				Weighted Average
			Exercise				Exercise
	Options		Price		Options		Price
Outstanding — beginning of period		8,070,000	$	0.37		8,070,000	$	0.37
Granted		—	$	—		—	$	—
Exercised		—	$	—		—	$	—
Expired		—	$	—		—	$	—

Outstanding — end of period		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 March 31, 2011:

	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		7.13		3,715,000	$	0.12		7.11
$0.36 - $0.99		3,980,000	$	0.63		5.05		3,980,000	$	0.63		5.05

		8,070,000	$	0.37		6.11		7,695,000	$	0.38		6.04

See Note 8 for a description of the Company’s share-based compensation, including the stock option activity during the three months ended March 31, 2011 and 2010.

Stock Warrants

A summary of the Company’s stock warrant activity and related information for the three months ended March 31, 2011 and 2010 is as follows:

	2011					2010
				Weighted Average					Weighted Average
	Warrant			Exercise Price		Warrant			Exercise Price
Outstanding — beginning of period		4,465,625		$	0.18		26,351,098		$	0.15
Granted		—		$	—		—		$	—
Exercised		—		$	—		—		$	—
Expired		(150,000	)	$	0.82		(21,885,473	)	$	0.03

Outstanding — end of period		4,315,625		$	0.15		4,465,625		$	0.18

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 March 31, 2011:

	Total Outstanding						Total Exercisable
	Number		Weighted Average				Number		Weighted Average
Price Range	of Shares		Exercise Price		Life (Years)		of Shares		Exercise Price		Life (Years)
$0.08 - $0.20		4,315,625	$	0.15		2.90		4,315,625	$	0.15		2.90

8. Share-Based Compensation

As of March 31, 2011, 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 three months ended March 31, 2011 and 2010 requiring an assessment of value pursuant to the Black-Scholes option-pricing model.

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 is being charged to operations on a straight-line basis over the requisite service period. During the three months ended March 31, 2011 and 2010, the Company charged continuing operations for share-based compensation expense of $5,205 and $5,205, 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 was charged to operations on a straight-line basis over the requisite service period. During the three months ended March 31, 2011 and 2010, the Company charged continuing operations for share-based compensation expense of $-0- and $738, respectively, relating to these options.

During the three months ended March 31, 2011 and 2010, a total of $5,205 and $5,943, respectively, was charged to continuing operations for share-based compensation costs relating to common stock, stock options and warrants.

As of March 31, 2011, there was approximately $26,000 of total unrecognized compensation cost related to share-based compensation arrangements, which is expected to be recognized over the ensuing 16 months.

As of March 31, 2011 and December 31, 2010 there were no unexercised in-the-money stock options and warrants. Accordingly, they had no intrinsic value on those dates, based on a fair market value of $0.006 per share and $0.026 per share, respectively, on each of those dates.

9. 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 10).

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 May 16, 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 March 31, 2011 in the accompanying condensed 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.

10. 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 9).

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 three months ended March 31, 2011 and 2010, the Company had income from its discontinued research and development operation of $-0- and $24,386, 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 9), 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 condensed consolidated statement of operations.

Item 2. 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 March 31, 2011, 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 assurance that the Company will be successful in obtaining any 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 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.

Arbitration Proceedings

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 May 16, 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 March 31, 2011 in its condensed 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 condensed 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 condensed 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.

Recent Accounting Pronouncements

Significant Accounting Policies

The Company prepared its condensed 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 condensed 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 condensed consolidated statement of operations.

Stock-Based Compensation

Income Taxes

Contingencies

Results of Operations for the Three Months Ended March 31, 2011 and 2010

The Company had no revenues from operations for the three months ended March 31, 2011 and 2010; however, the Company generated revenue from the sale of the Company’s technology rights during 2010.

General and administrative expenses were $139,642 for the three months ended March 31, 2011, as compared to $131,350 for the three months ended March 31, 2010, an increase of $8,292 or 6%. Included in such costs was stock-based compensation of $5,205 and $5,943 in 2011 and 2010, respectively.

Interest expense (all to a related party) was $-0- for the three months ended March 31, 2011, as compared to $197,030 for the three months ended March 31, 2010. The decrease in 2011, as compared to 2010, was the result of amortization in 2010 of discounts on notes payable that were borrowed in prior years to fund the Company’s working capital needs. Such notes payable were repaid in 2010 from the proceeds received in 2010 relating to the sale of the Company’s technology rights.

Other income was $-0- for the three months ended March 31, 2011, as compared to $156,145 for the three months ended March 31, 2010. Other income in 2010 was due primarily to the forgiveness of payables by vendors.

Income tax expense related to continuing operations was $-0- for the three months ended March 31, 2011. Income tax expense related to continuing operations of $683,000 was recorded for the three months ended March 31, 2010, and related primarily to the gain from legal settlement of $1,871,430 recognized in 2010.

Loss from continuing operations was $139,361 for the three months ended March 31, 2011, as compared to income from continuing operations of $1,016,195 for the three months ended March 31, 2010. The income from continuing operations in 2010 related primarily to the gain from legal settlement, net of income taxes.

Income from discontinued operations was $1,980,118 for the three months ended March 31, 2010, due primarily to the gain from the sale of assets, net of income taxes. There was no income (loss) from discontinued operations for the three months ended March 31, 2011.

Net loss was $139,361 for the three months ended March 31, 2011, as compared to net income of $2,996,313 for the three months ended March 31, 2010.

The Company expects to report continuing losses from operations and negative operating cash flows for the remainder of 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.

Liquidity and Capital Resources

The Company had cash and money market funds of $54,158 at March 31, 2011, as compared to $1,522,374 at December 31, 2010, a decrease of $1,468,216. The Company had funds on deposit with law firms of $967,663 at March 31, 2011. The Company had no funds on deposit with law firms at March 31, 2010. The Company had a working capital deficiency of $54,976 at March 31, 2011, as compared to a working capital surplus of $79,180 at December 31, 2010.

The Company does not have sufficient working capital assets and resources to meet its continuing 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.

Operating Activities

During the three months ended March 31, 2011, the Company used cash of $1,468,216 in continuing operating activities, as compared to generating cash of $1,573,117 from continuing operating activities during the three months ended March 31, 2010, a net decrease of $3,041,333. Cash used in continuing operations during the three months ended March 31, 2011 was primarily the result of amounts placed on deposit with legal and other professionals. Cash provided by continuing operations during the three months ended March 31, 2010 was due primarily to the proceeds received from the legal settlement, net of income taxes.

During the three months ended March 31, 2010, the Company used cash of $134,930 in discontinued operating activities. The Company had no discontinued operating activities during the three months ended March 31, 2011.

Investing Activities

During the three months ended March 31, 2011, the Company generated $1,378,219 in cash from investing activities, consisting of amounts transferred from the Company’s money market funds. During the three months ended March 31, 2010, the Company utilized $97,268 of cash in investing activities, consisting of the proceeds received from the sale of assets of $78,570, offset by $175,838 transferred to the Company’s money market funds.

Financing Activities

During the three months ended March 31, 2011, the Company had no financing activities. During the three months ended March 31, 2010, the Company used $1,281,112 of cash in financing activities, consisting primarily of principal and interest payments made on debt incurred in prior periods to finance the Company’s activities.

The following significant financing transactions, primarily equity related, were completed in 2010 and 2011:

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 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 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. 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 March 31, 2011, 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.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of such internal control that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

On December 1, 2006, Xcorporeal filed a demand for arbitration at JAMS in Santa Monica, California against the Company, alleging an unspecified anticipatory breach of the License Agreement that the Company entered into with Xcorporeal on September 1, 2006. At the same time that the Company entered into the License Agreement, the Company entered into an interrelated and inter-dependent Merger Agreement with Xcorporeal. Effective as of December 29, 2006, the Company terminated the Merger Agreement and the License Agreement 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 that the Company terminated the Merger Agreement and the License Agreement, the Company filed a lawsuit against Xcorporeal and against Victor Gura, a former officer and director of the Company. Xcorporeal and Gura stipulated to the filing of the Company’s claims against them as part of the arbitration proceedings related to the License Agreement, and the Company dismissed its lawsuit without prejudice. The arbitration was terminated with the closing of the Asset Sale in March 2010. A description of the Asset Sale is set forth at “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation — Sale of Assets”.

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 May 16, 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 March 31, 2011 in its condensed 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.

Item 1A – Risk Factors

Not applicable.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures

None.

Item 5 – Other Information

None.

Item 6 – Exhibits

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.

SIGNATURES

Pursuant to the requirements of Securities Exchange 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.
	(Registrant)

Date: May 17, 2012	By:	/s/Robert M. Snukal
		Robert M. Snukal
		Chief Operating Officer and President
		(Principal Executive Officer)

Date: May 17, 2012	By:	/s/Leonardo Berezovsky
		Leonardo Berezovsky
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

INDEX TO EXHIBITS

Exhibit
No.		Description

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.

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.

NATIONAL QUALITY CARE INC - FORM 10-Q - May 21, 2012

Attached files

NATIONAL QUALITY CARE INC Reports