RESPONSE GENETICS INC - FORM 10-Q

Attached files

file	filename
EX-32 - RESPONSE GENETICS INC	v166414_ex32.htm
EX-31.2 - RESPONSE GENETICS INC	v166414_ex31-2.htm
EX-10.1 - RESPONSE GENETICS INC	v166414_ex10-1.htm
EX-31.1 - RESPONSE GENETICS INC	v166414_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

	(MARK ONE)

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

For the quarterly period ended September 30, 2009

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ___________ to __________

Commission file number: 001-33509

RESPONSE GENETICS, INC.

(Exact name of registrant as specified in its charter)

Delaware	11-3525548
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1640 Marengo St., 6th Floor, Los Angeles, California	90033
(Address of principal executive offices)	(Zip Code)

(323) 224-3900

(Registrant’s telephone number, including area code)

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

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

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

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

On November 16, 2009, there were 15,297,183 shares of common stock, $.01 par value per share, issued and outstanding.

Response Genetics, Inc.

Form 10-Q

Table of Contents

		Page
		Number
Part I.	Financial Information

Item 1.	Financial Statements
	Unaudited Consolidated Balance Sheets — December 31, 2008 and September 30, 2009		1

	Unaudited Consolidated Statements of Operations and Comprehensive Loss — Three and nine months ended September 30, 2008 and 2009		2

	Unaudited Consolidated Statements of Cash Flow — Three and nine months ended September 30, 2008 and 2009		3

	Notes to Unaudited Consolidated Financial Statements		4 - 24

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operation		25

Item 3.	Qualitative and Quantitative Disclosures About Market Risk		36

Item 4T.	Controls and Procedures		36

Part II.	Other Information

Item 1.	Legal Proceedings		36

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		36

Item 3.	Defaults Upon Senior Securities		37

Item 4.	Submission of Matters to a Vote of Security Holders		37

Item 5.	Other Information		37

Item 6.	Exhibits		37

Signatures			37
Exhibit Index
	EX-31.1
	EX-31.2
	EX-32

RESPONSE GENETICS, INC.

CONSOLIDATED BALANCE SHEETS

	December 31, 2008			September 30, 2009
				(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	9,545,000		$	9,299,183
Accounts receivable, net		2,119,496			1,704,362
Prepaid expenses and other current assets		399,612			434,273
Total current assets		12,064,108			11,437,818
Property and equipment, net		1,414,842			1,300,840
Other assets		69,103			69,102
Total assets	$	13,548,053		$	12,807,760
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	545,971		$	871,153
Accrued expenses		513,868			531,259
Accrued royalties		526,712			555,641
Accrued payroll and related liabilities		154,185			373,093
Deferred revenue		2,580,498			2,123,590
Total current liabilities		4,321,234			4,454,736

Deferred revenue, net of current portion		2,355,948			2,277,709
Total liabilities		6,677,182			6,732,445
Commitments and contingencies (Note 6)
Stockholders’ equity
Common stock, $0.01 par value; 50,000,000 shares authorized; 10,239,276 and 15,297,183 shares issued and outstanding at December 31, 2008 and September 30, 2009, respectively		102,393			152,972
Additional paid-in capital		36,805,932			43,542,320
Accumulated deficit		(29,805,729	)		(37,423,960	)
Accumulated other comprehensive loss		(231,725	)		(196,017	)
Total stockholders’ equity		6,870,871			6,075,315
Total liabilities and stockholders’ equity	$	13,548,053		$	12,807,760

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

RESPONSE GENETICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2009			2008			2009
Net revenue	$	1,957,030		$	2,259,523		$	5,683,409		$	5,694,988
Operating expenses:
Cost of revenue		1,025,383			1,175,615			2,849,482			3,646,358
Selling and marketing		-			934,946			-			2,759,108
General and administrative		2,101,864			1,305,247			5,580,186			4,453,204
UK operating expenses		688,794			21,645			1,939,828			465,910
UK redundancy costs		-			66,140			-			268,374
Research and development		410,469			726,696			1,719,013			1,734,223
Total operating expenses		4,226,510			4,230,289			12,088,509			13,327,177
Operating loss		(2,269,480	)		(1,970,766	)		(6,405,100	)		(7,632,189	)
Other income (expense):
Interest expense		(58	)		(2,360	)		(3,027	)		(8,199	)
Interest income		76,087			256			319,383			22,157
Other		(2,266	)		-			(3,692	)		-
Net loss	$	(2,195,717	)	$	(1,972,870	)	$	(6,092,436	)	$	(7,618,231	)
Unrealized gain on foreign currency translation		5,270			18,467			-			35,708
Total comprehensive loss	$	(2,190,447	)	$	(1,954,403	)	$	(6,092,436	)	$	(7,582,523	)
Net loss per share — basic and diluted	$	(0.21	)	$	(0.14	)	$	(0.60	)	$	(0.60	)
Weighted-average common shares — basic and diluted		10,239,276			14,599,182			10,239,276			12,594,995

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

RESPONSE GENETICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Nine Months Ended September 30,
	2008			2009
Cash flows from operating activities:
Net loss	$	(6,092,436	)	$	(7,618,231	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		524,431			307,585
Share-based compensation		1,186,033			725,066
Loss (gain) on sale of property and equipment		1,427			(48,615	)
Changes in operating assets and liabilities:
Accounts receivable		3,498,702			415,134
Prepaid expenses and other current assets		(34,451	)		(28,405	)
Other assets		(42,749	)		-
Accounts payable		476,132			324,325
Accrued expenses		149,478			16,246
Accrued royalties		210,886			28,929
Accrued payroll and related liabilities		(276,373	)		218,908
Deferred revenue		(3,584,115	)		(535,147	)
Net cash used in operating activities		(3,983,035	)		(6,194,205	)
Cash flows from investing activities:
Purchase of property and equipment		(683,213	)		(193,583	)
Proceeds from sale of property and equipment		-			48,615
Net cash used in investing activities		(683,213	)		(144,968	)
Cash flows from financing activities:
Proceeds from issuance of common stock		-			5,975,279
Capital contributions		-			86,622
Net cash used in investing activities		-			6,061,901
Effect of foreign exchange rates on cash and cash equivalents		(83,451	)		31,455
Net decrease in cash and cash equivalents		(4,749,699	)		(245,817	)
Cash and cash equivalents:
Beginning of period		17,024,209			9,545,000
End of period	$	12,274,510		$	9,299,183
Cash paid during the period for:
Income taxes	$	39,000		$	-
Interest	$	3,027		$	8,199

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

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization, Operations and Basis of Accounting

Response Genetics, Inc. (the “Company”) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin wax. In August 2000, the Company changed its name to Response Genetics, Inc. In November 2006, the Company established Response Genetics Ltd., a wholly owned subsidiary in Edinburgh, Scotland. On February 9, 2009 we implemented a reduction of workforce (“reduction of workforce”) pursuant to which we have closed our subsidiary in Edinburgh. See Note 13“UK OPERATIONS”.

The Company is a life science company engaged in the research, development, marketing and sale of pharmacogenomic tests for use in the treatment of cancer. Pharmacogenomics is the science of how an individual’s genetic makeup relates to drug response. Tests based on pharmacogenomics facilitate the prediction of a response to drug therapy or survival following surgery based on an individual’s genetic makeup. In order to generate pharmacogenomic information from patient specimens for these tests, the Company developed and patented enabling methods for maximizing the extraction and analysis of nucleic acids and, therefore, accessing the genetic information available from each patient sample. The Company’s platforms include analysis of single biomarkers using the polymerase chain reaction method as well as global gene interrogation using microarray methods from paraffin or frozen tissue specimens. The Company primarily derives its revenue by providing pharmacogenomic testing services to pharmaceutical companies in the United States, Asia and Europe.

The Company’s goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. The Company’s pharmacogenomic analysis of clinical trial specimens for the pharmaceutical industry may provide data that will lead to a better understanding of the molecular basis for response to specific drugs and, therefore lead to individualized treatment.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions for Form 10-Q promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the fiscal year. The financial statements should be read in conjunction with the Company’s audited December 31, 2008 and 2007 consolidated financial statements and accompanying notes included in the Company’s Form 10-K previously filed with the SEC. In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (the “Codification”). This standard replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, and establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The FASB Accounting Standards Codification (“ASC”) will become the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other nongrandfathered, non-SEC accounting literature not included in the Codification will become nonauthoritative. This standard is effective for financial statements for interim or annual reporting periods ending after September 15, 2009. The adoption of the Codification changed the Company’s references to GAAP accounting standards but did not impact the Company’s results of operations, financial position or liquidity.

2. Summary of Significant Accounting Policies

Basis of Consolidation

The consolidated financial statements include the accounts of Response Genetics, Inc. and its wholly owned subsidiary, Response Genetics, Ltd., a Scottish corporation, which was incorporated in November 2006. All significant intercompany transactions and balances have been eliminated in consolidation.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity at date of purchase of three months or less to be cash equivalents. The carrying value of cash equivalents approximates fair value due to the short-term nature and liquidity of these instruments. The Company’s cash equivalents are comprised of cash on hand, deposits in banks and money market investments.

Accounts Receivable

Clinical Accounts Receivable

The Company invoices its clients as specimens are processed and any other contractual obligations are met. The Company’s contracts with clients typically require payment within 45 days of the date of invoice. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its clients to make required payments. The Company specifically analyzes accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, the Company’s clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal. There were no allowances for doubtful accounts recorded at December 31, 2008 and September 30, 2009.

ResponseDX Accounts Receivable

ResponseDX accounts receivable related to Medicare billings is recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors from third party payers and patients. Management performs ongoing evaluations of account receivable balances based on management’s evaluation of historical experience and current industry trends. Management believes that no allowance for doubtful accounts is currently needed. Although the Company expects to collect amounts due, actual collections may differ materially from estimated amounts.

ResponseDX accounts receivable as of September 30, 2009, consisted of the following:

	September 30, 2009
Gross ResponseDX Medicare receivable	$	1,138,824

Less contractual allowances		(737,501	)
Net ResponseDX Medicare accounts receivable	$	401,323

Currently, we recognize ResponseDX revenue from third party and private payors on a cash basis until a collection history can be determined. Until we are reasonably assured about a pattern of collections, we will continue to record revenues from third party payors of ResponseDX on a cash basis.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Property and Equipment

Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using an accelerated method over the estimated useful lives of the assets. The Company has determined the estimated useful lives of its property and equipment, as follows:

Laboratory equipment		5 to 7 years
Furniture and Equipment		5 to 7 years
Leasehold Improvements		Shorter of the useful life or the lease term

Maintenance and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the related accounts and the resulting gain or loss is reflected in the statements of operations. During the year ended December 31, 2008 and the nine months ended September 30, 2009, the Company has capitalized costs related to database software development. The Company has not yet placed this database into service and accordingly has not depreciated these software development costs. The Company intends to place those database software costs into service and amortize those costs beginning January 2010 in accordance with ASC 350.40, Internal-Use Software, (formerly SOP 98-1) and the amortization period will be three years using the straight line method.

Revenue Recognition

Revenues are derived from pharmacogenomic testing services provided to pharmaceutical companies and are recognized on a contract specific basis pursuant to the terms of the related agreements. Revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectibility is reasonably assured.

Revenues are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through the Company’s laboratory under a specified contractual protocol. Certain contracts have minimum assay requirements that, if not met, result in payments that are due upon the completion of the designated period. In these cases, revenues are recognized when the end of the specified contract period is reached.

On occasion, the Company may enter into a contract that requires the client to provide an advance payment for specimens that will be processed at a later date. In these cases, the Company records this advance as deferred revenue and recognizes the revenue as the specimens are processed or at the end of the contract period, as appropriate.

We recognize revenue from our ResponseDX tests invoiced to Medicare on an accrual basis and revenue invoiced to third-party payers, including private payors, on a cash basis. We have received our Medicare provider number which allows us to invoice and collect from Medicare. Our invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes. We recognize revenue from third party and private payors currently on a cash basis until a collection history can be determined. Until we are reasonably assured about a pattern of collections we will continue to record revenues from third party payors of ResponseDX on a cash basis.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Cost of Revenue

Cost of revenue represents the cost of materials, direct labor, costs associated with processing tissue specimens including pathological review, staining, microdissection, paraffin extraction, reverse transcription polymerase chain reaction, or (“RT-PCR”) and quality control analyses, license fees and delivery charges necessary to render an individualized test result. Costs associated with performing tests are recorded as the tests are processed.

Patent License Fees

The Company has licensed technology for the extraction of mRNA from formalin-fixed, paraffin-embedded tumor specimens from the University of Southern California (“USC”). Under the terms of the license agreement, the Company is required to pay royalties to USC based on the revenue generated by use of this technology. The Company maintains a non-exclusive license to use the polymerase chain reaction (“PCR”), homogenous PCR, and reverse transcription PCR processes of Roche Molecular Systems, Inc. (“Roche”). The Company pays Roche Molecular Systems a royalty fee based on revenue that the Company generates through use of this technology. The Company accrues for such royalties at the time revenue is recognized. Such royalties are included in cost of revenue in the accompanying statements of operations.

Research and Development

The Company expenses costs associated with research and development activities as incurred. Research and development costs are allocated on a pro rata basis using the number of research-only specimens that are processed by the Company versus specimens that are processed and paid for by various third parties via contract. Research and development costs include employee costs (salaries, payroll taxes, benefits, and travel), equipment depreciation and warranties and maintenance, laboratory supplies, primers and probes, reagents, patent costs and occupancy costs.

Income Taxes

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

ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. At the date of adoption, and as of December 31, 2008 and September 30, 2009, the Company does not have a liability for unrecognized tax benefits.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC 718, Stock Compensation (formerly SFAS 123(R), Share- Based Payment) , which requires the measurement and recognition of compensation expense for all share-based payment awards based on estimated fair values.

Stock-based compensation expense recognized in accordance with ASC 718 was $538,850 and $221,514 for the three months ended September 30, 2008 and 2009, respectively, and $1,186,033 and $725,066 for the nine months ended September 30, 2008 and 2009, respectively. The Company accounts for equity instruments issued to non-employees in accordance with ASC 505, Equity, (formerly EITF 96-18). Under ASC 505, stock option awards issued are measured at fair value using the Black-Scholes option-pricing model.

Management Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. Management has identified revenue, stock-based compensation, the assessment of the realizability of deferred income tax assets, and share-based compensation as areas where significant estimates and assumptions have been made in preparing the financial statements.

Long-lived Assets

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

Foreign Currency Translation

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

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Comprehensive Income (Loss)

Comprehensive income (loss) encompasses the change in equity from transactions and other events and circumstances from non-owner sources and the Company’s net income (loss). The components of comprehensive loss and accumulated other comprehensive loss comprise net loss and foreign currency translation adjustments as of December 31, 2008 and September 30, 2009 and for the three and nine months ended September 30, 2009 and 2008.

Fair Value of Financial Instruments

Cash and cash equivalents are stated at cost, which approximates fair market value. Cash equivalents consist of money market accounts, with fair values estimated based on quoted market prices. For additional information see NOTE 15 Fair Value Measurements.

Reclassifications

Prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation. Reclassified amounts for 2008 related to UK operations had no impact on the company’s net losses.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Concentration of Credit Risk and Clients and Limited Suppliers

Cash and cash equivalents consist of financial instruments that potentially subject the Company to concentrations of credit risk to the extent recorded on the balance sheets. The Company maintains cash in United States financial institutions within the insurance limits of the Federal Deposit Insurance Corporation as of September 30, 2009. In addition, the Company has invested its excess cash in money market instruments which are not insured under the Federal Deposit Insurance Corporation but are insured under the Securities Industry Protection Corporation. The Company had approximately $7,240,000 of cash in money market instruments and has not incurred any losses on these cash balances as of September 30, 2009. At September 30, 2009, approximately $258,000 of cash was held outside of the United States and is uninsured.

Revenue sources that account for greater than 10 percent of revenue are provided below.

	Three Months Ended September 30,										Nine Months Ended September 30,
	2008					2009					2008					2009
	Revenue		Percent of Total Revenue			Revenue		Percent of Total Revenue			Revenue		Percent of Total Revenue			Revenue		Percent of Total Revenue
Taiho Pharmaceutical	$	356,300		18	%	$	260,700		12	%	$	1,183,575		21	%	$	581,050		10	%
GlaxoSmithKline	$	393,233		20	%	$	77,225		*		$	1,024,531		18	%	$	92,525		*
GlaxoSmithKline Biologicals	$	1,070,160		55	%	$	781,707		35	%	$	3,108,309		55	%	$	2,357,234		41	%
The Foundation of Biomedical Research	$	74,175		*		$	180,400		*		$	165,625		*		$	669,750		12	%

*less than 10%

Clients that account for greater than 10 percent of accounts receivable are provided below.

	As of December 31, 2008					As of September 30, 2009

	Receivable Balance		Percent of Total Receivables			Receivable Balance		Percent of Total Receivables
Taiho Pharmaceutical	$	388,275		18	%	$	350,275		21	%
GlaxoSmithKline	$	1,294,768		61	%	$	806,774		47	%
Hitachi Chemical	$	265,415		12	%	$	*		*

*less than 10%

Many of the supplies and reagents used in the Company’s testing process are procured from a limited number of suppliers. Any supply interruption or an increase in demand beyond the suppliers’ capabilities could have an adverse impact on the Company’s business. Management believes it can identify alternative sources, if necessary, but it is possible such sources may not be identified in sufficient time to avoid an adverse impact on its business. Refer also to Notes 6 and 7 for further discussion regarding these supply agreements.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

Recent Accounting Pronouncement

In April 2009, the Company adopted a new accounting standard included in ASC 820, Fair Value Measurements and Disclosures, (formerly the FASB issued Staff Position SFAS No. 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1, Interim Disclosures about Fair Value of Financial Instruments ). ASC 820 requires disclosure about fair value of financial instruments in interim financial statements as well as in annual financial statements. The new standard requires those disclosures in all interim financial statements. The provisions of the new standard was effective for interim reporting period ended June 30, 2009 and the application of the provisions of the standard did not affect our results of operations or financial condition.

In May 2009, the FASB issued new guidance for subsequent events. The new guidance, which is part of ASC 855, Subsequent Events, (formerly SFAS No. 165, Subsequent Events) is intended to establish standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. See Note 16 for additional information. The adoption of ASC 855 resulted in additional quarterly disclosures beginning in the second quarter of 2009 but did not affect the results of operations or financial condition..

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, now ASC 86-20 Sale of Financial Assets, which has not yet been adopted into Codification. SFAS No. 166 removes the concept of a qualifying special-purpose entity (QSPE) from SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, and removes the exception from applying FIN 46(R). This statement also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This statement is effective for fiscal years beginning after November 15, 2009. As such, the Company plans to adopt SFAS No. 166 effective January 1, 2010. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), now ASC 810 Consolidation,Variable Interest Entities, which has not yet been adopted into Codification. SFAS 167, which amends FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, (FIN 46(R)), prescribes a qualitative model for identifying whether a company has a controlling financial interest in a variable interest entity (VIE) and eliminates the quantitative model prescribed by FIN 46(R). The new model identifies two primary characteristics of a controlling financial interest: (1) provides a company with the power to direct significant activities of the VIE, and (2) obligates a company to absorb losses of and/or provides rights to receive benefits from the VIE. SFAS No. 167 requires a company to reassess on an ongoing basis whether it holds a controlling financial interest in a VIE. A company that holds a controlling financial interest is deemed to be the primary beneficiary of the VIE and is required to consolidate the VIE. This statement is effective for fiscal years beginning after November 15, 2009. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. This standard replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles , and establishes only two levels of U.S. generally accepted accounting principles, authoritative and nonauthoritative. The FASB Accounting Standards Codification will become the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other nongrandfathered, non-SEC accounting literature not included in the Codification will become nonauthoritative. This standard is effective for financial statements for interim or annual reporting periods ending after September 15, 2009. The adoption of the Codification changed the Company’s references to GAAP accounting standards but did not impact the Company’s results of operations, financial position or liquidity.

In June 2009, the FASB issued FASB Accounting Standards Update (“ASU”) 2009-01 “Topic 105 – Generally accepted Accounting Principles amendments based on the Statement of Financial Accounting Standards No. 168 - The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles.” ASU 2009-01 establishes the FASB Accounting Standards Codification as the single source of authoritative nongovernmental U.S. generally accepted accounting principles. The Company adopted ASU 2009-01 during the quarter ended September 30, 2009, and its application did not affect our results of operations or financial condition.

In June 2009, the FASB issued ASU No. 2009-02, “Omnibus Update — Amendments to Various Topics for Technical Corrections” (ASU 2009-02). The FASB issued ASU 2009-02 in order to make technical corrections to the Codification. The Company adopted ASU 2009-02 during the quarter ended September 30, 2009, and its application did not affect our results of operations or financial condition.

In August 2009, the FASB issued ASU No. 2009-03, “SEC Update — Amendments to Various Topics Containing SEC Staff Accounting Bulletins” (ASU 2009-03). The Codification includes certain SEC and SEC staff guidance in order to increase usefulness of the Codification for public companies. The SEC guidance is presented in separate sections and is limited to material on the basic financial statements. ASU 2009-03 includes technical corrections to various topics containing SEC Staff Accounting Bulletins to update cross-references to Codification text. The Company adopted ASU 2009-03 during the quarter ended September 30, 2009, and its application did not affect our results of operations or financial condition.

In August 2009, the FASB issued ASU No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820) — Measuring Liabilities at Fair Value” (ASU 2009-05). This ASU amends Subtopic 820-10, Fair Value Measurements and Disclosures-Overall, for the fair value measurement of liabilities, and provides clarification regarding required valuations techniques for circumstances in which a quoted price in an active market for the identical liability is not available. The Company adopted ASU 2009-05 during the quarter ended September 30, 2009, and its application did not affect our results of operations or financial condition.

In September 2009, the FASB issued ASU No. 2009-07, “Accounting for Various Topics — Technical Corrections to SEC Paragraphs” (ASU 2009-07). This ASU represents technical corrections to various topics containing SEC guidance based on external comments received. The Company adopted ASU 2009-07 during the quarter ended September 30, 2009, and its application did not affect our results of operations or financial condition.

In August 2009, the FASB issued new guidance relating to the accounting for the fair value measurement of liabilities. The new guidance, which is now part of ASC 820, provides clarification that in certain circumstances in which a quoted price in an active market for the identical liability is not available, a company is required to measure fair value using one or more of the following valuation techniques: the quoted price of the identical liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of fair value measurements. The new guidance clarifies that a company is not required to include an adjustment for restrictions that prevent the transfer of the liability and if an adjustment is applied to the quoted price used in a valuation technique, the result is a Level 2 or 3 fair value measurement. The new guidance is effective for interim and annual periods beginning after August 27, 2009. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations or financial position.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

3. Property and Equipment

Property and equipment consists of the following:

	December 31, 2008			September 30, 2009

Laboratory equipment	$	2,198,036		$	2,311,350
Furniture and equipment		451,908			528,831
Leasehold improvements		183,514			188,509
Software development		377,321			371,872
Total		3,210,779			3,400,562
Less: accumulated depreciation and amortization		(1,795,937	)		(2,099,722	)
Total property and equipment, net	$	1,414,842		$	1,300,840

Depreciation expense for the three months ended September 30, 2008 and 2009 was $185,234 and $86,970, respectively and for the nine months ended September 30, 2008 and 2009 was $524,431 and $307,585, respectively.

As a result of the reduction of workforce management implemented on February 9, 2009, management performed a recoverability test of the long-lived assets located at the United Kingdom testing facility in accordance with ASC 360, Property, Plant and Equipment, (formerly SFAS No. 144). Based on the recoverability analysis performed, the Company recorded a non-cash charge for the impairment of long-lived assets of $0.9 million as of December 31, 2008 to write down the carrying value of the long-lived assets to their estimated fair value of $0. The fair value was estimated based upon offers received from third parties to purchase the long-lived assets.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

4. Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:

	December 31,		September 30,
	2008		2009
Prepaid insurance	$	146,084	$	105,761
Prepaid maintenance contracts		98,513		191,011
Other		155,015		137,501
	$	399,612	$	434,273

5. Loss Per Share

The Company calculates net loss per share in accordance with ASC 260, Earnings Per Share, (formerly SFAS No. 128). Under the provisions of ASC 260, basic net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding for the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive common stock equivalents then outstanding. Common stock equivalents consist of shares of common stock issuable upon the exercise of stock options and warrants.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2009			2008			2009
Numerator:
Net loss	$	(2,195,717	)	$	(1,972,870	)	$	(6,092,436	)	$	(7,618,231	)
Numerator for basic loss per share		(2,195,717	)		(1,972,870	)		(6,092,436	)	$	(7,618,231	)
Denominator:
Denominator for basic and diluted loss per share — weighted-average common shares		10,239,276			14,599,182			10,239,276			12,594,995
Basic and diluted loss per share	$	(0.21	)	$	(0.14	)	$	(0.60	)	$	(0.60	)

Outstanding stock options and warrants to purchase 1,762,990 shares and 2,056,490 shares for the periods ended September 30, 2008 and 2009, respectively, were excluded from the calculation of diluted loss per share as their effect would have been antidilutive.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

6. Commitments and Contingencies

Operating Leases

The Company leases office and laboratory space under a noncancelable operating lease that expires on January 31, 2010. The lease contains two two-year options to extend the term of the lease and contains annual scheduled rate increases tied to the Consumer Price Index for the Los Angeles/Long Beach California metropolitan area. In March 2007, the Company entered into a noncancelable operating lease, which expired in March 2009, for office and laboratory space in Scotland. As a result of the reduction in workforce implemented by the Company on February 9, 2009, the Company extended its lease in Scotland for one additional month. For additional information see Note 13 UK Operations. The Company also leases space at 103 South Carroll Street, Suite 2b, Fredrick, Maryland 21701, for administrative purposes. This lease expires on August 31, 2010. Rent expense, included in cost of revenue, G&A, and R&D, was $163,880 and $84,289 for the three months ended September 30, 2008 and 2009, respectively and was $481,043 and $330,913 for the nine months ended September 30, 2008 and 2009, respectively.

Future minimum lease payments by year and in the aggregate, under the Company’s noncancelable operating leases, consist of the following at September 30, 2009:

Year Ending December 31,
remainder of 2009	$	108,942
2010		36,251
Total	$	145,193

Agreements with Suppliers

The Company purchases certain lab supplies and reagents primarily from three suppliers. Purchases from these companies accounted for approximately 85% and 82% of the Company’s reagent purchases for the period ended September 30, 2008 and 2009, respectively.

Guarantees

The Company enters into indemnification provisions under its agreements with other counterparties in its ordinary course of business, typically with business partners, clients and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities. These indemnification provisions generally survive termination of the underlying agreement. The Company reviews its exposure under these agreements no less than annually, or more frequently when events indicate. The Company believes the estimated fair value of these agreements is minimal as historically, no payments have been made by the Company under these indemnification obligations. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2009.

7. License and Collaborative Agreements

License Agreement with the University of Southern California (“USC”)

In April 2000, as amended in September 2002 and April 2005, the Company entered into a license agreement with USC. Under this agreement, USC granted the Company a worldwide, exclusive license with the right to sublicense, the patents for RGI-1 and related technology, for use in human and veterinary diagnostic laboratory services, the sale of clinical diagnostic products, and the sale of research products to the research community. USC retains the right under the agreement to use the technology for research and educational purposes.

In consideration for this license, the Company agreed to pay to USC royalties based on a percentage of the revenues generated by the use of RGI-1 and related technology. Royalty expense relating to this agreement amounted to $17,525 and $58,361 for the three months ended September 30, 2008 and 2009, respectively, and $58,105 and $135,369 for the nine months ended September 30, 2008, and 2009, respectively. Such expense is included in cost of revenue in the accompanying statements of operations.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

7. License and Collaborative Agreements - (continued)

License Agreement with Roche Molecular Systems (“Roche”)

In July 2001, the Company entered into a diagnostic services agreement with Roche to provide the Company with access to Roche’s patented PCR technology. In November 2004, this agreement was replaced by a non-exclusive license to use Roche’s PCR, homogenous PCR, and reverse transcription PCR processes. In consideration for these rights, the Company is obligated to pay royalties to Roche, based on a percentage of net sales of products or services that make use of the PCR technology. Royalty expense relating to this agreement amounted to $77,637 and $(84,058) for the quarter ended September 30, 2008 and 2009, respectively, and $236,473 and $116,402 for the nine months ended September 30, 2008, and 2009, respectively. Such expense is included in cost of revenue in the accompanying statements of operations.

In November 2004, the Company entered into an agreement with Roche, pursuant to which the Company is collaborating with Roche to produce commercially viable assays used in the validation of genetic markers for pharmaceutical companies. Specifically, the Company has licensed the rights to Roche to use the pre-diagnostic assays the Company develops in the course of using its RNA-extraction technologies to provide testing services to pharmaceutical companies and to produce diagnostic kits that then can be sold commercially to those pharmaceutical companies. Roche is required to pay the Company royalties of a certain percentage of net sales of such diagnostic kits sold to pharmaceutical companies. Through September 30, 2009, Roche has not been required to pay any royalties to the Company pursuant to this agreement.

Services Agreement with Taiho Pharmaceutical Co., Ltd. (“Taiho”)

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

In consideration for the testing services provided, Taiho paid an upfront payment at the commencement of the agreement and is obligated to pay regular testing fees, covering the specific services performed on a monthly basis.

Taiho is obligated to purchase a minimum amount of testing services from the Company each calendar quarter. Revenue recognized under this agreement was $356,300 and $441,100 for the quarter ended September 30, 2008 and 2009, respectively, and $1,183,575 and $1,244,800 for the nine months ended September 30, 2008, and 2009, respectively.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

7. License and Collaborative Agreements - (continued)

Services Agreement with SmithKline Beecham Corporation (d.b.a. GlaxoSmithKline or “GSK”)

In January 2006, the Company entered into an agreement with GSK pursuant to which the Company provides services in connection with profiling the expression of various genes from a range of human cancers. Under the agreement, the Company will provide GSK with testing services as described in individual protocols and GSK will pay the Company for such services based on the pricing schedule established for each particular protocol. GSK is obligated to make minimum annual payments to the Company under the agreement and also was obligated to make a non-refundable upfront payment to the Company, to be credited against work undertaken pursuant to the agreement. In January 2006, the Company received an upfront payment of $2,000,000. The contract also provides for minimum annual assay testing requirements over a three year period ending January 2009. The minimum amount of revenue to be recognized during the term, which expired in January 2009, was $6,500,000. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. The Company recognized $393,233 and $77,225 of revenue under this agreement during the quarter ended September 30, 2008 and 2009, respectively, and $1,024,531 and $92,525 for the nine months ended September 30, 2008, and 2009, respectively.

In December 2008, we amended and restated our master service agreement with GSK. Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment by December 31, 2008 of approximately $1,300,000 which was received on January 5, 2009 and included as part of deferred revenue as of December 31, 2008 and September 30, 2009. The amount of deferred revenue for this agreement at September 30, 2009 is $1,499,433.

Master Laboratory Test Services Agreement with GlaxoSmithKline Biologicals (“GSK Bio”)

In December 2006, the Company entered into an agreement with GSK Bio pursuant to which it will provide testing services, principally in relation to profiling the expression of various genes from a range of human cancers. The Company will conduct the testing services on tissue specimens provided by GSK Bio. The agreement required that GSK Bio make an upfront payment of $2,620,000, which was received by the Company in December 2006. The agreement further specifies that GSK Bio will pay annual minimum payments in 2007, 2008 and 2009 and that the upfront payment made in December 2006 will be credited against the annual minimum payments in 2007 and 2008. The agreement also provides that any differences between the annual minimum payments made in 2007, 2008 or 2009 and the amounts due to the Company for testing services performed on specimens submitted by GSK Bio during the three years ending December 31, 2009 be credited towards services performed during the year ending December 31, 2010, the final year of the agreement. The minimum amount of revenue to be recognized during the term of this contract, which will expire in December 2010, is approximately $7,300,000. If the Company ceases to provide services under the Amended and Restated Agreement for any reason, the Company shall remit to GSK Bio payment of the then remaining balance of the existing credit within sixty days of the date on which the Company ceased to provide services to GSK Bio.

In December 2007, the Company amended its agreement with GSK Bio whereby GSK Bio would make the remaining minimum payments under the agreement in one lump sum. This payment of approximately $2,722,000 was received in January 2008. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. The Company recognized $1,070,159 and $781,707of revenue under this agreement during the quarters ended September 30, 2008 and 2009, respectively, and $3,108,309 and $2,357,234or the nine months ended September 30, 2008, and 2009, respectively.

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

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

The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products. The amount of deferred revenue for this agreement at September 30, 2009 is $2,883,456.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

7. License and Collaborative Agreements - (continued)

Collaboration Agreement with Shanghai BioChip Company, Ltd. (“SBC”)

On March 5, 2007, the Company entered into a collaboration agreement with SBC pursuant to which SBC will provide exclusive pharmacogenomic testing services to the Company’s clients in China.

Pursuant to the agreement, the Company has granted SBC an exclusive license in China to provide services in China using the Company’s proprietary RNA extraction technologies. Subject to consent from USC, the Company will grant SBC an exclusive sublicense to patents licensed from USC for distribution of testing services in China. In turn, SBC will perform RNA extraction from FFPE tissue specimens exclusively for the Company during the term of the agreement.

This agreement has an initial term of five years, with an automatic renewal for an additional three-year term unless either party gives 90 days notice in advance of the renewal date of its intent not to renew. Pursuant to the agreement, SBC will receive a percentage of the gross margin, as defined in the agreement, collected from the Company’s clients in China as compensation for its testing services performed. For the three and nine months ended September 30, 2008 and 2009, respectively no testing services were performed.

Collaboration Agreement with Hitachi Chemical Co., Ltd.

On July 26, 2007, the Company entered into a collaboration agreement with Hitachi Chemical Co., Ltd. (“Hitachi”), a leading diagnostics manufacturer in Japan (the “Hitachi Agreement”). Under the terms of this agreement, Hitachi will begin using the Company's proprietary and patented techniques to extract genetic information from formalin-fixed paraffin-embedded (“FFPE”) tissue samples collected in Southeast Asia, Australia and New Zealand. As part of this collaboration agreement, the Company will provide Hitachi with the technical information and assistance necessary to perform the testing services. Hitachi also plans to introduce the Company to potential new testing services customers in the region to expand the testing of FFPE clinical samples in Asia. The Southeast Asian countries covered under this agreement include Japan, North Korea, South Korea, Taiwan, Mongolia, Pakistan, Bangladesh, Sri Lanka, Nepal, Singapore, Malaysia, Indonesia, Brunei, Thailand, Myanmar, Laos, Cambodia, Vietnam and the Philippines (the “Territory”).

This Agreement has an initial term expiring on March 31, 2010, with an automatic renewal for one year at the end of the original period under the same terms and conditions. Pursuant to the agreement, Hitachi will receive a percentage of the revenue, as provided in the agreement, collected from the Company's clients in the Territory, for its testing services performed which totaled $57,830 for the third quarter and nine months ended September 30, 2008, and $334,824 and $1,025,982 of expense for the third quarter and nine months ended September 30, 2009, respectively.

Hitachi is responsible for expenses related to the cost of laboratory equipment and modification to the laboratory facilities, as well as the cost of reagents. The Company has provided to Hitachi required laboratory equipment which Hitachi has agreed to pay the Company and is included as part of accounts receivable totaling $248,799 at December 31, 2008. This amount was paid during April 2009.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

8. Stock Option Plan

In March 2000, the Company adopted a Stock Option Plan (the “2000 Plan”) as approved by its board of directors. Under the 2000 Plan, the Company may grant options to acquire up to 1,600,000 shares of common stock. In connection with the adoption of the 2006 Employee, Director and Consultant Stock Plan, as further discussed below, the Company will grant no additional options under its 2000 Plan under which options to purchase 190,000 shares remained outstanding as of September 30, 2009. Although no more options may be granted under the 2000 Plan, the terms of the 2000 Plan continue to apply to all outstanding options. The Company also granted options to purchase 16,000 shares of common stock to two consultants which were granted under separate agreements outside of the 2000 Plan.

On October 26, 2006, the Board of Directors of the Company approved, and on May 1, 2007, reapproved, the adoption of the 2006 Employee, Director and Consultant Stock Plan (the “2006 Stock Plan”). The stockholders approved the 2006 Stock Plan on September 1, 2007. Under this plan, the Company may grant up to a maximum of 2,160,000 options to purchase the Company’s common stock. As of September 30, 2009, there were 409,510 options available to grant under the 2006 Stock Plan.

Employee options vest according to the terms of the specific grant and expire 10 years from the date of grant. Non-employee option grants to date vest typically over a 2 to 3 year period. The Company had 1,956,490 options outstanding at a weighted average exercise price of $5.12 at September 30, 2009. There were 892,069 nonvested stock options with a weighted average grant date fair value of $3.48 outstanding at September 30, 2009.

The Company estimated share-based compensation expense for the nine months ended September 30, 2009 and 2008 using the Black-Scholes model with the following weighted average assumptions:

	Nine Months Ended September 30, 2008			Nine Months Ended September 30, 2009
Risk free interest rate		3.54 – 5.03	%		3.01	%
Expected dividend yield		—			—
Expected volatility		65.28 – 77.4	%		67.0	%
Expected term (in years)		7			6
Forfeiture rate		5	%		5	%

The following table summarizes the stock option activity for the nine months ended September 30, 2009:

	Number of Shares			Weighted Average Exercise Price		Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding, December 31, 2008		1,586,490		$	6.24		7.98		—
Granted (Unaudited)		477,000		$	1.35
Exercised (Unaudited)		—		$	—
Forfeited (Unaudited)		(107,000	)	$	5.03
Outstanding, September 30, 2009 (Unaudited)		1,956,490		$	5.12		7.78	$	142,500
Exercisable, September 30, 2009 (Unaudited)		1,064,421		$	6. 49		6.84	$	30,450

The weighted-average grant-date fair value of options granted during the three months ended September 30, 2008 was $2.11. There were no options granted or exercised during the three months ended September 30, 2009. The weighted-average grant-date fair value of options granted during the nine months ended September 30, 2008 and 2009 was $2.15 and $0.84, respectively. There were no options exercised during the three and nine months ended September 30, 2008 and 2009.

As of September 30, 2009, there was $1.9 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 2.34 years.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

8. Stock Option Plan - (continued)

Information about stock-based compensation included in the results of operations for the three and nine months ended September 30, 2008 and 2009 are as follows:

	Three Months Ended September 30				Nine Months Ended September,30
	2008		2009		2008		2009
Cost of revenue	$	78,216	$	53,646	$	223,511	$	181,335
General and administrative		439,229		152,114		876,919		485,414
Research and development		21,405		15,754		85,603		58,317
Totals	$	538,850	$	221,514	$	1,186,033	$	725,066

9 . Common Stock Warrants

The Company issues warrants to purchase common shares of the Company either as compensation for services, or as additional incentive for investors who may purchase common stock. The value of warrants issued for compensation is accounted for as a non-cash expense to the Company at the fair value of the warrants issued.

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

There were no warrants granted during the three months and nine ended September 30, 2008 and 2009.

The following table summarizes all common stock warrant activity during the three months ended September 30, 2009:

	Number of Shares		Weighted Average Price		Remaining Contractual Life (years)
Outstanding, December 31, 2008		100,000	$	7.70		3.50

Outstanding, September 30, 2009		100,000	$	7.70		2.75
Exercisable, September 30, 2009		100,000	$	7.70		2.75

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

10. Income Taxes

Deferred income taxes result from temporary differences between income tax and financial reporting computed at the effective income tax rate. The Company has established a valuation allowance against its net deferred tax assets due to the uncertainty surrounding the realization of such assets. Management periodically evaluates the recoverability of the deferred tax assets. At such time it is determined that it is more likely than not that deferred tax assets are realizable, the valuation allowance will be reduced.

We file U.S. federal, U.S. state, and foreign tax returns. Our major tax jurisdictions are U.S. federal and the State of California and are subject to tax examinations for the years 2001 through 2008.

11. Segment Information

The Company operates in a single reporting segment, with operating facilities in the United States and the United Kingdom. Our United Kingdom facility ceased operations on April 30, 2009.

The following enterprise wide disclosure was prepared on a basis consistent with the preparation of the financial statements. The following tables contain certain financial information by geographic area:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2009		2008		2009
Revenue:
United States	$	456,395	$	1,036,716	$	1,225,899	$	2,086,954
Europe		1,070,160		781,707		3,108,310		2,357,234
Japan		430,475		441,100		1,349,200		1,250,800
Totals	$	1,957,030	$	2,259,523	$	5,683,409	$	5,694,988

	December 31, 2008		September 30, 2009
Long-lived assets: Net
United States	$	1,414,842	$	1,300,840
	$	1,414,842	$	1,300,840

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

12. Net ResponseDX Revenue

Net ResponseDX revenue for the three and nine months ended September 30, 2009 was comprised of the following:

	Three			Nine
	Months			Months
	Ended			Ended
	September 30,2009			September 30,2009
Gross patient service revenue	$	2,865,342		$	5,134,653

Contractual allowances		(1,950,693	)		(3,510,916	)

Net patient service revenue	$	914,649		$	1,623,737

ResponseDX revenues recorded during the three and nine months ended September 30, 2008 were $58,597. The Company began recording revenues for ResponseDX during the third quarter ended September 30, 2008.

Cost-Containment Measures

Both government and private pay sources have instituted cost-containment measures designed to limit payments made to providers of health care services, and there can be no assurance that future measures designed to limit payments made to providers will not adversely affect the Company.

Regulatory Matters

Laws and regulations governing Medicare programs are complex and subject to interpretation. Compliance with such laws and regulations can be subject to future governmental review and interpretation, as well as significant regulatory action including fines, penalties and exclusions from certain governmental programs. The Company believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing.

A portion of the Company’s revenues are derived from Medicare for which reimbursement rates are subject to regulatory changes and government funding restrictions. Although the Company is not aware of any significant future rate changes, significant changes to the reimbursement rates could have a material effect on the Company’s operations.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

13. U.K. Operations

On February 9, 2009, management implemented a reduction of workforce (“Reduction of Workforce”) pursuant to which the Company has closed its United Kingdom testing facility to consolidate services at its CLIA-certified laboratory facilities in Los Angeles. In connection with the Reduction of Workforce, the Company incurred expenses associated with redundancy costs of approximately $268,000. These costs are included in the Company’s statement of operations for the nine months ended September 30, 2009. Additionally, management performed a recoverability test of the long-lived assets located at the United Kingdom testing facility in accordance with ASC 360, Property, Plant and Equipment . Based on the recoverability analysis performed, the Company recorded a non-cash charge for the impairment of long-lived assets of $0.9 million as of December 31, 2008 to write down the carrying value of the long-lived assets to their estimated fair value of $0. The fair value was estimated based upon offers received from third parties to purchase the long-lived assets. Our lease for our United Kingdom testing facility expired on March 31, 2009. We extended the lease, pursuant to its terms, for an additional month, in order to facilitate the winding down of our operations in the United Kingdom. The Reduction of Workforce was substantially completed on March 31, 2009. We undertook the Reduction of Workforce as part of a strategic plan to increase operational efficiency in conjunction with the consolidation of our services at our Los Angeles facilities and it will not affect our genetic testing services or current partnership agreements.

14. Private Placement

On February 27, 2009, the Company entered into a Purchase Agreement with certain affiliates of Special Situations Funds for the private placement of 2,000,000 newly-issued shares of the Company's common stock at a per share price of $1.00. The closing of the sale of the Shares occurred on March 2, 2009. The aggregate offering price of the shares was $2 million and the Company received the funds on March 2, 2009.

In connection with the Special Situations Funds Private Placement, we also entered into a Registration Rights Agreement, dated February 27, 2009, with the Purchasers (the "Registration Rights Agreement") pursuant to which the Company filed a registration statement with the Securities and Exchange Commission ("SEC") to register the 2,000,000 shares for resale, which registration statement became effective on June 30, 2009.

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

In connection with the Lansdowne Private Placement, we also entered into a Registration Rights Agreement, dated July 22, 2009, with the Purchasers (the "Registration Rights Agreement") pursuant to which the Company filed a registration statement with the SEC to register the 3,057,907 shares for resale, which registration statement became effective on November 3, 2009. The Company also granted certain "piggyback" registration rights to Lansdowne which are triggered if the Company proposes to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the shares or the shares become eligible for sale under Rule 144(b)(1) without restriction.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

15. Fair Value Measurements

On January 1, 2009, the Company adopted ASC 820 (formerly SFAS No. 157) which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. In February 2008, the FASB deferred the effective date of ASC 820 by one year for certain non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted the provisions of ASC 820, except as it applies to those nonfinancial assets and nonfinancial liabilities for which the effective date has been delayed by one year. ASC 820 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The first two inputs are considered observable and the last unobservable, that may be used to measure fair value and include the following:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

As of September 30, 2009, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis, including its cash and cash equivalents. The fair value of these assets and liabilities was determined using the following inputs in accordance with ASC 820 at September 30, 2009:

	Fair Value Measurement as of September 30, 2009
	Total	Level 1		Level 2		Level 3
Description	$	$		$		$
Money market accounts (1)	7,240,403		7,240,403		-		-

(1) Included in cash and cash equivalents on the accompanying consolidated balance sheet.

16. Related Party Transactions

While employed at USC, Kathleen Danenberg, president, chief executive officer and director, developed and patented (United States Patent 6,248,535; Danenberg , et al., Method For Isolation of RNA From Formalin-Fixed Paraffin-Embedded Tissue Specimens) an extraction method that allowed reliable and consistent isolation of RNA from FFPE suitable for RT-PCR. USC retains ownership of this patent but has exclusively licensed this technology to the Company. In consideration for this license, the Company is obligated to pay royalties to USC, as a percentage of net sales of products or services using the technology, and to meet a certain minimum in royalty payments. Pursuant to USC policy, the inventors of technology owned by the University and then licensed for commercialization are paid a portion of royalties received by the University from the licensed technology. USC therefore pays a portion of royalties received from the Company to Ms. Danenberg in recognition of her invention. Amounts paid to Ms. Danenberg amounted to $29,993 and $5,465 for the nine months ended September 30, 2008 and 2009, respectively.

17. Subsequent Event

The Company has performed an evaluation of subsequent events through November 16, 2009, the date the Company filed these financial statements.

RESPONSE GENETICS, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

18. Correction of errors

In the course of preparing the financial statements for the third quarter ended September 30, 2009, management identified certain prior period errors. The errors related to an overstatement of net revenues in the amount $278,123. In accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99, Materiality and SAB No. 108 Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, management evaluated the materiality of the errors from qualitative and quantitative perspectives and concluded that the errors were not material to any prior periods. The correction of the errors in the current period is material to the third quarter financial statements but is not anticipated to be material to the full fiscal year or the trend of financial results. Accordingly, management has corrected the errors in the third quarter of 2009. The impact of the adjustments to correct the errors to the specific line items of the financial statements for the three months and nine months ended September 30, 2009 was as follows:

	Increase
	(Decrease)
Statement of operations:
Net revenue	$	(278,123	)
Operating loss		278,123
Net loss		278,123
Net loss per share – basic and diluted		0.02

Balance Sheet:
Deferred revenue	$	278,123
Total liabilities		278,123
Accumulated deficit		(278,123	)

Item 2: Managements Discussions and Analysis

Special Note Regarding Forward Looking Statements

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

The following discussion of our financial condition and results of operation should be read in conjunction with our unaudited financial statements and related notes to the financial statements included elsewhere in this Quarterly Report on Form 10-Q as of September 30, 2009 and our audited financial statements for the year ended December 31, 2008 included in our Annual Report on Form 10-K previously filed with the SEC. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward looking statements.

Overview

Response Genetics, Inc. (the “Company”) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin wax. In August 2000, we changed our name to Response Genetics, Inc. In November 2006, we established Response Genetics Ltd., a wholly owned subsidiary in Edinburgh, Scotland. On February 9, 2009 we implemented a reduction of workforce pursuant to which we closed our subsidiary in Edinburgh. See "liquidity and capital resources" for additional information.

Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. Our pharmacogenomic analysis of clinical trial specimens for the pharmaceutical industry may provide data that will lead to a better understanding of the molecular basis for response to specific drugs and, therefore lead to individualized treatment. We are focusing our efforts in the following areas:

Commercialization of our ResponseDX ™ tests;

Developing additional diagnostic tests for assessing the risk of cancer recurrence, prediction of chemotherapy response and tumor classification in cancer patients; and

Expanding our pharmacogenomic testing services business into and creating a standardized and integrated testing platform in the major markets of the healthcare industry, including outside of the United States.

Our patented technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, or FFPE, specimens and thereby to analyze genetic information contained in these tissues. This is significant because the majority of patients diagnosed with cancer have a tumor biopsy sample stored in paraffin, while only a small percentage of patients’ tumor specimens are frozen. Our technologies also enable us to use the FFPE patient biopsies for the development of diagnostic tests. To our knowledge, we were the first company to generate clinically relevant information regarding the risks of recurrence of cancer or chemotherapy response using approximately 30,000 genes available from microarray profiling of FFPE specimens.

ResponseDX™

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

At present most chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients’ tissues that may predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we are developing genetic tests that will measure predictive factors for tumor response in tumor tissue samples. We have begun offering tests for non-small cell lung cancer (NSCLC) (ResponseDX: Lung Ô ) and colorectal cancer (CRC) (ResponseDX: Colon Ô ) and gastric and gastroesophageal (GE) cancer (ResponseDX: Gastric Ô ) patients’ tumor tissue through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 (CLIA), and we anticipate offering additional tests for ovarian, and pancreatic cancer in the future. These tests are proprietary based tests which serve to help oncologists make optional therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among chemotherapy regimens to treat their cancer patients. On September 29, 2008, we announced an exclusive agreement with NeoGenomics Laboratories (OTCBB: NGNM) whereby NeoGenomics will offer our proprietary ResponseDx:Colon and ResponseDx: Lung tests nationwide. Under the terms of the agreement NeoGenomics will be the national exclusive clinical reference laboratory authorized to offer our proprietary tests through NeoGenomics national sales force and our sales team. Currently, our recently formed sales team has been expanded to 11 sales people located in the West Coast, Midwest, and East Coast areas of the United States.

Diagnostic Tests for Other Cancers

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

Expansion of our pharmacogenomic testing services business

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

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

We anticipate that, over the next 12 months, a substantial portion of our capital resources and efforts will be focused on research and development to expand our series of diagnostic tests for cancer patients, to establish a laboratory overseas in collaboration with certain of our current pharmaceutical clients, sales and marketing activities related to our ResponseDX diagnostic tests, and for other general corporate purposes.

Research and development expenses represented 13% and 14 % of our total operating expenses for the nine months ended September 30, 2009 and September 30, 2008, respectively. Major components in research and development expenses for the nine months ended September 30, 2009 included supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, and sample procurement costs.

Critical Accounting Policies and Significant Judgments and Estimates

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

Revenue Recognition

Revenues are derived from services provided to pharmaceutical companies and from revenues generated from our ResponseDX tests. Revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

Revenues from pharmaceutical company contracts are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through our laboratory under a specified contractual protocol. Certain contracts have minimum assay requirements that, if not met, result in payments that are due upon the completion of the designated period. In these cases, revenues are recognized when the end of the specified contract period is reached.

On occasion, we may enter into a contract that requires the client to provide an advance payment for specimens that will be processed at a later date. In these cases, we record this advance as deferred revenue and recognize the revenue as the specimens are processed or at the end of the contract period, as appropriate.

We recognize a portion of product revenue from our ResponseDX tests invoiced to Medicare on an accrual basis and to third-party payors, including private payors on a cash basis. We have received our Medicare provider number which allows us to invoice and collect from Medicare. Our invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes. We recognize revenue from third party and private payors currently on a cash basis until a collection history can be determined. Until we are reasonably assured about a pattern of collections we will continue to record revenues from third party payors of ResponseDX on a cash basis. We continue to process samples for ResponseDX testing services. Currently we are processing more samples for ResponseDX testing services than revenue is being recorded. This is primarily due to timing and recognition of revenue from third party payors until a collection history can be established.

We are subject to potentially significant variations in the timing of revenue recognized from period to period due to a variety of factors including: (1) the timing of when specimens are submitted to us for testing; and (2) the specific terms, such as minimum assay requirements in any given period, advance payment requirements, and terms of agreements, as set forth in each contract we have with significant clients.

License Fees

We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from USC in exchange for royalty fees on revenue generated by use of this technology. These royalties are calculated as a fixed percentage of revenue that we generate from use of the technology licensed from USC. Total license fees due under the royalty agreement to USC were $135,369 and $57,781 for the nine months ended September 30, 2009 and September 30, 2008, respectively. We also maintain a non-exclusive license to use Roche’s polymerase chain reaction (PCR), homogenous PCR, and reverse transcription PCR processes. We pay Roche a fixed percentage royalty fee for revenue that we generate through use of certain applications of this technology. Royalties accrued under this agreement totaled $116,402 and $236,473 for the nine months ended September 30, 2009 and September 30, 2008, respectively.

We are subject to potentially significant variations in royalties recorded in any period. While the amount paid is based on a fixed percentage from revenues of specific tests pursuant to terms set forth in the agreements with USC and Roche, the amount due is calculated based on the revenue we recognize using the respective licensed technology. As discussed above, this revenue can vary from period to period as it is dependent on the timing of the specimens submitted by our clients for testing.

Accounts Receivable

We invoice our pharmaceutical clients as specimens are processed and any other contractual obligations are met. Our contracts with pharmaceutical clients typically require payment within 45 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, our clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal.

We bill Medicare and third-party payors for ResponseDX upon completion of the required testing services. As such, we take assignment of benefits and the risk of collection with Medicare and third-party payors. As we continue to generate revenues from ResponseDX, we will monitor the collection history from third party payors. Until we are reasonably assured about a pattern of collections, we will continue to record revenues from third party payors of ResponseDX on a cash basis.

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

Income Taxes

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

Results of Operations

Correction of Errors

Quarters Ended September 30, 2009 and 2008

Revenues. Revenues were $2,259,523 for the quarter ended September 30, 2009, as compared to $1,957,030 for the comparable period in 2008, an increase of $302,493 or 15%. This increase was generated primarily through growth in the number of Response DX assays processed by our laboratory. Revenues from ResponseDX were $914,650 for the quarter ended September 30, 2009 compared to $58,597 in the third quarter of 2008. This increase in Response DX related revenues was partially offset by a decrease in revenue related to our pharmaceutical clients of $553,559 in the third quarter of 2009 as compared to the third quarter of 2008. The decrease in our pharmaceutical client revenue was generated primarily due to a delay in receipt of samples to be tested from our pharmaceutical clients which we expect to receive later in 2009 and 2010. For the quarter ended September 30, 2009, two of our clients, GSK and Taiho, accounted for approximately 58% of our revenue, as compared to approximately 95% of our revenue for the quarter ended September 30, 2008.

Cost of Revenues. Cost of revenues for the quarter ended September 30, 2009 were $1,175,615 as compared to $1,025,383 for the quarter ended September 30, 2008, an increase of $150,232 or 14.7%. This increase is primarily related to an increase of $276,994 in processing costs associated with our sample processing relationship with Hitachi in Japan, offset by a reduction of $93,870 in consulting expenses and $57,004 in lab supply and reagent costs.

Research and Development Expenses . Research and development expenses were $726,696 for the quarter ended September 30, 2009, as compared to $410,469 for the same period in 2008, an increase of $316,227 or 77.0%. This increase resulted primarily from an increase in personnel costs of $171,968, an increase of $59,278 in lab supplies and reagents, and an increase of $69,638 in consultation fees. We expect research and development expenses to increase as we continue work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

General and Administrative Expenses. General and administrative expenses totaled $1,305,247 for the quarter ended September 30, 2009, as compared to $2,101,864 for the comparable period in 2008, a decrease of $796,617 or 38%. This decrease resulted primarily from a reduction of $74,432 in staff salary and benefits expenses, a decrease in stock option expense of $287,115, a reduction of $106,585 in business consulting expenses, a $116,938 decrease in insurance expenses, a $54,893 reduction in depreciation and amortization expenses. We expect general and administrative expenses to increase as a result of the need to hire additional administrative personnel due to higher legal, accounting, compliance and related expenses associated with being a public company and to support the growth of ResponseDX.

Sales and Marketing Expenses: Historically, the Company has included sales and marketing expenses in the general and administrative expense category. With the hiring of a sales force to bring our ResponseDX assay to market the Company has commenced with the quarter ended March 31, 2009 to report expenses associated with our sales and marketing efforts separately. For the quarter ended September 30, 2009 our sales and marketing expenses totaled $934,946. These expenses primarily were comprised of $540,505 in personnel costs, $83,668 for business meetings and travel related expenses, and $202,702 in marketing costs such as press releases, promotional event costs and marketing materials. We expect that sales and marketing costs will continue to increase as we expand our sales and marketing activities in order to gain clinical acceptance of our ResponseDX assays.

U.K. Operating Costs and U.K. Impairment of Property and Equipment: In December, 2008, we made the decision to increase the operational efficiency of the Company by consolidating our UK operations with our US operations. Based on this decision we implemented a reduction of workforce pursuant to which we have closed our UK testing facility and consolidated testing services in our laboratory facilities located in Los Angeles. As a result of the implementation of the reduction of workforce management performed a recoverability test of the long-lived assets located at the United Kingdom testing facility. Based on the recoverability analysis performed, the Company recorded a non-cash charge for the impairment of long-lived assets of approximately $0.9 million as of December 31, 2008 to write down the carrying value of the long-lived assets to their estimated fair value of $0. The fair value was estimated based upon offers received from third parties to purchase the long-lived assets. The operating costs related to our UK lab, which were previously included in general and administrative expenses, were $21,645 for the quarter ended September 30, 2009 compared to $688,794 for the same period in 2008. Additionally, in connection with the reduction of workforce we incurred expenses related to redundancy costs of $66,140 in the quarter ended September 30, 2009.

Interest Income: Interest income was $256 for the quarter ended September 30, 2009, compared with $76,087 for the same period in 2008. This $75,831 decrease was due to lower average cash and cash equivalent balances and lower rates of return during the period ending September 30, 2009.

Nine Months Ended September 30, 2009 and 2008

Revenues: Revenues were $5,694,988 for the nine month ended September 30, 2009, as compared to $5,683,409 for the comparable period in 2008, an increase of $11,579 or 0%. This increase was attributable to a $1,623,737 in net revenue associated with our new ResponseDX assays processed by our laboratory. This increase was partially offset by a $1,553,561 decrease in revenues from pharmaceutical clients. The decrease in our pharmaceutical client revenue was generated primarily due to a delay in receipt of samples to be tested from our pharmaceutical clients which we expect to receive later in 2009 and 2010. For the nine months ended September 30, 2009, two of our clients, GSK and Taiho, accounted for approximately 63% of our revenue, as compared to approximately 97% of our revenue for the nine months ended September 30, 2008.

Cost of Revenues: Cost of revenues for the nine month period ended September 30, 2009 were $3,646,358 as compared to $2,849,482 for the same period ended September 30, 2008, an increase of $796,876 or 28.0%. This increase is primarily related to an increase of $968,152 associated with our sample processing relationship with Hitachi in Japan. This increase was partially offset by a $93,870 reduction in business consulting expenses, a $42,176 reduction in employee stock option expenses and a $36,344 reduction in costs associated with processing fluorescence in situ hybridization assays and bioinformatics.

Research and Development Expenses. Research and development expenses were $1,734,223 for the nine month period ended September 30, 2009, as compared to $1,719,013 for the same period in 2008, an increase of $15,210 or 0.1%. This increase resulted primarily from an increase in personnel costs of $38,878, and an increase in consultation fees of $135,764 offset by a decrease in royalties and patent fees of $91,970, a reduction in employee stock option expense of 27,286 and a reduction in equipment related costs of $26,420. We expect research and development expenses to increase as we continue work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

General and Administrative Expenses. General and administrative expenses totaled $4,453,204for the nine month period ended September 30, 2009, as compared to $5,580,186 for the comparable period in 2008, a decrease of $1,126,982 or 24.4%. This decrease resulted primarily from a reduction of salary and benefits costs of $225,923, a decrease in stock option expense of $391,505, a reduction of $363,813 in business consulting fees, , a reduction of $145,811 in legal and accounting fees. We expect general and administrative expenses to increase as a result of the need to hire additional administrative personnel and due to higher legal, accounting, compliance and related expenses associated with being a public company and to support the growth of ResponseDX.

Sales and Marketing Expenses: Historically, the Company has included sales and marketing expenses in the general and administrative expense category. With the hiring of a sales force to bring our ResponseDX assay to market the Company has commenced with the quarter ended March 31, 2009 to report expenses associated with our sales and marketing efforts separately. For the nine month period ended September 30, 2009 our sales and marketing expenses totaled $2,759,108. These expenses were primarily comprised of $1,441,291 in personnel costs, $270,458 for business meetings and travel related expenses, $545,784 in marketing costs such as press releases, promotional event costs and marketing materials, and $251,771 in royalty and license fees. We expect that sales and marketing costs will continue to increase as we expand our sales and marketing activities in order to gain clinical acceptance of our ResponseDX assays.

U.K. Operating Costs and U.K. Impairment of Property and Equipment. In December, 2008, we made the decision to increase the operational efficiency of the Company by consolidating our UK operations with our US operations. Based on this decision we implemented a reduction of workforce pursuant to which we have closed our UK testing facility and consolidated testing services in our laboratory facilities located in Los Angeles. As a result of the implementation of the reduction of workforce management performed a recoverability test of the long-lived assets located at the United Kingdom testing facility. Based on the recoverability analysis performed, the Company recorded a non-cash charge for the impairment of long-lived assets of $0.9 million as of December 31, 2008 to write down the carrying value of the long-lived assets to their estimated fair value of $0. The fair value was estimated based upon offers received from third parties to purchase the long-lived assets. The operating costs related to our UK lab, which were previously included in general and administrative expenses, were $465,910 for the nine month ended September 30, 2009 compared to $1,939,828 for the same period in 2008. Additionally, in connection with the reduction of workforce we incurred expenses related to redundancy costs of $268,374 through the nine month period ended September 30, 2009.

Interest Income. Interest income was $22,157 for the nine month period ended September 30, 2009, compared with $319,383 for the same period in 2008. This $297,226 decrease was due to lower average cash balances and lower rates of return during the period ending September 30, 2009.

Income Taxes. As of September 30, 2009 and 2008, a full valuation allowance has been recorded for the deferred tax assets since we do not believe the recoverability of the deferred income tax assets in the near future is more likely than not.

Liquidity and Capital Resources

We incurred net losses of $7,618,231 and $6,092,436 during the nine months ended September 30, 2009 and 2008, respectively. Since our inception in September 1999, we have incurred cumulative losses and as of September 30, 2009, we had an accumulated deficit of $37,423,960. We have not yet achieved profitability and anticipate that we will likely incur additional losses. We cannot provide assurance as to when will achieve profitability. We expect that our cash and cash equivalents will be used to fund our selling and marketing activities primarily related to our ResponseDX tests, research and development, and general corporate purposes. As a result, we will need to generate significant revenues to achieve profitability. Until we can generate and maintain sufficient revenues to finance our cash requirements, which we may never do, we expect to finance additional cash needs primarily through public or private equity offerings, strategic collaborations, and other financing opportunities as they may arise. We do not know whether additional funding will be available on acceptable terms, if at all. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate selling and marketing activities or research and development programs.

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

Following is a summary of recent events and the expected impact these events may or have had on our liquidity and future realization of revenues.

Contract amendments

On December 26, 2008, we amended and restated our master service agreement with GlaxoSmith Kline, Ltd. ("GSK"), a leading pharmaceutical manufacturer (the "GSK Agreement"). Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000 which was received on January 5, 2009. This payment was classified as deferred revenue and will be used for future work undertaken in the period beginning on January 1, 2009 and ending on December 31, 2010. The amount of deferred revenue for this agreement at September 30, 2009 is $1,499,433.

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

Private placements

On February 27, 2009, we entered into a Purchase Agreement with certain affiliates of Special Situations Funds for the private placement of 2,000,000 newly-issued shares of the Company's common stock at a per share price of $1.00. The closing of the sale of the Shares occurred on Monday, March 2, 2009 and we received the funds on the same date.

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

UK operations

Comparison of nine months ended September 30, 2009 and 2008

As of September 30, 2009, we had $9,299,183 in cash and cash equivalents, working capital of $6,983,082 and an accumulated deficit of $37,423,960.

Cash flows provided by operating activities

During the nine months ended September 30, 2009, the Company generated negative cash flows from operations of $6,194,205 compared to cash flows used in operations activities of $3,983,035 from operations in the nine months ended September 30, 2008. The reasons for using more cash in operating activities was due mainly to the increase in net loss of $1,525,795, and in combination, a decrease in receivables, increases in accounts payable and accrued expenses, an increase in accrued payroll and related liabilities, and a decrease in deferred revenue.

The decrease in accounts receivable, of $415,134, related mainly to an amendment entered into the fourth quarter of 2008 to the contract with GSK. In this amendment GSK agreed to make a non-refundable upfront payment of approximately $1,300,000 which was received on January 5, 2009. This payment may be credited against future work undertaken in the period beginning January 1, 2009 and ending on December 31, 2010.

The decrease in deferred revenue related to a decrease in advance billings to our customers, along with recognition of deferred revenue totaling $535,147.

The increase in accounts payable and accrued expenses primarily resulted from increased sales and marketing and business development activities related to the launch of ResponseDX.

The change in accrued payroll and related liabilities is primarily due to an increased number of employees at September 30, 2009.

Cash flows used in investing activities

Net cash used in investing activities was $144,968 for the quarter ended September 30, 2009 and $683,213 for the quarter ended September 30, 2008. This decrease was attributable to reduced need for capital equipment purchases in our laboratories.

Cash flows used in financing activities

Cash flows from financing activities for the nine months ended September 30, 2009 provided net cash of $6,061,901 related to the sale of common stock. There were no financing activities undertaken in the nine months ended September 30, 2008.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Recent Accounting Pronouncements

ITEM 3. Qualitative and Quantitative Disclosures about Market Risk.

Not applicable as we are a smaller reporting company.

ITEM 4T. Controls and Procedures.

Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings.

None.

ITEM 1A. Risk Factors

Not applicable as we are a smaller reporting company.

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

ITEM 3. Defaults Upon Senior Securities.

None.

ITEM 4. Submission of Matters to a Vote of Security Holders.

None.

ITEM 5. Other Information.

None.

ITEM 6. Exhibits.

10.1	Amended and Restated Master Agreement for the supply of Laboratory Test Services by and between GlaxoSmithKline Biologicals and the Company, dated as of September 7, 2009.

31.1	Certification of Principal Executive Officer Pursuant to Section 302.

31.2	Certification of Principal Financial Officer Pursuant to Section 302.

32	Section 906 certification of periodic financial report by Chief Executive Officer and Chief Financial Officer.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	RESPONSE GENETICS, INC.

DATE: November 16, 2009	By:	/s/ Kathleen Danenberg
		Kathleen Danenberg
		President and Chief Executive Officer (Principal Executive Officer)

DATE: November 16, 2009	By:	/s/ Thomas Stankovich
		Thomas Stankovich
		Chief Financial Officer (Principal Financial Officer)

Attached files

RESPONSE GENETICS INC Reports

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