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RESPONSE GENETICS INC 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32
Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549> 
 

 
FORM 10-Q
 (MARK ONE)

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

¨
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 
For the transition period from ___________ to __________

Commission file number: 001-33509
 

 

Delaware
11-3525548
(State or other jurisdiction of
 incorporation or organization)
(I.R.S. Employer
Identification No.)
   
1640 Marengo St., 6th Floor, Los Angeles, California
90033
(Address of principal executive offices)
(Zip Code)

(323) 224-3900
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer ¨
(do not check if a smaller reporting company)
Smaller reporting company x
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x

  
Response Genetics, Inc.
 
Form 10-Q
Table of Contents

   
Page
 
   
Number
 
Part I.
Financial Information
     
         
Item 1.
Financial Statements
     
           
 
Consolidated Balance Sheets — December 31, 2010 and September 30, 2011 (Unaudited)
   
1
 
           
 
Unaudited Consolidated Statements of Operations and Comprehensive Loss — Three and Nine Months ended September 30, 2010 and 2011
   
2
 
           
 
Unaudited Consolidated Statements of Cash Flows —Nine Months ended September 30, 2010 and 2011
   
3
 
           
 
Notes to Unaudited Consolidated Financial Statements
   
4 - 18
 
           
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
   
19
 
           
Item 3.
Qualitative and Quantitative Disclosures About Market Risk
   
27
 
           
Item 4.
Controls and Procedures
   
27
 
           
Part II.
Other Information
       
           
Item 1.
Legal Proceedings
   
27
 
           
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
   
27
 
           
Item 3.
Defaults Upon Senior Securities
   
28
 
           
Item 4.
Removed and Reserved
   
28
 
           
Item 5.
Other Information
   
28
 
           
Item 6.
Exhibits
   
28
 
           
Signatures
   
29
 
         
Exhibit Index
       
         
 
EX- 3.2.1 Amended and Restated Bylaws of Response Genetics, Inc., effective July 13, 2010
       
 
EX-31.1  (Certification required under Section 302 of the Sarbanes-Oxley Act of 2002)
       
 
EX-31.2  (Certification required under Section 302 of the Sarbanes-Oxley Act of 2002)
       
 
EX-32  (Certification required under Section 906 of the Sarbanes-Oxley Act of 2002)
       
 
EX-101 Instance Document
       
 
EX-101 Schema Document
       
 
EX-101 Calculation Linkbase Document
       
 
EX-101 Labels Linkbase Document
       
 
EX-101 Presentation Linkbase Document
       
 
EX-101 Definition Linkbase Document
       
 
 
ii

 
 
RESPONSE GENETICS, INC.
 
CONSOLIDATED BALANCE SHEETS

   
December 31,
2010
   
September 30,
2011
 
  
       
(Unaudited)
 
ASSETS
           
Current assets
           
Cash and cash equivalents
 
$
4,120,074
   
$
2,532,009
 
Accounts receivable
   
4,733,698
     
5,096,486
 
Prepaid expenses and other current assets
   
941,981
     
793,738
 
Total current assets
   
9,795,753
     
8,422,233
 
Property and equipment, net
   
698,755
     
1,033,565
 
Intangible assets, net
   
107,062
     
46,846
 
Total assets
 
$
10,601,570
   
$
9,502,644
 
                 
LIABILITIES, COMMON STOCK CLASSIFED OUTSIDE OF
STOCKHOLDERS’ EQUITY (DEFICIT) AND STOCKHOLDERS’ EQUITY (DEFICIT)
               
Current liabilities
               
Accounts payable
 
$
1,247,151
   
$
1,200,455
 
Accrued expenses
   
1,075,636
     
288,589
 
Accrued royalties
   
809,694
     
477,890
 
Accrued payroll and related liabilities
   
1,271,037
     
1,096,174
 
Capital lease obligation
   
     
102,101
 
Deferred revenue
   
1,518,696
     
485,451
 
Total current liabilities
   
5,922,214
     
3,650,660
 
Deferred revenue, net of current portion
   
100,070
     
 
Capital lease obligation net of current portion
   
     
226,858
 
Total liabilities
   
6,022,284
     
3,877,518
 
                 
Commitments and contingencies (Note 5)
               
                 
Common stock classified outside of stockholders’ equity (deficit)
   
7,854,682
     
7,854,682
 
                 
Stockholders’ equity (deficit)
               
Common stock, $0.01 par value; 50,000,000 shares authorized; 18,357,406 and 19,537,232 shares issued and outstanding at December 31, 2010 and September 30, 2011, respectively
   
122,942
     
134,327
 
Additional paid-in capital
   
40,612,785
     
43,490,116
 
Accumulated deficit
   
(43,817,163
)
   
(45,576,937
)
Accumulated other comprehensive loss
   
(193,960
)
   
(277,062
)
Total stockholders’ equity (deficit)
   
(3,275,396)
     
(2,229,556
)
Total liabilities and stockholders’ equity (deficit)
 
$
10,601,570
   
$
9,502,644
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
1

 
 
RESPONSE GENETICS, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30
 
  
 
2010
   
2011
   
2010
   
2011
 
Net Revenue
 
$
 5,574,649
   
$
 5,100,649
   
$
14,914,212
   
$
17,730,785
 
Operating expenses:
                               
Cost of revenue
   
2,738,693
     
2,538,176
     
7,392,756
     
8,040,003
 
Selling and marketing
   
1,554,430
     
1,251,054
     
4,395,400
     
4,107,639
 
General and administrative
   
2,021,654
     
2,268,517
     
5,417,635
     
6,493,079
 
Research and development
   
319,271
     
452,734
     
1,279,501
     
838,622
 
Total operating expenses
   
6,634,048
     
6,510,481
     
18,485,292
     
19,479,343
 
Operating loss
   
(1,059,399
   
(1,409,832
)
   
(3,571,080
   
(1,748,558
)
Other income (expense):
                               
Interest expense
   
(2,702
)
   
(5,804
)
   
(7,759
)
   
(11,379
)
Interest income
   
185
     
96
     
448
     
162
 
Other
   
     
     
(1,854
)
   
 
Loss before provision for income taxes
   
(1,061,916
   
(1,415,540
)
   
(3,580,245
   
(1,759,775
)
Provision for income taxes
   
     
     
1,256
     
 
Net loss
 
$
(1,061,916
 
$
 (1,415,540
)
 
$
(3,581,501
 
$
(1,759,775
)
                                 
Unrealized gain (loss) on foreign currency translation
   
9,045
     
(25,593
)
   
(4,397
 )
   
(25,593
)
Total comprehensive loss
 
$
(1,052,871
)
 
$
(1,441,133
)
 
 $
(3,585,898
)
 
$
(1,785,368
)
Net loss per share — basic and diluted
 
$
 (0.06
)
 
$
 (0.07
)
 
$
(0.20
)
 
$
(0.09
)
Weighted-average shares — basic and diluted
   
18,314,379
     
19,537,232
     
17,612,982
     
18,979,010
 
 
 The accompanying notes are an integral part of these consolidated financial statements.
 
 
2

 
 
RESPONSE GENETICS, INC.
 
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

   
Nine Months Ended
September 30,
 
  
 
2010
   
2011
 
Cash flows from operating activities:
           
Net loss
 
$
(3,581,501
)
 
$
(1,759,775
)
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
   
258,302
     
262,591
 
Share-based compensation
   
524,290
     
703,771
 
Bad debt expense
   
132,186
     
460,883
 
Loss on sale of property and equipment
   
1,854
     
7,728
 
Loss on asset impairment
   
     
157,241
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(2,898,412
)
   
(823,671
)
Prepaid expenses and other current assets
   
109,319
     
148,244
 
Accounts payable
   
628,075
     
(46,697)
 
Accrued expenses
   
136,777
     
(787,047)
 
Accrued royalties
   
458,482
     
(331,803)
 
Accrued payroll and related liabilities
   
350,782
     
(174,863)
 
Deferred revenue
   
(1,323,802
)
   
(1,133,316
)
Net cash used in operating activities
   
(5,203,648
)
   
(3,316,714
)
Cash flows from investing activities:
               
Purchase of property and equipment and software development
   
(308,904
   
(357,154
)
Net cash used in investing activities
   
(308,904
   
(357,154
)
Cash flows from financing activities:
               
Net proceeds from issuance of common stock
   
3,897,795
     
2,179,535
 
Capital contributions
   
     
5,411
 
Cash payments on capital lease
   
     
(16,041)
 
Net cash provided by financing activities
   
3,897,795
     
2,168,905
 
Effect of foreign exchange rates on cash and cash equivalents
   
(4,397
)
   
(83,102
)
Net decrease in cash and cash equivalents
   
(1,619,154
   
(1,588,065
)
Cash and cash equivalents:
               
Beginning of period
   
7,058,365
     
4,120,074
 
End of period
 
$
5,439,211
   
$
2,532,009
 
Cash paid during the period for:
               
Income taxes
 
$
1,256
   
$
 
Interest
 
$
7,759
   
$
11,379
 
Supplemental disclosure of non-cash financing activities
               
Property and equipment acquired by capital lease
 
$
   
$
345,000
 

The accompanying notes are an integral part of these consolidated financial statements.
 
 
3

 
 
RESPONSE GENETICS, INC.
  
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
1. Organization, Operations and Basis of Accounting
 
Response Genetics, Inc. (the “Company”) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin wax. In August 2000, the Company changed its name to Response Genetics, Inc.
 
The Company is a life science company engaged in the research, development, marketing and sale of pharmacogenomic tests for use in the treatment of cancer. Pharmacogenomics is the science of how an individual’s genetic makeup relates to drug response. Tests based on pharmacogenomics facilitate the prediction of a response to drug therapy or survival following surgery based on an individual’s genetic makeup. In order to generate pharmacogenomic information from patient specimens for these tests, the Company developed and patented enabling methods for maximizing the extraction and analysis of nucleic acids and, therefore, accessing the genetic information available from each patient sample. The Company’s platforms include analysis of single biomarkers using the polymerase chain reaction method as well as global gene interrogation using microarray methods from paraffin or frozen tissue specimens. The Company primarily derives its revenue from the sale of its ResponseDX™ diagnostic testing products and by providing pharmacogenomic testing services to pharmaceutical companies in the United States, Asia and Europe.
 
The Company’s goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. The Company’s pharmacogenomic analysis of clinical trial specimens for the pharmaceutical industry may provide data that will lead to a better understanding of the molecular basis for response to specific drugs and, therefore lead to individualized treatment.
 
Since its inception, the Company has devoted substantial effort in developing its product and has incurred losses and negative cash flows from operations, and as of September 30, 2011 has an accumulated deficit of $45,576,937. The Company is forecasting continued losses and negative cash flows as it funds its selling and marketing activities and research and development programs.
 
Based on the Company’s current operating plan which includes various assumptions concerning the level and timing of cash receipts from product sales and cash outlays for operating expenses and capital expenditures, management believes that existing cash and cash equivalents will be sufficient to meet the Company’s working capital requirements through the next twelve months. The Company’s ability to successfully carry out its business plan is primarily dependent upon its ability to (1) obtain sufficient additional capital at acceptable costs, (2) attract and retain knowledgeable workers, and (3) generate significant revenues. The Company plans to seek additional financing and/or strategic investments; however, there can be no assurance that any additional financing or strategic investments will be available on acceptable terms, if at all.
 
    However, if events or circumstances occur such that the Company does not meet its operating plan as expected, in addition to seeking the additional capital as described above, the Company will most likely be required to reduce certain discretionary spending, which could have a material adverse effect on the Company’s ability to achieve its intended business objectives. No adjustments have been made to the accompanying financial statements to reflect any of the matters discussed above. The consolidated financial statements have been prepared on the basis that the Company will continue as a going concern.
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions for Form 10-Q promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the fiscal year. The financial statements should be read in conjunction with the Company’s audited December 31, 2009 and 2010 consolidated financial statements and accompanying notes included in the Company’s Form 10-K and 10-KA previously filed with the SEC.

2. Summary of Significant Accounting Policies
 
Basis of Consolidation
 
The consolidated financial statements include the accounts of Response Genetics, Inc. and its wholly owned subsidiary, Response Genetics, Ltd., a Scottish corporation, which was incorporated in November 2006. All significant intercompany transactions and balances have been eliminated in consolidation.
 
Cash and Cash Equivalents
 
The Company considers all highly liquid investments with a maturity at date of purchase of three months or less to be cash equivalents. The carrying value of cash equivalents approximates fair value due to the short-term nature and liquidity of these instruments. The Company’s cash equivalents are comprised of cash on hand, deposits in banks and money market investments.
 
 
 
4

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
2. Summary of Significant Accounting Policies - (continued)

Accounts Receivable
 
Clinical Accounts Receivable
 
The Company invoices its clients as specimens are processed and any other contractual obligations are met. The Company’s contracts with clients typically require payment within 45 days of the date of invoice. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its clients to make required payments. The Company specifically analyzes accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, the Company’s clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal. Pharmaceutical company accounts receivable as of December 31, 2010 and September 30, 2011 were $1,694,130 and $1,917,364 respectively.  There were no allowances for doubtful accounts recorded against these accounts receivable at December 31, 2010 and September 30, 2011.

ResponseDX Accounts Receivable

Response DX accounts receivable are recorded from two primary payors: Medicare, and Private Payors, based upon their respective applicable billing rates. ResponseDX accounts receivable related to Medicare are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. Currently the Company determines historical cash collection percentages based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. Management performs ongoing valuations of accounts receivable balances based on management’s evaluation of historical collection experience and industry trends. Based on the historical experience for our Medicare accounts, management has determined that billings over one year are unlikely to be collected. The Company has not recorded an allowance for doubtful accounts as of September 30, 2011. During the three months ended September 30, 2010 and September 30, 2011, the Company recorded bad debt expense of $0 and $160,952, for the nine months ended September 30, 2010 and 2011, the Company recorded bad debt expense of $132,186 and $460,883, respectively.

ResponseDX accounts receivable as of December 31, 2010 and September 30, 2011, consisted of the following:

    
December 31,
 2010
   
September 30,
 2011
 
         
(Unaudited)
 
Net Medicare receivable
 
$
1,092,386
   
$
878,402
 
Net Private Payor receivable
   
2,061,020
     
2,264,363
 
Other
   
     
36,357
 
     
3,153,406
     
3,179,122
 
Allowance for doubtful accounts - Medicare
   
(113,838
 )
   
 
Net ResponseDX accounts receivable
 
$
3,039,568
   
$
3,179,122
 

The receivable for Medicare is net of contractual allowances.  The receivables for Private Payors are net of an allowance to reflect the estimated collection percentage established from historical collection data.
 
 
5

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
2. Summary of Significant Accounting Policies - (continued)

Property and Equipment
 
Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the double declining balance and straight-line methods over the estimated useful lives of the assets. The Company has determined the estimated useful lives of its property and equipment, as follows:
 
Laboratory equipment
 
5 to 7 years
Furniture and Equipment
 
5 to 7 years
Leasehold Improvements
 
Shorter of the useful life or the lease term (5 to 7 years)
 
Maintenance and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the related accounts and the resulting gain or loss is reflected in the statements of operations. As of December 31, 2010 the Company had capitalized costs related to database software development (see Note 3). As of September 30, 2011 the Company has placed a portion of this database into service and accordingly has started to depreciate this software development cost in accordance with ASC 350-40, Internal-Use Software.  The amortization period will be three years using the straight line method.

Capital Lease

     The Company leases certain equipment that is recorded as capital leases. This equipment is included in property and equipment on the accompanying balance sheet as of September 30, 2011.

     Future minimum lease payments under capital leases as of September 30, 2011 are as follows:
 
    
September 30,
 2011
 
 Years Ending December 31
 
(Unaudited)
 
2011
 
$
32,670
 
2012
   
130,680
 
2013
   
130,680
 
     2014
   
87,119
 
Total minimum lease payments
 
381,149
 
Less represented by interest
   
52,190
 
Less current portion
   
102,101
 
Capital Lease obligation net of current portion
 
$
226,858
 
 
Revenue Recognition

Pharmacogenomic Revenue
 
Revenues that are derived from pharmacogenomic testing services provided to pharmaceutical companies are recognized on a contract specific basis pursuant to the terms of the related agreements. Revenue is recognized in accordance with ASC 605, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

Revenues are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through the Company’s laboratory under a specified contractual protocol and are recorded on the date the tests are resulted. On occasion, the Company may enter into a contract that requires the client to provide an advance payment for specimens that will be processed at a later date. In these cases, the Company records this advance as deferred revenue and recognizes the revenue as the specimens are processed or at the end of the contract period, as appropriate.

ResponseDX Revenue

The Company recognizes all product revenue from its ResponseDX tests on an accrual basis.  ResponseDX and Medicare revenue are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors.

 
6

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
2. Summary of Significant Accounting Policies - (continued)

Revenue Recognition – (continued)

The Company recognizes revenue from ResponseDX Private Payors and Medicare on the accrual basis. The revenue recorded from ResponseDX sales to Private Payors and Medicare for the nine months ended September 30, 2010 and September 30, 2011 was $8,213,567 and $9,425,747, respectively.

The Company has a Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes.  ResponseDX revenues related to Medicare billings are recorded at established billing rates net of an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors.  Response DX revenue related to Private Payors are recorded at established billing rates less an allowance to reflect the revenue at the amounts expected based on historical collections patterns.  

The following details ResponseDX revenue for the three and nine months ended September 30, 2010 and 2011:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
(Unaudited)
   
(Unaudited)
 
   
2010
   
2011
   
2010
   
2011
 
                         
Net Medicare Revenue
 
$
1,269,681
   
$
1,572,807
   
$
3,159,882
   
$
4,029,675
 
                                 
Private Payor Revenue
   
1,690,761
     
1,765,753
     
4,863,024
     
5,389,199
 
                                 
Other
   
22,181
     
2,076
     
190,661
     
6,873
 
                                 
Net ResponseDX Revenue
 
$
2,982,623
   
$
3,340,636
   
$
8,213,567
   
$
9,425,747
 
 
Cost-Containment Measures
 
Both government and private pay sources have instituted cost-containment measures designed to limit payments made to providers of health care services, and there can be no assurance that future measures designed to limit payments made to providers will not adversely affect the Company.

Regulatory Matters
 
Laws and regulations governing Medicare programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation, as well as significant regulatory action including fines, penalties and exclusions from certain governmental programs. The Company believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing.
 
A portion of the Company’s revenues are derived from Medicare for which reimbursement rates are subject to regulatory changes and government funding restrictions. Although the Company is not aware of any significant future rate changes, significant changes to the reimbursement rates could have a material effect on the Company’s operations.
 
Cost of Revenue
 
Cost of revenue represents the cost of materials, direct labor, costs associated with processing tissue specimens including pathological review, staining, microdissection, paraffin extraction, reverse transcription polymerase chain reaction, or (“RT-PCR”) and quality control analyses, license fees and delivery charges necessary to render an individualized test result. Costs associated with performing tests are recorded as the tests are processed.  
 
License Fees
 
The Company has licensed technology for the extraction of mRNA from formalin-fixed, paraffin-embedded tumor specimens from the University of Southern California (“USC”). Under the terms of the license agreement, the Company is required to pay royalties to USC based on the revenue generated by use of this technology. The Company maintains a non-exclusive license to use the polymerase chain reaction (“PCR”), homogenous PCR, and reverse transcription PCR processes of Roche Molecular Systems, Inc. (“Roche”). The Company pays Roche Molecular Systems a royalty fee based on revenue that the Company generates through use of this technology. The Company accrues for such royalties at the time revenue is recognized. Such royalties are included in cost of revenues in the accompanying statements of operations. 
 
 
7

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS>
  
2. Summary of Significant Accounting Policies - (continued)
 
Research and Development
 
The Company expenses costs associated with research and development activities as incurred. Research and development costs are allocated on a pro rata basis using an estimate of employee time as a percentage of total hours worked for which specific employees are conducting research and development. Research and development costs include employee costs (salaries, payroll taxes, benefits, and travel), equipment depreciation and warranties and maintenance, laboratory supplies, primers and probes, reagents, patent costs and occupancy costs.

Income Taxes
 
Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. As of December 31, 2010 and September 30, 2011, the Company does not have a liability for unrecognized tax benefits. The Company recognizes interest and penalties associated with tax matters as part of the income tax provision and includes accrued interest and penalties with the related tax liability in the balance sheet.

Stock-Based Compensation
 
The Company accounts for stock-based compensation in accordance with Accounting Standards Codification (“ASC”) 718, Stock Compensation. Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value estimated in accordance with the provisions of ASC 718.  The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of three to four years

The Company accounts for equity instruments issued to non-employees in accordance with ASC 505, Equity, Under ASC 505, stock option awards issued to non-employees are measured at fair value using the Black-Scholes option-pricing model and recognized pursuant to a performance model.
 
Management Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ materially from those estimates.

Long-lived Assets
 
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the asset with the estimated undiscounted future cash flows associated with the use of the asset and its eventual disposition. Should the review indicate that the asset is not recoverable, the Company’s carrying value of the asset would be reduced to its estimated fair value, which is measured by future discounted cash flows.

Foreign Currency Translation
 
The financial position and results of operations of the Company’s foreign subsidiary are determined using local currency as the functional currency. Assets and liabilities of these operations are translated at the exchange rate in effect at each period-end. Statement of Operations amounts are translated at the average rate of exchange prevailing during the period. Translation adjustments arising from the use of differing exchange rates from period to period are included in accumulated other comprehensive loss in stockholders’ equity (deficit). The Company accounts for deferred revenue related to a specific contract as a nonmonetary obligation using historical exchange rates.

Comprehensive Loss
 
Comprehensive loss encompasses the change in equity from transactions and other events and circumstances from non-owner sources and the Company’s net loss. The components of comprehensive loss and accumulated other comprehensive loss comprise net loss and foreign currency translation adjustments as of December 31, 2010 and September 30, 2011, and for the three and nine months ended September 30, 2010 and 2011.

Fair Value of Financial Instruments
 
Cash and cash equivalents are stated at cost, which approximates fair market value.  Cash equivalents consist of money market accounts, with fair values estimated based on quoted market prices. For additional information see Note 14.

Selling and Marketing Costs
 
The Company markets its services through its advertising activities in trade publications and on line. Advertising costs are included in selling and marketing expenses on the statements of operations and are expensed as incurred.  Advertising costs for the three months ended September 30, 2010 and 2011 were $222,410 and $16,985 respectively, and $457,788 and $83,462 for the nine months ended September 30, 2010 and 2011, respectively.

Reclassifications

Prior year amounts in the consolidated financial statements have been reclassified to conform with the current year presentation. Reclassified amounts had no impact on the company’s net losses.
 
 
 
8

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Concentration of Credit Risk and Clients and Limited Suppliers
 
Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were fully insured at September 30, 2011 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits. In addition, the Company has invested its excess cash in money market instruments which are not insured under the Federal Deposit Insurance Corporation but are insured under the Securities Industry Protection Corporation.  At September 30, 2011, the Company had $10,000 of cash in money market instruments and has not incurred any losses on these cash balances.  At September 30, 2011, $99,506 of cash was held outside of the United States and is uninsured.

Revenue sources that account for greater than 10 percent of total revenue are provided below.
 
   
Three Months Ended
 September 30,
   
Nine Months Ended
 September 30,
 
   
2010
   
2011
   
2010
   
2011
 
   
(Unaudited)
   
(Unaudited)
 
   
Revenue
   
Percent
of Total
Revenue
   
Revenue
   
Percent
of Total
Revenue
   
Revenue
   
Percent
of Total
Revenue
   
Revenue
   
Percent
of Total
Revenue
   
GlaxoSmithKline and GlaxoSmithKline Biologicals
 
$
1,804,935
     
32%
   
$
1,465,706
     
29
%
 
$
4,956,629
     
33%
   
$
7,046,744
     
40
%
 
                                                                   
Medicare, net of contractual allowances
 
$
1,269,681
     
23%
   
$
1,572,807
     
31
%
 
$
3,153,882
     
21%
   
$
4,029,676
     
23
%
 
  
Customers that account for greater than 10 percent of accounts receivable are provided below.

   
As of December 31, 2010
   
As of September 30, 2011
 
         
(Unaudited)
 
   
Receivable
Balance
   
Percent of
Total
Receivables
   
Receivable
Balance
   
Percent of
Total
Receivables
 
GlaxoSmithKline and GlaxoSmithKline Biologicals
 
$
1,305,829
     
28
 
$
1,707,354
     
34
                                 
Medicare, net of contractual allowances
 
$
1,092,386
     
23
 
$
878,402
     
17
 
Many of the supplies and reagents used in the Company’s testing process are procured from a limited number of suppliers. Any supply interruption or an increase in demand beyond the suppliers’ capabilities could have an adverse impact on the Company’s business. Management believes it can identify alternative sources, if necessary, but it is possible such sources may not be identified in sufficient time to avoid an adverse impact on its business. Refer also to Note 6 for further discussion regarding these supply agreements. The Company purchases certain laboratory supplies and reagents primarily from two suppliers. Purchases from the top two of those companies accounted for approximately 73% and 76% of the Company’s reagent purchases for the three months ended September 30, 2010 and 2011, respectively, and approximately 66% and 75% for the nine months ended September 30, 2010 and 2011, respectively.
 
 
9

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements, amends FASB ASC 820-10, Fair Value Measurements and Disclosures, and requires new disclosures about transfers into and out of Level 1 and 2 of the fair value hierarchy and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements.  It is effective for interim and annual reporting periods beginning after December 15, 2009, except for the Level 3 measurement disclosures, which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  Early adoption is permitted. The partial adoption of this guidance did not have a material effect on our results of operations or financial position with the adoption of the remaining portion of this not expected to have a material effect.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition — Milestone Method (Topic 605): Milestone Method of Revenue Recognition”. This ASU provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. The updated guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Entities may elect to adopt the amendments in the ASU retrospectively for all prior periods. The adoption of this guidance did not have a material effect on our consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13 establishes a selling-price hierarchy for determining the selling price of each element within a multiple-deliverable arrangement. Specifically, the selling price assigned to each deliverable is to be based on vendor-specific objective evidence (VSOE) if available, third-party evidence, if VSOE is unavailable, and estimated selling prices if neither VSOE or third-party evidence is available. In addition, ASU 2009-13 eliminates the residual method of allocating arrangement consideration and instead requires allocation using the relative selling price method. ASU 2009-13 will be effective prospectively for multiple-deliverable revenue arrangements entered into, or materially modified, in fiscal years beginning on or after June 15, 2010. The adoption of this guidance did not have a material effect on our results of operation or financial position.

In July 2011, the FASB issued ASU 2011-7, “Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities” (“ASU2011-7”). In accordance with ASU 2011-7, the Company will be required to present its provision for doubtful accounts related to patient service revenue as a deduction from revenue, similar to contractual discounts. Accordingly, the Company’s revenues will be required to be reported net of both contractual discounts as well as its provision for doubtful accounts related to patient service revenues. Additionally, ASU 2011-7 will require the Company to make certain additional disclosures designed to help users understand how contractual discounts and bad debts affect recorded revenue in both interim and annual financial statements. ASU 2011-7 is required to be applied retrospectively and is effective for public companies for fiscal years beginning after December 15, 2011, and interim periods within those fiscal years. Early adoption is permitted. Management is still evaluating the potential effect that the adoption of this guidance will have on the results of operations or our financial position.

3. Property and Equipment and Intangible Assets
 
Property and equipment and intangible assets consists of the following:
 
   
December 31,
 2010
   
September 30,
 2011
 
         
(Unaudited)
 
Laboratory equipment
  $ 2,389,339     $ 2,909,225  
Furniture and equipment
    735,731       736,680  
Leasehold improvements
    194,899       194,899  
      3,319,969       3,840,804  
Less: Accumulated depreciation
    (2,621,214 )     (2,807,239 )
Total property and equipment, net
  $ 698,755     $ 1,033,565  
                 
Internally developed software
  $ 107,062     $ 48,461  
Less: Accumulated depreciation and amortization
          (1,615 )
Total intangible assets, net
  $ 107,062     $ 46,846  
 
Internally developed software consists of various projects the Company has developed. The projects were completed during the third quarter of 2011. Depreciation and amortization expense, included in cost of revenue, general and administrative expenses, and research and development expenses, for the three months ended September 30, 2010 and 2011 was $90,600 and $90,606, respectively, and for the nine months ended September 30, 2010 and 2011 was $258,302 and $262,591, respectively. During the period ending September 2011 the company established a capital lease for various lab equipment. The fair value of the lease was $345,000, and the lease is for a three year term. Amortization expense for this lease for the period ending September 30, 2011 was $19,167.

During September 2011, the company recognized as asset impairment in the amount of $157,241. This represents the amount of internal costs that were capitalized for software development. Employees that were tasked with this project were terminated during the period and management concluded that the work done to date was not expected to provide substantive service potential to the Company.

 
10

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

4. Loss Per Share
 
The Company calculates net loss per share in accordance with ASC 260, Earnings Per Share, Under the provisions of ASC 260, basic net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding for the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive common stock equivalents then outstanding. Common stock equivalents consist of shares of common stock issuable upon the exercise of stock options and warrants.

The following table sets forth the computation for basic and diluted loss per share:

   
Three Months Ended
 September 30,
   
Nine Months Ended
 September 30,
 
  
 
2010
   
2011
   
2010
   
2011
 
   
(Unaudited)
   
(Unaudited)
 
                         
Numerator:
                       
Net loss
 
$
(1,061,916
)
 
$
(1,415,540
)
 
$
(3,581,501
)
 
$
(1,759,775
)
Numerator for basic and diluted earnings per share
 
$
(1,061,916
)
 
$
(1,415,540
)
 
$
(3,581,501
)
 
$
(1,759,775
)
                                 
Denominator for basic and diluted earnings per  share — weighted-average shares
   
18,314,379
     
19,537,232
     
17,612,982
     
18,979,010 
 
Basic and diluted loss per share
 
$
(0.06
)
 
$
(0.07
)
 
$
(0.20
)
 
$
(0.09
)
 
Outstanding stock options and warrants to purchase 1,972,157 shares and 1,996,931 shares for the periods ended September 30, 2010 and 2011, respectively, of which 100,000 warrants are included in these amounts for 2010 and 2011, were excluded from the calculation of diluted loss per share as their effect would have been antidilutive.

5. Commitments and Contingencies
 
Operating Leases

The Company leases office and laboratory space under a noncancelable operating lease that expires on March 31, 2012. The lease contains two two-year options to extend the term of the lease and contains annual scheduled rate increases tied to the Consumer Price Index for the Los Angeles/Long Beach California metropolitan area. The Company also leases space in Fredrick, Maryland, for administrative purposes. This lease has been extended through December 31, 2011 at a rate of $1,500 per month.  Rent expense, included in cost of revenue, general and administrative, and research and development was $118,957 and $112,548 for the three months ended September 30, 2010 and 2011, respectively, and $338,057 and $371,553 for the nine months ended September 30, 2010 and 2011, respectively.
  
Future minimum lease payments by year and in the aggregate, under the Company’s noncancelable operating leases, consist of the following at September 30, 2011:
 
Period Ending June 31,
     
Remainder of 2011
 
141,350
 
2012
   
162,778
 
Thereafter
   
 
Total
 
$
304,128
 
 
 
11

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
5. Commitments and Contingencies – (continued)
 
Guarantees

The Company enters into indemnification provisions under its agreements with other counterparties in its ordinary course of business, typically with business partners, clients and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities. These indemnification provisions generally survive termination of the underlying agreement. The Company reviews its exposure under these agreements no less than annually, or more frequently when events indicate. The Company believes the estimated fair value of these agreements is minimal as historically, no payments have been made by the Company under these indemnification obligations and in many cases, the Company maintains insurance against any losses. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2010 and September 30, 2011.

Legal Matters>    The Company is, from time to time, involved in legal proceedings, regulatory actions, claims and litigation arising in the ordinary course of business. These matters are not expected to have a material adverse effect upon the Company’s financial statements.

Employment Agreements
 
The Company has employment contracts with several individuals, which provide for annual base salaries and potential bonuses. These contracts contain certain change of control, termination and severance clauses that require the Company to make payments to certain of these employees if certain events occur as defined in their respective contracts.
 
6. License and Collaborative Agreements
 
License Agreement with the University of Southern California (“USC”)
 
In April 2000, as amended in June 2002 and April 2005, the Company entered into a license agreement with USC. Under this agreement, USC granted the Company a worldwide, exclusive license with the right to sublicense, the patents for RGI-1 and related technology, for use in human and veterinary diagnostic laboratory services, the sale of clinical diagnostic products, and the sale of research products to the research community. USC retains the right under the agreement to use the technology for research and educational purposes.

In consideration for this license, the Company agreed to pay to USC royalties based on a percentage of the revenues generated by the use of RGI-1 and related technology. Royalty expense included in cost of revenue relating to this agreement amounted to $142,594 and $123,873 for the three months ended September 30, 2010 and 2011, respectively, and $380,263 and $382,685 for the nine months ended September 30, 2010 and 2011.

License Agreement with Roche Molecular Systems (“Roche”)
 
In July 2001, the Company entered into a diagnostic services agreement with Roche to provide the Company with access to Roche’s patented PCR technology. In November 2004, this agreement was replaced by a non-exclusive license to use Roche’s PCR, homogenous PCR, and reverse transcription PCR processes. In consideration for these rights, the Company is obligated to pay royalties to Roche, based on a percentage of net sales of products or services that make use of the PCR technology. Royalty expense included in cost of revenue relating to this agreement amounted to $148,144 and $116,867 for the three months ended September 30, 2010 and 2011, respectively, and $359,507 and $425,232 for the nine months ended September 30, 2010 and 2011.
 
In November 2004, the Company entered into an agreement with Roche, pursuant to which the Company is collaborating with Roche to produce commercially viable assays used in the validation of genetic markers for pharmaceutical companies. Specifically, the Company has licensed the rights to Roche to use the pre-diagnostic assays the Company develops in the course of using its RNA-extraction technologies to provide testing services to pharmaceutical companies and to produce diagnostic kits that then can be sold commercially to those pharmaceutical companies. Roche is required to pay the Company royalties of a certain percentage of net sales of such diagnostic kits sold to pharmaceutical companies. Through September 30, 2011, Roche has not been required to pay any royalties to the Company pursuant to this agreement.
 
 
12

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
6. License and Collaborative Agreements - (continued)

Services Agreement with Taiho Pharmaceutical Co., Ltd. (“Taiho”)
 
In July of 2001, the Company entered into an agreement with Taiho pursuant to which it will provide Taiho with RGI-1 generated molecular-based tumor analyses for use in guiding chemotherapy treatment for cancer patients and for use in its business developing and marketing pharmaceutical and diagnostic products for use against cancer. Pursuant to the agreement, the Company appointed Taiho as the exclusive purchaser in Japan of tests and testing services based upon the RGI-1 using gene expression for (i) any one or the combination of specified molecular markers, (ii) the therapeutic use of specified compounds, or (iii) the diagnosis or therapeutic treatment of specified precancerous and cancerous diseases. The Company also granted Taiho the right to be a non-exclusive purchaser in Japan of tests and testing services based upon the RGI-1 using gene expression, other than those for which Taiho has exclusivity, for, (i) any one or combination of molecular markers, (ii) the therapeutic use of any compound or biological product against cancer, or (iii) the diagnosis or therapeutic treatment of precancerous and cancerous diseases.

In consideration for the testing services provided, Taiho paid an upfront payment at the commencement of the agreement and is obligated to pay regular testing fees, covering the specific services performed on a monthly basis.  In January 2010, the Company amended its agreement with Taiho and the agreement was renewed for an additional three years.

Revenue recognized from Taiho was $512,975 and $158,500 for the three months ended September 30, 2010 and 2011, respectively, and $1,334,500 and $803,600 for the nine months ended September 30, 2010 and 2011.

Services Agreement with SmithKline Beecham Corporation (d.b.a. GlaxoSmithKline or “GSK”)
 
In January 2006, the Company entered into an agreement with GSK, a leading pharmaceutical manufacturer, pursuant to which the Company provides services in connection with profiling the expression of various genes from a range of human cancers. Under the agreement, the Company will provide GSK with testing services as described in individual protocols and GSK will pay the Company for such services based on the pricing schedule established for each particular protocol. GSK is obligated to make minimum annual payments to the Company under the agreement and also was obligated to make a non-refundable upfront payment to the Company, to be credited against work undertaken pursuant to the agreement. In January 2006, the Company received an upfront payment of $2,000,000 which was initially recorded as deferred revenue. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. The Company recognized $187,002 and $356,594 for the three months ended September 30, 2010, and 2011, respectively, and $901,387 and $2,878,860 for the nine months ended September 30, 2010 and 2011.

In December 2008, the Company amended and restated its master service agreement with GSK. Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000 which was received on January 5, 2009.  

There was no amount of deferred revenue for this agreement at September 30, 2011. There is no amount of deferred revenue remaining for the Amended and Restated Master Service Agreement signed in December 2008.

Non-Exclusive License Agreement with GSK

In March 2010, the Company entered into a non-exclusive license agreement with GSK.  Under the agreement, the Company granted GSK a non-exclusive, sublicenseable license to its proprietary PCR analysis technology and diagnostic expertise to assess BRAF gene mutations in human tumor samples.  As part of the agreement, the Company received a non-refundable technology access fee in consideration for the transfer of the Company’s technology to GSK. The agreement also contains milestone provisions which would allow the Company to earn further payments from GSK.  The Company had not earned any milestone payments from GSK as of September 30, 2011.
 
 
13

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
6. License and Collaborative Agreements - (continued)

Master Laboratory Test Services Agreement with GlaxoSmithKline Biologicals (“GSK Bio”)
 
In December 2006, the Company entered into an agreement with GSK Bio, the vaccine division of GSK (see above), pursuant to which it will provide testing services, principally in relation to profiling the expression of various genes from a range of human cancers. The Company will conduct the testing services on tissue specimens provided by GSK Bio. The agreement required that GSK Bio make an upfront payment of €2,000,000 (approximately $2,620,000), which was received by the Company in December 2006. The agreement further specified that GSK Bio  pay annual minimum payments in 2007, 2008 and 2009 and that the upfront payment made in December 2006 will be credited against the annual minimum payments in 2007 and 2008. The agreement also provided that any differences between the annual minimum payments made in 2007, 2008 or 2009 and the amounts due to the Company for testing services performed on specimens submitted by GSK Bio during the three years ended December 31, 2010 be credited towards services performed during the year ending December 31, 2010, the final year of the agreement. If the Company ceases to provide services under the agreement or any reason, the Company shall remit to GSK Bio payment of the then remaining balance of the existing credit within sixty days of the date on which the Company ceased to provide services to GSK Bio.

In December 2007, the Company amended its agreement with GSK Bio whereby GSK Bio would make the remaining minimum payments under the agreement in one lump sum. This payment of approximately $2,722,000 was received in January 2008.

On September 7, 2009, the Company amended and restated its master service agreement with GSK Bio (the “Amended and Restated Agreement”).  Pursuant to the Amended and Restated Agreement, the parties agreed that GSK Bio has accrued an aggregate credit under the terms, representing the balance of deferred revenue relating to this agreement at the date of amendment of the original agreement, which amount shall be allocated towards services rendered to GSK Bio during the remaining term of the agreement as described below.

For each calendar quarter of 2009 and the first two quarters of 2010, €200,000 of the existing credit shall apply to all services rendered to GSK Bio during such calendar quarter.  Pursuant to the Amended and Restated Agreement, GSK Bio has extended the term of the agreement for an additional one-year period through December 31, 2011.   As provided in the Amended and Restated Agreement, the remaining balance of the existing credit of approximately €1,357,800 was divided into six equal quarterly amounts and will be applied to all services rendered to GSK Bio in each of the last two quarters of 2010 and the four calendar quarters of 2011.  In the first quarter of 2011, the amount of the credit to be applied to all services rendered to GSK Bio is €226,300. In all cases, GSK Bio shall remit payment to the Company for all services rendered to GSK Bio in any such calendar quarter that is in excess of the applicable credit amount.  In the event the amount of services rendered to GSK Bio in a calendar quarter does not exceed the applicable credit amount, the existing credit for the following calendar quarter shall be increased by such unused amount.  

The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products. The amount of deferred revenue for this agreement at December 31, 2010 and September 30, 2011 is $1,333,186 and $333,294, respectively.  The timing of the recognition of these amounts is dependent upon when GSK Bio submits the specimens for testing. The Company recognized revenue of $1,617,933 and $1,109,112 relating to the GSK Bio agreement for the three months ended September 30, 2010, and 2011, respectively, of which $333,296 was relieved from deferred revenue for the period ended September 30, 2011.  The Company recognized revenue of $4,055,242 and $4,186,385, related to the GSK Bio agreement for the nine months ended September 30, 2010 and 2011, respectively, of which $999,888 was relieved from deferred revenue for the period ended September 30, 2011.
 
Collaboration Agreement with Shanghai BioChip Company, Ltd. (“SBC”)
 
On March 5, 2007, the Company entered into a collaboration agreement with SBC pursuant to which SBC will provide exclusive pharmacogenomic testing services to the Company’s clients in China.
 
Pursuant to the agreement, the Company has granted SBC an exclusive license in China to provide services in China using the Company’s proprietary RNA extraction technologies. Subject to consent from USC, the Company did grant SBC an exclusive sublicense to patents licensed from USC for distribution of testing services in China. In turn, SBC will perform RNA extraction from FFPE tissue specimens exclusively for the Company during the term of the agreement.
 
This agreement has an initial term of five years, with an automatic renewal for an additional three-year term unless either party gives 90 days notice in advance of the renewal date of its intent not to renew. Pursuant to the agreement, SBC will receive a percentage of the gross margin, as defined in the agreement, collected from the Company’s clients in China as compensation for its testing services performed.  For the three months ended September 30, 2010 and September 30, 2011, testing services performed totaled $51,773 and $84,275 and for the nine months ended September 30, 2010 and September 30, 2011, testing services performed totaled $63,594 and $234,512 respectively.
 
Commission Agreement with Hitachi Chemical Co., Ltd.
 
On July 26, 2007, the Company entered into a collaboration agreement with Hitachi Chemical Co., Ltd. (“Hitachi”), a leading diagnostics manufacturer in Japan (the “Hitachi Agreement”). Under the terms of this agreement, Hitachi will begin using the Company's proprietary and patented techniques to extract genetic information from formalin-fixed paraffin-embedded (“FFPE”) tissue samples collected in Southeast Asia, Australia and New Zealand. As part of this collaboration agreement, the Company will provide Hitachi with the technical information and assistance necessary to perform the testing services. Hitachi also plans to introduce the Company to potential new testing services customers in the region to expand the testing of FFPE clinical samples in Asia. The Southeast Asian countries covered under this agreement include Japan, North Korea, South Korea, Taiwan, Mongolia, Pakistan, Bangladesh, Sri Lanka, Nepal, Singapore, Malaysia, Indonesia, Brunei, Thailand, Myanmar, Laos, Cambodia, Vietnam and the Philippines (the “Territory”).
 
This Agreement has an initial term expiring on March 31, 2010, with an automatic renewal for one year at the end of the original period under the same terms and conditions. Pursuant to the agreement, Hitachi will receive a percentage of the revenue collected from the Company's clients in the Territory for its testing services performed which totaled $352,247 and $106,260 for the three months ended September 30, 2010 and 2011, respectively, and $969,375 and $481,951 for the nine months ended September 30, 2010 and 2011, respectively. Due to the natural disasters and related events that occurred in Japan in February of 2011, the processing of samples in Japan under our collaboration agreement with Hitachi was suspended. During the third quarter of 2011, these samples were processed in our Los Angeles laboratory. As such, we were not required to make payments to Hitachi under our agreement. The financial impact was that our cost of revenue was reduced and our net loss for the quarter was reduced. It is unclear when Hitachi will begin to process samples in Japan. Once they do, our cost of revenue and our net loss will be impacted.

 
14

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
7. Stock Option Plan
 
In March 2000, the Company adopted a Stock Option Plan (the “2000 Plan”) as approved by its board of directors. Under the 2000 Plan, the Company may grant options to acquire up to 1,600,000 shares of common stock. In connection with the adoption of the 2006 Employee, Director and Consultant Stock Plan, as further discussed below, the Company will grant no additional options under its 2000 Plan under which options to purchase 190,000 shares remained outstanding as of September 30, 2011. Although no more options may be granted under the 2000 Plan, the terms of the 2000 Plan continue to apply to all outstanding options. The Company also granted options to purchase 16,000 shares of common stock to two consultants which were granted under separate agreements outside of the 2000 Plan.
 
On October 26, 2006, the Board of Directors of the Company approved, and on May 1, 2007, reapproved the adoption of the 2006 Employee, Director and Consultant Stock Plan (the “2006 Stock Plan”). The stockholders approved the 2006 Stock Plan on June 1, 2007. The initial number of shares which may be issued from time to time pursuant to this Plan is 2,160,000 shares of common stock.  In addition, on the first day of each fiscal year of the Company during the period beginning in fiscal year 2008, and ending on the second day of fiscal year 2017, the number of shares that may be issued from time to time pursuant to the Plan shall be increased by 200,000 shares.  The initial number of shares available for issuance of 2,160,000 increased by 200,000 in 2008, 2009 2010 and 2011, resulting in the total number of shares that may be issued as of January 1, 2011 to be 2,960,000.  As of September 30, 2011, there were 963,069 options available to grant under the 2006 Stock Plan.
 
Employee options vest according to the terms of the specific grant and expire 10 years from the date of grant. Non-employee option grants to date vest typically over a 2 to 3 year period. The Company had 1,996,931 options outstanding at a weighted average exercise price of $3.77 at September 30, 2011. There were 785,572 non-vested stock options with a weighted average grant date fair value of $1.35 outstanding at September 30, 2011.  As of September 30, 2011, there was $1,216,434 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 2.59 years.

The Company estimated share-based compensation expense for the three months ended September 30 using the Black-Scholes model with the following weighted average assumptions:
   
2010
   
2011
 
Risk free interest rate
    3.0 %      
Expected dividend yield
     —        
Expected volatility
    82 %      
Expected term (in years)
    6.25        
Forfeiture rate
    7.8 %      

During the three months ended September 30, 2010, there were 281,500 option shares granted with a fair value of $1.90. The Company estimated the fair value using the Black-Scholes model with a risk free interest rate of 1.9%, expected volatility of 82%, and an expected term of 5.94 years.  During the nine months ended September 30, 2010, there were 381,500 option shares granted with an average fair value of $1.82. Also during the nine months ended September 30, 2010, the Company modified an award for a terminated employee by extending the term on 40,000 shares for an additional one year period expiring in April 2011.  The fair value of the modification was $1.06 per share and it was estimated using the Black-Scholes model with a risk free interest rate of 0.46% and expected volatility of 95%. For the three months ended September 30, 2011, there were no option shares granted.
 
The following table summarizes the stock option activity for the nine months ended September 30, 2011:

   
Number of
Shares
   
Weighted
Average
Exercise
Price
   
Remaining
Contractual
Life (Years)
   
Aggregate
Intrinsic
Value
 
Outstanding, December 31, 2010
   
1,995,280
   
$
4.18
     
7.52
   
 $
446,501  
 
Granted (Unaudited)
   
295,000
   
$
2.27
                 
Exercised (Unaudited)
   
(4,314
 
$
                 
Forfeited (Unaudited)
   
(289,035
 
$
2.71
                 
Outstanding, September 30, 2011 (Unaudited)
   
1,996,931
   
$
3.77
     
7.48
   
$
191,332
 
Exercisable, September 30, 2011 (Unaudited)
   
1,211,359
   
$
4.75
     
6.63
   
$
120,260
 
 
Information about stock-based compensation included in the results of operations for the three and nine months ended September 30, 2010 and 2011 are as follows:
  
   
Three Months Ended
 September 30,
   
Nine Months Ended
 September 30,
 
   
(Unaudited)
   
(Unaudited)
 
  
 
2010
   
2011
   
2010
   
2011
 
Cost of revenue
 
$
78,916
   
$
61,395
   
$
138,100
   
$
208,672
 
     Research and development
   
8,051
     
10,951
     
19,029
     
37,221
 
Sales and marketing
   
53,976
     
5,521
     
53,976
     
18,765
 
General and administrative
   
173,340
     
128,852
     
313,185
     
439,113
 
Totals
 
$
314,283
   
$
206,719
   
$
524,290
   
$
703,771
 
 
8. Common Stock Warrants>
 
The Company issues warrants to purchase common shares of the Company either as compensation for services, or as additional incentive for investors who may purchase common stock. The value of warrants issued for compensation is accounted for as a non-cash expense to the Company at the fair value of the warrants issued.

In June 2007, in conjunction with the initial public offering, the Company issued 100,000 warrants to purchase 100,000 shares of its common stock at an exercise price of $7.70 to the underwriters as part of the initial public offering.

There were no warrants granted during the three and nine months ended September 30, 2010 and 2011.  As of September 30, 2011, all of the warrants were outstanding and exercisable and had a remaining contractual life of nine months.
 
 
15

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
9. Income Taxes
 
Deferred income taxes result from temporary differences between income tax and financial reporting computed at the effective income tax rate. The Company has established a valuation allowance against its net deferred tax asset due to the uncertainty surrounding the realization of such asset. Management periodically evaluates the recoverability of the deferred tax assets. At such time it is determined that it is more likely than not that deferred tax assets are realizable, the valuation allowance will be reduced.
 
We file U.S. federal, U.S. state, and foreign tax returns. Our major tax jurisdictions are U.S. federal and the State of California and are subject to tax examinations for the open years from 2007 through September 2011.
 
10. Related Party Transactions
 
While employed at USC, Kathleen Danenberg, former Chief Executive Scientific and Technology Officer and director, developed and patented an extraction method that allowed reliable and consistent isolation of RNA from FFPE suitable for RT-PCR. USC retains ownership of this patent but has exclusively licensed this technology to the Company. In consideration for this license, the Company is obligated to pay royalties to USC, as a percentage of net sales of products or services using the technology, and to meet a certain minimum in royalty payments. Pursuant to USC policy, the inventors of technology owned by the University and then licensed for commercialization are paid a portion of royalties received by the University from the licensed technology. USC therefore pays a portion of royalties received from the Company to Mrs. Danenberg in recognition of her invention. For nine months ended September, 2010, Mrs. Danenberg was paid $32,758. No amounts were paid during the three months ended September 30, 2010. For the three months ended September 30, 2011, Mrs. Danenberg was paid $106,950 and for the nine months ended Mrs. Danenberg was paid $261,599.
 
11. Segment Information
 
The Company operates in a single reporting segment, with an operating facility in the United States.
 
The following enterprise wide disclosure was prepared on a basis consistent with the preparation of the consolidated financial statements. The following tables contain certain financial information by geographic area:
 
   
Three Months Ended
 September 30,
   
Nine Months Ended
 September 30,
 
Net Revenue:
 
2010
   
2011
   
2010
   
2011
 
   
(Unaudited)
   
(Unaudited)
 
United States
 
$
3,443,741
   
$
3,833,037
   
$
9,524,470
   
$
12,740,800
 
Europe
   
 1,617,933
     
1,109,112
     
4,055,242
     
4,186,385
 
Japan
   
512,975
     
158,500
     
1,334,500
     
803,600
 
  
 
$
5,574,649
   
$
5,100,649
   
$
14,914,212
   
$
17,730,785
 

 
Long-lived assets:
  
December 31,
2010
  
  
September 30,
2011
(Unaudited)
 
United States
 
$
805,817
   
$
1,080,411
 
 
 
16

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
 
There are no current operations in the U.K. subsidiary. The operating costs related to the U.K. subsidiary were $10,799 and $3,325 for the three months ended September 30, 2010 and 2011, respectively, and $18,190 and $17,346 for the nine months ended September 30, 2010 and 2011, respectively, included in the general and administrative expenses in the accompanying statements of operations.

13. Issuance of Stock
 
Equity Raises:

On May 6, 2011, the Company issued 1,175,512 shares of its common stock at a price of $1.99 per share in a registered direct public offering to certain institutional investors and received net proceeds of approximately $2.2 million from the sales, after deducting its estimated offering expenses. The securities issued with this financing were registered under the Securities and Exchange Act of 1933, as amended. The shares were issued pursuant to a prospectus supplement dated May 4, 2011 and an accompanying prospectus dated January 6, 2011, pursuant to the Company’s existing effective shelf registration statement on Form S-3 (File No. 333-171266), which was filed with the Securities and Exchange Commission on December 17, 2010 and declared effective by the SEC on January 6, 2011. 

Common stock classified outside of stockholders’ equity (deficit)

On July 22, 2009, the Company entered into a Purchase Agreement with certain funds managed by Lansdowne Partners Limited Partnership for the private placement of 3,057,907 newly-issued shares of the Company's common stock at a per share price of $1.30. The closing of the sale of the shares occurred on July 22, 2009.  The aggregate offering price of the shares was approximately $4 million and the Company received the funds on July 23, 2009.  In connection with the acquisition of the shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of the Company’s capital stock, subject to various exceptions and limitations.

Pursuant to the Lansdowne Registration Rights Agreement which is dated July 22, 2009, the Company filed a registration statement with the SEC to register the 3,057,907 shares sold to Lansdowne for resale, which became effective on November 3, 2009 and which registration statement is currently effective.

Under the Lansdowne Registration Rights Agreement, the Company was required to have the registration statement declared effective within 120 days after the private placement closed.  In addition, the Company is obligated to use commercially reasonable efforts (i) to cause the registration statement described above to remain continuously effective and (ii) to maintain the listing of the Company’s common stock on NASDAQ or other exchanges, as defined, for a period that will terminate on the earlier of July 22, 2012 or the date on which Lansdowne has sold all of its shares of common stock.  The Company is also required to file with the SEC in a timely manner all reports and other documents required of the Company under the 1934 Act. In the event the Company fails to satisfy its obligations under the Lansdowne Registration Rights Agreement, the Company would be in breach of said agreement, in which event Lansdowne would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief.  The Lansdowne Registration Rights Agreement does not provide an explicitly stated or defined penalty due upon a breach.  Because (i) the potential penalty for any breach of the Lansdowne Registration Rights Agreement is not explicitly stated or defined, which prohibits the Company from applying the guidance of ASC 825-20-15, Registration Payment Arrangements and (ii) complying will all filing requirements under the 1934 Act as described above is not solely within the Company’s control, the Company is required to present Lansdowne’s investment of $3,975,279 in the Company’s common stock as common stock outside of stockholders’ equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.
 
On March 5, 2010, the Company entered into a Purchase Agreement with certain affiliates of and funds managed by Lansdowne Partners Limited Partnership, Greenway Capital Partners and Paragon Associates for the private placement of 3,005,349 newly-issued shares of our common stock at a per share price of $1.31.  The closing of the sale of the shares occurred on Friday, March 5, 2010.  In connection with the acquisition of the shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of the Company’s capital stock, subject to various exceptions and limitations.  Lansdowne participated in the Private Placement by electing to exercise the preemptive rights granted to it pursuant to the Purchase Agreement by and between the Company and Lansdowne, dated July 22, 2009.  Net proceeds received from this financing were approximately $3,879,403.
 
In connection with the private placement, the Company also entered into a Registration Rights Agreement, dated March 5, 2010, with the Purchasers (the “Registration Rights Agreement”) pursuant to which it has agreed to file, within 45 days of the closing of the Private Placement, a registration statement with the SEC to register the shares for resale, which registration statement is required to become effective within 120 days following the closing.  The Company also granted certain "piggyback" registration rights to the Purchasers which are triggered if the Company proposes to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the shares or the shares become eligible for sale under Rule 144(b)(1) without restriction.
 
 
17

 
 
RESPONSE GENETICS, INC.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

13. Issuance of Stock – (continued)

Under the Registration Rights Agreements with the Purchasers, the Company is obligated to use commercially reasonable efforts to (i) cause the registration statements described above to remain continuously effective and (ii) to maintain the listing of Company’s common stock on NASDAQ or other exchanges, as defined, for a period that will terminate on the earlier of March 5, 2013 or the date on which the Purchasers have sold all shares of common stock.  The Company is also required to file with the SEC in a timely manner all reports and other documents required of the Company required of the Company under the 1934 Act.  In the event the Company fails to satisfy its obligations under the registration rights agreements, the Company would be in breach of said agreements, in which event, the Purchases would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief. These registration rights agreements do not provide an explicitly stated or defined penalty due upon a breach.  Because (i) the potential penalty for any breach of these Registration Rights Agreement is not explicitly stated or defined, which prohibits the Company from applying the guidance of ASC 825-20-15, Registration Payment Arrangements and (ii) complying with all filing requirements under the 1934 Act as described above is not solely within the Company’s control, the Company  is required to present the investment of approximately $3,879,403 in the Company’s common stock as common stock outside of stockholders’ equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.

As of December 31, 2010 and September 30, 2011, $7,854,682 of common stock was classified outside of stockholders’ equity (deficit).

14. Fair Value Measurements

On January 1, 2009, the Company adopted ASC 820 Fair Value Measurements and Disclosures which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.  ASC 820 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The first two inputs are considered observable and the last unobservable, that may be used to measure fair value and include the following:

Level 1 - Quoted prices in active markets for identical assets or liabilities.
 
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

As of September 30, 2011, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis, including its cash and cash equivalents. The fair value of these assets and liabilities was determined using the following inputs in accordance with ASC 820 at September 30, 2011:

   
Fair Value Measurement as of September 30, 2011
  
  
 
Total
  
Level 1
  
  
Level 2
  
  
Level 3
 
Description
 
$
 
$
   
$
   
$
 
Money market accounts (1)
 
10,000
   
10,000
     
     
 
 

(1)
Included in cash and cash equivalents on the accompanying consolidated balance sheet.
 
15. Subsequent Events>

    On September 23, 2011, Kathleen Danenberg the former Chief Executive Officer and Executive Scientific and Technology Officer resigned from employment with the company, effective October 7, 2011.
 
 
18

 

Item 2: Managements Discussions and Analysis
 
Special Note Regarding Forward Looking Statements
 
Certain statements in this report constitute “forward-looking statements.” These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance, or achievements of Response Genetics, Inc. to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Specifically, the actions of competitors and customers and our ability to execute our business plan, and our ability to increase revenues is dependent upon our ability to continue to expand our current business and to expand into new markets, general economic conditions, and other factors. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues,” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligations to publicly update or review any forward-looking statements, whether as a result of new information, future developments or otherwise.

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and related notes to the financial statements included elsewhere in this Quarterly Report on Form 10-Q as of September 30, 2011 and our audited financial statements for the year ended December 31, 2010 included in our Annual Report on Form 10-K previously filed with the SEC. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward looking statements.
 
Overview
 
Response Genetics, Inc. (the “Company”) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin wax. In August 2000, we changed our name to Response Genetics, Inc. In November 2006, we established Response Genetics Ltd., a wholly owned subsidiary in Edinburgh, Scotland. On February 9, 2009 we implemented a reduction of workforce pursuant to which we closed our subsidiary in Edinburgh. See "liquidity and capital resources" for additional information.

Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. Our pharmacogenomic analysis of clinical trial specimens for the pharmaceutical industry may provide data that will lead to a better understanding of the molecular basis for response to specific drugs and, therefore lead to individualized treatment. We are focusing our efforts in the following areas:
 
 
Continued commercialization of our ResponseDX ™ tests;
     
 
•  
Developing additional diagnostic tests for assessing the risk of cancer recurrence, prediction of chemotherapy response and tumor classification in cancer patients; and
 
 
•  
Expanding our pharmacogenomic testing services business into and creating a standardized and integrated testing platform in the major markets of the healthcare industry, including outside of the United States.
 
Our patented technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, specimens and thereby to analyze genetic information contained in these tissues. This is significant because the majority of patients diagnosed with cancer have a tumor biopsy sample stored in paraffin, while only a small percentage of patients’ tumor specimens are frozen. Our technologies also enable us to use the FFPE patient biopsies for the development of diagnostic tests. To our knowledge, we were the first company to generate clinically relevant information regarding the risks of recurrence of cancer or chemotherapy response using approximately 30,000 genes available from microarray profiling of FFPE specimens.
 
 
19

 
 
ResponseDX™
 
The outcome of cancer chemotherapy is highly variable due to genetic differences among patients. Some patients respond well with tumor shrinkage and increase in life span. Other patients do not obtain benefit from the same therapy but may still experience toxic side effects as well as delay in effective treatment and psychological trauma.

At present, most chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However, recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients’ tissues that may predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we are developing genetic tests that will measure predictive factors for tumor response in tumor tissue samples. We have begun offering tests for non-small cell lung cancer (NSCLC) (ResponseDX:Lung™ ),  colorectal cancer (CRC) (ResponseDX:Colon™), melanoma (ResponseDX:Melanoma™) and gastric and gastro esophageal (GE) cancer  (ResponseDX: Gastric™) patients’ tumor tissue through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 (CLIA), and we anticipate offering additional tests for ovarian and pancreatic cancer in the future. These tests are proprietary based tests which serve to help oncologists make optional therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among chemotherapy regimens to treat their cancer patients. Currently, our recently formed sales team has been expanded to 18 sales people located in the West Coast, Midwest, and East Coast areas of the United States.

Diagnostic Tests for Other Cancers
 
In addition to ResponseDX:Lung, ResponseDX:Colon, ResponseDX: Gastric and ResponseDX:Melanoma, we are developing and intend to commercialize tests for other types of cancer that identify genetic profiles of tumors that are more aggressive and recur rapidly after surgery. We also are identifying genetic profiles of tumors that are more or less responsive to a particular chemotherapy. Following the development of tests to predict the risk of recurrence after surgery, we intend to develop tests to determine the most active chemotherapy regimen for the individual patient at risk. Once developed and after obtaining any necessary regulatory approvals, we intend to leverage our relationships in the healthcare industry to market, sell or license these tests as a means for physicians to determine the courses of cancer treatment

Expansion of our pharmacogenomic testing services business
 
We have started the expansion of our pharmacogenomic testing services business into major markets of the healthcare industry outside of the United States. We have a service laboratory in Japan and in China, through collaboration with some of our current clients in the pharmaceutical industry. The pharmaceutical industry is in need of standardized integrated worldwide analysis of clinical trial specimens. It is important to the pharmaceutical industry and the regulatory agencies that the same analytical methods are used for each clinical trial sample around the world so that the data can be easily compared and used for global drug development. Also, export of clinical trial specimens to the United States is restricted from some areas of the world, such as China. Our goal is to offer an analysis of patient specimens and generate consistent data based on integrated common platforms and technology into the major markets of the healthcare industry including outside of the United States.

There are no assurances that we will be able to continue making our current ResponseDX tests available, or make additional ResponseDX tests available; will be able to develop and commercialize tests of other types of cancer; or will be able to expand our pharmacogenomic testing service business.


Research and development expenses represented 4.8% and 7.0% of our total operating expenses for the three months ended September 30, 2010 and 2011, respectively, and 6.9% and 4.3% for the nine months ended September 30, 2010 and 2011, respectively. Major components of the $319,271 and $452,734 in research and development expenses for the three months ended September 30, 2010 and 2011, respectively, and $1,279,501 and $838,622 for the nine months ended September 30, 2010 and 2011, respectively,  included supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees,  insurance, business consulting and sample procurement costs.
 
 
20

 
 
Critical Accounting Policies and Significant Judgments and Estimates
 
This discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differ materially from those estimates under different assumptions or conditions. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our financial statements.

Revenue Recognition
 
Revenues are derived from services provided to pharmaceutical companies and from revenues generated from our ResponseDX tests. Revenue is recognized in accordance with ASC 605-10-S99 Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered.  We record revenues when our tests have confirmed results which is evidence that the services have been performed; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

Revenues from pharmaceutical company contracts are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through our laboratory under a specified contractual protocol. Certain contracts have minimum assay requirements that, if not met, result in payments that are due upon the completion of the designated period. In these cases, revenues are recognized when the end of the specified contract period is reached.
 
On occasion, we may enter into a contract that requires the client to provide an advance payment for specimens that will be processed at a later date. In these cases, we record this advance as deferred revenue and recognize the revenue as the specimens are processed or at the end of the contract period, as appropriate.
 
Starting July 1, 2011 the Company transitioned from our former billing provider to a new billing provider, Xifin. This new provider allows the Company to process the billing and cash receipts in house as opposed to outsourcing as was the previous practice. The Company recognizes all product revenue from its ResponseDX tests on an accrual basis. ResponseDX Private Payor and Medicare revenue are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. Xifin updates historical collection percentages on a monthly basis. Our Medicare provider number allows us to invoice and collect from Medicare. Our invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT).

We are subject to potentially significant variations in the timing of revenue recognized from period to period due to a variety of factors including: (1) the timing of when specimens are submitted to us for testing; and (2) the specific terms, such as minimum assay requirements in any given period, advance payment requirements, and terms of agreements, as set forth in each contract we have with significant clients.
 
License Fees
 
We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from USC in exchange for royalty fees on revenue generated by use of this technology. These royalties are calculated as a fixed percentage of revenue that we generate from use of the technology licensed from USC. Total license fees expensed in cost of revenue under the royalty agreement to USC were $142,594 and $123,873 for the three months ended September 30, 2010 and 2011, respectively, and $380,263 and $382,685 for the nine months ended September 30, 2010 and 2011, respectively. We also maintain a non-exclusive license to use Roche’s polymerase chain reaction (PCR), homogenous PCR, and reverse transcription PCR processes. We pay Roche a fixed percentage royalty fee for revenue that we generate through use of this technology. Royalties expensed in cost of revenue under this agreement totaled $148,144 and $116,867 for the three months ended September 30, 2010 and 2011, respectively, and $359,507 and $425,232 for the nine months ended September 30, 2010 and 2011, respectively.

We are subject to potentially significant variations in royalties recorded in any period. While the amount paid is based on a fixed percentage from revenues of specific tests pursuant to terms set forth in the agreements with USC and Roche, the amount due is calculated based on the revenue we recognize using the respective licensed technology. As discussed above, this revenue can vary from period to period as it is dependent on the timing of the specimens submitted by our clients for testing.
 
 
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Accounts Receivable
 
We invoice our pharmaceutical clients as specimens are processed and any other contractual obligations are met. Our contracts with pharmaceutical clients typically require payment within 45 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, our clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal and there is no allowance for doubtful accounts for our pharmaceutical revenue at either December 31, 2010 or September 30, 2011.
 
We bill Medicare and Private Payors for ResponseDX upon completion of the required testing services. As such, we take assignment of benefits and the risk of collection with Medicare and Private Payors. We continue to monitor the collection history for Medicare and Private Payors.  Based on the historical experience for our Medicare accounts, we have determined that billings over one year old are unlikely to be collected.  Therefore, we have recognized bad debt expense and reduced our receivables by $160,952 for the three months ending September 30, 2011, the Company did not recognize any bad debt for the three months ended September 30, 2010. For the nine months ended September 30, 2010 and 2011, the Company recognized bad debt in the amount of $132,186 and $460,883, respectively.

We cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and financial health of specific customers. We consider all available information in our assessments of the adequacy of the reserves for uncollectible accounts. 

Line of Credit
 
 
     On July 14, 2011 the company received a line of credit from Silicon Valley Bank. The line of credit is collateralized with the pharmaceutical receivables the company has recorded. The maximum amount that can be borrowed from the credit line is $3,000,000. As needed, from time to time the Company plans to draw on this line for use for general corporate purposes and repay the funds when available. As of September 30, 2011 we have not drawn any funds from the line of credit.

Income Taxes
 
We estimate our tax liability through calculations we perform for the determination of our current tax liability, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded in our balance sheets. Our management then assesses the likelihood that deferred tax assets will be recovered in future periods through future operating results. To the extent that we cannot conclude that it is more likely than not that the benefit of such assets will be realized, we establish a valuation allowance to adjust the net carrying value of such assets. The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income, based on management’s estimates and assumptions. These estimates and assumptions take into consideration future taxable income and ongoing feasible tax strategies in determining recoverability of such assets. Our valuation allowance is subject to significant change based on management’s estimates of future profitability and the ultimate realization of the deferred tax assets. The Company has established a full valuation allowance against its net deferred tax assets due to the uncertainty surrounding the realization of such assets.

Results of Operations
 
Quarters Ended September 30, 2011 and September 30, 2010
 
Revenues:  Revenues were $5,100,649 for the quarter ended September 30, 2011, as compared to $5,574,649 for the quarter ended September 30, 2010, a decrease of $474,000, or 8.5%. The decrease was primarily due to decreases in pharmaceutical revenues of $808,166 offset by an increase in ResponseDX revenue of $358,029. For the quarter ended September 30, 2011, our two most significant pharmaceutical customers accounted for approximately 29% of our revenue, as compared to approximately 32% of our revenue for the quarter ended September 30, 2010.
 
Cost of Revenues:   Cost of revenues for the quarter ended September 30, 2011 were $2,538,176 as compared to $2,738,693 for the quarter ended September 30, 2010, a decrease of $200,517 or 7.3%.  This decrease resulted primarily from decreases in personnel costs of $122,902, temporary help costs of $17,514, relocation expense of $47,695 and royalty costs of $56,086 offset by increases in lab supplies and reagents of $123,030. Cost of revenues as a percentage of revenues was 49.8% for the quarter ended September 30, 2011, as compared to 49.1% for the quarter ended September 30, 2010, an increase of 0.7%.  
 
Research and Development Expenses:  Research and development expenses were $452,734 for the quarter ended September 30, 2011, as compared to $319,271 for the quarter ended September 30, 2010, an increase of $133,463 or 41.8%.  This increase resulted primarily from increases in personnel costs of $45,869, and reagent and lab supply costs of $54,106. Research and development expenses increased during this quarter, as a result of providing validation testing for our largest pharmaceutical customer, and we continue to expect research and development expenses to continue to increase as we continue work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

General and Administrative Expenses:  General and administrative expenses were $2,268,517 for the quarter ended September 30, 2011, as compared to $2,021,654 for the quarter ended September 30, 2010, an increase of $246,863 or 12.2%.  This increase resulted primarily from increases in personnel costs of $125,713, billing services of $70,697, consulting of $49,894, business taxes of $11,283, an asset impairment of $157,241 and bad debt of $160,952, offset by a decrease in legal costs of $365,363.   

Sales and Marketing Expenses:  Sales and marketing expenses were $1,251,054 for the quarter ended September 30, 2011, as compared to $1,554,430 for the quarter ended September 30, 2010, a decrease of $303,376 or 19.5%.  The decrease primarily resulted from decreased sales and marketing activities for ResponseDX, which included decreases in travel costs of $3,492, speaker fees of $19,600, advertising of $205,425, promotional events of $23,877, exhibit costs of $22,329, personnel costs of $22,174 and legal fees of $14,390. We expect that sales and marketing costs will increase as we expand our sales and marketing activities in order to gain clinical acceptance of our ResponseDX assays.
 
 
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Interest Income:  Interest income was $96 for the quarter ended September 30, 2011, compared with $185 for the same period in 2010. This $89 decrease was due to lower rates of return during the period ending September 30, 2011.
 
Income Taxes:   As of September 30, 2011 and 2010, there is no income tax due and a full valuation allowance has been recorded for the deferred tax assets since we do not believe the recoverability of the deferred income tax assets in the near future is more likely than not.

Nine Months Ended September 30, 2011 and September 30, 2010
 
Revenues:  Revenues were $17,730,785 for the nine months ended September 30, 2011, as compared to $14,914,212 for the nine months ended September 30, 2010, an increase of $2,816,573, or 18.9%.     The increase was primarily due to increases in ResponseDX revenue of $1,212,196 and pharmaceutical revenues of $2,226,927.    For the nine months ended September 30, 2011, our two most significant pharmaceutical customers accounted for approximately 40% of our revenue, as compared to approximately 33% of our revenue for the nine months ended September 30, 2010.

Cost of Revenues:   Cost of revenues for the nine months ended September 30, 2011 were $8,040,003 as compared to $7,392,756 for the nine months ended September 30, 2010, an increase of $647,247 or 8.8%.  This increase resulted primarily from increases in personnel and temporary help costs of $950,573, consultation costs of $459,878, and royalties of $239,637. Cost of revenues as a percentage of revenues was 45.3% for the nine months ended September 30, 2011, as compared to 49.6% for the nine months ended September 30, 2010, a decrease of 4.3%.  

Research and Development Expenses:  Research and development expenses were $838,622 for the nine months ended September 30, 2011, as compared to $1,279,501 for the nine months ended September 30, 2010, a decrease of $440,879 or 34.5%.  This decrease resulted primarily from decreases in personal costs of $448,095, lab supplies and reagent costs of $173,726 and legal costs of $92,398. Even though research and development expenses decreased during this nine month period, we expect research and development expenses to increase as we continue work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

General and Administrative Expenses:  General and administrative expenses were $6,493,079 for the nine months ended September 30, 2011, as compared to $5,417,635 for the nine months ended September 30, 2010, an increase of $1,075,444 or 19.9%.  This increase resulted primarily from increases in personnel costs of $657,540, business travel of $46,031, billing services of $253,546, business taxes of $153,265, an asset impairment of $157,241 and bad debts of $433,111, offset by a decrease in legal costs of $580,949 and insurance costs of $13,358. 

Sales and Marketing Expenses:  Sales and marketing expenses were $4,107,640 for the nine months ended September 30, 2011, as compared to $4,395,400 for the nine months ended September 30, 2010, a decrease of $287,760 or 6.5%.  The decrease primarily resulted from decreases in business travel of $25,052, speaker fees of $141,542, medical meetings of $36,560, advertising of $305,062, promotional events of $74,538 and legal services of $67,672, offset by increases in personnel costs of $418,997 which includes an increase of $168,550 in recruiting costs. The Company heavily recruited to increase the size of the sales force in the second and third quarters of 2011. We expect that sales and marketing costs will continue to increase as we expand our sales and marketing activities in order to gain clinical acceptance of our ResponseDX assays.

United Kingdom ( U.K ) Expenses:  The costs related to our UK subsidiary were $17,346 for the nine months ended September 30, 2011 compared to $18,190 for the same comparable period in 2010. For presentation purposes the amount of expense for the U.K. subsidiary is included in general and administrative expenses in the accompanying statement of operations. 

Interest Income:  Interest income was $162 for the nine months ended September 30, 2011, compared with $448 for the same period in 2010. This $286 decrease was due to lower rates of return during the nine month period ending September 30, 2011.
 
Income Taxes:   As of September 30, 2011 and 2010, there were no income taxes due and a full valuation allowance has been recorded for the deferred tax assets since we do not believe the recoverability of the deferred income tax assets in the near future is more likely than not.
 
Liquidity and Capital Resources
 
We incurred net losses of $1,061,916 and $1,415,540 during the quarters ended September 30, 2010 and 2011, respectively. Since our inception in September 1999, we have incurred cumulative losses and as of September 30, 2011, we had an accumulated deficit of $45,576,937. We have not yet achieved profitability and anticipate that we will likely incur additional losses.  We cannot provide assurance as to when will achieve profitability. We expect that our cash and cash equivalents will be used to fund our selling and marketing activities primarily related to our ResponseDX tests, research and development, and general corporate purposes. As a result, we will need to generate significant revenues to achieve profitability.  Management expects that cash on the balance sheet plus cash generated from operations will be sufficient to meet current obligations through at least the third quarter of 2012. Nevertheless, until we can generate and maintain sufficient revenues to finance our cash requirements, which we may never do, we expect to finance additional cash needs primarily through public or private equity offerings, strategic collaborations, our line of credit and other financing opportunities as they may arise.  We do not know whether additional funding will be available on acceptable terms, if at all.  If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate selling and marketing activities or research and development programs.

In addition, we expect to use our capital to fund research and development and to make capital expenditures to keep pace with the expansion of our research and development programs and to scale up our commercial operations. The amount and timing of actual expenditures may vary significantly depending upon a number of factors, such as the progress of our product development, regulatory requirements, commercialization efforts, and the amount of cash used by operations. We expect that we will continue to generate revenue through our pharmacogenomic testing services and through ResponseDX testing services business provided to pharmaceutical clients and to the users of our ResponseDX testing services which partially include oncologists, hospitals, and cancer care centers.  These revenues are not guaranteed and are not expected to substantially offset the costs associated with our expansion efforts.
 
 
23

 
 
Issuance of Stock
 
Equity Raises:

On May 6, 2011, the Company issued 1,175,512 shares of its common stock at a price of $1.99 per share in a registered direct public offering to certain institutional investors and received net proceeds of approximately $2.2 million from the sales, after deducting its estimated offering expenses. The securities issued with this financing are registered under the Securities and Exchange Act of 1933, as amended. The shares were issued pursuant to a prospectus supplement dated May 4, 2011 and an accompanying prospectus dated January 6, 2011, pursuant to the Company’s existing effective shelf registration statement on Form S-3 (File No. 333-171266), which was filed with the Securities and Exchange Commission on December 17, 2010 and declared effective by the SEC on January 6, 2011. 
 
Common stock classified outside of stockholders’ equity (deficit)

On July 22, 2009, we entered into a Purchase Agreement with certain funds of Lansdowne Partners Limited for the private placement of 3,057,907 newly-issued shares of the Company's common stock at a per share price of $1.30. The closing of the sale of the Shares occurred on July 23, 2009. The aggregate offering price of the shares was approximately $4 million.  In connection with the acquisition of the Shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of the Company’s capital stock, subject to various exceptions and limitations. We received the funds on July 23, 2009.
 
Pursuant to the Lansdowne Registration Rights Agreement which is dated July 22, 2009, the Company filed a registration statement with the SEC to register the 3,057,907 shares sold to Lansdowne for resale, which became effective on November 3, 2009 and which registration statement is currently effective.
 
Under the Lansdowne Registration Rights Agreement, the Company was required to have the registration statement declared effective within 120 days after the private placement closed.  In addition, the Company is obligated to use commercially reasonable efforts (i) to cause the registration statement described above to remain continuously effective and (ii) to maintain the listing of the Company’s common stock on NASDAQ or other exchanges, as defined, for a period that that will terminate on the earlier of July 22, 2012 or the date on which Lansdowne has sold all of its shares of common stock.  The Company is also required to file with the SEC in a timely manner all reports and other documents required of the Company under the 1934 Act. In the event the Company fails to satisfy its obligations under the Lansdowne Registration Rights Agreement, the Company would be in breach of said agreement, in which event Lansdowne would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief.  The Lansdowne Registration Rights Agreement does not provide an explicitly stated or defined penalty due upon a breach.  Because (i) the potential penalty for any breach of the Lansdowne Registration Rights Agreement is not explicitly stated or defined, which prohibits the Company from applying the guidance of ASC 825-20-15, Registration Payment Arrangements and (ii) complying will all filing requirements under the 1934 Act as described above is not solely within the Company’s control, the Company is required to present Lansdowne’s investment of $3,975,279 in the Company’s common stock as common stock outside of stockholders’ equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.
 
On March 5, 2010, we entered into a Purchase Agreement with certain affiliates of and funds managed by Lansdowne Partners Limited Partnership, Greenway Capital Partners and Paragon Associates for the private placement of 3,005,349 newly-issued shares of our common stock at a per share price of $1.31.  The closing of the sale of the shares occurred on Friday, March 5, 2010.  In connection with the acquisition of the shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of our capital stock, subject to various exceptions and limitations.  Lansdowne participated in the Private Placement by electing to exercise the preemptive rights granted to it pursuant to the Purchase Agreement by and between the Company and Lansdowne, dated July 22, 2009. Net proceeds received from this financing were approximately $3,879,403.
 
 
24

 
 
In connection with the Private Placement, we also entered into a Registration Rights Agreement, dated March 5, 2010, with the Purchasers (the “Registration Rights Agreement”) pursuant to which it has agreed to file, within 45 days of the closing of the Private Placement, a registration statement with the SEC to register the shares for resale, which registration statement is required to become effective within 120 days following the closing.  We also granted certain "piggyback" registration rights to the Purchasers which are triggered if we propose to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the shares or the shares become eligible for sale under Rule 144(b)(1) without restriction.
 
Under the Registration Rights Agreements with the Purchasers, the Company is obligated to use commercially reasonable efforts to (i) cause the registration statements described above to remain continuously effective and (ii) to maintain the listing of Company’s common stock on NASDAQ or other exchanges, as defined, for a period that will terminate on the earlier of March 5, 2013 or the date on which the Purchases have sold all shares of common stock.  The Company is also required to file with the SEC in a timely manner all reports and other documents required of the Company required of the Company under the 1934 Act.  In the event the Company fails to satisfy its obligations under the registration rights agreements, the Company would be in breach of said agreements, in which event, the Purchases would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief. These registration rights agreements do not provide an explicitly stated or defined penalty due upon a breach.  Because (i) the potential penalty for any breach of these Registration Rights Agreement is not explicitly stated or defined, which prohibits the Company from applying the guidance of ASC 825-20-15, Registration Payment Arrangements and (ii) complying with all filing requirements under the 1934 Act as described above is not solely within the Company’s control, the Company  is required to present the investment of approximately $3,900,000 in the Company’s common stock as common stock outside of stockholders’ equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.

Comparison of Cash Flows for the Nine Months Ended September 30, 2011 and 2010
 
As of September 30, 2011, we had $2,532,009 in cash and cash equivalents, working capital of $4,771,573 and an accumulated deficit of $45,576,937.
 
Cash flows used in operating activities
 
During the nine months ended September 30, 2011, the Company used cash flows in operating activities of $3,316,714 compared to $5,203,648 used in the nine months ended September 30, 2010. The reasons for the decrease in cash used in operating activities of $1,886,934 was due mainly to the decrease in net loss for the period ending September 30, 2011 increase in accrued account receivable, offset by the decrease in accrued expenses.
 
The increase in accounts receivable of $823,671 related to an increase in revenue for the quarter from the Company’s pharmaceutical clients and from the ResponseDX sales increases.
 
The decrease in accrued expenses of $787,047 relates to a decrease in the amount of accrued business taxes and other payments that the company has incurred but are not yet payable.
 
Cash flows used in investing activities
 
Net cash used in investing activities was $357,154 for the nine months ended September 30, 2011 and $308,904 for the nine months ended September 30, 2010.  This increase was attributable to the additional need for capital equipment purchases in our laboratories.
 
Cash flows provided by financing activities
 
Cash flows from financing activities for the nine months ended September 30, 2011 provided net cash of $2,168,905 relating to the sale of common stock and payments of the leasing of capital equipment.  Cash flows from financing activities for the nine months ended September 30, 2010 provided net cash of $3,897,795 relating to the sale of common stock.  
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements.
 
 
25

 
 
Recent Accounting Pronouncements
 
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements, amends FASB ASC 820-10, Fair Value Measurements and Disclosures, and requires new disclosures about transfers into and out of Level 1 and 2 of the fair value hierarchy and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements.  It is effective for interim and annual reporting periods beginning after December 15, 2009, except for the Level 3 measurement disclosures, which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  Early adoption is permitted. The partial adoption of this guidance did not have a material effect on our results of operations or financial position with the adoption of the remaining portion of this not expected to have a material effect.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition — Milestone Method (Topic 605): Milestone Method of Revenue Recognition”. This ASU provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. The updated guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Entities may elect to adopt the amendments in the ASU retrospectively for all prior periods. The adoption of this guidance did not have a material effect on our consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13 establishes a selling-price hierarchy for determining the selling price of each element within a multiple-deliverable arrangement. Specifically, the selling price assigned to each deliverable is to be based on vendor-specific objective evidence (VSOE) if available, third-party evidence, if VSOE is unavailable, and estimated selling prices if neither VSOE or third-party evidence is available. In addition, ASU 2009-13 eliminates the residual method of allocating arrangement consideration and instead requires allocation using the relative selling price method. ASU 2009-13 will be effective prospectively for multiple-deliverable revenue arrangements entered into, or materially modified, in fiscal years beginning on or after June 15, 2010. The adoption of this guidance did not have a material effect on our results of operation or financial position.

In July 2011, the FASB issued ASU 2011-7, “Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities” (“ASU2011-7”). In accordance with ASU 2011-7, the Company will be required to present its provision for doubtful accounts related to patient service revenue as a deduction from revenue, similar to contractual discounts. Accordingly, the Company’s revenues will be required to be reported net of both contractual discounts as well as its provision for doubtful accounts related to patient service revenues. Additionally, ASU 2011-7 will require the Company to make certain additional disclosures designed to help users understand how contractual discounts and bad debts affect recorded revenue in both interim and annual financial statements. ASU 2011-7 is required to be applied retrospectively and is effective for public companies for fiscal years beginning after December 15, 2011, and interim periods within those fiscal years. Early adoption is permitted. Management is still evaluating the potential effect that the adoption of this guidance will have on the results of operations or our financial position.
 
 
26

 
 
ITEM 3. Qualitative and Quantitative Disclosures about Market Risk.
 
Not applicable as we are a smaller reporting company.
 
ITEM 4. Controls and Procedures.
 
Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
 
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
 
PART II. OTHER INFORMATION
 
ITEM 1. Legal Proceedings.
 
The Company is, from time to time, involved in legal proceedings, regulatory actions, claims and litigation arising in the ordinary course of business. These matters are not expected to have a material adverse effect upon the Company’s financial statements.
 
ITEM 1A. Risk Factors
 
Not applicable as we are a smaller reporting company.
 
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 
None.
 
 
27

 
 
ITEM 3. Defaults Upon Senior Securities.
 
None.
 
ITEM 4. (Removed and Reserved).
 
 
ITEM 5. Other Information.
 
None

31.1
Certification of Principal Executive Officer Pursuant to Section 302.
   
31.2
Certification of Principal Financial Officer Pursuant to Section 302.
   
32
Section 906 certification of periodic financial report by Chief Executive Officer and Chief Financial Officer.
   
EX-101
 
EX-101
 
EX-101
 
EX-101
 
EX-101
 
EX-101
Instance Document
 
Schema Document
 
Calculation Linkbase Document
 
Labels Linkbase Document
 
Presentation Linkbase Document
 
Definition Linkbase Document

 
28

 
 
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.
 
 
RESPONSE GENETICS, INC.
     
DATE: November 11, 2011
By:  
/s/ Denise McNairn
 

Denise McNairn
 
Chief Executive Officer
(Principal Executive Officer)
     
DATE: November 11, 2011
By:  
/s/ David O’Toole
 

David O’Toole
 
Chief Financial Officer
(Principal Financial Officer)
 
 
29

 
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