GENOPTIX INC - FORM 10-Q - November 5, 2009

Attached files

file	filename
EX-31.1 - CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER - GENOPTIX INC	dex311.htm
EX-31.2 - CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER - GENOPTIX INC	dex312.htm
EX-32.1 - CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER - GENOPTIX INC	dex321.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2009

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

For the transition period from to

Commission file number: 001-33753

Genoptix, Inc.

(Exact name of registrant as specified in its charter)

Delaware

33-0840570

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

1811 Aston Avenue

Carlsbad, CA 92008

(Address of principal executive offices, including zip code)

(760) 268-6200

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)


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 (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).		Yes ¨ No ¨

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


Large accelerated filer ¨		Accelerated filer x



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


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

The number of shares outstanding of the registrant’s common stock, $0.001 par value per share, was 17,164,948 as of October 26, 2009.

GENOPTIX, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Quarterly Period Ended September 30, 2009

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements.	3
	Condensed Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31, 2008	3
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (unaudited)	5
	Notes to the Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	27
Item 4.	Controls and Procedures.	27
PART II — OTHER INFORMATION
Item 1A.	Risk Factors.	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 6.	Exhibits.	48
SIGNATURE		49
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

GENOPTIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par values)


	September 30, 2009			December 31, 2008
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	19,865		$	38,108
Short-term investment securities		117,922			64,830
Accounts receivable, net of allowance for doubtful accounts of $4,948 and $4,126 at September 30, 2009 and December 31, 2008, respectively		23,529			15,604
Deferred tax asset		4,735			4,707
Other current assets		2,754			2,179

Total current assets		168,805			125,428
Property and equipment, net		12,759			12,189
Long-term investment security		3,883			3,775
Long-term deferred tax asset		2,347			2,510
Restricted cash		270			360
Other long-term assets		350			183

Total assets	$	188,414		$	144,445


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued expenses	$	9,509		$	6,580
Accrued compensation		7,558			3,006
Income tax payable		95			—
Deferred revenues		1,119			365
Deferred rent		301			241

Total current liabilities		18,582			10,192
Long-term deferred rent		1,766			1,955
Other long-term liabilities		300			79

Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000 shares authorized; no shares issued and outstanding at September 30, 2009 and December 31, 2008		—			—
Common stock, $0.001 par value; 100,000 shares authorized; 17,156 and 16,682 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively		17			17
Additional paid-in capital		155,476			143,616
Treasury stock, at cost; 0 shares and no shares at September 30, 2009 and December 31, 2008, respectively		(11	)		—
Accumulated other comprehensive loss		(354	)		(774	)
Accumulated earnings (deficit)		12,638			(10,640	)

Total stockholders’ equity		167,766			132,219

Total liabilities and stockholders’ equity	$	188,414		$	144,445

See accompanying notes to the condensed consolidated financial statements.

GENOPTIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)


	Three Months Ended September 30,					Nine Months Ended September 30,
	2009		2008			2009		2008
Revenues	$	50,807	$	32,087		$	135,294	$	82,210
Cost of revenues		18,402		12,282			50,603		32,663

Gross profit		32,405		19,805			84,691		49,547
Operating expenses:
Sales and marketing		8,217		5,098			22,538		14,529
General and administrative		7,287		5,786			21,168		16,091
Research and development		522		333			1,049		1,003

Total operating expenses		16,026		11,217			44,755		31,623

Income from operations		16,379		8,588			39,936		17,924
Interest and other income		334		650			1,268		2,302

Income before income taxes		16,713		9,238			41,204		20,226
Income tax expense (benefit)		7,251		(6,190	)		17,926		(5,780	)

Net income	$	9,462	$	15,428		$	23,278	$	26,006


Net income per share:
Basic	$	0.55	$	0.93		$	1.38	$	1.59

Diluted	$	0.53	$	0.87		$	1.30	$	1.48

Shares used to compute net income per share:
Basic		17,089		16,535			16,909		16,336

Diluted		17,965		17,754			17,892		17,616

See accompanying notes to the condensed consolidated financial statements.

GENOPTIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)


	Nine Months Ended September 30,
	2009			2008
Operating activities:
Net income	$	23,278		$	26,006
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,583			878
Provision for doubtful accounts		2,240			2,280
Stock-based compensation expense		7,306			5,156
Excess tax benefits from stock-based compensation awards		(3,403	)		(118	)
Amortization of premium (discount) on investment securities, net		458			(163	)
Deferred taxes		(29	)		(9,519	)
Realized loss on sale of investment		—			66
Loss (gain) on sale of property and equipment		6			(10	)
Changes in operating assets and liabilities:
Accounts receivable		(10,165	)		(9,629	)
Other current and long-term assets		(713	)		(50	)
Accounts payable and accrued expenses		2,922			3,075
Accrued compensation		4,552			2,443
Income taxes		3,756			2,897
Deferred revenues		754			(37	)
Deferred rent		43			149

Net cash provided by operating activities		33,588			23,424


Investing activities:
Purchase of property and equipment		(3,240	)		(6,961	)
Proceeds from sales of property and equipment		—			21
Purchase of investment securities		(120,508	)		(103,605	)
Proceeds from sales and maturities of investment securities		67,434			58,100
Purchase of intangibles		(150	)		—
Change in restricted cash		90			(360	)

Net cash used in investing activities		(56,374	)		(52,805	)


Financing activities:
Proceeds from issuance of common stock, net		1,151			1,177
Excess tax benefits from stock-based compensation awards		3,403			118
Costs paid in connection with public offerings		—			(764	)
Repurchase of common stock		(11	)		—
Proceeds from exercise of warrants		—			35

Net cash provided by financing activities		4,543			566

Net decrease in cash and cash equivalents		(18,243	)		(28,815	)
Cash and cash equivalents at beginning of period		38,108			50,624

Cash and cash equivalents at end of period	$	19,865		$	21,809


Supplemental information:
Income taxes paid	$	14,222		$	842

Interest paid	$	—		$	5


Non-cash investing and financing activities:
Unrealized gain on investment securities, net	$	584		$	1,342

Capitalized tenant improvement allowance	$	—		$	1,285

Change in accrued purchases of property and equipment	$	69		$	248

See accompanying notes to the condensed consolidated financial statements.

GENOPTIX, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Summary of Significant Accounting Policies

Organization

Genoptix, Inc., or the Company, was incorporated in Delaware on January 20, 1999 and does business as Genoptix Medical Laboratory. The Company operates as a certified “high complexity” clinical laboratory in accordance with the federal government’s Clinical Laboratory Improvement Amendments of 1988, or CLIA, and is dedicated to the delivery of clinical diagnostic services to community-based hematologist/oncologist physician customers.

Basis of Presentation and Principles of Consolidation

The Company’s industry is highly regulated. The manner in which licensed physicians can organize to perform and bill for medical services is governed by state laws and regulations. Business corporations, like the Company, often are not permitted to employ physicians to practice medicine or to own corporations that employ physicians to practice medicine or to otherwise exercise control over the medical judgments or decisions of physicians.

The Company provides its medical services through Cartesian Medical Group, or Cartesian, an entity that it manages. Cartesian is the entity that employs the physicians who provide medical services on behalf of the Company. The Company has a controlling financial interest in Cartesian and consolidates the results of Cartesian in accordance with the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC or the Codification, Topic 810, Consolidations (see the Recent Accounting Pronouncements in these Notes to the condensed consolidated financial statements for detailed description of the recently issued FASB ASC).

The Company has prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments have been included and represent only normal recurring adjustments considered necessary for a fair presentation. Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes thereto for the year ended December 31, 2008 included in the Annual Report on Form 10-K filed by the Company with the Securities and Exchange Commission, or SEC, on February 26, 2009. Further, in connection with preparation of the condensed consolidated financial statements and in accordance with the recently issued FASB authoritative guidance for subsequent events, the Company evaluated subsequent events after the balance sheet date of September 30, 2009 through November 5, 2009. Based on the Company’s evaluation, no material events have occurred requiring disclosure.

The condensed consolidated financial statements of the Company include the accounts of the Company, Cartesian and Genoptix, PR LLC, a wholly-owned subsidiary of the Company located in Puerto Rico. All intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and these notes to the condensed consolidated financial statements. The most significant estimates in the Company’s condensed consolidated financial statements relate to revenue recognition, allowance for doubtful accounts, valuation of investment securities, long-lived assets, stock-based compensation expense and income tax. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenues as required by FASB ASC Topic 605, Revenue Recognition, or ASC Topic 605, when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed and collectability of the resulting receivable is reasonably assured.

The Company’s specialized diagnostic services are performed based on a written test requisition form and revenues are recognized once the diagnostic services have been performed, the results have been delivered to the ordering physician, the payor has been identified and eligibility and insurance have been verified. These diagnostic services are billed to various payors, including Medicare, commercial insurance companies, other directly billed healthcare institutions such as hospitals and individuals. The Company reports revenues from contracted payors, including Medicare, certain insurance companies and certain healthcare institutions, based on the contractual rate, or in the case of Medicare, the published fee schedules. The Company reports revenues from non-contracted payors, including certain insurance companies and individuals, based on the amount expected to be collected. The difference between the amount billed and the amount expected to be collected is recorded as a contractual allowance to arrive at the reported revenues. The expected revenues from non-contracted payors are based on the historical collection experience of each payor or payor group, as appropriate. In each reporting period, the Company reviews its historical collection experience for non-contracted payors and adjusts its expected revenues for current and subsequent periods accordingly. During the three months ended September 30, 2009, the Company recorded positive changes in prior period accounting estimates to reduce contractual allowances, which increased its revenues by $4.4 million, of which $3.1 million pertained to the six months ended June 30, 2009. During the nine months ended September 30, 2009, the Company recorded positive changes impacting revenue by $6.4 million. During the three months ended September 30, 2008, the Company recorded similar positive changes in prior period accounting estimates to reduce contractual allowances, which increased its revenues by $2.5 million, of which $1.6 million pertained to the six months ended June 30, 2008. During the nine months ended September 30, 2008, the Company recorded positive changes impacting revenue by $2.2 million. These favorable changes in accounting estimates related primarily to non-contracted payors and resulted from continued improvements to the Company’s collection processes, as well as increased hiring of personnel and management focused on the collection of accounts receivable for services rendered in prior periods and changes in reimbursement policies by certain payors. As of September 30, 2009 and December 31, 2008, the Company had uncollected accounts receivable from non-contracted payors of approximately $13.8 million and $9.1 million, respectively.

Recent Accounting Pronouncements

During the quarter ended September 30, 2009, the Company adopted FASB ASC Topic 105, Generally Accepted Accounting Principles. This standard establishes only two levels of accounting standards, authoritative and non-authoritative. The Codification will become the source of authoritative, non-governmental accounting standards, except for rules and interpretive releases of the SEC, which are sources of authoritative accounting standards for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative. This standard is effective for financial statements issued for interim and annual financial periods ending after September 15, 2009. As the Codification was not intended to change or alter existing accounting standards, the adoption of this new standard did not have an impact on the Company’s condensed consolidated results of operations and financial position.

In August 2009, the FASB issued Accounting Standards Update No. 2009-05, Measuring Liabilities at Fair Value, which provides clarification for circumstances where a quoted market price in an active market for an identical liability is not available. In such circumstances, a reporting entity must measure fair value of the liability using one of the following techniques: 1) the quoted price of the identical liability when traded as an asset; 2) quoted prices for similar liabilities or similar liabilities when traded as assets; or 3) another valuation technique, such as a present value technique or the amount that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability that is consistent with the provisions of FASB ASC Topic 820, Fair Value Measurements and Disclosures, or ASC Topic 820. The adoption of this new standard did not have a material impact on the Company’s consolidated results of operations and financial position.

In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to ASC Topic 605), or ASU No. 2009-13. ASU No. 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for a deliverable will be based on vender-specific objective evidence if available, third party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third party evidence is available. The standard eliminates the residual method of revenue allocation and requires revenue to be allocated using the relative selling price method. This standard is effective for fiscal years beginning after June 15, 2010 and may be applied retrospectively or prospectively for new or materially modified arrangements. Early adoption of ASU No. 2009-13 is permitted. The Company is currently evaluating the potential impact of ASU No. 2009-13 on its condensed consolidated results of operations and financial position.

2. Net Income Per Share

The Company computes net income per share in accordance with FASB ASC Topic 260, Earnings Per Share. Basic earnings per share, or EPS, is calculated by dividing the net income or loss allocable to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed by dividing the net income allocable to common stockholders by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, options, restricted stock units, or RSUs, and unissued employee stock purchase plan, or ESPP, shares are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive.

The net income per share amounts presented below are based on share and net income amounts that are not rounded and, as such, may result in minor differences from the amounts computed based on the equivalent information presented in thousands.

The following table presents a summary of the Company’s basic and diluted EPS:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
	*(in thousands, except per share data)*
Numerator:
Net income	$	9,462	$	15,428	$	23,278	$	26,006

Denominator:
Weighted average shares of common stock outstanding, net - basic		17,089		16,535		16,909		16,336
Dilutive effect of common equivalent shares		876		1,219		983		1,280

Weighted average shares of common stock outstanding, net - diluted		17,965		17,754		17,892		17,616


Net income per share:
Basic	$	0.55	$	0.93	$	1.38	$	1.59

Diluted	$	0.53	$	0.87	$	1.30	$	1.48

For the three and nine months ended September 30, 2009, the Company excluded stock options of approximately 588,000 and 546,000 shares, respectively, from its dilutive common equivalent shares in its calculation of diluted net income per share because of their anti-dilutive effect. Similarly, for the three and nine months ended September 30, 2008, the Company excluded stock options of approximately 76,000 and 87,000 shares, respectively.

3. Stock-Based Compensation

The following table presents a summary of the Company’s recognized stock-based compensation expense in the condensed consolidated statements of operations:


	Three Months Ended September 30,
	2009								2008
	Options		RSUs		ESPP		Total		Options		RSUs		ESPP		Total
	*(in thousands)*
Cost of revenues	$	562	$	232	$	51	$	845	$	318	$	133	$	142	$	593
Sales and marketing		319		19		117		455		139		—		226		365
General and administrative		632		562		51		1,245		447		430		113		990

	$	1,513	$	813	$	219	$	2,545	$	904	$	563	$	481	$	1,948


	Nine Months Ended September 30,
	2009								2008
	Options		RSUs		ESPP		Total		Options		RSUs		ESPP		Total
	*(in thousands)*
Cost of revenues	$	1,510	$	653	$	186	$	2,349	$	676	$	335	$	634	$	1,645
Sales and marketing		819		58		433		1,310		317		—		1,169		1,486
General and administrative		1,769		1,618		260		3,647		852		627		546		2,025

	$	4,098	$	2,329	$	879	$	7,306	$	1,845	$	962	$	2,349	$	5,156

The Company recognizes compensation expense for options and RSUs over the vesting period using the straight-line method and ESPP compensation expense consistent with FASB ASC Topic 718, Compensation, or ASC Topic 718. The Company classifies these amounts in the condensed consolidated statements of operations based on the department to which the related employee reports. The standard vesting period is four years for most option awards and ranges from one to four years for RSU awards. The Company values RSU grants at their intrinsic value. The Company uses the Black-Scholes valuation model to calculate the fair value of stock options and ESPP shares. The fair value of employee stock options and ESPP shares was estimated at the grant date using the following weighted average assumptions:


	Stock Options												ESPP
	Three Months Ended September 30,						Nine Months Ended September 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008			2009			2008			2009			2008
Grant date fair value (per share)	$	14.97		$	16.79		$	15.36		$	14.43		$	10.50		$	11.45		$	11.10		$	14.45

Assumptions:
Expected life of awards (years)		6.08			6.02			6.04			6.01			1.38			1.16			1.19			1.12
Risk-free interest rate		3.04	%		3.27	%		2.09	%		2.92	%		0.80	%		2.38	%		0.63	%		2.83	%
Volatility		49.00	%		48.82	%		50.41	%		51.47	%		44.95	%		37.68	%		49.28	%		37.85	%
Forfeitures		7.00	%		7.00	%		7.00	%		7.00	%		—			—			—			—
Dividend yield		—			—			—			—			—			—			—			—

The Company derived the risk-free interest rate assumption from the U.S. Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The Company based the assumed dividend yield on its expectation of not paying dividends in the foreseeable future. The Company calculated the weighted average expected life of options using the simplified method as prescribed by ASC Topic 718. This decision was based on the lack of relevant historical data due to the Company’s limited operating experience as a public company. In addition, due to the Company’s limited historical data, the estimated volatility also reflects the application of ASC Topic 718, incorporating the historical volatility of comparable companies within the Company’s peer group with publicly available share prices.

ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense recognized during the period is based on the value of the portion of awards that is ultimately expected to vest and thus the gross expense is reduced for estimated forfeitures, if any. For the ESPP, the Company does not utilize a separate forfeiture rate since it adjusts ESPP stock-based compensation expense to the greater of the actual employee contributions or original estimate for the remaining participants at the end of each respective purchase period.

The following table presents a summary of the Company’s outstanding, unvested stock-based awards, adjusted for estimated forfeitures and prior to income taxes:


	September 30, 2009
	Weighted Average Remaining Expense Life	Unrecognized Compensation Expense
	*(years)*	*(in thousands)*
Options	2.78	$	13,733
RSUs	2.03		4,462
ESPP	1.50		427

The following table presents a summary of the Company’s equity incentive plans:


	Shares Available for Issuance Under Equity Incentive Plans		Options Outstanding							RSUs Outstanding
	Shares Available for Issuance Under Equity Incentive Plans		Number of Shares		Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term *(Years)*	Aggregate Intrinsic Value		Number of Shares		Weighted Average Remaining Contractual Term *(Years)*	Aggregate Intrinsic Value
	*(in thousands, except years and per share amounts)*
Balance at December 31, 2008	1,389		1,991		$	12.23	7.38	$	43,596	145		1.08	$	4,953
Additional shares reserved	547		—			—				—
Granted/issued	(742	)	611			30.91				132
Exercised/released	—		(363	)		2.12				(61	)
Cancelled	137		(113	)		28.95				(24	)

Balance at September 30, 2009	1,331		2,126		$	18.43	7.65	$	34,818	192		1.09	$	6,689

Vested and expected to vest at September 30, 2009			1,956		$	17.69	7.54	$	33,490	165		1.00	$	5,747

Exercisable at September 30, 2009			1,040		$	8.53	6.32	$	27,318	—		—	$	—

During the nine months ended September 30, 2009, 50,000 shares were purchased under the ESPP. Additionally, on January 1, 2009, approximately 167,000 shares were automatically added to the shares authorized for issuance under the ESPP as additional shares reserved.

4. Investment Securities

The following table presents a summary of the Company’s available-for-sale investment securities:


	September 30, 2009
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
	*(in thousands)*
Short-term investment securities:
Municipal securities	$	51,814	$	207	$	(3	)	$	52,018
Government-sponsored enterprise securities		43,670		51		(1	)		43,720
Certificates of deposit		12,528		—		—			12,528
Corporate debt securities		9,597		64		(5	)		9,656

	$	117,609	$	322	$	(9	)	$	117,922

Long-term investment security:
Auction rate security	$	4,925	$	—	$	(1,042	)	$	3,883


	December 31, 2008
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
	*(in thousands)*
Short-term investment securities:
Government-sponsored enterprise securities	$	38,999	$	279	$	(2	)	$	39,276
Corporate debt securities		25,918		55		(419	)		25,554

	$	64,917	$	334	$	(421	)	$	64,830

Long-term investment security:
Auction rate security	$	5,000	$	—	$	(1,225	)	$	3,775

As of September 30, 2009, the gross unrealized losses of $9,000 on short-term investment securities primarily represent temporary impairments on the debt securities of multiple issuers, including one corporate debt security that had been in a loss position for more than twelve consecutive months. The gross unrealized loss related to this one security amounted to $5,000 as of September 30, 2009, which represented a decrease from the unrealized loss of $138,000 recorded as of December 31, 2008. The loss related to this security was due to the interest rate environment for this security, which the Company believes is improving based on increases in the fair market value of the security over the previous twelve months as it nears maturity in the first quarter of 2010. The Company does not intend to sell the security and believes it will not be required to sell the security before recovery of par value. The Company’s remaining investment securities in loss positions have been in such positions for less than twelve consecutive months and were primarily caused by negative changes in the overall economic environment.

As of September 30, 2009, the Company held one auction rate security, or ARS, with a cost basis of $4.9 million compared to $5.0 million at December 31, 2008. The ARS is classified as a long-term investment security at fair value of $3.9 million, net of a temporary impairment of $1.0 million due to the illiquidity of the investment security (see Note 5 in these notes to the condensed consolidated financial statements). During the three months ended September 30, 2009, the ARS was partially redeemed at par by the issuer, resulting in cash proceeds of $75,000. The Company intends to hold the ARS for an adequate period of time to allow for the full recovery of the par value. The Company believes this will exceed twelve months, and accordingly, the ARS has been classified as a long-term investment.

All impairments were recognized as temporary impairments and were recorded, net of tax, on the condensed consolidated balance sheet in accumulated other comprehensive loss. The Company had no realized gains or losses for the three or nine months ended September 30, 2009, as compared to a gross realized loss of $66,000 for the three and nine months ended September 30, 2008.

The following table presents a summary of the Company’s value of available-for-sale investment securities by contractual maturity:


	September 30, 2009
	Amortized Cost		Estimated Fair Value
	*(in thousands)*
Contractual maturity:
One year or less	$	87,849	$	87,973
One to two years		23,073		23,208
Two to three years		6,687		6,741
Greater than three years		4,925		3,883

	$	122,534	$	121,805

Although certain municipal securities and ARS have contractual maturities up to 20 years, the effective maturities for our available-for-sale investment securities do not exceed 31 months.

5. Fair Value Measurements

Valuation techniques used to measure fair value, as required under ASC Topic 820, must maximize the use of observable inputs and minimize the use of unobservable inputs. ASC Topic 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, which may be used to measure fair value, as follows:


Level 1		Real-time quoted prices in active exchange markets for identical assets or liabilities

Level 2		Other significant and readily available observable inputs for comparable instruments, 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

The following table presents a summary of the Company’s financial instruments subject to ASC Topic 820 measured on a recurring basis:


	Balance at September 30, 2009		Fair Value Measurements
	Balance at September 30, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	*(in thousands)*
Short-term investment securities:
Municipal securities	$	52,018	$	—	$	52,018	$	—
Government-sponsored enterprise securities		43,720		—		43,720		—
Certificates of deposit		12,528		12,528		—		—
Corporate debt securities		9,656		—		9,656		—

	$	117,922	$	12,528	$	105,394	$	—

Long-term investment security:
Auction rate security	$	3,883	$	—	$	—	$	3,883

The Company’s level 1 financial instruments consist of certificates of deposit that mature in greater than 90 days from date of purchase and are each fully insured by the Federal Deposit Insurance Corporation.

The Company’s level 2 financial instruments are valued using market prices on less active markets. These valuations use pricing models that vary by asset class, incorporating such data as available trade information for similar securities, expected cash flows and credit information.

The Company’s level 3 financial instruments consist of an ARS issued by a municipality, which is underwritten by an insurance agency. ARS are collateralized debt instruments with long-term contractual maturities that are structured with short-term holding periods. They provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals, typically every 7 to 35 days. The length of each holding period is determined at the original issuance of the ARS. The Company can sell at each auction at par, assuming there are buyers for the ARS at such auction. In order for the auction to be successful, demand in the marketplace must meet or exceed the supply. If an auction is unsuccessful, the interest rate on the security resets at a predetermined auction failure rate. An investor can continue to hold the investment security until the next auction date or attempt to sell in the secondary market, usually at a sizable discount. The ARS has a contractual maturity in 2038, with a 35-day holding period between scheduled auctions. Although unsuccessful, the last auction occurred on September 10, 2008, prior to the filing of bankruptcy by the broker/dealer that managed the auction. This investment security has been valued as level 3 with unobservable inputs since its auctions began failing in February 2008. As of September 30, 2009, the ARS was rated “Baa1” by Moody’s Investors Service and “A” by Standard & Poor’s based on the underwriter’s guarantee. The funds associated with this security will not be accessible until the issuer redeems the ARS through a debt restructure, a buyer is found outside of the auction process, or the ARS matures in 2038.

The Company has evaluated this ARS based on interest rate spreads, credit quality, underlying assets of the issuer and underwriter, likelihood of a successful auction or redemption in the near term and the ability of the issuer to restructure the debt in the current credit environment. The Company assumed that the issuer and underwriter would not be able to satisfy its debt obligation until the credit market would provide a debt restructuring opportunity (within the next 4 years) and applied a 1.0% liquidity discount. The issuer of the ARS continues to make interest payments as scheduled and has made two partial redemptions during the three months ended September 30, 2009, of which the Company benefited from one due to the lottery system used to distribute the redemption proceeds. This redemption resulted in cash proceeds to the Company of $75,000 for the three months ended September 30, 2009. As a result of the internal valuation, the Company has recorded a temporary impairment of approximately $1.0 million as of September 30, 2009 against a cost basis of $4.9 million, as compared to a temporary impairment of $1.2 million as of December 31, 2008 against a cost basis of $5.0 million.

The following table provides a summary of the Company’s change in fair value of the level 3 financial asset:


	Level 3 Auction Rate Security
	*(in thousands)*
Balance at December 31, 2008	$	3,775
Transfers into level 3		—
Earned income		—
Total realized/unrealized losses:
Included in earnings		—
Included in accumulated other comprehensive income (loss)		183
Net purchases (redemptions)		(75	)

Balance at December 31, 2009	$	3,883

6. Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2009 was $7.3 million and $17.9 million, respectively. The Company’s effective tax rate of 43% and 44% for the three and nine months ended September 30, 2009, respectively, differs from the statutory rate primarily due to the impact of stock-based compensation expense.

As of June 30, 2008, the Company maintained a valuation allowance against deferred tax assets, as the Company concluded it did not meet the “more likely than not” threshold required under FASB ASC Topic 740, Income Taxes, or ASC Topic 740, to reverse the valuation allowance. During the three months ended September 30, 2008, the Company evaluated the valuation allowance and determined it was more likely than not the Company would be able to realize its net deferred tax assets through the ordinary course of

business and expected future taxable income. Therefore, the Company recorded a $9.8 million tax benefit representing the release of the valuation allowance against the net deferred tax assets during the three months ended September 30, 2008. As a result, the Company’s income tax benefit for the three and nine months ended September 30, 2008 of $6.2 million and $5.8 million, respectively.

The Company’s unrecognized tax benefits were unchanged during the three and nine months ended September 30, 2009. The Company does not anticipate that total unrecognized tax benefits will significantly change due to the settlement of examinations or the expiration of the statute of limitations within the next twelve months.

In August 2009, the Internal Revenue Service, or IRS, commenced an examination of the Company’s U.S. federal income tax return for the tax year ended December 31, 2007. To date, there have been no proposed adjustments communicated to management. The Company believes its current reserves are adequate to cover any potential assessments that may result from the examination. The Company is subject to U.S. federal income tax as well as income tax in jurisdictions of each state having an income tax. The tax years that remain subject to examination are 2006 for federal income taxes and 2004 for state income taxes, including years ending thereafter. However, to the extent allowed by law, the tax authorities may have the right to examine prior periods where net operating losses or tax credits were generated and carried forward, and make adjustments up to the amount of the net operating losses or credit carry forward amount.

7. Comprehensive Income

In accordance with FASB ASC Topic 220, Comprehensive Income, all components of comprehensive income are reported in the condensed consolidated financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources.

The following table presents a summary of the Company’s comprehensive income:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
	*(in thousands)*						*(in thousands)*
Net income	$	9,462		$	15,428		$	23,278		$	26,006
Accumulated other comprehensive income (loss):
Net unrealized gain (loss) on investment securities		313			(1,217	)		584			(1,342	)
Deferred tax		(53	)		529			(164	)		529

		260			(688	)		420			(813	)

Comprehensive income	$	9,722		$	14,740		$	23,698		$	25,193

8. Commitments and Contingencies

Operating Leases

As of September 30, 2009, the Company leased office and laboratory space and certain equipment under various non-cancelable operating leases. Rent expense under the Company’s operating leases totaled $875,000 and $2.3 million for the three and nine months ended September 30, 2009, respectively, as compared to $575,000 and $1.4 million for the comparable periods in 2008. The Company recognizes operating lease rent expense on a straight-line basis over the lease term.

The following table presents a summary of the Company’s future minimum lease payments as of September 30, 2009:


	Operating Leases
	*(in thousands)*
2009	$	954
2010		3,662
2011		3,726
2012		3,061
2013		2,406
Thereafter		2,834

Total future minimum lease payments	$	16,643

9. Treasury Stock

The Company repurchased shares of common stock issued to certain directors under their RSU agreement for the purpose of satisfying the director’s tax obligations created by the vesting of their RSUs. For the three and nine months ended September 30, 2009, the Company repurchased 374 shares representing a total value of $11,000. No repurchase of shares occurred during the three and nine months ended September 30, 2008. The Company accounted for these share purchases as treasury stock transactions using the cost method. The value of the withheld shares was classified as treasury stock as a reduction in stockholders’ equity on the condensed consolidated balance sheets.

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

The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q. The interim financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto for the year ended December 31, 2008 and our related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Annual Report on Form 10-K filed by us with the Securities and Exchange Commission, or SEC, on February 26, 2009. Unless the context indicates otherwise, as used in this Quarterly Report on Form 10-Q, the terms “we,” “us” and “our” refer to Genoptix, Inc.

We maintain a website at www.genoptix.com to which we regularly post copies of our press releases as well as additional information about us. Our filings with the SEC are available free of charge through our website as soon as reasonably practicable after being electronically filed with or furnished to the SEC. Interested persons can subscribe on our website to email alerts that are sent automatically when we issue press releases, file our reports with the SEC or certain other information is available. Information contained in our website does not constitute a part of this report.

Forward-Looking Statements

The information in this discussion and in other items of this Quarterly Report on Form 10-Q contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the SEC. We do not assume any obligation to update any forward-looking statements.

Overview

We are a specialized laboratory service provider focused on delivering personalized and comprehensive diagnostic services to community-based hematologists/oncologists, or hem/oncs. Our highly trained group of hematopathologists, or hempaths, utilizes sophisticated diagnostic technologies to provide a differentiated, specialized and integrated assessment of a patient’s condition, aiding physicians in making vital decisions concerning the treatment of malignancies of the blood and bone marrow, and other forms of cancer.

We were organized in 1999, and we began offering specialized diagnostic services in the third quarter of 2004. Our key service offerings include COMPASS and CHART. By ordering our COMPASS service offering, the hem/onc authorizes our hempath to determine the appropriate diagnostic tests to be performed, and our hempath then integrates patient history and previous and current test results into a comprehensive diagnostic report. As part of our CHART service offering, the hem/onc also receives a detailed assessment of a patient’s disease progression over time. Test requisitions for more than half of the patient samples we processed for the three and nine months ended September 30, 2009 and 2008, included our COMPASS or CHART service offerings.

We estimate that the U.S. bone marrow testing market alone represents at least a $1.0 billion opportunity annually and that our current market share for bone marrow procedures is approximately 7%. Our objective is to continue to increase our market share, revenues and profitability at a rate significantly faster than the overall market for blood and bone marrow testing services by continuing to provide and expand our high quality, community hem/onc focused specialized diagnostic services. In furtherance of this objective, our growth strategy has the following key elements:

•

expand our organization and infrastructure by increasing our personnel and expanding our sales and other infrastructure to enable us to visit more hem/oncs on a more frequent basis and, in time, to expand into new markets;

•

support our sales and marketing efforts by hiring and retaining Cartesian Medical Group, or Cartesian, hempaths and additional laboratory resources to continue to provide high-quality, specialized diagnosic services;

•

expand service offerings to hem/oncs by being first to market with new technologies and innovations;

•

leverage our existing infrastructure to increase operating efficiencies by taking advantage of economies of scale and volume discounts, where possible; and

•

pursue additional collaborations and acquisitions to supplement our business.

As a specialized diagnostic service provider, we rely extensively on our high quality of service to promote and maintain our relationships with our community-based hem/oncs. We compete primarily based on the quality of testing, reporting and information systems, reliability in patient sample transport, reputation in the medical community and access to our highly qualified hempaths. Our primary competitors include hospital pathologists, esoteric testing laboratories, national reference laboratories and academic laboratories.

Our revenues consist primarily of payments or reimbursements received from governmental payors, such as Medicare and Medicaid; private insurers, including managed care organizations; and private payors, such as hospitals, patients, and others for the specialized diagnostic services rendered to our hem/onc customers. Our revenues are affected by changes in customer and case volume, case complexity, specimen type, payor mix, contractual allowances and reimbursement rates.

Additionally, billing for diagnostic services is highly complex. Depending on our billing arrangement with each third party payor and applicable law, we are often obligated to bill in the specific manner prescribed by the various payors, each of which may have different billing requirements. Billing for diagnostic services in connection with governmental payor programs is subject to numerous federal and state regulations and other requirements, resulting in additional costs to us. We report revenues from contracted payors, including Medicare, certain insurance companies and certain healthcare institutions, based on the contractual rate, or in the case of Medicare, the published fee schedules. We report revenues from non-contracted payors, including certain insurance companies and individuals, based on the amount expected to be collected. We estimate amounts to be collected based on our historical collection experience.

We believe the key challenges in being able to continue to increase our market share, revenues and profitability are our ability to continue to hire and retain qualified field sales representatives, key management and other personnel, Cartesian’s ability to hire and retain hempaths, changes in reimbursement levels for our specialized diagnostic services, changes in regulations, payor policies and contracting arrangements with payors, increased competition from competitors attempting to replicate our key service offerings or provide other services that compete with ours, our ability to scale our internal infrastructure, our ability to maintain and strengthen our relationships with our hem/onc customers and our ability to continue to improve our operational, financial and management controls, and reporting systems and procedures.

To address these challenges, our management is focused upon expanding our sales organization as the primary driver for our continued growth while maintaining our existing hem/onc customer relationships. Our management tracks and measures the general buying patterns of our hem/onc customers (including cases per month, revenues and cost of revenues per case and turn-around-time per case) and is focused on adding additional sales management and sales representatives in key markets to enhance our penetration in those markets. Our management is also engaged in ensuring Cartesian is focused on recruiting, hiring and retaining hempaths to provide the professional services component to support continued growth. Management measures the levels and timeliness of reimbursement from third party payors and reviews on a monthly basis the levels of receivables and average time for collections, as well as cost and margin trends to ensure that investments in our infrastructure and personnel are in line with current sales levels.

We have also been building a team of business and corporate development employees to opportunistically pursue additional collaborations with pharmaceutical companies and acquisitions or in-licensing of businesses, products or technologies that will enable us to accelerate the implementation of our strategic plan and to increase the number of hem/onc customers we serve and/or expand the services we provide to them, by way of investments in other companies, expansion into new markets, licensing of technology, co-development arrangements, collaborations, asset purchases and other similar transactions. For example, we currently provide specialized testing services and access to our hempaths through collaborations with select pharmaceutical companies. We expect these collaborations to grow over time, which we believe will improve our financial performance and name recognition and reputation among hem/oncs, and potentially provide us with early access to new technologies available for commercialization.

Seasonality

The majority of our testing volume is dependent on patient visits to hem/oncs’ offices and other healthcare providers. Volume of testing generally declines during the vacation seasons, year-end holiday periods and other major holidays, particularly when those holidays fall during the middle of the week. In addition, volume of testing tends to decline due to adverse weather conditions, such as excessively hot or cold spells or hurricanes or tornados in certain regions, consequently reducing revenues and cash flows in any affected period. Therefore, comparison of the results of successive periods may not accurately reflect trends for future periods.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We continually evaluate our estimates and judgments, the most critical of which are those related to revenue recognition, allowance for doubtful accounts, valuation of investment securities, long-lived assets, income taxes and stock-based compensation expense. We base our estimates and judgments on historical experience and other factors that we believe to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known.

We believe there have been no significant changes during the three and nine months ended September 30, 2009 to the items that we disclosed as our critical accounting policies and estimates in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2008.

Recent Accounting Pronouncements

See Note 1 in the accompanying notes to the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Results of Operations

Comparison of Three and Nine Months Ended September 30, 2009 and 2008

The following table presents a summary of the condensed consolidated statements of operations as percentages of revenues:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
	*(% of revenues)*				*(% of revenues)*
Revenues	100	%	100	%	100	%	100	%
Cost of revenues	36	%	38	%	37	%	40	%

Gross profit	64	%	62	%	63	%	60	%
Operating expenses:
Sales and marketing	16	%	16	%	17	%	18	%
General and administrative	14	%	18	%	16	%	20	%
Research and development	1	%	1	%	1	%	1	%

Total operating expenses	32	%	35	%	33	%	38	%

Income from operations	32	%	27	%	30	%	22	%
Interest and other income	1	%	2	%	1	%	3	%

Income before income taxes	33	%	29	%	30	%	25	%
Income tax expense (benefit)	14	%	-19	%	13	%	-7	%

Net income	19	%	48	%	17	%	32	%

Revenues

Revenues consist primarily of payments or reimbursements for the specialized diagnostic services rendered to our hem/onc customers. Substantially all of our revenues result from our having been assigned the right to bill and collect for the professional services provided by the hempaths employed by Cartesian who work with us in our laboratory facility pursuant to our Clinical Laboratory Professional Services Agreement, or PSA, with Cartesian. Our revenues from services not performed by Cartesian were less than 5% of our total revenues during the three and nine months ended September 30, 2009 and 2008.

For both the three and nine months ended September 30, 2009, we derived approximately 59% of our revenues from private insurance, including managed care organizations and other healthcare insurance providers; approximately 40% for both periods from Medicare and Medicaid; and the remaining approximate 1% for both periods from other sources. For the three and nine months ended September 30, 2008, we derived approximately 62% and 60%, respectively, of our revenues from private insurance, including managed care organizations and other healthcare insurance providers; approximately 37% and 39%, respectively, from Medicare and Medicaid during each period; and the remaining approximate 1% from other sources. Our revenues are affected by changes in customer and case volume, case complexity, specimen type, payor mix, contractual allowances and reimbursement rates. Billing and reimbursement for our specialized diagnostic services in connection with governmental payor programs are subject to numerous federal and state regulations and other billing requirements.

Reimbursement under the Medicare program for our specialized diagnostic services is subject to both the national Medicare clinical laboratory fee schedule and physician fee schedule. Both are typically updated annually and subject to geographic adjustments. The physician fee schedule is designed to set compensation rates for those medical services provided to Medicare beneficiaries who require a degree of physician supervision. Outpatient clinical diagnostic laboratory tests are traditionally paid according to the clinical laboratory fee schedule. However, although the clinical laboratory fee schedule is generally the only basis of payment that can be made by the Medicare program with respect to most clinical laboratories, certain laboratory tests performed by physicians are exempt from the clinical laboratory fee schedule and are paid under the physician fee schedule. As a result, most of the services provided by us are reimbursed under the physician fee schedule.

The clinical laboratory fee schedule sets the maximum amount payable under Medicare for each specific laboratory billing code. We bill the program directly and must accept the scheduled amount as payment in full for covered tests performed on behalf of Medicare beneficiaries. Those services reimbursed under the clinical laboratory fee schedule generally do not result in coinsurance amounts but may result in beneficiary deductible responsibility. Payment under the clinical laboratory fee schedule has been limited from year-to-year by Congressional action such as imposition of national limitation amounts and freezes on the otherwise applicable annual consumer price index, or CPI, updates. Although the CPI update of the clinical laboratory fee schedule has been frozen since 2004 by the Medicare Prescription Drug Improvement and Modernization Act of 2003, after July 1, 2009, the freeze on the clinical laboratory fee schedule is updated using the percentage increase for the CPI from the previous 12-month (measured July through June) period minus 0.5%. On July 15, 2009, the CPI for 2009 was released and it showed a year over year decline of 1.4%. This implies that clinical laboratories will receive a 1.9% rate decrease from Medicare in 2010 as compared to the 4.5% rate increase that the laboratories experienced under the 2009 clinical laboratory fee schedule. The payment amounts under the Medicare clinical laboratory fee schedule are important not only for our reimbursement under Medicare, but also because the schedule often establishes the payment amounts set by other third party payors. For example, state Medicaid programs are prohibited from paying more than the Medicare fee schedule limit for clinical laboratory services furnished to Medicaid recipients. As a result, in light of the anticipated reduction in the clinical laboratory fee schedule, certain third party payors may also reduce reimbursement amounts.

For the many anatomic pathology services we provide, we are reimbursed separately under the Medicare physician fee schedule and beneficiaries are responsible for applicable coinsurance and deductible amounts. The amounts paid under the physician fee schedule are based on geographically adjusted relative value units, or RVUs, for each procedure or service, adjusted by a budget neutrality adjustor, and multiplied by an annually determined conversion factor. Historically, the formula used to calculate the fee schedule conversion factor resulted, or would have resulted, in significant decreases in payment levels. However, in recent years, Congress has intervened multiple times to freeze or increase the conversion factor. The Medicare Improvements for Patient and Providers Act of 2008 included a provision for a 1.1% update to the conversion factor for calendar year 2009. Additionally, the budget neutrality adjustor was reduced by approximately 6.4% and shifted from being an RVU adjustor to being a conversion factor adjustor. The resulting conversion factor for 2009 is therefore approximately 5% lower than the 2008 conversion factor. However, the aforementioned shift of the budget neutrality adjustor to the conversion factor had the impact of increasing the calculated RVUs for each procedure. Consequently, this shift of the budget neutrality adjustor, along with other annual RVU updates, resulted in an increase of approximately 6.8% on the procedures that we perform under the Medicare physician fee schedule in 2009.

As for calendar year 2010, on October 30, 2009, CMS released a final rule with comment period which is intended to update the payment policies and rates for the Medicare physician fee schedule for calendar year 2010. Unless there is legislative intervention, the 2010 final rule provides that CMS will implement a 21.2% reduction to the conversion factor applicable to the physician fee schedule for calendar year 2010. However, as noted above, Congress has typically enacted legislation each year to suspend such proposed decreases in physician fee schedule rates. Several health care reform bills being considered by Congress address Medicare payments to physicians, including reform of the physician payment formula which would result in an avoidance of the 21.2% reduction to the conversion factor for 2010.

Nevertheless, future Congressional action cannot be assured and future methodological changes may result in reductions or increases to the Medicare physician fee schedule. Reductions in Medicare’s reimbursement rates for pathology services, for which we currently are paid under the Medicare physician fee schedule, would reduce the amount we receive for a substantial number of our specialized diagnostic tests. Because the vast majority of our diagnostic services currently are reimbursed under the physician fee schedule, changes to this fee schedule could result in a greater impact on our revenues than changes to the Medicare clinical laboratory fee schedule.

Additionally, as part of the final rule with comment period, CMS has implemented changes in the practice expense relative value unit amounts used to calculate reimbursement for procedures billed under the physician fee schedule, including many of the procedures we perform. The implementation of these proposed changes to the physician fee schedule (assuming the 21.2% reduction to the conversion factor discussed above is not implemented for 2010), in conjunction with the proposed clinical fee schedule rate decrease discussed above, are estimated to result in an approximate 1% reduction in the 2010 Medicare reimbursement per case.


	Three Months Ended September 30,				% Change		Nine Months Ended September 30,				% Change
	2009		2008		% Change		2009		2008		% Change
Revenues⁽¹⁾ (in thousands)	$	50,807	$	32,087	58	%	$	135,294	$	82,210	65	%
Number of cases		14,735		10,168	45	%		41,839		27,330	53	%
Revenues per case	$	3,448	$	3,156	9	%	$	3,234	$	3,008	8	%

(1)

During the three months ended September 30, 2009, we recorded positive changes in prior period accounting estimates to reduce contractual allowances, which increased our revenues by $4.4 million, of which $3.1 million pertained to the six months ended June 30, 2009. During the nine months ended September 30, 2009, we recorded positive changes impacting revenue by $6.4 million. In comparison, during the three months ended September 30, 2008, we recorded similar positive changes in prior period accounting estimates to reduce contractual allowances, which increased our revenues by $2.5 million, of which $1.6 million pertained to the six months ended June 30, 2008. During the nine months ended September 30, 2008, we recorded positive changes impacting revenue by $2.2 million. These favorable changes in accounting estimates related primarily to non-contracted payors and resulted from continued improvements to our collection processes, as well as increased hiring of personnel and management focused on the collection of accounts receivable for services rendered in prior periods and changes in reimbursement policies by certain payors. We expect to continue to have strong billing and collection efforts, but these adjustments could fluctuate both favorably and unfavorably in future periods.

Revenues increased to $50.8 million and $135.3 million for the three and nine months ended September 30, 2009, respectively, from $32.1 million and $82.2 million for the comparable periods in 2008 (inclusive of the changes in prior period accounting estimates noted above). The increase of $18.7 million, or 58%, and $53.1 million, or 65%, for the three and nine months ended September 30, 2009, respectively, as compared to the comparable periods in 2008, was primarily due to case volume increases of 45% and 53%, respectively; revenue per case increases of $292 and $226, or 9% and 8%, respectively; better than expected collections on our non-contracted business as reflected by the changes in accounting estimates, as discussed above; and a net increase in Medicare reimbursement rates for our key service offerings. Case volumes, and therefore revenues, have increased during the three and nine months ended September 30, 2009, primarily as a result of a 29% increase in our field sales representatives from 52 at September 30, 2008 to 67 at September 30, 2009. In addition, we have expanded our sales administration and management personnel from two at September 30, 2008 to fourteen at September 30, 2009. The expansion of our sales team has enabled us to penetrate more accounts over a wider geographic area, increase our customer base and further focus our sales representatives on in-person customer visits. Sales force productivity during the three and nine months ended September 30, 2009 increased primarily as a result of more efficient selling efforts, enhanced recognition of Genoptix in the market, smaller geographies per sales representative, price increases and expanded service offerings.

Cost of Revenues

Cost of revenues consists of employee-related costs (such as salaries, fringe benefits and stock-based compensation expense) of our Cartesian hempaths, licensed technicians, clinical service coordinators and other support personnel, as well as outside laboratory costs, laboratory supplies, logistic costs, depreciation and administrative-related costs allocated to cost of revenues. Our cost of revenues generally increases as our case volumes and revenues increase. We expect that our cost of revenues will continue to increase as we hire additional Cartesian hempaths, technicians and support personnel; expand into additional laboratory space; incur increased outside laboratory costs; and spend additional funds on supplies to support anticipated increases in case volumes and revenues.


	Three Months Ended September 30,						% Change		Nine Months Ended September 30,						% Change
	2009			2008			% Change		2009			2008			% Change
Cost of revenues (in thousands)	$	18,402		$	12,282		50	%	$	50,603		$	32,663		55	%
Cost of revenues (% of revenues)		36	%		38	%				37	%		40	%
Number of cases		14,735			10,168		45	%		41,839			27,330		53	%
Cost of revenues per case	$	1,249		$	1,208		3	%	$	1,209		$	1,195		1	%

Cost of revenues increased to $18.4 million and $50.6 million for the three and nine months ended September 30, 2009, respectively, from $12.3 million and $32.7 million for the comparable periods in 2008. As a percentage of revenue, cost of revenues for the three and nine months ended September 30, 2009 decreased to 36% and 37%, respectively, from 38% and 40% for the comparable periods in 2008, despite increased facility costs due to our expanded laboratory capacity, stock-based compensation expense and payroll-related expenses associated with the hiring of laboratory personnel and Cartesian physicians. This improvement is primarily attributable to higher revenues, leveraging our fixed costs, gaining efficiencies with our in-house processes, and supplier discounts on direct materials. These, in addition to favorable changes in revenue accounting estimates from prior periods as noted above under revenues, have resulted in increased gross margins for the three and nine months ended September 30, 2009 of 64% and 63%, respectively, from 62% and 60% for the comparable periods in 2008. Stock-based compensation expense as a component of cost of revenues was $845,000 and $2.3 million for the three and nine months ended September 30, 2009, respectively, as compared to $593,000 and $1.6 million for the comparable periods in 2008. As a percentage of revenue, stock-based compensation expense was consistently 2% of revenues for the three and nine months ended September 30, 2009 and 2008.

Sales and Marketing Expenses

Sales and marketing expenses relate to sales management, field sales representatives, marketing, business and corporate development, contracts and managed care, and customer service consisting of primarily employee-related costs (such as salaries, commissions, fringe benefits, stock-based compensation expense and related travel costs for our field sales representatives) and facilities, information technology and related depreciation, provision for doubtful accounts, and other administrative-related costs allocated to sales and marketing expense functions. We expect our sales and marketing expenses to increase as we hire additional field sales representatives, sales management, marketing and corporate development personnel as part of our growth strategy.


	Three Months Ended September 30,						% Change		Nine Months Ended September 30,						% Change
	2009			2008			% Change		2009			2008			% Change
Sales and marketing (in thousands)	$	8,217		$	5,098		61	%	$	22,538		$	14,529		55	%
Sales and marketing (% of revenues)		16	%		16	%				17	%		18	%

Sales and marketing expenses increased to $8.2 million and $22.5 million for the three and nine months ended September 30, 2009, respectively, from $5.1 million and $14.5 million for the comparable periods in 2008. The increase of $3.1 million, or 61%, and $8.0 million, or 55%, for the three and nine months ended September 30, 2009, respectively, from the comparable periods in 2008, were primarily due to incremental increases of $2.2 million and $5.6 million, respectively, for employee-related costs (including salaries, sales commissions, stock-based compensation expense and travel), $333,000 and $1.4 million, respectively, for facility, equipment and other cost increases and allocations due to the increased number of sales representatives, sales managers, field based managed care personnel, corporate and business development and customer service personnel that we have hired to drive and support our revenue growth and explore new opportunities. The number of sales employees increased from 54, including two administrative and management personnel, as of September 30, 2008 to 81, including fourteen administrative and management personnel, at September 30, 2009. As a percentage of revenues, sales and marketing expenses have remained consistent at 16% for the three months ended September 30, 2009 and 2008 and decreased to 17% for the nine months ended September 30, 2009 from 18% for the comparable period in 2008, due to higher revenues and improved efficiencies with expanded geographic coverage, offset by the incremental expense attributable to the added sales management. Stock-based compensation expense as a component of sales and marketing expenses was $455,000 and $1.3 million for the three and nine months ended September 30, 2009, respectively, as compared to $365,000 and $1.5 million for the comparable periods in 2008. As a percentage of revenue, stock-based compensation expense was consistently 1% of revenues for the three and nine months ended September 30, 2009, as compared to 1% and 2%, respectively, for the comparable periods in 2008.

General and Administrative Expenses

General and administrative expenses relate to billing, finance, human resources and other administrative functions consisting of employee-related costs (such as salaries, fringe benefits and stock-based compensation expense), professional services, and depreciation and administrative-related costs allocated to general and administrative expenses. We anticipate an absolute dollar increase in our general and administrative expenses as we add personnel; increase our billing and collections efforts; incur additional expenses associated with the expansion of our facilities and backup systems; and continue to build our corporate infrastructure to support our anticipated growth.


	Three Months Ended September 30,						% Change		Nine Months Ended September 30,						% Change
	2009			2008			% Change		2009			2008			% Change
General and administrative (in thousands)	$	7,287		$	5,786		26	%	$	21,168		$	16,091		32	%
General and administrative (% of revenues)		14	%		18	%				16	%		20	%

General and administrative expenses increased to $7.3 million and $21.2 million for the three and nine months ended September 30, 2009, respectively, from $5.8 million and $16.1 million for the comparable periods in 2008. The increase of $1.5 million, or 26%, and $5.1 million, or 32%, for the three and nine months ended September 30, 2009, respectively, as compared to the comparable periods in 2008, was primarily due to incremental increases of $1.8 million and $5.0 million, respectively, for employee-related costs (including salaries, bonuses, stock-based compensation expense and travel) and $589,000 and $1.4 million, respectively, for legal, insurance and consulting costs. These incremental increases were offset by $160,000 and $1.4 million for the three and nine months ended September 30, 2009, respectively, due to allocations to cost of revenues and sales and marketing associated with our facility and equipment improvements and deployment of previously undeveloped space within our existing facility. In addition, incremental offsets of $811,000 and $40,000 for the three and nine months ended September 30, 2009, respectively, were due to decreased provision for doubtful accounts due to improved collections over time. Employee-related costs increased as a result of the general and administrative headcount increasing 44% from 59 at September 30, 2008 to 85 at September 30, 2009 in support of increased billing and collection efforts and overall company growth. We have also increased our infrastructure requirements and are actively expanding our information systems and facilities while implementing corporate initiatives. Legal and consulting expenses increased as a result of regulatory initiatives, increased contract management and ongoing development and maintenance of our compliance programs. In addition, we recorded a provision for doubtful accounts at a rate of approximately 0% and 2% of revenues for the three and nine months ended September 30, 2009, respectively, as compared to 3% for both periods in 2008. During the three and nine months ended September 30, 2009, we recorded $10,000 and $2.2 million, respectively, of provision for doubtful accounts, as compared to $822,000 and $2.3 million for the comparable periods in 2008. The decrease in our provision for doubtful accounts for the three months ended September 30, 2009 is due to stronger than expected collections on previously reserved accounts. Going forward, we expect our provision for doubtful accounts to be approximately 2% of revenues. As a percentage of revenues, general and administrative expenses have decreased to 14% and 16% for the three and nine months ended September 30, 2009, respectively, from 18% and 20% for the comparable periods in 2008 due to higher revenues, lower provision for doubtful accounts requirements and increased leverage of our administrative functions as the company grows. Stock-based compensation expense as a component of general and administrative expenses was $1.2 million and $3.6 million for the three and nine months ended September 30, 2009, respectively, as compared to $990,000 and $2.0 million for the comparable periods in 2008. As a percentage of revenue, stock-based compensation expense was 2% and 3% of revenues for the three and nine months ended September 30, 2009, respectively, as compared to 3% for both the comparable periods in 2008.

Interest and Other Income

Interest and other income for the three and nine months ended September 30, 2009 decreased to $334,000 and $1.3 million, respectively, from $650,000 and $2.3 million for the comparable periods in 2008, primarily due to lower investment returns and the partial shift in our investment portfolio into tax exempt municipal securities that will assist in lowering our effective tax rate. We intend to continue to manage our investment securities to minimize the overall risk and maximize our returns.

Income Tax Expense


	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Income tax expense (benefit) (in thousands)	$	7,251		$	(6,190	)	$	17,926		$	(5,780	)
Effective tax rate		43	%		-67	%		44	%		-29	%

Our effective tax rate for the three and nine months ended September 30, 2009 was 43% and 44%, respectively. Our effective tax rate for the three and nine months ended September 30, 2009 differs from the statutory rate primarily due to the impact of stock-based compensation expense. In comparison, during the three months ended September 30, 2008, we reversed a valuation allowance against deferred tax assets, which we previously concluded did not meet the “more likely than not” threshold required under ASC Topic 740. The income tax benefit for the three and nine months ended September 30, 2008 was $6.2 million and $5.8 million, respectively.

Due to our sustained profitability, we estimate our future effective tax rate to be approximately 44% of income before taxes. This rate is subject to the impact of nondeductible stock-based compensation expense offset by any tax deductions from disqualifying dispositions.

Liquidity and Capital Resources

The following table presents a summary of our liquidity and cash flows:


	September 30, 2009			December 31, 2008
	*(in thousands)*
Cash, cash equivalents and short-term investment securities	$	137,787		$	102,938

Working capital	$	150,223		$	115,236


	Nine Months Ended September 30,
	2009			2008
	*(in thousands)*
Net cash provided by (used in):
Operating activities	$	33,588		$	23,424
Investing activities		(56,374	)		(52,805	)
Financing activities		4,543			566

Net decrease in cash and cash equivalents	$	(18,243	)	$	(28,815	)

As of September 30, 2009, we had $137.8 million in cash, cash equivalents and short-term investments, consisting primarily of money market funds, municipal securities, government-sponsored enterprise securities, certificates of deposit and corporate debt securities. We have established guidelines relating to diversification and maturities of our investment securities to minimize overall risk with the objectives of preserving principal and maintaining liquidity while maximizing our returns. Our certificates of deposit are fully insured by the Federal Deposit Insurance Corporation, or FDIC.

Our primary ongoing sources of cash are cash receipts on accounts receivable from our revenues and proceeds from common stock issuances. Net cash collections of accounts receivable are impacted by the efficiency of our cash collections process as measured by the change in days sales outstanding, or DSO. DSO can vary from period to period depending on the payment cycles and the mix of our payors. As of September 30, 2009 and 2008, our DSO was 51 days and 56 days, respectively.

Our primary uses of cash and investments are to fund operating expenses, the acquisition of property and equipment and income tax payments. Cash used to fund operating expenses is impacted by the timing of payments as reflected in the change in our outstanding accounts payable and accrued expenses. Acquisitions of property and equipment generally consist of purchases of facility improvements, laboratory equipment and computer hardware and software. Income tax payments consist of federal and state payments of an approximately 44% effective tax rate, since the majority of our net operating losses and other credits have been exhausted.

Operating Activities

Net cash provided by operating activities during the nine months ended September 30, 2009 and 2008 was $33.6 million and $23.4 million, respectively. For the nine months ended September 30, 2009 as compared to September 30, 2008, the net incremental increase of $10.2 million was primarily due to incremental increases of $9.5 million of deferred taxes due to a release of our valuation allowance against our net deferred tax asset in the prior year; an additional $2.2 million of stock-based compensation expense due to increase in headcount; an increase of $2.1 million in accrued compensation due to timing of payouts; a $791,000 change in deferred revenue cash in-flows; and a incremental increase in the amortization of premium on investment securities of $621,000. These are offset by additional non-cash changes that incrementally decreased net income by $2.7 million primarily due to increases in our operating costs adjusted for incremental operating changes such as an additional $2.4 million of excess tax benefits from stock-based compensation awards related to disqualifying dispositions on stock-based compensation awards categorized as a financing activity; an incremental decrease of $536,000 to accounts receivable as a result of increased revenue and the associated timing of collection efforts; and incremental decreases of $922,000 of deferred rent, other current and long-term assets, and accounts payable and accrued expenses due to timing of payouts.

Investing Activities

Net cash used in investing activities during the nine months ended September 30, 2009 and 2008 was $56.4 million and $52.8 million, respectively. This primarily pertains to an incremental increase of $7.6 million of net purchases of investment securities based on timing of purchases and sales, which is offset by a decrease in purchases of property and equipment of $3.7 million.

Financing Activities

For the nine months ended September 30, 2009 and 2008, net cash of $4.5 million and $566,000, respectively, was provided by financing activities. The incremental increase primarily pertains to $3.3 million of excess tax benefits related to disqualifying dispositions on stock-based compensation awards during the nine months ended September 30, 2009 and a change of $764,000 related to costs paid during the nine months ended September 30, 2008 in conjunction with our public offering in March 2008.

Liquidity Restrictions

As of September 30, 2009, we held one auction rate security, or ARS, with a cost basis of $4.9 million. The ARS is classified as a long-term investment security at fair value of $3.9 million, net of a temporary impairment of $1.0 million due to the illiquidity of the investment security (see Note 5 in the notes to the condensed consolidated financial statements).

ARS are collateralized debt instruments with long-term contractual maturities that are structured with short-term holding periods. They provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals, typically every 7 to 35 days. The length of each holding period is determined at the original issuance of the ARS. We can sell at each auction at par, assuming there are buyers for the ARS at such auction. In order for the auction to be successful, demand in the marketplace must meet or exceed the supply. If an auction is unsuccessful, the interest rate on the security resets at a predetermined auction failure rate. An investor can continue to hold the investment security until the next auction date or attempt to sell in the secondary market, usually at a sizable discount.

The ARS in our investment securities portfolio consists of debt issued by a municipality that is also underwritten by an insurance agency. The ARS auctions began failing in February 2008. As of September 30, 2009, the ARS was rated “Baa1” by Moody’s Investors Service and “A” by Standard & Poor’s based on the underwriter’s guarantee. Although unsuccessful, the last auction occurred on September 10, 2008, prior to the bankruptcy of the broker/dealer that managed the auction. The funds associated with this security will not be accessible until the issuer restructures the debt, a buyer is found outside of the auction process, or the ARS matures in 2038. As such, we have recorded a temporary impairment of approximately $1.0 million as of September 30, 2009. The issuer continues to pay the interest as scheduled and shows no indication that it will be unable to meet its current obligations. We do not need to access these funds for operational purposes for the foreseeable future. Because we do not need the current liquidity, we will hold the security until the auctions begin occurring, the issuer restructures the debt or until the contractual maturity date. Based on our ability to access our cash and cash equivalents and short-term investment securities and our expected operating cash flows, we do not anticipate that the temporary illiquidity of this investment will affect our ability to execute our current business plan.

As of September 30, 2009, we had total restricted cash of $270,000. Restricted cash consists of amounts held in a certificate of deposit to collateralize a standby letter of credit per the terms of an operating lease agreement. The standby letter of credit requirement expires on August 31, 2012, allowing for $90,000 annual reductions on June 30 of each year through 2011.

Income Tax

As of September 30, 2009, most remaining and available federal and state income tax net operating losses and other credits have been utilized, which will result in increased income tax payments that will decrease our cash flows from operations. As of December 31, 2008, we had state tax net operating loss carryforwards of approximately $27.1 million. However, California has suspended any usage of its state tax net operating loss carryforward until 2010, which will cause us to be fully taxed in California without the benefit of net operating loss credits until 2010. Subsequently, the state net operating losses will begin to expire in 2010.

Utilization of net operating loss carryforwards, credit carryforwards and certain deductions have been subject to substantial annual limitations due to ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership have required us to limit the amount of net operating loss and research and development credit carryforwards that were previously available to offset future taxable income. We have had three “change in ownership” events that limit the utilization of net operating loss and credit carryforwards. The “change in ownership” events occurred in March 2000, December 2001 and March 2008 and resulted in annual net operating loss carryforward limitations of $63,000, $96,000 and $16.1 million, respectively. As a result of a net unrealized built-in gain from the March 2008 change in ownership, our net operating loss carryforward annual limitation of $16.1 million was increased to $39.7 million for each of the five years starting after the change in ownership. Additional limitations on the use of these tax attributes could occur in the event of possible disputes arising in examination from various taxing authorities. Any net operating loss or credit carryforwards that will expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding charge to income tax expense on the condensed consolidated statements of operations.

Capital Resources

We believe that our cash, cash equivalents and short-term investment securities as of September 30, 2009, combined with our positive cash flows from operations, will be adequate to fund our planned growth and operating activities in the foreseeable future.

Our future capital uses and requirements depend on numerous factors. These factors include but are not limited to the following:

•

the current economy and financial markets;

•

changes in regulations or payor policies, including reimbursement levels from governmental payors and private insurers, or contracting arrangements with payors or changes in other laws, regulations or policies;

•

the extent to which we expend resources on pursuing and completing additional collaborations, acquisitions or in-license of businesses, products and technologies in connection with the implementation of our strategic plan; and

•

the extent to which we expand our operations and increase our market share.

We may be required to or otherwise may (for strategic or other reasons) elect to raise additional funds through public or private equity offerings or debt financings. We do not know if we will be able to obtain additional financing on favorable terms, if at all (particularly in light of the difficult current financial environment and weak economic conditions). If we cannot raise funds on acceptable terms, if and when needed, we may not be able to maintain or grow our business at the rate that we currently anticipate, we may not be able to respond to competitive pressures or unanticipated capital requirements, or we may be required to reduce operating expenses, which would significantly harm our business, financial condition and results of operations. As of September 30, 2009, we did not have any outstanding debt. We do not anticipate having to obtain any debt financing in the near future.

Contractual Obligations and Commitments

There have been no material changes, outside of the ordinary course of business, in our outstanding contractual obligations from those disclosed within “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as contained in our Annual Report on Form 10-K filed by us with the SEC on February 26, 2009, except as noted below.

In June 2009, we entered into a six-year operating lease beginning June 1, 2009 for an additional 44,000 square feet of office and laboratory space in Carlsbad, California, into which we will expand our current laboratory facilities as of the date of substantial completion of improvements, estimated to occur in early 2010. The lease contains one four-year extension option and is subject to annual rent increases. The non-cancellable future minimum payments under the lease total approximately $133,000, $451,000, $465,000, $479,000, $493,000 and $864,000 in 2009, 2010, 2011, 2012, 2013 and thereafter, respectively.

From time to time, we may enter into contracts with suppliers, manufacturers and other third parties under which we may be required to make payments. Our disclosures do not reflect any future obligations that may arise in the event that we establish additional facilities to house our operations.

Off-Balance Sheet Arrangements

We have not engaged and do not expect to engage in any off-balance sheet activities.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Market Risk

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk primarily in the area of changes in U.S. interest rates. We do not have any material foreign currency or other derivative financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We attempt to increase the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities.

Interest Rate Risk

All of our investment securities are classified as available-for-sale and therefore reported on the balance sheet at fair value. Changes in the overall level of interest rates affect our interest income that is generated from our cash, cash equivalents and investment securities.

Item 4. Controls and Procedures.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and no evaluation of controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended, or Exchange Act, prior to the filing of this report we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on their evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

In addition, management, including our chief executive officer and chief financial officer, did not identify any change in our internal control over financial reporting that occurred during the three months ended September 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1A. Risk Factors.

You should consider carefully the following information about the risks described below, together with the other information contained in this Quarterly Report on Form 10-Q and in our other public filings in evaluating our business. We have marked with an asterisk (*) those risk factors that reflect substantive changes from the risk factors included in our Annual Report on Form 10-K that we filed with the SEC on February 26, 2009. If any of the following risks actually occurs, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our common stock would likely decline.

Risks Relating to Our Business Operations

*	Reimbursement levels for our specialized diagnostic services are subject to continuing change and any reductions in reimbursement levels would decrease our revenues and adversely affect our results of operations and financial condition.

Reimbursement to healthcare providers, such as specialized diagnostic service providers like us, is subject to continuing change in policies by governmental payors, such as Medicare and Medicaid, private insurers, including managed care organizations and other private payors, such as hospitals and private medical groups. Reimbursement from governmental payors is subject to statutory and regulatory changes, retroactive rate adjustments and administrative rulings and other policy changes, all of which could materially decrease the range of services for which we are reimbursed or the reimbursement rates we are paid.

The clinical laboratory fee schedule sets the maximum amount payable under Medicare for each specific laboratory billing code. We bill the program directly and must accept the scheduled amount as payment in full for covered tests performed on behalf of Medicare beneficiaries. Those services reimbursed under the clinical laboratory fee schedule generally do not result in coinsurance amounts but may result in beneficiary deductible responsibility. Payment under the clinical laboratory fee schedule has been limited from year-to-year by Congressional action such as imposition of national limitation amounts and freezes on the otherwise applicable annual consumer price index, or CPI, updates. Although the CPI update of the clinical laboratory fee schedule has been frozen since 2004 by the Medicare Prescription Drug Improvement and Modernization Act of 2003, after July 1, 2009, the freeze on the clinical laboratory fee schedule is updated using the percentage increase for the CPI from the previous 12-month period (measured July thru June) minus 0.5%. On July 15, 2009, the CPI for 2009 was released and it showed a year-over-year decline of 1.4%. This implies that clinical laboratories will receive a 1.9% rate decrease from Medicare in 2010 as compared to the 4.5% rate increase that the laboratories experienced under the 2009 clinical laboratory fee schedule. The payment amounts under the Medicare clinical laboratory fee schedule are important not only for our reimbursement under Medicare, but also because the schedule often establishes the payment amounts set by other third party payors. For example, state Medicaid programs are prohibited from paying more than the Medicare fee schedule limit for clinical laboratory services furnished to Medicaid recipients. As a result, in light of the anticipated reduction in the clinical laboratory fee schedule, certain third party payors may also reduce reimbursement amounts.

conversion factor for 2009 is therefore approximately 5% lower than the 2008 conversion factor. However, the aforementioned shift of the budget neutrality adjustor to the conversion factor had the impact of increasing the calculated RVUs for each procedure. Consequently, this shift of the budget neutrality adjustor, along with other annual RVU updates, resulted in an increase of approximately 6.8% on the procedures that we perform under the Medicare physician fee schedule in 2009.

As for calendar year 2010, on October 30, 2009, CMS released a final rule with comment period which is intended to update the payment policies and rates for the Medicare physician fee schedule for calendar year 2010. Unless there is legislative intervention, the 2010 final rule provides that CMS will implement a 21.2% reduction to the conversion factor applicable to the physician fee schedule for calendar year 2010, which could lead to a significant decrease in payment levels. However, as noted above, Congress has typically enacted legislation each year to suspend such proposed decreases in physician fee schedule rates. Several health care reform bills being considered by Congress address Medicare payments to physicians, including reform of the physician payment formula which would result in an avoidance of the 21.2% reduction in the conversion factor for 2010.

The Medicare Modernization Act of 2003 mandated creation of Medicare Administrative Contractors, or MACs, replacing the system of fiscal intermediaries who oversee fee-for-service claims for the Medicare Part A and Part B programs. In November 2007, CMS awarded the MAC Jurisdiction 1 (California, Hawaii, Nevada, American Samoa, Guam and the Northern Mariana Islands) to Palmetto GBA. The full transition to Palmetto GBA occurred effective September 2, 2008. The MAC stated methodology for consolidation and transition of Local Coverage Determinations, or LCD, was based on the principal of “least restrictive.” New LCD’s related to our specialized diagnostic services were introduced as a result of the consolidation process, while others were retired, which may result in reductions to, delays in or denials for reimbursement for the services offered. Additionally, the transition from a fiscal intermediary to a MAC is in a very early stage and may result in delays in or denials for reimbursement that could have an adverse impact on us and our results of operations.

Effective January 1, 2009, CMS implemented Phase VIII Medically Unlikely Edits, or MUEs. CMS developed MUEs to place limits on certain Medicare billing codes in order to reduce the paid claims error rate for Medicare Part B claims. An MUE value is the maximum units of service that a provider may be paid for a single beneficiary on a single date of service.

Several of the MUEs pertain to procedures that we perform. In response to concerns from the laboratory industry, effective April 1, 2009, CMS temporarily suspended certain MUEs for pathology, cytopathology, and molecular diagnostics services. If in the future CMS implements these edits or some other MUEs related to our services, it could inhibit our ability to be reimbursed for services that we report. However, if it is medically reasonable and necessary to provide units of service in excess of an MUE, we may be able to modify such claims in order to be fully reimbursed.

Other policy changes may include competitive bidding by clinical laboratories for the provision of services to the Medicare program, which was the subject of a CMS demonstration project in Carlsbad, California, pursuant to the requirements of the Medicare Modernization Act, or MMA. The implementation of the demonstration project was delayed due to a federal preliminary injunction and The Medicare Improvements for Patients and Providers Act of 2008, or MIPPA, subsequently repealed the competitive bidding demonstration project. If later implemented, competitive bidding could decrease our reimbursement rates for clinical laboratory tests.

In addition, some private insurers and other third party payors link their rates to Medicare’s reimbursement rates and a reduction in Medicare reimbursement rates for clinical laboratory and pathology services could result in a corresponding reduction in the reimbursements we receive from such third party payors. Any reductions in reimbursement levels for our specialized diagnostic services would decrease our revenues and adversely affect our results of operations and financial condition.

*	Operating as a non-contracting provider with certain payors may adversely affect our results of operations and financial condition and contracting with those payors may be disadvantageous to us.

We are currently considered a “non-contracting provider” by a number of third party payors because we have not entered into a specific contract to provide our specialized diagnostic services to their insured patients at specified rates of reimbursement. We were generally subject to reimbursement as a non-contracting provider for approximately half of our revenues for the three and nine months ended September 30, 2009 and 2008. Use of a non-contracting provider typically results in greater coinsurance or copayment requirements for the patient, unless we elect to treat them as in-network in accordance with applicable law, which results in decreased revenues because we do not generally collect the full applicable out-of-network patient coinsurance or copayment obligations. In instances where we are prohibited by law from treating these patients as in-network, thus requiring them to pay additional costs or copayments, such patients may express concern about these additional costs to their hem/onc. As a result, that hem/onc may reduce or avoid prescribing our services for such patients, which would adversely affect our results of operations and financial condition.

Should any of the third party payors with whom we are not contracted insist that we enter into a contract for the specialized diagnostic services we provide, the resulting contract may contain pricing and other terms that are materially less favorable to us than the terms under which we currently operate. If reimbursement from a particular payor increases, there is heightened risk that such a third party payor will insist that we enter into contractual arrangements that contain such terms. If we refuse to enter into a contract with such a third party payor, they may refuse to cover and reimburse for our services, which may lead to a decrease in case volume and a corresponding decrease in our revenues. If we contract with such a third party payor, although our case volume may increase as a result of the contract, our revenues per case under the contractual agreement and our gross margins may decrease. The overall net result of contracting with third party payors may adversely affect our business, results of operations and financial condition.

Changes in regulations, payor policies or contracting arrangements with payors or changes in other laws, regulations or policies may adversely affect coverage or reimbursement for our specialized diagnostic services, which may decrease our revenues and adversely affect our results of operations and financial condition.

Governmental payors, private insurers and other private payors have implemented and will continue to implement measures to control the cost, utilization and delivery of healthcare services, including clinical laboratory and pathology services. Congress has from time to time considered and implemented changes to laws and regulations governing healthcare service providers, including specialized diagnostic service providers. These changes have adversely affected and may in the future adversely affect coverage for clinical laboratory and pathology services, including the specialized diagnostic services we provide. In addition, as a result of the new presidential administration’s focus on healthcare reform, there is risk that the Federal government may implement changes in laws and regulations governing healthcare service providers, including measures to control costs or reductions in reimbursement levels, which may have an adverse impact on our business. We also believe that healthcare professionals, including hem/oncs, will not use our services if third party payors do not provide adequate coverage and reimbursement for them. These changes in federal, state, local and third party payor regulations or policies may decrease our revenues and adversely affect our results of operations and financial condition.

For approximately half of our revenues for the three and nine months ended September 30, 2009 and 2008, we were generally subject to reimbursement as a non-contracting provider and payments to us as a non-contracting provider can be changed by third party payors at any time. We will continue to be a non-contracting provider until such time as we enter into contracts with third party payors for whom we are not currently contracted. We estimate contractual allowances with respect to revenues from third party payors with whom we are not currently contracted. During the three months ended September 30, 2009, we recorded positive changes in prior period accounting estimates to reduce contractual allowances, which increased our revenues by $4.4 million, of which $3.1 million pertained to the six months ended June 30, 2009. During the nine months ended September 30, 2009, we recorded positive changes impacting revenue by $6.4 million. In comparison, during the three months ended September 30, 2008, we recorded similar positive changes in prior period accounting estimates to reduce contractual allowances, which increased our revenues by $2.5 million, of which $1.6 million pertained to the six months ended June 30, 2008. During the nine months ended September 30, 2008, we recorded positive changes impacting revenue by $2.2 million. These favorable changes in accounting estimates related primarily to non-contracted payors and resulted from continued improvements to our collection processes, as well as increased hiring of personnel and management focused on the collection of accounts receivable for services rendered in prior periods and changes in reimbursement policies by certain payors. Because a substantial portion of our revenues is from third party payors with whom we are not currently contracted, it is likely that we will be required to make positive or negative adjustments to accounting estimates with respect to

contractual allowances in the future (as we have made in each of the last several quarters and annual reporting periods), which may adversely affect our results of operations, our credibility with financial analysts and investors and our stock price. Although, during the past several periods, we have recorded favorable changes in accounting estimates resulting in net increases in our revenues, it is possible that future adjustments may be less favorable and may result in net decreases in our revenues, which would adversely affect our results of operations.

*	Increased competition, including from competitors replicating our key service offerings in the future and the failure to provide a higher quality of service than that of our competitors could adversely affect our revenues and profitability.

The laboratory services industry generally is intensely competitive both in terms of service and price and it continues to undergo significant consolidation, permitting larger clinical laboratory service providers to increase cost efficiencies and change service levels, resulting in more intense competition. Most of our existing competitors and many potential competitors have substantially greater financial, selling, logistical and laboratory resources, more experience in dealing with third party payors for the services we provide and greater market penetration, purchasing power and marketing budgets, as well as more experience in providing diagnostic services.

As a specialized diagnostic service provider, we rely extensively on our high quality of service to attract and retain community-based hem/oncs and other healthcare professionals as our customers at the expense of our larger competitors. We compete primarily on the basis of the quality of testing, reporting and information systems, reliability in patient sample transport, reputation in the medical community, access to our highly qualified hempaths and our ability to expand our service offerings to our core hem/onc customers. For example, we generally provide treating hem/oncs with telephonic access on an almost real-time basis to the specific hempath that generates a report and analysis on the specific patient. Our failure to provide services superior to the laboratories with which we compete could adversely affect our revenues and profitability.

Because we do not rely on our intellectual property portfolio to impede others from copying our business, there are no significant barriers to entry into our business and new or existing laboratories could replicate our key service offerings and business model and enter our market to compete with us with relatively low upfront investments, which would adversely affect our business and prospects.

We are highly dependent on Cartesian Medical Group, Inc. for the services of our hempaths and any significant difficulties in recruiting or retaining these highly trained hempaths could adversely affect our revenues and results of operations.

Our business is highly dependent on the availability of hempaths, who provide professional services to us through Cartesian and we would be unable to provide our specialized diagnostic services without them. Cartesian is actively recruiting additional hempaths to work with us as we continue to expand our business. There are currently approximately 1,500 hempaths licensed in the United States and only approximately 75 new hempaths receive board certification in the United States each year. Our PSA with Cartesian is automatically renewed on a yearly basis but may be terminated by us at any time on 60 days’ prior written notice and either party may terminate the PSA upon the other party’s uncured material breach. Should Cartesian be unable to retain the hempaths that provide professional services to us, or if Cartesian fails in its efforts to recruit additional hempaths to provide us professional services, our ability to maintain and grow our business may be impaired. In addition, Cartesian may be required to offer higher compensation to hempaths in connection with recruitment and retention efforts and these increased compensation expenses would be reflected in the amount we pay to Cartesian through the PSA. We may be unable to recover these increased expenses through price increases or reimbursements for our diagnostic services. We have not used the services of any hempaths from any entity other than Cartesian and we do not believe there is another organization operating in our geographic region that would be able to provide us with comparable professional services. In addition, if Cartesian were to experience significant turnover in hempaths, our ability to perform our specialized diagnostic services and our revenues and results of operations could be adversely affected.

We must hire and retain qualified sales representatives to grow our sales.

Our ability to retain existing customers for our specialized diagnostic services and attract new customers is dependent upon retaining existing field sales representatives and hiring new field sales representatives, which is an expensive and time-consuming process. We face intense competition for qualified sales personnel and our inability to hire or retain an adequate number of field sales representatives could limit our ability to maintain or expand our business and increase sales. Even if we are able to increase our sales force, our new sales personnel may not commit the necessary resources or provide sufficient high quality service and attention to hem/oncs to effectively market and sell our specialized diagnostic services. If we are unable to maintain and expand our marketing and sales networks or if our sales personnel do not perform to our high standards, we may be unable to maintain or grow our existing business and our results of operations and financial condition will likely suffer accordingly.

Our sales personnel have developed and maintain close relationships with a number of healthcare professionals. In particular, our sales force focuses its efforts on developing relationships with community-based hem/oncs and other healthcare professionals who are decision makers in their offices. Our sales depend on the use of our specialized diagnostic services by these community-based hem/oncs and other healthcare professionals and successful marketing of our services depends on educating these community-based hem/oncs and other healthcare professionals as to the distinctive characteristics, benefits, high quality and value of our specialized diagnostic services as compared to those of our competitors.

If a sales representative ceases employment, we risk the loss of customer goodwill based on the impairment of relationships developed between the sales representative and the healthcare professionals for whom the sales representative was responsible. This is particularly a risk if the representative goes to work for a competitor, as the healthcare professionals that are our customers may choose to use a competitor’s services based on their relationship with the departed sales representative.

If we fail to attract and retain key management and other personnel, we may be unable to successfully maintain or develop our business.

Our success depends on our continued ability to attract, retain and motivate highly qualified management, laboratory and other personnel. For example, we are highly dependent on the operational and financial expertise of our executive officers. The loss of the services of any of our executive officers, particularly Tina S. Nova, Ph.D., our president and chief executive officer, could impede our growth. In particular, our executive officers currently perform most of our policy-making functions, are in charge of our principal business units, divisions and functions and are solely responsible for most of our key decisions. We are also dependent on our key employees and consultants, who are important to our business and assist and support our executive officers in implementing and executing these officers’ key decisions. If we lose any of our executive officers or key employees and consultants, other of these individuals may be required to fulfill his or her duties and spend time finding a replacement. We may not be able to find suitable replacements and our business may be harmed as a result. We do not maintain “key woman” or “key man” insurance policies on the lives of these individuals or the lives of any of our other employees. We employ our executive officers and key employees on an at-will basis and their employment can be terminated by them or us at any time.

Our industry has experienced a high rate of turnover of management personnel in recent years. In addition to the intense competition for qualified personnel in the healthcare industry, the San Diego area is characterized by a high cost of living, particularly for housing. As such, we could have difficulty attracting experienced personnel to our company and may be required to expend significant financial resources in our employee recruitment and retention efforts. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede significantly the achievement of our operational objectives, our revenue growth and our ability to implement our business strategy.

*	We may experience difficulties in managing our growth and our growth rate may decline.

Our revenues have grown to $50.8 million and $135.3 million for the three and nine months ended September 30, 2009, respectively, up from $32.1 million and $82.2 million for the comparable periods in 2008. This growth has put significant pressure on our systems and operations. As of September 30, 2009, we employed 417 employees, including Cartesian employees and seven part-time employees. Our current organization, and our systems and facilities currently in place, may not be adequate to support our future growth. In order to effectively manage our operations and any significant growth, we may need to:

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scale our internal infrastructure, including expansion of our laboratory facilities, while continuing to provide quality services on a timely basis to community-based hem/oncs and other customers;

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maintain and strengthen our relationships with our hem/onc customers as we increase the number of our sales and marketing personnel and increase our presence in the various geographic markets we serve;

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attract and retain sufficient numbers of talented employees and consultants, including sales personnel, hempaths, clinical service coordinators, scientists, laboratory technicians and administrative employees, to handle the increasing number of tests we are requested to conduct;

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manage our relationship with Federal Express to ensure its ability to handle increasing sample transport and deliveries;

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manage our relationships with third parties for the provision of certain services and the manufacture and supply of certain test kits, reagents and other laboratory materials;

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continue to enhance our compliance and quality assurance systems; and

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continue to improve our operational, financial and management controls and reporting systems and procedures.

If we are not able to successfully implement the tasks necessary to further expand our operations, our business, including the quality of our services and our billing, reimbursement, compliance and quality assurance systems, our results of operations and our financial results could be adversely affected. In addition, as our revenues grow, our period over period growth rate will likely decline.

*	We are continuing to expand our infrastructure by establishing additional laboratory space and implementing additional backup systems, which, among other things, could divert our resources and may cause our margins to suffer.

As of September 30, 2009, we leased and occupied laboratory and administrative facilities in Carlsbad, California. The facilities include one existing laboratory facility, one newly leased laboratory facility and a corporate office building, which serves as our administrative headquarters. Although all our facilities are currently in close proximity, there may be logistical issues that arise by virtue of separating these departments from the rest of our operations, including issues related to information systems integration and connectivity speed.

Moreover, in order to better serve our expanding nationwide customer base, to create a backup to our current laboratory facility and to gain additional referrals for our specialized diagnostic services, we may replicate our current California-based operations in a geographically different location in the future. In order to perform tenant improvements on the newly leased laboratory space in Carlsbad, CA and to later establish a backup laboratory facility in another region, we will be required to spend considerable time and resources securing adequate space, constructing the facility, obtaining the federal, state and local certifications required by all applicable laws and regulations, recruiting and training employees and establishing the additional operational, logistical and administrative infrastructure necessary to support a facility. Even after the new laboratory facility is operational; it may take time for us to derive the same economies of scale as in our existing facility. Moreover, we may suffer reduced economies of scale in our existing laboratory facility as we seek to balance the amount of work allocated to each laboratory facility. Similarly, we may invest in new backup systems in order to prevent the interruption in our current systems, which may be costly and would take time and resources to implement. Each expansion of our facilities or systems could divert resources, including the focus of our management, away from our current business. As we expand into other locations, including limited international expansion, there will be enhanced potential for logistical or other issues, including regulatory compliance issues and issues that may be specific to particular jurisdictions. In addition, each expansion of our facilities may increase our costs and potentially decrease operating margins, both of which would, individually or in the aggregate, negatively impact our business, financial condition and results of operations. We will need to continue to expand our managerial, operational, financial, sales, marketing and other infrastructure in order to adequately manage our business and provide support for our services. In addition, to the extent our service levels in our existing or new facilities suffer, this may adversely impact our business, financial condition and results of operations.

If our Carlsbad facilities become inoperable, we will be unable to perform our specialized diagnostic services and our business will be harmed.

We currently do not have redundant laboratory or administrative facilities. We perform all of our diagnostic testing in our laboratory facility located in Carlsbad, California. Carlsbad is situated on or near earthquake fault lines and is located in an area that has experienced severe wildfires during the past several years. In addition, we do not have redundant systems for all of our business processes. Our facilities, the equipment we use to perform our tests and services and our other business process systems would be costly to replace and could require substantial time to repair or replace. The facilities may be harmed or rendered inoperable by natural or people-made disasters, including earthquakes, wildfires, floods, acts of terrorism or other criminal activities, infectious disease outbreaks and power outages, which may render it difficult or impossible for us to perform our tests for some period. In addition, such events may temporarily interrupt our ability to receive specimens or materials from our suppliers and to have access to our various systems necessary to operate our business. For example, in late 2007 we experienced a power outage at our Carlsbad laboratory facility and the evacuation of our facilities as a result of severe wildfires. Although our backup generator and other backup procedures and systems allowed us to continue our operations without material interruption, we cannot assure you that similar incidents will not adversely affect our business in the future. The inability to perform our tests and services would result in the loss

of customers and harm our reputation and we may be unable to regain those customers in the future. Our insurance carriers and insurance policies covering damage to our property and the disruption of our business may become financially unstable or may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.

In the event our laboratory facility is damaged or destroyed, we would need to engage a third party to perform laboratory testing services on our behalf. In order to rely on a third party to perform these testing services, we could only use another facility with established state licensure and CLIA accreditation. We cannot assure you that we would be able to find another CLIA-certified facility, or that another laboratory would be willing to perform the necessary tests for us on commercially reasonable terms. Finding a new laboratory that meets the required state licensure and CLIA accreditation standards or developing new systems necessary to operate our business would be time-consuming and costly and result in delays in our ability to provide our specialized diagnostic services or to provide the same level of quality in our services as we currently provide, which would harm our reputation and adversely affect our business, results of operations and financial condition.

*	We incur financial risk related to collections.

Substantially all of our revenues are derived from specialized diagnostic services for which we bill on a fee-for-service basis. Billing for diagnostic services is a complex process and we bill many different payors such as insurance companies, governmental payor programs and patients, each of which has different billing requirements. Although we have experienced favorable trends in the collection of accounts receivable and related reductions to our provisions for doubtful accounts, we face risks in our collection efforts, including potential write-offs of doubtful accounts and long collection cycles for accounts receivable, including reimbursements by third party payors, such as Medicare, Medicaid and other governmental payor programs, hospitals, private insurance plans and managed care organizations. As a result of the current economic climate, we may face increased risks in our collection efforts, which could adversely affect our business. In addition, increases in write-offs of doubtful accounts (particularly in response to a recent increase in personal bankruptcies), delays in receiving payments or potential retroactive adjustments and penalties resulting from audits by payors could adversely affect our business, results of operations and financial condition. As of September 30, 2009 and December 31, 2008, we had an allowance for doubtful accounts of $5.0 million and $4.1 million, respectively, which we reduced by $1.4 million and $611,000, respectively, for write-offs, net of recoveries.

We or our suppliers and/or manufacturers may be subject to litigation relating to, among other things, payor and customer disputes, regulatory actions, professional liability, intellectual property, employee-related matters, product liability and other potential claims, which could adversely affect our business.

We or our suppliers and/or manufacturers may become subject in the ordinary course of business to material litigation related to, among other things, payor or customer disputes, professional liability, regulatory actions, intellectual property, employee-related matters, product liability and other potential claims, as well as investigations and audits by governmental agencies and governmental payors relating to the specialized diagnostic services we provide or other aspects of our business. Responding to these types of claims, investigations or audits, regardless of their merit, could result in significant expense and divert the time, attention and resources of our management. Legal actions could result in substantial monetary damages, fines and penalties as well as significant harm to our reputation with community-based hem/oncs and other healthcare professionals and with payors, which could adversely affect our business, financial condition and results of operations.

We, Cartesian and/or our hempaths may be sued, or may be added as an additional party, under physician liability or other liability law for acts or omissions by our hempaths, laboratory personnel, clinical service coordinators, and other employees and consultants, including but not limited to being sued for misdiagnoses or liabilities arising from the professional interpretations of test results. We, Cartesian and/or our hempaths may periodically become involved as defendants in medical malpractice and other lawsuits and are subject to the attendant risk of substantial damage awards, in particular in connection with our COMPASS service offering. Our hempaths are insured for medical malpractice risks on a claims-made basis under traditional professional liability insurance policies. We also maintain general liability insurance that covers certain claims to which we may be subject. Our general insurance does not cover all potential liabilities that may arise, including governmental fines and penalties that we may be required to pay, liabilities we may incur under indemnification agreements and certain other uninsurable losses that we may suffer. It is possible that future claims will not be covered by or will exceed the limits of our insurance coverage.

We and the suppliers and manufacturers of the diagnostic tests we perform, which are critical to the performance of our specialized diagnostic services, may be exposed to, or threatened with, future litigation by third parties having patent or other

intellectual property rights alleging that their diagnostic tests infringe the intellectual property rights of these third parties. In such event, we could no longer have access to, we may be prohibited from marketing or performing, or we may be subject to liabilities or litigations relating to such diagnostic tests unless we obtained a license from such third party. A license may not be available to us on acceptable terms, if at all. If we are unable to license diagnostic tests that are important to our specialized diagnostic services, our business, financial condition and results of operations may be adversely affected.

We rely on a limited number of third parties for manufacture and supply of all of our laboratory instruments, tests and materials, including consumables, and we may not be able to find replacement suppliers or manufacturers in a timely manner in the event of any disruption, which could adversely affect our business.

We rely on third parties for the manufacture and supply of all of our laboratory instruments, equipment and materials, including consumables such as reagents and disposable test kits, that we need to perform our specialized diagnostic services and rely on a limited number of suppliers for certain laboratory materials and some of the laboratory equipment with which we perform our diagnostic services. We do not have long-term contracts with our suppliers and manufacturers that commit them to supply equipment and materials to us. Certain of our suppliers provide us with analyte specific reagents, or ASRs, which serve as building blocks in the diagnostic tests we conduct in our laboratory. These suppliers are subject to regulation by the U.S. Food and Drug Administration, or FDA, and must comply with federal regulations related to the manufacture and distribution of ASR products. Because we cannot ensure the actual production or manufacture of such critical equipment and materials, or the ability of our suppliers to comply with applicable legal and regulatory requirements, we may be subject to significant delays caused by interruption in production or manufacturing. If any of our third party suppliers or manufacturers were to become unwilling or unable to provide this equipment or these materials in required quantities or on our required timelines, we would need to identify and acquire acceptable replacement sources on a timely basis. While we have developed alternate sourcing strategies for the equipment and materials we use, we cannot be certain that these strategies will be effective and even if we were to identify other suppliers and manufacturers for the equipment and materials we need to perform our specialized diagnostic services, there can be no assurance that we will be able to enter into agreements with such suppliers and manufacturers or otherwise obtain such items on a timely basis or on acceptable terms, if at all. If we encounter delays or difficulties in securing necessary laboratory equipment or materials, including consumables, we would face an interruption in our ability to perform our specialized diagnostic services and experience other disruptions that would adversely affect our business, results of operations and financial condition.

Performance issues, service interruptions or price increases by our shipping carrier could adversely affect our business, results of operations and financial condition and harm our reputation and ability to provide our specialized diagnostic services on a timely basis.

Expedited, reliable shipping is essential to our operations. One of our marketing strategies entails highlighting the reliability of our point-to-point transport of patient samples.

We rely almost exclusively on a single carrier, Federal Express, for reliable and secure point-to-point transport of patient bone marrow and other samples to our laboratory and enhanced tracking of these patient samples. Federal Express has tailored some of its systems and processes to meet our specific needs in providing high quality services to our hem/onc customers. In our specialty diagnostic field, patient samples more often than not include bone marrow biopsies, which are both technically difficult for a physician to obtain and extremely uncomfortable for patients to endure. Should Federal Express encounter delivery performance issues such as loss, damage or destruction of a sample, it would be difficult to replace our patient samples in a timely manner and such occurrences may damage our reputation and lead to decreased referrals from physicians for our specialized diagnostic services and increased cost and expense to our business. In addition, any significant increase in shipping rates or fuel surcharges could adversely affect our operating margins and results of operations. Similarly, strikes, severe weather, natural disasters or other service interruptions by delivery services we use would adversely affect our ability to receive and process patient samples on a timely basis.

If Federal Express or we were to terminate our relationship, we would be required to find another party to provide expedited, reliable point-to-point transport of our patient samples. There are only a few other providers of such nationwide transport services and there can be no assurance that we will be able to enter into arrangements with such other providers on acceptable terms, if at all. Finding a new provider of transport services would be time-consuming and costly and result in delays in our ability to provide our specialized diagnostic services. Even if we were to enter into an arrangement with such provider, there can be no assurance that they will provide the same level of quality in transport services currently provided to us by Federal Express. If the new provider does not provide the required quality and reliable transport services, it could adversely affect our business, reputation, results of operations and financial condition.

Proprietary trademarks, service marks, trade secrets and unpatented expertise are very important to our business.

We use numerous trademarks and service marks to identify the products and services we offer, some of which have been registered with the U.S. Patent and Trademark Office, or USPTO, and others of which are undergoing USPTO review. In addition, we are seeking registration of the name Genoptix in additional fields of use. We cannot guarantee that any of the trademarks or service marks for which we have applied for registration will be granted. Moreover, should a third party challenge one or more of our trademarks or service marks, we cannot guarantee that we would prevail in that challenge. Despite the use of our trademarks or service marks in connection with our services, we are not the sole person entitled to use the names COMPASS or CHART in every category in the United States. For example, third parties have registered the name COMPASS in the United States in the medical field and other categories. None of these third parties has contacted us with a claim that our COMPASS trademark infringes their rights. We cannot guarantee that a third party with rights in a COMPASS or CHART trademark, or in another trademark we use, will not assert those rights against us in the future, by opposing one of our trademark applications, petitioning to cancel one of our trademark registrations, or filing suit against us for trademark infringement seeking damages and/or an injunction to stop us from using our mark.

Although we have taken steps to protect our trade secrets and unpatented expertise, including entering into confidentiality agreements with third parties and confidential information and inventions agreements with employees, consultants and advisors, third parties may still be able to obtain this information or we may be unable to protect our rights. There can be no assurance that binding agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors. Enforcing a claim that a third party illegally obtained and is using our trade secrets or unpatented expertise is expensive and time-consuming and the outcome is unpredictable. Moreover, our competitors may independently develop equivalent knowledge, methods and expertise and we would not be able to prevent their use.

If technological innovation or prophylactic treatments were to reduce the need to conduct diagnostic testing on blood and bone marrow samples or allow our customers or other third parties to perform specialized diagnostic services similar to ours, our business, prospects, results of operations and financial condition could be adversely affected.

In order for hem/oncs to arrive at the correct diagnosis, choose or modify appropriate therapeutic regimens and monitor the effectiveness of these regimens, they currently require highly specialized diagnostic services that analyze blood and bone marrow samples. We focus our diagnostic efforts primarily on specific malignancies of the blood and bone marrow. Serial blood and bone marrow examinations are often performed to follow the progress of the disease and the patient’s response to therapy. Technological innovations or other advances in medicine that result in the creation of enhanced diagnostic tools may enable other clinical laboratories, hospitals, physicians or other medical providers, or patients, to provide specialized diagnostic services similar to ours in a more patient-friendly, efficient or cost-effective manner than is currently possible. Advances in technology or medicine may also result in a cure or prophylactic treatment for some of the diseases on which we focus which could reduce or eliminate the need to obtain and analyze bone marrow samples. This could substantially reduce or eliminate our market opportunity and adversely affect our business, prospects, results of operations and financial condition.

Failure in our information systems, or IS, telephone or other systems could significantly disrupt our operations and adversely affect our business and financial condition.

IS and telephone systems are used extensively in virtually all aspects of our business, including laboratory testing, sales, billing, customer service, logistics and management of medical data. The success of our business depends on the ability to obtain, process, analyze, maintain and manage this data and periodically enhance our IS, telephone and other systems to facilitate the continued growth of our business. Our management relies on our information systems because:

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patient samples must be received, tracked and processed on a timely basis;

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test results must be monitored and reported on a timely basis;

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billings and collections for all customers must be managed efficiently and accurately;

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third party ancillary billing services require proper tracking and reporting;

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pricing and other information related to our services is needed by our sales force and other personnel in a timely manner to conduct business;

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centralized procurement and test inventory management systems are required for effective test inventory management;

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regulatory compliance requires proper tracking and reporting; and

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proper recordkeeping is required for operating our business, regulatory compliance, managing employee compensation and other personnel matters.

Our business, results of operations and financial condition may be adversely affected if, among other things:

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our IS, telephone or other systems are interrupted or fail for any extended length of time;

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services relating to our IS, telephone or other systems are not kept current;

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our IS, telephone or other systems become unable to support expanded operations and increased levels of business;

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services provided by one or more of our vendors fail to operate within the expected technical parameters;

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information is lost or unable to be restored or processed; or

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information security is breached.

Our success depends, in part, on the continued and uninterrupted performance of our IS, telephone and other systems, which are vulnerable to damage from a variety of sources, including telecommunications or network failures, computer viruses, natural disasters and physical or electronic break-ins. We are especially vulnerable to losses of patient information, which could result in violations of federal and state privacy laws. Despite the precautionary measures we have taken to prevent breakdowns in our IS and telephone systems, sustained or repeated system failures that interrupt our ability to process test orders, deliver test results or perform tests in a timely manner or that cause us to lose patient information could adversely affect our business, results of operations and financial condition.

We may experience difficulty in identifying, acquiring or in-licensing and integrating third parties’ products, services, businesses and technologies into our current infrastructure or otherwise expanding our service offerings and we may not be able to successfully execute on and integrate such products, services, businesses or technologies, which could disrupt our business and adversely affect our results of operations and financial condition.

An important part of our business strategy is to opportunistically expand our service offerings and pursue additional technologies, collaborations and acquisitions that will enable us to accelerate the implementation of our strategic plan and to increase the number of customers we serve and the specialized diagnostic services we provide to those customers, including by way of investments in other companies, expansion into new markets, licensing of technology, co-development arrangements, collaborations, asset purchases and other similar transactions. For example, we currently outsource select specialized services that we offer and we may in the future seek to acquire the necessary capabilities to provide these services internally. Although we are not currently a party to any other agreements or commitments and we have no understandings with respect to any such opportunities, we may seek to expand our services and technologies, on an opportunistic basis and as resources allow, by acquiring or in-licensing products, services, businesses or technologies that we believe are a strategic fit with our business and growth plans. Future acquisitions or in-licensing of products, services, businesses or technologies, however, may entail numerous operational and financial risks including:

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exposure to unknown liabilities;

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disruption of our business and diversion of our management’s time and attention;

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the availability of financing to pay for these transactions;

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incurrence of substantial debt or dilutive issuances of securities to pay for these transactions;

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higher than expected acquisition, in-licensing and integration costs;

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increased amortization expenses;

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difficulties in and costs of combining the operations and personnel of any acquired or in-licensed products, services, businesses or technologies with our operations and personnel;

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increased regulatory, compliance and litigation risk;

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impairment of relationships with key suppliers or customers of any acquired or in-licensed products, services, businesses or technologies due to changes in management and ownership; and

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inability to retain key employees of any acquired or in-licensed products, services, businesses or technologies.

Finally, we may devote resources to potential acquisitions, expansion efforts, in-licensing or collaboration opportunities that are never completed, acquired by others, or fail to realize the anticipated benefits of such efforts. We may not be able to successfully expand our service offerings to our community hem/onc customers and successfully provide them with new technologies and innovations. Any of these matters could disrupt our business and adversely affect our growth prospects, results of operations and financial condition, and reputation with our customers.

We use biological and hazardous materials that require considerable expertise and expense for handling, storage or disposal and may result in claims against us.

We work with hazardous materials, including chemicals, biological agents and compounds, blood and bone marrow samples and other human tissue, that could be dangerous to human health and safety or the environment. Our operations also produce hazardous and biohazardous waste products. Federal, state and local laws and regulations govern the use, generation, manufacture, storage, handling and disposal of these materials and wastes. Compliance with applicable environmental laws and regulations may be expensive and current or future environmental laws and regulations may impair business efforts. If we do not comply with applicable regulations, we may be subject to fines and penalties.

In addition, we cannot entirely eliminate the risk of accidental injury or contamination from these materials or wastes. Our general liability insurance and/or workers’ compensation insurance policy may not cover damages and fines arising from biological or hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources and our operations could be suspended or otherwise adversely affected.

*	We have a limited operating history and we are unable to predict with certainty whether we will be able to continue our revenue growth and become increasingly profitable.

We are a relatively early stage company with a limited operating history. We did not commence selling our specialized diagnostic services until the third quarter of 2004 and only became profitable in the first quarter of 2007. Consequently, any predictions about our future performance may not be as accurate as they could be if we had a longer history of successfully commercializing specialized diagnostic services.

We incurred losses in each full fiscal year from inception to 2006, and have recovered our maximum accumulated deficit of $55.3 million as of December 31, 2006, resulting in accumulated earnings of $12.6 million as of September 30, 2009. This is compared to an accumulated deficit of $10.6 million as of December 31, 2008. Although we have continued to increase our revenues and profitability, there is no guarantee that we will be able to continue our revenue growth and maintain or increase our profitability. It is possible that we may incur operating losses in the future as we expand our infrastructure, increase selling expenses and general and administrative expenses or if we are unable to continue to maintain or increase our revenues or control expenses. Because of the numerous risks and uncertainties associated with our growth prospects, sales and marketing and other efforts and other factors, we are unable to predict with certainty whether we will be able to maintain our strong revenue growth and remain profitable or predict the extent of our future profitability or losses.

We may be subject to claims that our employees, consultants or independent contractors have wrongfully used or disclosed alleged trade secrets of their other clients or former employers to us.

In addition to our employees, we engage the services of consultants to assist us with certain aspects of our business. Many of these employees or consultants were previously employed at or may have previously been or are currently providing consulting services to, other clinical laboratories or diagnostics companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that we or these employees or consultants have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers or their former or current customers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

Risks Relating to Regulatory and Compliance Matters

*	We conduct business in a heavily regulated industry and changes in regulations or violations of regulations may, directly or indirectly, reduce our revenues, adversely affect our results of operations and financial condition and harm our business.

The clinical laboratory testing industry is highly regulated and there can be no assurance that the regulatory environment in which we operate will not change significantly and adversely in the future. In particular, there is risk of healthcare reform or other legislative activity in the near term, which may result in changes in the regulatory or payor environment that may adversely affect our business. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:

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federal and state laws applicable to billing and claims payment and/or regulatory agencies enforcing those laws and regulations;

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federal and state laboratory anti-mark-up laws;

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federal and state anti-kickback laws;

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federal and state false claims laws;

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federal and state self-referral and financial inducement laws, including the federal physician anti-self-referral law, or the Stark Law;

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coverage and reimbursement levels by Medicare, Medicaid, other governmental payors and private insurers;

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restrictions on reimbursements for our services;

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federal and state laws governing laboratory testing, including CLIA;

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federal and state laws governing the development, use and distribution of diagnostic medical tests known as “home brews”;

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the Health Insurance Portability and Accountability Act of 1996, or HIPAA, including amendments thereto by the Health Information Technology for Economic and Clinical Health Act, or the HITECH Act, and analogous state laws;

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federal and state regulation of privacy, security and electronic transactions;

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state laws regarding prohibitions on the corporate practice of medicine;

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state laws regarding prohibitions on fee-splitting;

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federal, state and local laws governing the handling and disposal of medical and hazardous waste;

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the Federal Trade Commission’s “Red Flag Rules,” which requires creditors to comply with regulations regarding the prevention of identity theft;

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Occupational Safety and Health Administration rules and regulations; and

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changes to other federal, state and local laws, including tax laws.

These laws and regulations are extremely complex and in many instances, there are no significant regulatory or judicial interpretations of these laws and regulations. While we believe that we are currently in material compliance with applicable laws and regulations, a determination that we have violated these laws or regulations, or the public announcement that we are being investigated or audited for possible violations of these laws or regulations, would adversely affect our business, prospects, results of operations and financial condition. In addition, a significant change in any of these laws or regulations may require us to change our business model in order to maintain compliance with these laws or regulations, which could reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations and financial condition.

In August 2009, the Internal Revenue Service, or IRS, commenced an examination of our U.S. federal income tax return for the tax year ended December 31, 2007. To date, there are no proposed adjustments that will have a material effect on our financial results. Although we believe current reserves are adequate to cover any potential assessments that may result from the examination, it is possible that we may be required to pay additional U.S. federal income tax or be subject to fines or penalties. We are subject to U.S. federal income tax as well as income tax in jurisdictions of each state having an income tax. The tax years that remain subject to examination are 2006 for federal income taxes and 2004 for state income taxes, including years ending thereafter. However, to the extent allowed by law, the tax authorities may have the right to examine prior periods where net operating losses or tax credits were generated and carried forward, and make adjustments up to the amount of the net operating losses or credit carry forward amount.

*	If we fail to comply with healthcare fraud and abuse laws that govern, among other things, sales and marketing, billing and claims processing practices, we could face substantial penalties and our business, results of operations and financial condition could be adversely affected.

We are subject to various state and federal healthcare fraud and abuse laws and regulations, including, but not limited to:

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the federal Anti-Kickback Statute, which prohibits persons from knowingly and willfully soliciting, receiving, offering or providing remuneration, directly or indirectly, in cash or in kind, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under governmental payor programs such as Medicare and Medicaid;

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the federal False Claims Act that prohibits individuals or entities from knowingly presenting, or causing to be presented to the federal government, claims for payment that are false or fraudulent and knowingly concealing or knowingly improperly avoiding or decreasing an obligation to pay or transmit money to the federal government;

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HIPAA, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;

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the Stark Law, which prohibits a physician from making a referral to an entity for certain designated health services reimbursed by Medicare or Medicaid if the physician (or a member of the physician’s family) has a financial relationship with the entity and which also prohibits the submission of any claim for reimbursement for designated health services furnished pursuant to a prohibited referral; and

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state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third party payor, including commercial insurers.

Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a clinical laboratory’s participation in or reimbursement from governmental payor programs, criminal fines and imprisonment. Although we endeavor to comply in all material respects with these rules and regulations, our sales and marketing, billing and claims processing practices may not, in all cases, meet all of the criteria for safe harbor protection or exemptions from liability under these laws. For example, in most cases, patients who utilize service providers that are not participants in a preferred provider network are subject to increased financial obligations in the form of greater coinsurance or copayment requirements. For approximately half of our revenues for the three and nine months ended September 30, 2009 and 2008, we were generally subject to reimbursement as a non-contracting provider. In order to maintain our competitiveness with other clinical laboratories, except as required by applicable laws, we frequently accept third party insurance payment as payment in full and, in turn, waive all or a part of a patient’s coinsurance obligations such that the patient’s financial burden is no greater than if he or she would have selected an in-network provider. A successful challenge to our practice of accepting third party insurance payments as payment in full under the laws discussed above could adversely affect our business, results of operations and financial condition.

In addition, certain federal Anti-Kickback Statute safe harbors and certain exceptions to the Stark Law exist to promote the adoption of electronic health records, or EHR Systems, by physician offices. These safe harbors/exceptions may be modified or eliminated and may not provide adequate protection for companies relying on such provisions. Should we choose to rely on these safe harbors/exceptions to assist any physician customers with the purchase of an EHR System, we may not, in all cases, meet all of the

necessary criteria for protection. In addition to the added cost of providing EHR System assistance to physician practices, a successful challenge to any potential use of the safe harbors and exceptions could adversely affect our business, operations and reputation.

*	Our failure to comply with governmental payor regulations could result in our being excluded from participation in Medicare, Medicaid or other governmental payor programs, which would decrease our revenues and adversely affect our results of operations and financial condition.

Reimbursement from Medicare and Medicaid accounted for approximately 40% of our revenues for the three and nine months ended September 30, 2009, as compared to 37% and 39% for comparable periods in 2008. The Medicare program is administered by CMS, which, like the states that administer their respective state Medicaid programs, imposes extensive and detailed requirements on diagnostic services providers, including, but not limited to, rules that govern how we structure our relationships with physicians, how and when we submit reimbursement claims and how we provide our specialized diagnostic services. Our failure to comply with applicable Medicare, Medicaid and other governmental payor rules could result in our inability to participate in a governmental payor program, our returning funds already paid to us, civil monetary penalties, criminal penalties and/or limitations on the operational function of our laboratory. If we were unable to receive reimbursement under a governmental payor program, a substantial portion of our revenues would be lost, which would adversely affect our results of operations and financial condition.

Our business could be harmed by future interpretations of clinical laboratory mark-up prohibitions.

Our laboratory currently uses the services of outside reference laboratories to provide certain complementary laboratory services to those services provided directly by our laboratory. Although Medicare policies do not prohibit certain independent-laboratory-to-independent-laboratory referrals and subsequent mark-up for services, California and other states have rules and regulations that prohibit or limit the mark-up of these laboratory-to-laboratory services. A challenge to our charge-setting procedures under these rules and regulations could have a material adverse effect on our business, results of operations and financial condition.

Our business could be harmed from the loss or suspension of a license or imposition of a fine or penalties under, or future changes in, the law or regulations of the CLIA or those of other state or local agencies.

We are subject to CLIA, which is administered by CMS and extends federal oversight to virtually all clinical laboratories by requiring that they be certified by the federal government or by a federally approved accreditation agency. CLIA is designed to ensure the quality and reliability of clinical laboratories by mandating specific standards in the areas of personnel qualifications, administration and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. The sanction for failure to comply with CLIA requirements may be suspension, revocation or limitation of a laboratory’s CLIA certificate, which is necessary to conduct business, as well as significant fines and/or criminal penalties. If a laboratory is certified as “high complexity” under CLIA, the laboratory may obtain ASRs, which are used to develop in-house diagnostic tests known as “home brews.” We received our CLIA accreditation certificate as a “high complexity” laboratory in mid-2004. To renew this certificate, we are subject to survey and inspection every two years as well as the possibility of unannounced surveys at any time. Our CLIA accreditation was renewed in February 2009 and expires on February 3, 2011.

We are also subject to regulation of laboratory operations under state clinical laboratory laws. State clinical laboratory laws may require that laboratories and/or laboratory personnel meet certain qualifications, specify certain quality controls or require maintenance of certain records. For example, California requires that we maintain a license to conduct testing in California and California law establishes standards for our day-to-day laboratory operations, including the training and skill required of laboratory personnel and quality control. Potential sanctions for violation of these statutes and regulations include significant fines and the suspension or loss of various licenses, certificates and authorizations, which could adversely affect our business and results of operations.

Certain of our specialized diagnostic tests take advantage of the “home-brew” exception from the FDA review and any changes to the FDA’s policies with respect to this exception could adversely affect our business and results of operations.

Clinical laboratory diagnostic tests that are developed and validated by a laboratory for use in examinations the laboratory performs itself are called “home brew” tests. The FDA maintains that it has authority to regulate the development and use of “home brews” as diagnostic medical devices under the Federal Food, Drug and Cosmetic Act but to date has decided not to exercise its authority with respect to most “home brew” tests as a matter of enforcement discretion. A substantial portion of our specialized diagnostic tests is “home brew” tests for which we have not obtained the FDA premarket clearance or approval. In addition,

manufacturers and suppliers of ASRs, which we obtain for use in our “home brews,” are required to register with the FDA, to conform manufacturing operations to the FDA’s Quality System Regulation and to comply with certain reporting and other recordkeeping requirements. The FDA regularly considers the application of additional regulatory controls over the sale of ASRs and the development and use of “home brews” by laboratories such as ours. As a result of recent industry events, it is possible the FDA may look at the sale and use of “home brew” tests with heightened scrutiny or modify their regulatory approach with respect to “home brew” tests. We cannot predict the extent of the FDA’s future regulation and policies with respect to “home brew” tests and there can be no assurance that the FDA will not require us to obtain premarket clearance or approval for certain of the diagnostic tests that we perform. Any such premarket clearance requirements could restrict or delay our ability to provide our specialized diagnostic services and may adversely affect our business and results of operations.

Failure to comply with the HIPAA security and privacy regulations and other state regulations may increase our operational costs.

The HIPAA privacy and security regulations establish comprehensive federal standards with respect to the uses and disclosures of personal health information, or PHI, by health plans and healthcare providers, in addition to setting standards to protect the confidentiality, integrity and availability of electronic PHI. The regulations establish a complex regulatory framework on a variety of subjects, including:

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the circumstances under which uses and disclosures of PHI are permitted or required without a specific authorization by the patient, including but not limited to treatment purposes, activities to obtain payments for services and healthcare operations activities;

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a patient’s rights to access, amend and receive an accounting of certain disclosures of PHI;

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the content of notices of privacy practices for PHI; and

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administrative, technical and physical safeguards required of entities that use or receive PHI electronically.

We have implemented policies and procedures related to compliance with the HIPAA privacy and security regulations, as required by law. The privacy regulations establish a uniform federal “floor” and do not supersede state laws that are more stringent. Therefore, we are required to comply with both federal privacy regulations and varying state privacy laws. The federal privacy regulations restrict our ability to use or disclose patient identifiable laboratory data, without patient authorization, for purposes other than payment, treatment or healthcare operations (as defined by HIPAA), except for disclosures for various public policy purposes and other permitted purposes outlined in the privacy regulations. The privacy and security regulations provide for significant fines and other penalties for wrongful use or disclosure of PHI, including potential civil and criminal fines and penalties. Although the HIPAA statute and regulations do not expressly provide for a private right of damages, we also could incur damages under state laws to private parties for the wrongful use or disclosure of confidential health information or other private personal information.

The Health Information Technology for Economic and Clinical Health Act, or the HITECH Act, was signed into law on February 17, 2009, as part of the American Recovery and Reinvestment Act of 2009. The HITECH Act imposes stiffer penalties for HIPAA privacy and security violations. The Act also mandates that HHS investigate any complaints that are preliminarily determined to involve potential willful neglect. The HITECH Act heightens HIPAA enforcement by authorizing state attorneys general to file suit on behalf of their residents. Courts will be able to award damages, costs and attorneys’ fees related to violations of HIPAA.

Our business could be materially harmed by future interpretation or implementation of state laws regarding prohibitions on the corporate practice of medicine.

The manner in which licensed physicians can be organized to perform and bill for medical services is governed by state laws and regulations. Under the laws of some states, including California, business corporations generally are not permitted to employ physicians or to own corporations that employ physicians or to otherwise exercise control over the medical judgments or decisions of physicians. All of the hempaths that we utilize in connection with providing our specialized diagnostic services are employed by Cartesian. Cartesian is a California professional corporation formed for the purpose of providing professional medical services in conjunction with the diagnostic services that we provide. On December 31, 2005, we entered into the PSA with Cartesian, pursuant to which these hempaths provide professional services to us. Prior to that time, we employed these hempaths, which could result in the potential assertion by regulatory authorities that we were engaged in the corporate practice of medicine.

We believe that we currently are in compliance in all material respects with the laws governing the corporate practice of medicine in California. If regulatory authorities or other parties were to assert that we were engaged in the corporate practice of medicine currently or prior to December 31, 2005, or if California laws governing the corporate practice of medicine were to change, we could be required to restructure our contractual and other arrangements and we and/or our hempaths could be subject to civil or criminal penalties. In addition, the provision of our specialized diagnostic services, which rely heavily on the professional services provided by our hempaths, could be interrupted or suspended, which would adversely affect our business, results of operations and financial condition.

Risks Relating to Our Finances and Capital Requirements

*	Negative conditions in the global credit markets and financial services and other industries may impair the liquidity of a portion of our investment portfolio or may otherwise adversely affect our business.

All of our investment securities are classified as available-for-sale and therefore reported on the balance sheet at market value. Our investment securities consist of municipal securities, government-sponsored enterprise securities, corporate debt securities, certificates of deposit and a single ARS.

As of September 30, 2009, we held one ARS with a cost basis of $4.9 million. The ARS is classified as a long-term investment security at fair value of $3.9 million, net of a temporary impairment of $1.0 million due to the illiquidity of the investment security (see Note 5 in the notes to the condensed consolidated financial statements). ARS are collateralized debt instruments with long-term contractual maturities that are structured with short-term holding periods. They provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals, typically every 7 to 35 days. The length of each holding period is determined at the original issuance of the ARS. We can sell at each auction at par, assuming there are buyers for the ARS at such auction. In order for the auction to be successful, demand in the marketplace must meet or exceed the supply. If an auction is unsuccessful, the interest rate on the security resets at a predetermined auction failure rate. An investor can continue to hold the investment security until the next auction date or attempt to sell in the secondary market, usually at a sizable discount.

The ARS in our investment securities portfolio consists of debt issued by a municipality that is also underwritten by an insurance agency. The ARS auctions began failing in February 2008. As of September 30, 2009, the ARS was rated “Baa1” by Moody’s Investors Service and “A” by Standard & Poor’s based on the underwriter’s guarantee. Although unsuccessful, the last auction occurred on September 10, 2008, prior to the bankruptcy of the broker/dealer that managed the auction. The funds associated with this security will not be accessible until the issuer restructures the debt, a buyer is found outside of the auction process, or the ARS matures in 2038. As such, we have recorded a temporary impairment of approximately $1.0 million as of September 30, 2009. In the meantime, the issuer continues to pay the interest as scheduled and have had two redemptions and shows no indication that it will be unable to meet its current obligations. We do not need to access these funds for operational purposes for the foreseeable future. Based on our ability to access our cash and cash equivalents and short-term investment securities and our expected operating cash flows, we do not anticipate that the temporary illiquidity of this investment will affect our ability to execute our current business plan.

In addition to the continuing deterioration in the global credit markets, the financial services industry and the U.S. capital markets, the U.S. economy as a whole has been experiencing a period of substantial turmoil and uncertainty characterized by unprecedented intervention by the U.S. federal government and the failure, bankruptcy, or sale of various financial and other institutions. The impact of these events on our business and the severity of the current economic crisis is uncertain. It is possible that the current crisis in the global credit markets, the U.S. capital markets, the financial services industry and the U.S. economy may adversely affect our business, vendors and prospects as well as our liquidity and financial condition. More specifically, our insurance carriers and insurance policies covering all aspects of our business may become financially unstable or may not be sufficient to cover any or all of our losses and may not continue to be available to us on acceptable terms, or at all.

We may need to raise additional capital in the future, which may not be available on favorable terms or at all, which may cause dilution to our existing stockholders or require us to be subject to certain restrictions.

We may need to raise additional capital in the future to fund the continued expansion of our business. Although we have become profitable over the past two years, our operations have consumed substantial amounts of cash since inception. To date, our sources of cash have been primarily limited to our initial public offering, private placements of preferred stock and debt, and more recently cash flow from operations. We expect to continue to spend substantial amounts of capital to grow our business. To fund such growth, we may raise additional funds through public or private equity offerings or debt financings. We do not know if we will be able to continue to generate cash flow from operations or if we will be able to obtain additional financing on favorable terms, if at all (particularly in light of the difficult current financing environment and weak economic conditions). If we cannot raise funds on

acceptable terms, if and when needed, we may not be able to maintain or grow our business at the rate that we currently anticipate and respond to competitive pressures or unanticipated capital requirements, or we may be required to reduce operating expenses, which could significantly harm our business, financial condition and results of operations. In addition, to the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership in our company will be diluted.

*	We expect to continue to incur significant costs as a result of operating as a public company and our management expects to continue to devote substantial time to public company compliance programs.

As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and The NASDAQ Stock Market, or NASDAQ, in the past several years have imposed various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls, changes in corporate governance practices and substantial changes in executive compensation disclosure. The SEC and other regulators have continued to adopt new rules and regulations and make additional changes to existing regulations that require our compliance. Stockholder activism, the current political environment and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact (in ways we cannot currently anticipate) the manner in which we operate our business. Our management and other personnel continue to devote a substantial amount of time to these compliance programs and other programs related to being a public company, such as investor relations, risk management (including securing director and officer liability insurance) and monitoring of public company reporting obligations. These rules and regulations will continue to cause us to incur significant legal and financial compliance costs and will make some activities more time-consuming and costly.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting. In particular, each year we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, or Section 404. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal significant deficiencies or material weaknesses in our internal control over financial reporting. We incur significant expense and devote substantial management effort toward ensuring compliance with Section 404. If we are not able to comply with the ongoing requirements of Section 404, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be significant deficiencies or material weaknesses, the market price of our common stock could decline and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities, which would entail expenditure of additional financial and management resources.

Future changes in financial accounting standards or practices, or existing taxation rules or practices, may cause adverse unexpected revenue or expense fluctuations and affect our reported results of operations.

A change in accounting standards or practices, or a change in existing taxation rules or practices, can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements, taxation rules and varying interpretations of accounting pronouncements and taxation practice have occurred and may occur in the future. For example, in September 2008 the State of California passed a law, effective January 1, 2008, to suspend California net operating losses for two-years pertaining to certain corporations doing business within California. This net operating loss suspension had no impact on our income tax benefit, as reported. However, this does require us to pay income tax associated with our taxable income for the tax years 2008 and 2009, which our California deferred net operating loss otherwise would have reduced. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. Our effective tax rate can also be impacted by changes in estimates of prior year items, the outcome of audits by federal, state and foreign jurisdictions and changes in overall levels of income before income tax. Furthermore, changes in accounting rules, such as increased use of fair value measures, changes in accounting principles generally accepted in the U.S. and the potential requirement that U.S. registrants prepare financial statements in accordance with International Financial Reporting Standards could potentially have a significant effect on our reported results.

Risks Relating to the Securities Markets and Investment in Our Common Stock

There may not be a viable public market for our common stock.

We cannot predict the extent to which investor interest in our company will continue to sustain an active trading market for our stock on The NASDAQ Global Market or any other stock market or how liquid any such market might remain. If an active public market is not sustained, it may be difficult for our stockholders to sell their shares of common stock at a price that is attractive to them, or at all.

Fluctuations in our operating results and market volatility may affect our stock price.

The market price of our common stock is volatile and may fluctuate significantly in response to a number of factors, many of which we cannot control, including:

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changes in coverage and/or reimbursement guidelines and amounts;

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variations in deductible and coinsurance amounts;

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changes in regulations affecting the healthcare or diagnostic services industry;

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failure to comply with applicable regulations;

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changes in the payor mix or the mix or cost of our specialized diagnostic services;

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the timing and volume of patient orders and the timing and cost of our sales and marketing campaigns;

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changes in contracted status with third party payors;

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changes in compensation expense and other expenses that result in changes in our operating results;

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increased investigative or enforcement initiatives by governmental and other third party payors;

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additions or departures of key personnel;

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variations in our quarterly operating results, including the number of business days in each quarter;

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seasonality and volume declines due to adverse weather conditions and holidays;

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changes in our accounting estimates;

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changes in our DSO level;

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changes in securities analysts’ estimates of our financial performance;

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announcements of acquisitions or other strategic transactions by us or our competitors;

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announcements of new products or services offered by us or our competitors;

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fluctuations in stock market prices and trading volumes of similar companies or in the broader markets generally;

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changes in economic conditions, in the global credit markets and financial services and other industries and the U.S. Federal government response to developments in the economy and such markets and industries;

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sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;

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uncertainty with respect to the reasons for changes in the trading volume or the market price of our common stock;

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any litigation in which we become involved;

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fluctuations in security market indices of which we may be included now or in the future;

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discussion of us or our stock price by the general media, online investor communities or financial industry or medical press;

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changes in federal or state tax laws; and

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impairment of any of our assets, including our investment securities.

Due to these factors, stockholders may not be able to sell their shares of our common stock at favorable prices or at all.

*	Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, as amended, may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders and the ability of our board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which, subject to certain exceptions, prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

*	If our executive officers, directors and largest stockholders choose to act together, they may be able to control our operations and act in a manner that advances their interests and not necessarily those of other stockholders.

As of October 26, 2009, our executive officers, directors and holders of 5% or more, based on available information, of our outstanding common stock beneficially owned approximately 22% of our common stock. As a result, these stockholders, acting together, may be able to exert control or influence over matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders and they may act in a manner that advances their interests and not necessarily those of other stockholders.

*	Future sales of our common stock may depress our stock price.

Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. As a result of the provisions of Rule 144 under the Securities Act of 1933, as amended, or the Securities Act, and Rule 701 under the Securities Act, substantially all of the outstanding shares of our common stock are available for sale in the public market, subject in the case of shares of our common stock held by affiliates to volume limitations, manner of sale requirements and certain other requirements. We also registered all shares of common stock that we may issue under our equity compensation plans. As a result, approximately $1.2 million shares are eligible for sale upon the exercise of vested options and release of specific RSUs outstanding as of October 26, 2009. These shares can be freely sold in the public market upon issuance, subject to our window period and insider trading policies, if applicable.

We have never paid dividends on our capital stock and because we do not anticipate paying any cash dividends in the foreseeable future, capital appreciation, if any, of our common stock may be the sole source of gain on an investment in our stock.

We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Furthermore, to the extent we incur indebtedness in the future; the loan documents governing such indebtedness may restrict our ability to pay dividends. As a result, we anticipate that capital appreciation, if any, of our common stock may be our stockholders’ sole source of gain for the foreseeable future.

We may become involved in securities class action litigation that could divert management’s attention and harm our business.

The stock markets have from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of diagnostic companies. These broad market fluctuations may cause the market price of our common stock to decline. In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially relevant for us because clinical laboratory service companies have experienced significant stock price volatility in recent years. We may become involved in this type of litigation in the future. Litigation often is expensive and diverts management’s attention and resources, which could adversely affect our business.

If we are not the subject of securities analyst reports or if any securities analyst downgrades our common stock or our sector, the price of our common stock could be negatively affected.

Securities analysts may publish reports about us or our industry containing information about us that may affect the trading price of our common stock. There are many publicly traded companies active in the healthcare industry, which may mean it will be less likely that we receive analysts’ coverage, which in turn could affect the price of our common stock. In addition, if a securities or industry analyst downgrades the outlook for our stock or one of our competitors’ stocks or chooses to terminate coverage of our stock, the trading price of our common stock may also be negatively affected.

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

Issuer Purchases of Equity Securities

The following table provides information with respect to purchases made by us of shares of our common stock during the three months ended September 30, 2009:


Period	Total Number of Shares Purchased (1)	Average Price Paid per Share		Total Value Paid by the Company		Maximum Number of Shares that May Yet Be Purchased Under the Plan
September 1, 2009 through September 30, 2009	374	$	30.39	$	11,366	—
August 1, 2009 through August 31, 2009	—		—		—	—
July 1, 2009 through July 31, 2009	—		—		—	—

Total	374	$	30.39	$	11,366

(1)

The shares repurchased by us during the months listed above represent shares that were repurchased from our directors who elected, at the time of grant and pursuant to the terms of their Restricted Stock Unit Award Agreements under our 2007 Equity Incentive Plan, to sell us shares of our common stock underlying said RSUs, at a price per share equal to the fair market value of a share of our common stock on the vesting date, for the purpose of satisfying the tax obligation created by the vesting of such RSUs.

Item 6. Exhibits.

EXHIBIT INDEX


Exhibit Number		Description
3.1(1)		Amended and Restated Certificate of Incorporation of the Registrant.

3.2(2)		Amended and Restated Bylaws of the Registrant.

4.1(3)		Form of the Registrant’s Common Stock Certificate.

4.2(3)		Amended and Restated Investors’ Rights Agreement, dated May 9, 2005, by and among the Registrant and certain of its Stockholders.

4.3(3)		First Amendment to Amended and Restated Investors’ Rights Agreement, dated August 3, 2005, by and among the Registrant and certain of its Stockholders.

31.1*		Certification of the Principal Executive Officer Pursuant to Rule 13a-14 and Rule 15d-14of the Securities Exchange Act of 1934, as amended.

31.2*		Certification of the Principal Financial Officer Pursuant to Rule 13a-14 and Rule 15d-14of the Securities Exchange Act of 1934, as amended.

32.1*		Certification of Principal Executive Officer and Principal Financial and Accounting Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Genoptix, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

(1)	Incorporated herein by reference to the Registrant’s Current Report on Form 8-K (File No. 001-33753), as filed with the Securities and Exchange Commission on November 2, 2007.

(2)	Incorporated herein by reference to the Registrant’s Current Report on Form 8-K (File No. 001-33753), as filed with the Securities and Exchange Commission on January 8, 2009.

(3)	Incorporated herein by reference to the Registrant’s Registration Statement on Form S-1 (File No. 333-144997), as amended, filed with the Securities and Exchange Commission.

SIGNATURE

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.


	GENOPTIX, INC.

Date: November 5, 2009	By:	/s/ Douglas A. Schuling
		Douglas A. Schuling
		Executive Vice President and Chief Financial Officer
		(Duly Authorized Officer and Principal Financial Officer)

GENOPTIX INC - FORM 10-Q - November 5, 2009

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