UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
|
QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
FOR
THE QUARTERLY PERIOD ENDED
JUNE
30, 2008
|
|
|
p
|
TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
FOR
THE TRANSITION PERIOD FROM __________
TO
__________
|
Commission
file number
001-31608
XCORPOREAL,
INC.
(Exact
name of small business issuer as specified in its charter)
Delaware
|
75-2242792
|
(State
or other jurisdiction of
incorporation
or organization)
|
(IRS
Employer Identification Number)
|
12121
Wilshire Blvd., Suite 350, Los Angeles, California 90025
(Address
of principal executive offices)
(310)
923-9990
(Issuer’s
telephone number)
Check
whether the issuer (1) filed all reports required to be filed by Section 13
or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes
x
No
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.
|
o
Large accelerated filer
|
o
Accelerated filer
|
|
|
|
|
|
|
o
Non-accelerated filer
|
x
Smaller reporting company
|
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes
o
No
x
State
the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date.
Class
|
Outstanding
as of August 6, 2008
|
Common
Stock, $0.0001 par value
|
14,704,687
shares
|
|
INDEX
PART
I — FINANCIAL INFORMATION
|
2
|
|
|
Item
1. Interim Financial Statements
|
2
|
|
|
Balance
Sheets at June 30, 2008 (unaudited) and December 31, 2007
|
2
|
|
|
Statements
of Operations (unaudited) for the three and six months ended June
30, 2008
and June 30, 2007 and the period from inception (May 4, 2001) to
June 30,
2008
|
3
|
|
|
Statements
of Cash Flows (unaudited) for the six months ended June 30, 2008
and June
30, 2007 and the period from inception (May 4, 2001) to June 30,
2008
|
4
|
|
|
Statement
of Stockholders Equity (Deficit) for the six months ended June 30,
2008
and the period from inception (May 4, 2001) to June 30, 2008
(unaudited)
|
5
|
|
|
Notes
to the Interim Financial Statements
|
6
|
|
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
|
12
|
|
|
Item
3. Quantitative and Qualitative Disclosures about Market
Risk
|
15
|
|
|
Item
4. Controls and Procedures
|
16
|
|
|
PART
II — OTHER INFORMATION
|
17
|
|
|
Item
1. Legal Proceedings
|
17
|
|
|
Item
1A. Risk Factors
|
17
|
|
|
Item
2. Unregistered Sales of Equity Securities ; Use of Proceeds from
Registered Securities
|
18
|
|
|
Item
6. Exhibits
|
18
|
|
|
Signatures
|
19
|
PART
I — FINANCIAL INFORMATION
ITEM
1. Financial Statements
XCORPOREAL,
INC.
(a
Development Stage Company)
BALANCE
SHEETS
|
|
June
30,
|
|
December
31,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
Current
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
67,987
|
|
$
|
106,495
|
|
Marketable
securities, at fair value
|
|
|
9,241,096
|
|
|
16,401,898
|
|
Restricted
cash
|
|
|
67,873
|
|
|
68,016
|
|
Prepaid
Expenses & Other Current Assets
|
|
|
361,425
|
|
|
408,303
|
|
Total
current assets
|
|
|
9,738,381
|
|
|
16,984,712
|
|
Property
and equipment, net
|
|
|
320,250
|
|
|
266,912
|
|
Other
assets
|
|
|
892
|
|
|
922
|
|
Total
Assets
|
|
$
|
10,059,523
|
|
$
|
17,252,546
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,491,152
|
|
$
|
1,125,239
|
|
Accrued
professional fees
|
|
|
1,371,905
|
|
|
425,228
|
|
Accrued
royalties
|
|
|
208,333
|
|
|
83,333
|
|
Accrued
compensation
|
|
|
140,946
|
|
|
196,541
|
|
Accrued
other liabilities
|
|
|
105,075
|
|
|
68,946
|
|
Payroll
liabilities
|
|
|
64,505
|
|
|
11,926
|
|
Deferred
rent
|
|
|
38,309
|
|
|
-
|
|
Other
current liabilities
|
|
|
115,400
|
|
|
115,400
|
|
Total
Current Liabilities
|
|
|
3,535,625
|
|
|
2,026,613
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
Preferred
Stock, $0.0001 par value, 10,000,000 shares
|
|
|
|
|
|
|
|
authorized,
none outstanding
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Common
Stock, $0.0001 par value, 40,000,000 shares
|
|
|
|
|
|
|
|
authorized,
14,704,687 and 14,372,472 outstanding on
|
|
|
|
|
|
|
|
June
30, 2008 and December 31, 2007, respectively
|
|
|
1,470
|
|
|
1,437
|
|
Additional
paid-in capital
|
|
|
39,786,986
|
|
|
36,822,316
|
|
Deficit
accumulated during the development stage
|
|
|
(33,264,558
|
)
|
|
(21,597,820
|
)
|
Total
Stockholders' Equity
|
|
|
6,523,898
|
|
|
15,225,933
|
|
Total
Liabilities & Stockholders' Equity
|
|
$
|
10,059,523
|
|
$
|
17,252,546
|
|
See
accompanying notes to interim financial statements.
XCORPOREAL,
INC.
(a
Development Stage Company)
STATEMENTS
OF OPERATIONS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
May
4, 2001 (Date
|
|
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
of
Inception) to
|
|
|
|
June
30,
|
|
June
30,
|
|
June
30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
2008
|
|
Operating
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
$
|
1,895,013
|
|
$
|
1,611,188
|
|
$
|
5,644,652
|
|
$
|
5,590,288
|
|
$
|
20,047,344
|
|
Research
and development
|
|
|
3,473,480
|
|
|
1,482,037
|
|
|
6,205,972
|
|
|
2,688,134
|
|
|
14,634,464
|
|
Depreciation
and amortization
|
|
|
26,076
|
|
|
3,862
|
|
|
48,584
|
|
|
5,383
|
|
|
80,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
before other income and income taxes
|
|
|
(5,394,569
|
)
|
|
(3,097,087
|
)
|
|
(11,899,208
|
)
|
|
(8,283,805
|
)
|
|
(34,762,658
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income
|
|
|
78,196
|
|
|
308,060
|
|
|
234,070
|
|
|
619,926
|
|
|
1,501,300
|
|
Loss
before income taxes
|
|
|
(5,316,373
|
)
|
|
(2,789,027
|
)
|
|
(11,665,138
|
)
|
|
(7,663,879
|
)
|
|
(33,261,358
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
|
-
|
|
|
-
|
|
|
1,600
|
|
|
-
|
|
|
3,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(5,316,373
|
)
|
$
|
(2,789,027
|
)
|
$
|
(11,666,738
|
)
|
$
|
(7,663,879
|
)
|
$
|
(33,264,558
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share
|
|
$
|
(0.36
|
)
|
$
|
(0.20
|
)
|
$
|
(0.81
|
)
|
$
|
(0.54
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares outstanding
|
|
|
14,593,485
|
|
|
14,200,050
|
|
|
14,488,473
|
|
|
14,200,050
|
|
|
|
|
See
accompanying notes to interim financial statements.
XCORPOREAL,
INC.
(a
Development Stage Company)
STATEMENTS
OF CASH FLOWS
(Unaudited)
|
|
|
|
|
|
May
4, 2001 (Date
|
|
|
|
Six
Months Ended
|
|
of
Inception) to
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
Cash
flows used in operating activities
|
|
|
|
|
|
|
|
Net
Loss for the Period
|
|
$
|
(11,666,738
|
)
|
$
|
(7,663,879
|
)
|
$
|
(33,264,558
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net loss to net cash (used in) operating
activities:
|
|
|
|
|
|
|
|
|
|
|
Stock
Based Compensation
|
|
|
2,081,958
|
|
|
1,483,464
|
|
|
6,067,694
|
|
Non-employee
Stock Based Compensation
|
|
|
84,745
|
|
|
2,795,124
|
|
|
5,164,665
|
|
Common
Stock Issuance for consulting services rendered
|
|
|
798,000
|
|
|
-
|
|
|
896,000
|
|
Depreciation
|
|
|
48,554
|
|
|
5,383
|
|
|
80,742
|
|
Net
Change in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Decrease
(increase) in Prepaid Expenses & Other Current Assets
|
|
|
46,878
|
|
|
(80,640
|
)
|
|
(361,425
|
)
|
Decrease
(increase) in Other Assets
|
|
|
30
|
|
|
-
|
|
|
(892
|
)
|
Increase
(decrease) in Accounts Payable and Accrued Liabilities
|
|
|
1,470,703
|
|
|
(815,824
|
)
|
|
3,344,543
|
|
Increase
in Deferred Rent
|
|
|
38,309
|
|
|
-
|
|
|
38,309
|
|
Increase
in Other Current Liabilities
|
|
|
-
|
|
|
-
|
|
|
115,401
|
|
Net
Cash Used in Operating Activities
|
|
|
(7,097,561
|
)
|
|
(4,276,372
|
)
|
|
(17,919,521
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
Flows from Investing Activities
|
|
|
|
|
|
|
|
|
|
|
Capital
Expenditures
|
|
|
(101,892
|
)
|
|
(58,100
|
)
|
|
(400,992
|
)
|
Restricted
Cash
|
|
|
143
|
|
|
(83,050
|
)
|
|
(67,873
|
)
|
Purchase
of marketable securities
|
|
|
(8,598,102
|
)
|
|
(25,000,000
|
)
|
|
(33,598,102
|
)
|
Sale
of marketable securities
|
|
|
15,758,904
|
|
|
2,323,422
|
|
|
24,357,006
|
|
Net
Cash Provided by (Used in) Investing Activities
|
|
|
7,059,053
|
|
|
(22,817,728
|
)
|
|
(9,709,961
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
Flows from Financing Activities
|
|
|
|
|
|
|
|
|
|
|
Capital
Stock issued
|
|
|
-
|
|
|
-
|
|
|
27,434,349
|
|
Advances
from related party
|
|
|
-
|
|
|
-
|
|
|
64,620
|
|
Additional
Proceeds from the Sale of Common Stock in 2006
|
|
|
-
|
|
|
-
|
|
|
198,500
|
|
Net
Cash Provided by Financing Activities
|
|
|
-
|
|
|
-
|
|
|
27,697,469
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase/(decrease)
in cash during the period
|
|
|
(38,508
|
)
|
|
(27,094,100
|
)
|
|
67,987
|
|
Cash,
beginning of the period
|
|
|
106,495
|
|
|
27,440,987
|
|
|
-
|
|
Cash,
end of the period
|
|
$
|
67,987
|
|
$
|
346,887
|
|
$
|
67,987
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information; cash paid for:
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Income
taxes
|
|
$
|
1,600
|
|
$
|
-
|
|
$
|
3,200
|
|
See
accompanying notes to interim financial statements.
XCORPOREAL,
INC.
(a
Development Stage Company)
STATEMENTS
OF STOCKHOLDERS’ EQUITY (DEFICIENCY)
For
the Period May 4, 2001 (Inception) to June 30, 2008
(Unaudited)
|
|
Common
Stock
|
|
AdditionalPaid-in
|
|
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Stage
|
|
Total
|
|
Common
stock issued for cash at $0.01 per share
|
|
|
2,500,000
|
|
$
|
250
|
|
$
|
24,750
|
|
|
|
|
$
|
25,000
|
|
Net
Loss for the year ended December 31, 2001
|
|
|
|
|
|
|
|
|
|
|
$
|
(40,255
|
)
|
|
(40,255
|
)
|
Balance
as of December 31, 2001
|
|
|
2,500,000
|
|
|
250
|
|
|
24,750
|
|
|
(40,255
|
)
|
|
(15,255
|
)
|
Common
stock issued for cash at $0.05 per share
|
|
|
1,320,000
|
|
|
132
|
|
|
65,868
|
|
|
|
|
|
66,000
|
|
Net
Loss for the year ended December 31, 2002
|
|
|
|
|
|
|
|
|
|
|
|
(31,249
|
)
|
|
(31,249
|
)
|
Balance
as of December 31, 2002
|
|
|
3,820,000
|
|
|
382
|
|
|
90,618
|
|
|
(71,504
|
)
|
|
19,496
|
|
Net
Loss for the year ended December 31, 2003
|
|
|
|
|
|
|
|
|
|
|
|
(12,962
|
)
|
|
(12,962
|
)
|
Balance
as of December 31, 2003
|
|
|
3,820,000
|
|
|
382
|
|
|
90,618
|
|
|
(84,466
|
)
|
|
6,534
|
|
Net
Loss for the year ended December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
(23,338
|
)
|
|
(23,338
|
)
|
Balance
as of December 31, 2004
|
|
|
3,820,000
|
|
|
382
|
|
|
90,618
|
|
|
(107,804
|
)
|
|
(16,804
|
)
|
Net
Loss for the year ended December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
(35,753
|
)
|
|
(35,753
|
)
|
Balance
as of December 31, 2005
|
|
|
3,820,000
|
|
|
382
|
|
|
90,618
|
|
|
(143,557
|
)
|
|
(52,557
|
)
|
Common
stock issued for a licence rights at $0.0001 per
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
share
|
|
|
9,600,000
|
|
|
960
|
|
|
40
|
|
|
|
|
|
1,000
|
|
Capital
stock cancelled
|
|
|
(3,420,000
|
)
|
|
(342
|
)
|
|
342
|
|
|
|
|
|
-
|
|
Warrants
granted for consulting fees
|
|
|
|
|
|
|
|
|
2,162,611
|
|
|
|
|
|
2,162,611
|
|
Forgiveness
of related party debt
|
|
|
|
|
|
|
|
|
64,620
|
|
|
|
|
|
64,620
|
|
Common
stock issued for cash at $7.00, net of placement
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
fees
of $2,058,024d
|
|
|
4,200,050
|
|
|
420
|
|
|
27,341,928
|
|
|
|
|
|
27,342,348
|
|
Stock-based
compensation expense
|
|
|
|
|
|
|
|
|
264,251
|
|
|
|
|
|
264,251
|
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
(4,380,212
|
)
|
|
(4,380,212
|
)
|
Balance
as of December 31, 2006
|
|
|
14,200,050
|
|
|
1,420
|
|
|
29,924,410
|
|
|
(4,523,769
|
)
|
|
25,402,061
|
|
Capital
stock cancelled
|
|
|
(200,000
|
)
|
|
(20
|
)
|
|
20
|
|
|
|
|
|
-
|
|
Common
stock issued pursuant to consulting agreement at
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
4.90
per share
|
|
|
20,000
|
|
|
2
|
|
|
97,998
|
|
|
|
|
|
98,000
|
|
Recapitalization
pursuant to merger
|
|
|
352,422
|
|
|
35
|
|
|
(37,406
|
)
|
|
|
|
|
(37,371
|
)
|
Warrants
granted for consulting services
|
|
|
|
|
|
|
|
|
2,917,309
|
|
|
|
|
|
2,917,309
|
|
Stock-based
compensation expense
|
|
|
|
|
|
|
|
|
3,721,485
|
|
|
|
|
|
3,721,485
|
|
Additional
Proceeds from the Sale of Common Stock in
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
|
|
|
|
|
198,500
|
|
|
|
|
|
198,500
|
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
(17,074,051
|
)
|
|
(17,074,051
|
)
|
Balance
as of December 31, 2007
|
|
|
14,372,472
|
|
|
1,437
|
|
|
36,822,316
|
|
|
(21,597,820
|
)
|
|
15,225,933
|
|
Common
stock issued as compensation for consulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
services
at $3.61 per share
|
|
|
200,000
|
|
|
20
|
|
|
721,980
|
|
|
|
|
|
722,000
|
|
Warrants
granted for consulting services
|
|
|
|
|
|
|
|
|
75,489
|
|
|
|
|
|
75,489
|
|
Stock-based
compensation expense
|
|
|
|
|
|
|
|
|
1,121,118
|
|
|
|
|
|
1,121,118
|
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
(6,350,365
|
)
|
|
(6,350,365
|
)
|
Balance
as of March 31, 2008
|
|
|
14,572,472
|
|
|
1,457
|
|
|
38,740,903
|
|
|
(27,948,185
|
)
|
|
10,794,175
|
|
Common
stock issued as compensation for consulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
services
at $3.80 per share
|
|
|
20,000
|
|
|
2
|
|
|
75,998
|
|
|
|
|
|
76,000
|
|
Cashless
exercise of warrants
|
|
|
112,215
|
|
|
11
|
|
|
(11
|
)
|
|
|
|
|
0
|
|
Warrants
granted for consulting services
|
|
|
|
|
|
|
|
|
9,256
|
|
|
|
|
|
9,256
|
|
Stock-based
compensation expense
|
|
|
|
|
|
|
|
|
960,840
|
|
|
|
|
|
960,840
|
|
Net
loss for the period
|
|
|
|
|
|
|
|
|
|
|
|
(5,316,373
|
)
|
|
(5,316,373
|
)
|
Balance
as of June 30, 2008
|
|
|
14,704,687
|
|
$
|
1,470
|
|
$
|
39,786,986
|
|
$
|
(33,264,558
|
)
|
$
|
6,523,898
|
|
See
accompanying notes to interim financial statements.
XCORPOREAL,
INC.
(a
Development Stage Company)
NOTES
TO INTERIM FINANCIAL STATEMENTS
June
30, 2008
(Unaudited)
Note
1 — Interim Reporting
While
information presented in the accompanying interim financial statements is
unaudited, it includes all adjustments, which are, in the opinion of management,
necessary to present fairly the financial position, results of operations and
cash flows for the interim period presented. Except for the accrual for the
Licensor Expenses discussed in Note 11-License Agreement below, all adjustments
are of a normal recurring nature. It is suggested that these interim financial
statements be read in conjunction with our December 31, 2007 financial
statements.
The
results of operations for the period ended June 30, 2008 are not necessarily
indicative of the results that can be expected for the year ended December
31,
2008.
Note
2 — Nature of Operations and Going Concern Uncertainty
On
October 12, 2007, pursuant to a merger agreement with Xcorporeal, Inc. (referred
to hereinafter as Operations), our newly-formed wholly-owned merger subsidiary,
merged with and into Operations, which became our wholly-owned subsidiary and
changed its name to “Xcorporeal Operations, Inc.” We changed our name from CT
Holdings Enterprises, Inc. (CTHE) to “Xcorporeal, Inc.” and amended our
certificate of incorporation and bylaws to read substantially as Operations.
As
a result, our authorized common stock changed from 60,000,000 shares to
40,000,000 common shares, and our authorized preferred stock changed from
1,000,000 shares to 10,000,000 shares, resulting in total authorized capital
stock of 50,000,000 shares.
Immediately
prior to the merger, we caused a one-for-8.27 reverse split of our common stock.
Each share of Operations common stock was then converted into one share of
our
common stock. In addition, we assumed all outstanding Operations options and
warrants to purchase Operations common stock.
In
this
merger, CTHE is considered to be the legal acquirer and Xcorporeal to be the
accounting acquirer. As the former shareholders of Operations owned over 97%
of
the outstanding voting common stock of CTHE immediately after the merger and
CTHE was a public shell company, Operations is considered the accounting
acquirer and the transaction is considered to be a recapitalization of
Operations.
Historical
financial statements prior to the merger were restated to be those of
Operations. The merger is accounted for as if it were an issuance of the common
stock of Operations to acquire our net assets, accompanied by a
recapitalization. Historical stockholders’ equity of Operations is retroactively
restated for the equivalent number of shares received in the merger, after
giving effect to the difference in par value with an offset to paid-in capital.
The assets and liabilities of Operations are carried forward at their
predecessor carrying amounts. Retained deficiency of Operations is carried
forward after the merger. Operations prior to the merger are those of
Operations. Earnings per share for periods prior to the merger are restated
to
reflect the number of equivalent shares received by Operations’s stockholders.
The costs of the transaction will be expensed to the extent they exceed cash
received from CTHE. References to "we," "us, "our" and the "company" after
consummation of the merger include CTHE and Operations.
As
a
result of the merger, we transitioned to a development stage company focused
on
researching, developing and commercializing technology and products related
to
the treatment of kidney failure.
We
expect
to incur negative cash flows and net losses for the foreseeable future. Based
upon our current plans, we believe that our existing cash reserves will not
be
sufficient to meet our operating expenses and capital requirements before we
achieve profitability. Accordingly, we may seek to raise additional funds
through public or private placement of shares of preferred or common stock
or
through public or private financing. Our ability to meet our cash obligations
as
they become due and payable will depend on our ability to sell securities,
borrow funds, reduce operating costs or some combination thereof. We may not
be
successful in raising necessary funds on acceptable terms, or at all. As a
result of these conditions, there is substantial doubt about our ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Upon
receipt of the approximate $27.3 million raised through private placement,
we
strategically began our operating activities and research and development
efforts which resulted in a net loss of $17.1 million in 2007 and $11.7 million
in the six months ended June 30, 2008. In addition, we invested $25.0 million
in
high grade money market funds and marketable securities of which we sold $15.8
million of the investments, leaving a balance of $9.2 million as of June 30,
2008. The final product design of the PAK will be completed shortly and
units will undergo final verification and validation prior to a 510(k)
submission to the FDA for clinical use under direct medical supervision. We
intend to submit this 510(k) filing during the fourth quarter of 2008. It
generally takes 4 to 12 months from the date of a 510(k) submission to obtain
clearance from the FDA, although it may take longer. We expect that our monthly
expenditures will increase as we reduce our spending on research and development
costs as well as labor and material costs relating to the Aubrey agreement,
and
shift resources towards developing a marketing plan for the PAK.
Note
3 — Development Stage Company
We
are a
development stage company, devoting substantially all of our efforts to the
research, development and commercialization of kidney failure treatment
technologies.
Risks
and Uncertainties—
We
operate in an industry that is subject to intense competition, government
regulation and rapid technological change. Our operations are subject to
significant risk and uncertainties including financial, operational,
technological, regulatory and other risks associated with a development stage
company, including the potential risk of business failure.
Note
4 - Legal Proceedings
On
December 1, 2006, Operations initiated arbitration against National Quality
Care, Inc. (NQCI) for NQCI's failure to fully perform its obligations under
the
License Agreement dated September 1, 2006. On September 1, 2006, Operations
also
entered into a Merger Agreement with NQCI which contemplated that Operations
would acquire NQCI as a wholly owned subsidiary pursuant to a triangular merger,
or would issue to NQCI shares of common stock in consideration of the assignment
of the technology relating to the WAK and other medical devices (the “Technology
Transaction”). The merger was not consummated.
On
June
9, 2008, the arbitrator issued an Interim Award granting specific performance
of
the Technology Transaction. The Interim Award stated that the total aggregate
shares of stock to be received by NQCI at the Closing should equal 48% of all
Operations shares outstanding as of the date of the Merger Agreement. On
September 1, 2006, there were 10,000,000 shares of Operations common stock
outstanding. Copies of the License Agreement and Merger Agreement are attached
as exhibits to our amended current report on Form 8-K/A filed with the
Securities and Exchange Commission on June 11, 2008.
On
August
4, 2008, the arbitrator issued a Second Interim Award, stating that 9,230,000
shares of our common stock should be issued to NQCI to effectuate the Technology
Transaction. The arbitrator found that, with the exception of shareholder
approval, virtually all conditions to Closing the Technology Transaction have
been waived. The award further states that, if we or our stockholders do not
approve the issuance of our stock to effectuate the Technology Transaction,
all
of the Technology covered by the License will be declared the sole and exclusive
property of NQCI, and the arbitrator will schedule additional hearings to
address whether the PAK technology is included within that Technology, and
whether NQCI is entitled to compensatory damages and the amount of damages,
if
any, under these circumstances. The arbitrator has also stated that NQCI is
entitled to recover reasonable attorneys’ fees. NQCI has filed a motion seeking
$3.9 million in fees, which we have opposed. Each of the Interim Awards state
that it is an interim award subject to further proceedings, and is not intended
to be a final award subject to a motion to confirm before a court of competent
jurisdiction.
The
Second Interim Award also states that—contrary to the assertion made by NQCI in
its current report on Form 8-K filed on June 10, 2008—the License Agreement will
remain in full force and effect until the Technology Transaction closes or
the
arbitrator determines that it will never close. NQCI has made a claim for
reimbursement of approximately $690,000 in expenses under the License Agreement
which were accrued under “Accrued Professional Fees” as of June 30,
2008.
The
above interim awards are not yet binding or final.
Therefore, no liability for the above awards has been accrued as no reliable
estimate can currently be made.
Note
5 — Cash Equivalents and Marketable Securities
We
invest
available cash in short-term commercial paper, certificates of deposit, money
market funds, and high grade marketable securities. We consider any liquid
investment with an original maturity of three months or less when purchased
to
be cash equivalents. Investments, including certificates of deposit with
maturity dates greater than three months when purchased and which have readily
determined fair values, are classified as available-for-sale investments and
reflected in current assets as marketable securities at fair market value.
Our
investment policy requires that all investments be investment grade quality
and
no more than ten percent of our portfolio may be invested in any one security
or
with one institution. At June 30, 2008, all of our cash was held in high grade
money market funds and marketable securities.
Restricted
cash represents deposits secured as collateral for a bank credit card
program.
Note
6 — Fair Value Measurements
Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS
157”). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This statement
does not require any new fair value measurements; rather, it applies to other
accounting pronouncements that require or permit fair value measurements. In
February 2008, FSP FAS 157-2, “Effective Date of FASB Statement
No. 157”, was issued, which delays the effective date of SFAS 157 to
fiscal years and interim periods within those fiscal years beginning after
November 15, 2008 for non-financial assets and non-financial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). We elected to defer the
adoption of the standard for these non-financial assets and
liabilities.
Fair
value is defined under SFAS 157 as the price that would be received to sell
an
asset or paid to transfer a liability in the principal or most advantageous
market in an orderly transaction between market participants on the measurement
date. SFAS 157 also establishes a three-level hierarchy, which requires an
entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value.
Beginning
January 1, 2008, assets and liabilities recorded at fair value in the balance
sheet are categorized based upon the level of judgment associated with the
inputs used to measure their fair value. Level inputs, as defined by SFAS 157,
are as follows:
·
|
Level
I - inputs are unadjusted, quoted prices for identical assets or
liabilities in active markets at the measurement
date.
|
·
|
Level
II - inputs, other than quoted prices included in Level I, that are
observable for the asset or liability through corroboration with
market
data at the measurement date.
|
·
|
Level
III - unobservable inputs that reflect management’s best estimate of what
market participants would use in pricing he asset or liability at
the
measurement date.
|
The
following tables summarize fair value measurements by level at June 30, 2008
for
assets and liabilities measured at fair value on a recurring basis:
|
|
Level
I
|
|
Level
II
|
|
Level
III
|
|
Total
|
|
Cash
and cash equivalents
|
|
$
|
67,987
|
|
$
|
-
|
|
$
|
-
|
|
$
|
67,987
|
|
Marketable
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
paper
|
|
|
3,787,047
|
|
|
-
|
|
|
-
|
|
|
3,787,047
|
|
Corporate
securities fixed rate
|
|
|
660,336
|
|
|
-
|
|
|
-
|
|
|
660,336
|
|
Money
market fund
|
|
|
4,793,713
|
|
|
-
|
|
|
-
|
|
|
4,793,713
|
|
Restricted
cash
|
|
|
67,873
|
|
|
-
|
|
|
-
|
|
|
67,873
|
|
Total
assets
|
|
$
|
9,376,956
|
|
$
|
-
|
|
$
|
-
|
|
$
|
9,376,956
|
|
Short-term
investments classified as available-for-sale were as follows:
|
|
June
30, 2008
|
|
|
|
Aggregate
Fair
Value
|
|
Gross
Unrealized
Gains / (Losses)
|
|
|
|
Commercial
paper
|
|
|
3,787,047
|
|
|
-
|
|
|
3,787,047
|
|
Corporate
securities fixed rate
|
|
|
660,336
|
|
|
-
|
|
|
660,336
|
|
Total
|
|
$
|
4,447,383
|
|
$
|
-
|
|
$
|
4,447,383
|
|
Xcorporeal
reviews impairments associated with the above in accordance with SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” and FASB
Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments,” to determine the
classification of the impairment as temporary or other-than-temporary.
Xcorporeal considers these investments not to be temporarily impaired as of
June
30, 2008.
There
were no gross unrealized gains or losses as of June 30, 2008.
Note
7 - Property and Equipment
Property
and equipment consist of the following at June 30, 2008:
Property
and equipment
|
|
$
|
400,992
|
|
Accumulated
depreciation
|
|
|
(80,742
|
)
|
Property
and equipment, net
|
|
$
|
320,250
|
|
Depreciation
expense for the three and six months ended June 30, 2008 and 2007 was $26,061
and $48,554, and $3,847 and $5,334, respectively.
Note
8 - Leases
As
of
February 22, 2008, we entered into a 5 year lease agreement and relocated our
corporate office to a location in Los Angeles, CA. The total lease payments
will
be $1,096,878 over a 5 year period. As of June 30, 2008, our remaining total
lease payments are $1,062,062.
The
following is a schedule by years of future minimum lease payments required
under
the 5-year corporate office lease as of June 30, 2008:
Year
ending December 31:
|
|
|
|
|
|
2008
|
|
$
|
104,448
|
|
|
(1)
|
|
2009
|
|
|
215,859
|
|
|
|
|
2010
|
|
|
224,650
|
|
|
|
|
2011
|
|
|
233,528
|
|
|
|
|
2012
|
|
|
242,842
|
|
|
|
|
2013
|
|
|
40,735
|
|
|
(2)
|
|
|
|
|
|
|
|
|
|
Total
minimum payments required
|
|
$
|
1,062,062
|
|
|
|
|
(
1
) excludes lease payments made through June 30, 2008
|
(
2
) initial term of the lease agreement ends February
2013
|
On
May
15, 2008, we executed the second amendment to the sublease agreement for office
and warehouse space from Aubrey Group, Inc. Pursuant to the amendment, we
acquired additional office and warehouse space. In addition, our monthly
sublease rent increased to $8,715 through December 31, 2008. As of June 30,
2008, our remaining total sublease payments are $52,288 for this one year
sublease agreement.
Note
9 — Interest Income
Interest
income of $82,226 and $234,694, and $308,060 and $619,926 was reported for
the
three and six months ended June 30, 2008 and 2007, respectively.
Note
10 — Related Party Transactions
Pursuant
to a consulting agreement effective December 1, 2007, Daniel S. Goldberger,
director, provides consulting services as interim Chief Executive Officer with
a
devotion of at least 80 hours per month of services. In consideration of the
services, we shall pay Mr. Goldberger $15,000 per month during the first two
months and $12,500 per month thereafter. The term of the services is effective
December 1, 2007 and will continue on a month to month basis. From execution
through June 30, 2008, Mr. Goldberger was compensated $92,500 for his
services.
Our
Chief
Medical and Scientific Officer maintains an office located in Beverly Hills,
California. Pursuant to a reimbursement agreement effective January 29, 2008,
we
reimburse 50% of the rental and 50% of his monthly parking. The term of the
agreement commenced on April 23, 2007, the date of the office lease agreement,
and continue until the date on which he ceases to use the remote office to
perform his duties as our Chief Medical and Scientific Officer. From
commencement through June 30, 2008, we reimbursed our Chief Medical and
Scientific Officer $1,239 and $24,386 for 50% of the monthly parking and rental,
respectively.
Note
11 — License Agreement
On
August
31, 2006, we entered into a Contribution Agreement with a company whose sole
managing member is our current Chairman. We issued 9,600,000 shares of common
stock in exchange for (a) the right, title, and interest to the name
“Xcorporeal” and related trademarks and domain names, and (b) the right to enter
into a License Agreement with National Quality Care, Inc. (NQCI) dated September
1, 2006 pursuant to which we obtained the exclusive rights to the technology
relating to our kidney failure treatment and other medical devices. Operations
was a shell corporation prior to the transaction. We valued the License
Agreement at the carry-over basis of $1,000. As consideration for being granted
the License, we agreed to pay a minimum annual royalty of $250,000, or 7% of
net
sales. We recorded $458,333 in royalty expenses covering the minimum royalties
from commencement of the License Agreement through June 30, 2008. The License
Agreement expires in 2105. As of June 30, 2008, we made one payment of the
minimum annual royalty of $250,000.
The
License Agreement also stipulates the reimbursement of reasonable and necessary
expenses incurred in the ordinary course of business consistent with past
practices (“Licensor Expenses”) until the Closing or the termination of the
Merger Agreement. NQCI has made a claim for reimbursement of approximately
$690,000 in expenses under the License Agreement which were accrued under
“Accrued Professional Fees” as of June 30, 2008. See Note 4 - Legal Proceedings
for further additional information related to this License Agreement.
Note
12 — Stock Options and Warrants
Incentive
Compensation Plan
On
October 12, 2007, we adopted the Xcorporeal, Inc. 2007 Incentive Compensation
Plan and the related form of option agreement that are substantially identical
to the 2006 Incentive Compensation Plan in effect at Operations immediately
prior to the merger.
The
plan authorizes the grant of stock options, restricted stock, restricted stock
units and stock appreciation rights. Effective February 28, 2007, there are
3,900,000 shares of common stock reserved for issuance pursuant to the plan
(subject to adjustment in accordance with the provisions of the plan). The
plan
will continue in effect for a term of up to ten years.
On
October 12, 2007, we also assumed options to purchase up to 3,880,000 shares
of
common stock, net 450,000 of which have since been canceled or expired, that
were granted by Operations under its 2006 Incentive Compensation
Plan.
As
of
June 30, 2008, there were 137,500 optioned shares outstanding and 3,762,500
shares available under the 2007 Incentive Compensation Plan.
Stock
Options to Employees, Officer and Directors
The
Compensation Committee of our Board of Directors determines the terms of the
options granted, including the exercise price, the number of shares subject
to
option, and the vesting period. Options generally vest over five years and
have
a maximum life of ten years.
In
the
three months ended June 30, 2008, we granted options to purchase an aggregate
of
35,000 shares of common stock to three employees. The options vest over 5 years,
are exercisable at $7.00 per share, and expire in 2018.
We
reported $960,840 and $2,081,958 in stock-based compensation expense for
employees, officers, and directors for the three and six months ended June
30,
2008, respectively. For the three and six months ended June 30, 2007, we
reported $844,400 and $1,483,464 in stock-based compensation expense for
employees, officers, and directors, respectively.
All
compensation expense for stock options granted has been determined under the
fair value method using the Black-Scholes option-pricing model with the
following assumptions:
|
|
For
the six months ended
|
|
|
|
June
30, 2008
|
|
Expected
dividend yields
|
|
|
zero
|
|
Expected
volatility
|
|
|
136
|
%
|
Risk-free
interest rate
|
|
|
3.53-3.81
|
%
|
Expected
terms in years
|
|
|
10
years
|
|
Warrants
and Stock Options to Non-Employees
In
the
six months ended June 30, 2008, there were no issuance of warrants. However,
there were cashless exercises of warrants in the three months ended June 30,
2008.
We
reported $9,256 and $84,745 in stock-based compensation expense for consultants
for the three and six months ended June 30, 2008, respectively. We reported
$137,489 and $2,795,124 in stock-based compensation expense for consultants
for
the three and six months ended June 30, 2007, respectively.
Compensation
for options granted to non-employees has been determined in accordance with
SFAS
No. 123R, EITF 96-18, and EITF 00-18, “Accounting for Equity Instruments that
are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services.” Accordingly, compensation is determined using the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured.
For
options and warrants issued as compensation to non-employees for services that
are fully vested and non-forfeitable at the time of issuance, the estimated
value is recorded in equity and expensed when the services are performed and
benefit is received as provided by Financial Accounting and Standards Board
(“FASB”) Emerging Issues Task Force No. 96-18 “Accounting For Equity Instruments
That Are Issued To Other Than Employees For Acquiring or In Conjunction With
Selling Goods Or Services.”
All
charges for warrants granted have been determined under the fair value method
using the Black-Scholes option-pricing model with the following
assumptions:
|
|
For
the six months ended
June
30, 2008
|
|
Expected
dividend yields
|
|
|
zero
|
|
Expected
volatility
|
|
|
136
|
%
|
Risk-free
interest rate
|
|
|
2.36-4.69
|
%
|
Expected
terms in years
|
|
|
4.30-9.37
years
|
|
The
following table shows the change in unamortized compensation expense for stock
options and warrants issued to employees, officers, directors and non-employees
during the six months ended June 30, 2008:
|
|
|
|
|
|
|
|
|
|
Stock
Options and
Warrants
|
|
|
|
Unamortized
Compensation
|
|
|
|
Outstanding
|
|
|
|
Expense
|
|
January
1, 2008
|
|
|
4,674,221
|
|
|
|
|
$
|
18,228,742
|
|
Granted
in the period
|
|
|
55,000
|
|
|
|
|
|
207,447
|
|
Forfeited
in the period
|
|
|
(285,000
|
)
|
|
|
|
|
(1,355,844
|
)
|
Expensed
in the period
|
|
|
-
|
|
|
|
|
|
(3,167,215
|
)
|
Exercised
in the period
|
|
|
(325,000
|
)
|
|
(1)
|
|
|
-
|
|
June
30, 2008
|
|
|
4,119,221
|
|
|
|
|
$
|
13,913,130
|
|
(1)
The
cashless exercises of the granted 325,000 warrant shares resulted in the
issuance of an aggregate of 112,215 shares of our common stock.
|
|
|
|
Weighted
|
|
|
|
Number
of
|
|
Average
|
|
|
|
Options
and
|
|
Exercise
|
|
|
|
Warrants
|
|
Price
|
|
Stock
Options and Warrants
|
|
|
|
|
|
Balance
at January 1, 2008
|
|
|
4,674,221
|
|
$
|
6.01
|
|
Granted
|
|
|
55,000
|
|
|
7.00
|
|
Exercised
|
|
|
(325,000
|
)
|
|
1.00
|
|
Forfeited
|
|
|
(285,000
|
)
|
|
7.00
|
|
Balance
at June 30, 2008
|
|
|
4,119,221
|
|
$
|
6.35
|
|
Note
13 — Stockholders’ Equity
On
April
2, 2008, 20,000, shares of our common stock were granted as compensation for
consulting services rendered to us.
On
April
9, 2008, Consolidated National, LLC (CNL), a limited liability company whose
managing member is our Executive Chairman, sold 3,167,404 shares of our common
stock in a private placement. Approximately 230,000 shares were sold to our
officers and directors. We did not receive any proceeds from this sale by or
for
the account of the selling stockholder.
On
June
30, 2008, we issued an aggregate of 112,215 shares of our common stock pursuant
to cashless exercise of warrants by three warrant holders.
Note
14 — Product Development Agreement
In
July
2007, we entered into an agreement with Aubrey Group, Inc., an FDA-registered
third-party contract developer and manufacturer of medical devices for the
design and development of a Portable Artificial Kidney ("PAK"). The PAK will
be
designed for use as an Intermittent as well as a Continuous Renal Replacement
Therapy (CRRT) in the hospital with medical supervision. The development is
expected to be completed by the end of 2008 and projected labor and material
costs are estimated at approximately $5.1 million over the term. The agreement
can be terminated at any time with 30 business days notice. From commencement
through June 30, 2008, we incurred $2,553,387 in expense for the services
rendered under this agreement.
Note
15 — Subsequent Events
On
August
4, 2008, we relocated our laboratory to our Irvine subleased
facility.
On
August
4, 2008, the arbitrator issued a Second Interim Award, stating that 9,230,000
shares of our common stock should be issued to NQCI to effectuate the Technology
Transaction. The arbitrator found that, with the exception of shareholder
approval, virtually all conditions to Closing the Technology Transaction have
been waived. The award further states that, if we or our stockholders do not
approve the issuance of our stock to effectuate the Technology Transaction,
all
of the Technology covered by the License will be declared the sole and exclusive
property of NQCI, and the arbitrator will schedule additional hearings to
address whether the PAK technology is included within that Technology, and
whether NQCI is entitled to compensatory damages and the amount of damages,
if
any, under these circumstances. The arbitrator has also stated that NQCI is
entitled to recover reasonable attorneys’ fees.
ITEM
2. Management’s Discussion and Analysis or Plan of Operation.
The
following discussion of our financial condition and results of operations should
be read in conjunction with our financial statements and the related notes,
and
the other financial information included in this report.
Forward-Looking
Statements
This
report contains “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995 with respect to the financial
condition, results of operations, business strategies, operating efficiencies
or
synergies, competitive positions, growth opportunities for existing products,
plans and objectives of management, markets for stock of Xcorporeal and other
matters. Statements in this report that are not historical facts are
“forward-looking statements” for the purpose of the safe harbor provided by
Section 21E of the Exchange Act and Section 27A of the Securities Act. Such
forward-looking statements, including, without limitation, those relating to
the
future business prospects, revenues and income of Xcorporeal, wherever they
occur, are necessarily estimates reflecting the best judgment of the senior
management of Xcorporeal on the date on which they were made, or if no date
is
stated, as of the date of this report. These forward-looking statements are
subject to risks, uncertainties and assumptions, including those described
in
the “Risk Factors” described below, that may affect the operations, performance,
development and results of our business. Because the factors discussed in this
report could cause actual results or outcomes to differ materially from those
expressed in any forward-looking statements made by us or on our behalf, you
should not place undue reliance on any such forward-looking statements. New
factors emerge from time to time, and it is not possible for us to predict
which
factors will arise. In addition, we cannot assess the impact of each factor
on
our business or the extent to which any factor, or combination of factors,
may
cause actual results to differ materially from those contained in any
forward-looking statements.
Overview
We
are a
medical device company developing an innovative
extra-corporeal
platform
technology to be used in devices to replace the function of various human
organs. These devices will seek to provide patients with improved, efficient
and
cost effective therapy. The platform leads to three initial
products:
|
•
|
A
PAK for hospital Renal Replacement Therapy
(RRT);
|
|
•
|
A
PAK for home hemodialysis; and
|
|
•
|
A
Wearable Artificial Kidney (WAK) for continuous ambulatory
hemodialysis.
|
For
the
hospital market, we are developing a portable, multifunctional renal replacement
device that will offer cost-effective therapy for those patients suffering
from
Acute Renal Failure (ARF) causing a rapid decline in kidney function. We have
completed our functional prototype of the product, which is currently undergoing
bench testing, and will submit a 510(k) filing with the FDA during the fourth
quarter of 2008. We plan to commercialize the product after receiving approval
from the FDA. Timing of FDA approval is uncertain at this time.
We
also
plan to commercialize a home hemodialysis device for the End Stage Renal Disease
(ESRD) market, comprised of patients in whom the kidneys have ceased to
function. We have also completed our functional prototype of the product, which
is currently undergoing bench testing, and we will submit a 510(k) with the
FDA
during the second half of 2009. Clinical trials are anticipated to commence
within 12 months.
Our
WAK
is a device for the chronic treatment of ESRD. We have successfully demonstrated
a prototype system that weighs less than 6 kg., is battery operated, and can
be
worn by an ambulatory patient. We plan to continue our development of this
product over the next 12 months
.
We
are a
development stage company, have been unprofitable since our inception, and
will
incur substantial additional operating losses for at least the next twelve
months as we continue to implement commercial operations and allocate
significant and increasing resources to research, development, clinical trials
and other activities. Accordingly, our historical operations and financial
information are not indicative of our future operating results, financial
condition or ability to operate profitably as a commercial
enterprise.
Research
and Development
R&D
Team
We
have
recruited and currently employ a talented interdisciplinary team of scientists
and engineers who are developing our products. The team includes engineering
leaders from within the dialysis field who provide state of the art as well
as
historical insights into dialysis equipment. The team also includes seasoned
engineers from related medical fields providing us with cutting edge technology
in the areas of fluidics, sensors and electronics. In addition, we have retained
a medical device consulting firm, The Aubrey Group, Inc., an FDA-registered
third-party contract developer and manufacturer of medical devices, to provide
engineering support in the development of the PAK. We will continue development
of our products utilizing The Aubrey Group in conjunction with our existing
team.
We
incurred $3.5 million and $6.2 million in research and development costs in
the
three and six months ended June 30, 2008, respectively. This compares to $1.5
million and $2.7 million incurred in the three and six months ended June 30,
2007.
Third-party
Arrangements
In
July
2007, we entered into an agreement with Aubrey for the design and development
of
subsystems of the PAK. The PAK will be designed for intermittent hemodialysis
or
CRRT in a clinical setting as well as for treatments in a home setting. The
development is expected to be complete by the end of 2008. Total labor and
material costs over the term of the Aubrey agreement are budgeted at
approximately $5.1 million, though we can terminate the agreement at any time
with 30 business days notice.
We
also
contract with other third parties to assist in our research and development
efforts and to supplement our internal resources while we continue to grow
our
organization.
Management’s
Discussion and Analysis
Results
of Operations for the three and six months ended June 30,
2008.
We
have
not generated any revenues since inception. We incurred a net loss of $5.3
million and $11.7 million for the three and six months ended June 30, 2008,
respectively, compared to a net loss of $2.8 million and $7.7 million for the
three and six months ended June 30, 2007, respectively. The increase in net
loss
was primarily due to (i) research, development and other expenses related to
advancing our kidney failure treatment technologies, (ii) stock compensation
expense related to options and warrants granted to directors, officers,
employees, and consultants, (iii) legal fees, and (iv) increased company
personnel. At June 30, 2008, we had positive working capital of $6.2 million
compared to positive working capital of $15.0 million at the beginning of the
year.
Liquidity
and Capital Resources
We
expect
to incur operating losses and negative cash flows for the foreseeable future.
During the fourth quarter 2006, we raised approximately $27.3 million (net
of
placement fees of $2.1 million) through a private placement. Our ability to
execute on our current business plan is dependent upon our ability to develop
and market our products, and, ultimately, to generate revenue.
As
of
June 30, 2008, we had cash, cash equivalents and marketable securities of
approximately $9.3 million. We are currently expending cash at a rate of
approximately $1.2 million per month. In addition, we may become obligated
to
pay damages, costs or legal fees in connection with the ongoing arbitration
described under Part II, Item 1. Legal Proceedings, in amounts yet to be
determined.
At
present rates, we will have to raise additional funds during the next twelve
months. We may not be successful in doing so on terms acceptable to us, and
the
inability to raise capital could require us to curtail our current plans in
order to decrease spending, which could have a material adverse effect on our
plan of operation. Our ability to execute on our current business plan is
dependent upon our ability to obtain equity financing, develop and market our
products, and, ultimately, to generate revenue.
We
expect
to incur negative cash flows and net losses for the foreseeable future. Based
upon our current plans, we believe that our existing cash reserves will not
be
sufficient to meet our operating expenses and capital requirements before we
achieve profitability. Accordingly, we may seek to raise additional funds
through public or private placement of shares of preferred or common stock
or
through public or private financing. Our ability to meet our cash obligations
as
they become due and payable will depend on our ability to sell securities,
borrow funds, reduce operating costs or some combination thereof. We may not
be
successful in raising necessary funds on acceptable terms, or at all. As a
result of these conditions, there is substantial doubt about our ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Upon
receipt of the approximate $27.3 million raised through private placement,
we
strategically began our operating activities and research and development
efforts which resulted in a net loss of $17.1 million in 2007 and $11.7 million
in the six months ended June 30, 2008. In addition, we invested $25.0 million
in
high grade money market funds and marketable securities of which we sold $15.8
million of the investments, leaving a balance of $9.2 million as of June 30,
2008. The final product design of the PAK will be completed shortly and
units will undergo final verification and validation prior to a 510(k)
submission to the FDA for clinical use under direct medical supervision. We
intend to submit this 510(k) filing during the fourth quarter of 2008. It
generally takes 4 to 12 months from the date of a 510(k) submission to obtain
clearance from the FDA, although it may take longer. We expect that our monthly
expenditures will increase as we reduce our spending on research and development
costs as well as labor and material costs relating to the Aubrey agreement,
and
shift resources towards developing a marketing plan for the PAK.
Research
and Development
We
employ
an interdisciplinary team of scientists and engineers who are developing the
PAK
and a separate, interdisciplinary team developing the WAK. In addition, we
have
retained Aubrey to assist with the engineering of the PAK. The PAK will be
engineered to perform both hemodialysis, hemofiltration and ultrafiltration
under direct medical supervision. A variation of this device will be developed
for chronic home hemodialysis. An initial prototype of the PAK, capable of
performing the functions of a hemodialysis machine, and demonstrating our unique
new fluidics circuit, was completed at the end of 2007. Further refinements
to
this prototype including the addition of safety sensors and electronic controls
is now in progress. The final product design of the PAK will be completed
shortly and units will undergo final verification and validation prior to a
510(k) submission for clinical use under direct medical supervision. A clinical
study is not required for this submission.
In
a
clinical feasibility study conducted in London in March 2007, a research
prototype of the WAK was successfully demonstrated in eight patients with
end-stage renal disease. Patients were successfully treated for up to 8 hours
with adequate clearances of urea and creatinine. The device was well tolerated
and patients were able to conduct activities of normal daily living including
walking and sleeping. There were no serious adverse events although clotting
of
the dialyzer occurred in two patients. To our knowledge, this is the first
successful demonstration of a wearable artificial kidney in man. This year
we
are making substantial improvements to the WAK. These include improvement of
the
heparin pumping system intended to address the dialyzer clotting problem, the
addition of safety sensors required for commercial dialysis equipment, the
addition of electrical controls to provide a convenient user interface,
improvements to the blood flow circuit and further miniaturization of the device
to improve fit to the human body. Additional clinical studies will be conducted
upon completion of the prototype
We
incurred $3.5 million and $6.2 million in research and development costs in
the
three and six months ended June 30, 2008, respectively. This compares to $1.5
million and $2.7 million incurred in the three and six months ended June 30,
2007.
Contractual
Obligations and Commercial Commitments
Contractual
Obligations and Commercial Commitments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 1
|
|
|
|
|
|
More
than 5
|
|
Contractual
Obligations:
|
|
Total
|
|
year
|
|
1
- 3 years
|
|
3
- 5 years
|
|
years
|
|
Capital
Lease Obligations
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Operating
Lease Obligations (1)
|
|
|
1,264,424
|
|
|
194,649
|
|
|
786,199
|
|
|
283,576
|
|
|
-
|
|
Research
& Development Contractual Commitments
|
|
|
162,148
|
|
|
162,148
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Other
Liabilities
|
|
|
97,167
|
|
|
97,167
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
$
|
1,523,737
|
|
$
|
453,963
|
|
$
|
786,199
|
|
$
|
283,576
|
|
$
|
-
|
|
(1)
Operating lease commitments for our corporate office facility, product
development facility, Dr. Gura’s office which is a related party transaction,
and two corporate apartments.
The
table
excludes the agreement with Aubrey in relation to the PAK development which
can
be terminated at any time with 30 business days notice. Due to the successful
rate of the development, we anticipate coming under the agreement’s approximate
budget of $5.1 million. With the expected completion by end of 2008, we estimate
we will incur cost of $3.0 million for 2008 under this agreement.
Off-Balance
Sheet Arrangements
As
of
June 30, 2008, we had no off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial condition,
results of operations or cash flows.
Critical
Accounting Policies and Estimates
The
discussion and analysis of our financial condition and results of operations
is
based upon our financial statements, which have been prepared in accordance
with
accounting principles generally accepted in the United States. Generally
accepted accounting principles require management to make estimates, judgments
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, and the disclosure of contingent assets and liabilities.
We base our estimates on experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form
the
basis for making judgments about the carrying values of assets and liabilities
that may not be readily apparent from other sources. Our actual results may
differ from those estimates.
We
consider our critical accounting policies to be those that involve significant
uncertainties, require judgments or estimates that are more difficult for
management to determine or that may produce materially different results when
using different assumptions. We consider the following accounting policies
to be
critical:
Marketable
Securities
We
classify investments with maturity dates greater than three months when
purchased as marketable securities. Investments, including certificates of
deposit with maturity dates greater than three months when purchased and which
have readily determined fair values, are classified as available-for-sale
investments and reflected in current assets as marketable securities at fair
market value. Our investment policy requires that all investments be investment
grade quality and no more than ten percent of our portfolio may be invested
in
any one security or with one institution.
Short-term
investments classified as available-for-sale were as follows:
|
|
June
30, 2008
|
|
|
|
Aggregate
Fair
|
|
Gross
Unrealized
|
|
Estimated
Fair
|
|
|
|
Value
|
|
Gains
/ (Losses)
|
|
Value
|
|
Commercial
paper
|
|
|
3,787,047
|
|
|
-
|
|
|
3,787,047
|
|
Corporate
securities fixed rate
|
|
|
660,336
|
|
|
-
|
|
|
660,336
|
|
Total
|
|
$
|
4,447,383
|
|
$
|
-
|
|
$
|
4,447,383
|
|
Xcorporeal
reviews impairments associated with the above in accordance with SFAS No. 115,
“Accounting for Certain Investments in Debt and Equity Securities,” and FASB
Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments,” to determine the
classification of the impairment as temporary or other-than-temporary.
Xcorporeal considers these investments not to be temporarily impaired as of
June
30, 2008.
There
were no gross unrealized gains or losses as of June 30, 2008.
Stock-Based
Compensation
Statements
of Financial Accounting Standards (SFAS) No. 123 (revised 2004),
Share-Based
Payment
, (SFAS
123(R)) and Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 107 (SAB 107) require the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors
based
on estimated fair values. We have applied the provisions of SAB 107 in our
adoption of SFAS 123(R).
In
determining stock based compensation, we consider various factors in our
calculation of fair value using a Black-Scholes pricing model. These factors
include volatility, expected term of the options and forfeiture rates. A change
in these factors could result in differences in the stock based compensation
expense.
ITEM
3. Quantitative and Qualitative Disclosures about Market
Risk
We
invest
our cash in short term high grade commercial paper, certificates of deposit,
money market accounts, and marketable securities. We consider any liquid
investment with an original maturity of three months or less when purchased
to
be cash equivalents. We classify investments with maturity dates greater than
three months when purchased as marketable securities, which have readily
determined fair values and are classified as available-for-sale securities.
Our
investment policy requires that all investments be investment grade quality
and
no more than ten percent of our portfolio may be invested in any one security
or
with one institution.
Investments
in both fixed rate and floating rate interest earning instruments carry a degree
of interest rate risk arising from changes in the level or volatility of
interest rates; however, interest rate movements do not materially affect the
market value of our portfolio because of the short-term nature of these
investments. A reduction in the overall level of interest rates may produce
less interest income from our investment portfolio. The market risk associated
with our investments in debt securities is substantially mitigated by the
frequent turnover of our portfolio.
ITEM
4. Controls and Procedures
We
conducted an evaluation, under the supervision and with the participation of
our
Executive Chairman (principal executive officer) and Chief Financial Officer
(principal financial officer), of our disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Exchange Act) as of June 30, 2008. Based
upon this evaluation, our Executive Chairman and Chief Financial Officer
concluded that our disclosure controls and procedures were effective to ensure
that required material information is included in this quarterly report for
the
period ended June 30, 2008.
There
were no changes in our internal control over financial reporting during the
quarter ended June 30, 2008 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
PART
II — OTHER INFORMATION
ITEM
1. Legal Proceedings.
On
December 1, 2006, Operations initiated arbitration against National Quality
Care, Inc. (NQCI) for NQCI's failure to fully perform its obligations under
the
License Agreement dated September 1, 2006. On September 1, 2006, Operations
also
entered into a Merger Agreement with NQCI which contemplated that Operations
would acquire NQCI as a wholly owned subsidiary pursuant to a triangular merger,
or would issue to NQCI shares of common stock in consideration of the assignment
of the technology relating to the WAK and other medical devices (the “Technology
Transaction”). The merger was not consummated.
On
June
9, 2008, the arbitrator issued an Interim Award granting specific performance
of
the Technology Transaction. The Interim Award stated that the total aggregate
shares of stock to be received by NQCI at the Closing should equal 48% of all
Operations shares outstanding as of the date of the Merger Agreement. On
September 1, 2006, there were 10,000,000 shares of Operations common stock
outstanding. Copies of the License Agreement and Merger Agreement are attached
as exhibits to our amended current report on Form 8-K/A filed with the
Securities and Exchange Commission on June 11, 2008.
On
August
4, 2008, the arbitrator issued a Second Interim Award, stating that 9,230,000
shares of our common stock should be issued to NQCI to effectuate the Technology
Transaction. The arbitrator found that, with the exception of shareholder
approval, virtually all conditions to Closing the Technology Transaction have
been waived. The award further states that, if we or our stockholders do not
approve the issuance of our stock to effectuate the Technology Transaction,
all
of the Technology covered by the License will be declared the sole and exclusive
property of NQCI, and the arbitrator will schedule additional hearings to
address whether the PAK technology is included within that Technology, and
whether NQCI is entitled to compensatory damages and the amount of damages,
if
any, under these circumstances. The arbitrator has also stated that NQCI is
entitled to recover reasonable attorneys’ fees. NQCI has filed a motion seeking
$3.9 million in fees, which we have opposed. Each of the Interim Awards state
that it is an interim award subject to further proceedings, and is not intended
to be a final award subject to a motion to confirm before a court of competent
jurisdiction.
The
Second Interim Award also states that—contrary to the assertion made by NQCI in
its current report on Form 8-K filed on June 10, 2008—the License Agreement will
remain in full force and effect until the Technology Transaction closes or
the
arbitrator determines that it will never close. NQCI has made a claim for
reimbursement of approximately $690,000 in expenses under the License Agreement
which were accrued under “Accrued Professional Fees” as of June 30,
2008.
The
above interim awards are not yet binding or final.
Therefore, no liability for the above awards has been accrued as no reliable
estimate can currently be made.
ITEM
1A. Risk Factors.
Investing
in our common stock involves a high degree of risk. In addition to the
information in this report, you should carefully consider the risks described
under Risk Factors in Part I, Item 1 of our Annual Report on Form 10-KSB for
the
year ended December 31, 2007, and the revised risk factors noted below. If
any
of such risks actually occurs, our business, results of operations and financial
condition will likely suffer. As a result the trading price of our common stock
may decline, and you might lose part or all of your investment
An
unfavorable result in the pending arbitration could have a material adverse
effect on our capital structure, business and financial condition.
We
consider the protection of our proprietary technology for treatment of kidney
failure, which we have licensed and are developing, to be critical to our
business prospects. We obtained the rights to the wearable artificial kidney
(WAK) through a License Agreement with National Quality Care, Inc. (NQCI).
On
December 1, 2006 we initiated arbitration against NQCI for failure to fully
perform its obligations under our License Agreement. NQCI filed counterclaims
seeking to invalidate the License Agreement and claiming monetary damages
against us. In interim awards, the arbitrator has found that the License
Agreement will not survive if the Technology Transaction contemplated by the
Merger Agreement entered into concurrently with the License Agreement fails
to
close. If this determination were upheld by a court of competent jurisdiction,
we could be prevented from using the WAK technology we licensed from it. In
addition, if it were found that our rights to the portable artificial kidney
(PAK) are derived from licensed technology, that could significantly impact
our
ability to develop, manufacture and sell our PAK, which would have a material
adverse effect on our business and results of operations.
The
interim awards state that NQCI is entitled to reimbursement for reasonable
attorneys’ fees. NQCI has made a claim for approximately $3.9 million in such
fees, which we have opposed. NQCI has also made a claim for reimbursement of
approximately $690,000 in expenses related to the License Agreement which has
been accrued at June 30, 2008 If we ever become obligated to pay all or a
substantial portion of such amounts, doing so could have a material adverse
effect on our liquidity and financial ability to continue with ongoing
operations as currently planned.
The
interim awards also state that 9,230,000 shares of our common stock would have
to be issued to effectuate the Technology Transaction, if Closing such a
transaction were to be approved by our stockholders. The issuance of such shares
would result in NQCI owning approximately 38% of our total outstanding shares,
diluting current stockholders and giving it the ability to substantially
influence the outcome of matters submitted to stockholders.
We
expect to incur negative cash flows and net losses for the foreseeable future
and may not be able to continue as a going concern.
As
a
result of our expectation of negative cash flows and net losses for the
foreseeable future, based on our current plans, we believe our existing cash
reserves will not be sufficient to meet our operating expenses and capital
requirements before we achieve profitability. Our ability to meet our cash
obligations as they become due will depend on our ability to secure financing
on
acceptable terms. Unless we are able to raise capital sufficient to
support our operations there will be substantial doubt of our ability to
continue as a going concern.
Approximately
42% of our stock is controlled by a single stockholder who has the ability
to
substantially influence the election of directors and the outcome of matters
submitted to stockholders.
As
of
April 9, 2008, CNL, a limited liability company whose managing member is our
Executive Chairman, directly owned 6,232,596 shares, which represent
approximately 42.4% of our 14,704,687 shares of outstanding common stock. As
a
result, CNL presently and is expected to continue to have the ability to
determine the outcome of issues submitted to our stockholders. The interests
of
this stockholder may not always coincide with our interests or the interests
of
other stockholders, and it may act in a manner that advances its best interests
and not necessarily those of other stockholders. One consequence to this
substantial stockholder’s interest is that it may be difficult for investors to
remove management of the company. It could also deter unsolicited takeovers,
including transactions in which stockholders might otherwise receive a premium
for their shares over then current market prices.
Sales
of common stock by our existing stockholders, or the perception that such sales
may occur, could depress our stock price.
The
market price of our common stock could decline as a result of sales by, or
the
perceived possibility of sales by, our existing stockholders, including
stockholders who recently purchased their shares from CNL. Most of our
outstanding shares were registered on a Form S-4 registration statement in
connection with our October 2007 merger, and are eligible for public resale.
Approximately half of our shares of common stock are currently held by our
affiliates and may be sold pursuant to an effective registration statement
or in
accordance with the volume and other limitations of Rule 144 under the
Securities Act of 1933, as amended, or pursuant to other exempt transactions.
Future sales of common stock by significant stockholders, including those who
acquired their shares in private placements or who are affiliates, or the
perception that such sales may occur, could depress the price of our common
stock.
ITEM
2. Unregistered Sales of Equity Securities; Use of Proceeds from Registered
Securities.
In
April
2008, we issued 20,000 shares of restricted common stock to Steven Solomon,
our
former Chief Executive Officer, as compensation for pre and post merger
consulting services. We issued the shares in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended,
in a transaction not involving any public offering.
In
April 2008, we re-issued 20,000 shares of restricted common stock to Rachel
Glicksman pursuant to the request of CEOCast, Inc. and our Board approval.
The
initial authorization was for the issuance of the 20,000 shares directly to
CEOCast, Inc. as compensation for investor relations services. We issued the
shares in reliance upon the exemption from registration provided by Section
4(2), in a transaction not involving any public offering.
The
above
shares were registered for resale in a registration statement on Form S-3 filed
under the Securities Act of 1933, which was declared effective on April 18,
2008.
ITEM
6. Exhibits.
No.
|
|
Description
of Exhibit
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
|
Date:
August 14, 2008
|
By:
|
/s/
Robert Weinstein
|
|
Robert
Weinstein
Chief
Financial Officer
(Principal
Financial Officer and Principal
Accounting
Officer)
|
|
|