UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

Commission File Number 0-22677

CLARIENT, INC.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		75-2649072 (IRS Employer Identification Number)
31 Columbia
Aliso Viejo, CA (Address of principal executive offices)		92656-1460 (Zip code)

(949) 425-5700
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, par value $0.01		The Nasdaq Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act:
NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

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

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

As of June 30, 2009, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $112,434,296 based on the closing price as reported on the NASDAQ Capital Market.

The number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date,

Class		Outstanding at March 8, 2010
Common Stock, $0.01 par value per share		84,103,031 shares

The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K: definitive proxy statement for the registrant’s 2010 Annual Meeting of Stockholders—Part III, Items 10, 11, 12, 13, and 14

 

 

TABLE OF CONTENTS

		Page No.
PART I
Item 1. Business			3
Company Overview			3
Company Evolution			4
Significant Stockholders			4
Market Overview and Opportunity			5
Operating Segment			5
Our Services			6
Billing			7
Sales and Marketing			10
Managed Care			10
Primary Market Segments			10
Seasonality			11
Patents, Trademarks, and Proprietary Technology			11
Competition			11
Collaboration and Partnerships			12
Research and Development			12
Quality Assurance			12
Information Systems			13
Legal and Regulatory Environment			13
Clarient Pathology Services, Inc.			16
Employees			17
Recent Acquisition			17
Available Information			17
Item 1A. Risk Factors			18
Risks Related to our Business			18
Risks Related to Regulation of our Industry			26
Risks Related to Ownership of our Common Stock			27
Item 1B. Unresolved Staff Comments			30
Item 2. Properties			30
Item 3. Legal Proceedings			30
Item 4. Reserved
Item 4A. Executive Officers of the Registrant			31
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities			33
Item 6. Selected Financial Data			35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			36
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			48
Item 8. Financial Statements and Supplementary Data			49
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure			86
Item 9A. Controls and Procedures			86
Item 9B. Other Information			87
PART III
Item 10. Directors and Corporate Governance			88
Item 11. Executive Compensation			88
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			88
Item 13. Certain Relationships and Related Transactions, and Director Independence			89
Item 14. Principal Accounting Fees and Services			89
PART IV
Item 15. Exhibits and Financial Statement Schedules			90
Signatures			95
Schedule II Valuation and Qualifying Accounts			96
Exhibit 3.1
Exhibit 10.9
Exhibit 10.35
Exhibit 10.36
Exhibit 10.37
Exhibit 10.51
Exhibit 21
Exhibit 23
Exhibit 23.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Cautionary Note Concerning Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about us, the industries in which we operate and other matters, as well as management’s beliefs and assumptions and other statements regarding matters that are not historical facts. These statements include, in particular, statements about our plans, strategies and prospects. For example, when we use words such as “projects,” “expects,” “forecasts,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “should,” “would,” “could,” “will,” “opportunity,” “potential” or “may,” variations of such words or other words that convey uncertainty of future events or outcomes, we are making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Our forward-looking statements are subject to risks and uncertainties. Factors that might cause actual results to differ materially, include, but are not limited to: our ability to continue to develop and expand our diagnostic services business, uncertainties inherent in our product development programs, our ability to expand and maintain a successful sales and marketing organization, our ability to maintain compliance with financial and other covenants under our credit facility, limitations on our ability to borrow funds under our credit facility based on our qualified accounts receivable and other liquidity factors, our ability to obtain annual renewals of or replacements for our credit facility, our ability to successfully manage our in-house billing function, our ability to accurately forecast bad debt expense, the continuation of favorable third party payor reimbursement for laboratory tests, our ability to obtain additional financing on acceptable terms or at all, unanticipated expenses or liabilities or other adverse events affecting cash flow, uncertainty of success in identifying and developing new diagnostic tests or novel markers, our ability to fund development of new diagnostic tests and novel markers and the amount of resources we determine to apply to novel marker development and commercialization, failure to obtain Food and Drug Administration, or FDA, clearance or approval for particular applications if/when required, our ability to compete with other technologies and with emerging competitors in novel cancer diagnostics and our dependence on third parties for collaboration in developing new tests, and those factors set forth under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this Annual Report on Form 10-K and the financial statements and the notes thereto. Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied upon as an indication of future performance. All forward-looking statements attributable to us, or to persons acting on our behalf, are expressly qualified in their entirety by this cautionary statement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report might not occur.

PART I

Item 1.		Business

Company Overview

Clarient, Inc., a Delaware corporation (“Clarient,” the “Company,” “we,” “us,” or “our”), is an advanced oncology diagnostics services company, headquartered in Aliso Viejo, California, and incorporated in 1993. Our mission is to help improve the lives of those affected by cancer through translating cancer discoveries into better patient care. We combine innovative technologies, clinically meaningful diagnostic tests, and world-class pathology expertise to provide advanced diagnostic services that assess and characterize cancer for physicians treating their patients, as well as for biopharmaceutical companies in the process of clinically testing various therapies. Our customers are connected to our Internet-based portal, PATHSiTE^®, that delivers high resolution images and critical interpretative reports resulting from our diagnostic testing services.

Our strategic focus is centered on identifying high-value opportunities that enable the expansion and differentiation of our cancer diagnostic services within the highly competitive medical laboratories sector in which we operate. We commercialize our services through our highly developed channels with community pathologists, oncologists, universities, hospitals, and pharmaceutical researchers. An important aspect of our strategy is to develop and expand our diagnostic offerings by applying our technical and medical expertise in combination with available intellectual property. Our diagnostic tests utilize “biomarkers” which are present in human tissues, cells, or fluids to aid in understanding a cancer patient’s diagnosis, prognosis, and expected outcome from the use of specific therapeutics. We believe that diagnostic tests which utilize biomarkers help bring clarity to critical decision making points related to cancer treatment for healthcare providers and the biopharmaceutical industry.

Company Evolution

With the completion of the human genome project in the late 1990s, medical science has entered a new era of diagnostics that will move us closer than ever before to understanding the molecular causes of complex diseases, particularly cancer. As a result, the landscape of cancer management and treatment is undergoing significant change. There is now an escalating need for advanced oncology testing to provide physicians with necessary information on the cellular molecular profile of a specific tumor, enabling the selection of the most appropriate therapies. Significant business opportunities exist for companies that are able to execute strategies to extract value from this new environment. For this reason, we began operating under a new business plan in the third quarter of 2004 by launching a business initiative—building a laboratory facility providing comprehensive services focused on cancer testing for both the clinical and biopharmaceutical markets—capitalizing on the growth that is widely anticipated over the next five to ten years in the cancer diagnostics market.

In 2005, we changed our corporate name and completed the first stage of the transformation of our business from ChromaVision Medical Systems, Inc. (positioned as a medical device provider with a single application) to Clarient, Inc. (positioned as a technology and services company offering a broad menu of advanced tests to assess and characterize cancer). We gathered an experienced group of professionals from the anatomic pathology laboratory and the in-vitro diagnostics businesses to carefully guide this transition. We have achieved rapid growth by commercializing a set of services which focuses on the needs of the community pathologist. In June 2005, we kicked off the second stage of our business strategy when we signed a distribution and development agreement with Dako A/S (“Dako”), a Danish company recognized as a worldwide leader in pathology diagnostics systems. The agreement with Dako enabled us to strengthen our legacy position as a leader in cellular digital image analysis with the ACIS^® Automated Image Analysis System (“ACIS”).

In 2006, we built upon our core capabilities within immunohistochemistry (“IHC”), a diagnostic testing methodology, with the addition of flow cytometry and fluorescent in situ hybridization (“FISH”) molecular testing methodologies. These additions positioned us to move beyond solid tumor testing into the important area of leukemia/lymphoma assessment.

In March 2007, we entered the third stage of our business strategy by selling our instrument systems business, consisting of certain tangible assets, inventory, intellectual property (including our patent portfolio and the ACIS and ChromaVision trademarks), contracts, and other assets used in the operations of the instrument systems business (the “Technology Business”), to Carl Zeiss MicroImaging, Inc. (“Zeiss”), an international leader in the optical and opto-electronics industries (the “ACIS Sale”). The ACIS Sale provided us with additional financial resources to focus our efforts on the most profitable and fastest growing opportunities within our services business. We believe that our strength as an advanced oncology diagnostics services laboratory, our strong commercial reach with cancer-focused pathologists, our unique delivery of completed services through PATHSiTE^®, our deep domain expertise, and our access to robust intellectual property can propel our continued growth through the development of additional tests, unique analytical capabilities, and novel service offerings.

In December 2009, we acquired Applied Genomics, Inc. (“AGI”), a company focused on the research and development of multivariate IHC biomarkers for use in assessing the recurrence rates of various cancer types, and the likelihood of response to various treatment options. The AGI acquisition provides us with ready-for-market IHC-based tests, particularly in assessing and characterizing lung cancer, pending the completion of validation procedures required under clinical laboratory regulations. The AGI acquisition also provides us with intellectual property content and tissue bank samples for our ongoing research and development efforts.

Significant Stockholders

Safeguard Scientifics, Inc. (NYSE: SFE) and certain of its subsidiaries comprise our single largest stockholder, holding 28.0% of our issued and outstanding voting securities as of December 31, 2009. We refer to Safeguard Scientifics, Inc. and/or its subsidiaries collectively herein as “Safeguard.” Our other significant stockholder is Oak Investment Partners XII, Limited Partnership, holding 20.0% of our issued and outstanding voting securities as of December 31, 2009. We refer to Oak Investment Partners XII, Limited Partnership herein as “Oak.”

Market Overview and Opportunity

Personalized medicine is defined by the U.S. Congress, as “the application of genomic and molecular data to better target the delivery of health care, facilitate the discovery and clinical testing of new products, and help determine a person’s predisposition to a particular disease or condition”. Personalized medicine currently has the attention of the federal and state governments, the national healthcare community, and the national media. Such attention has impacted the awareness and demand for personalized cancer diagnostic testing, a market widely expected by analysts to grow between $1.5 billion and $3.0 billion over today’s market size. Many factors will contribute to the expected increase in demand for our diagnostic and interpretive services, including an increased incidence of cancer within an aging U.S. population, cancer therapeutics developed by biopharmaceutical companies which require companion diagnostics (defined below), and new technologies which will enable the development of novel diagnostic tests. Recent trends indicate that medical treatment decisions are likely to involve the assessment of a complex panel of protein-and-gene based testing, rather than simply a single test. Diagnostic and predictive testing for these therapies will likely become increasingly complex, which will increase demand for sophisticated diagnostic tests. Such tests will also require additional expertise to interpret test results and/or assist pathologists in such interpretations.

The advent of proteomics—the scientific study of the structure and function of proteins and their activation pathways—has provided the ability to characterize cells associated with a number of diseases, including cancer. Such knowledge may be applied to gain insight into the molecular profile of a disease and to clarify the most probable pathway of disease progression. Many biopharmaceutical companies are rapidly developing drugs to inhibit or reduce the adverse effects of certain proteins in cancer progression. These drugs target tumor cells which exhibit certain molecular characteristics, with the goals of yielding better patient outcomes and fewer drug side effects.

Biopharmaceutical companies are investing billions of dollars in the development of high-potential targeted therapies, making this one of the fastest growing segments of oncology drug development. Each day of a delay to market has a substantial and quantifiable cost for these companies. Furthermore, many of these therapies will require a specific test (referred to as a “theranostic” or “companion diagnostic”) to assist physicians in selecting the right drug for the right patient. Beginning early in the process, the same theranostic is likely to accelerate the process for drug approval and market introduction by guiding selection of the most appropriate patients for the clinical trials. The FDA’s “Critical Path Initiative” is facilitating a national effort to modernize the scientific process through which a potential human drug, biological product, or medical device is transformed from a discovery or “proof of concept” into a medical product. We believe the companion diagnostic tests which we currently offer, and the tests that we are developing, are a key to this transformation.

Based on data from industry consultants, we estimate that there are over 600 active drug projects in clinical trials focused on an estimated 45 cancer indications. Of these, over 80 therapies are in Phase III clinical trials, and more than 300 compounds are in Phase II clinical trials. Over 65% of these compounds are directed at specific molecular targets. Of the compounds directed at specific targets, we believe over 50% are directed at the top five solid tumor cancers (lung, breast, ovarian, colon, and prostate), and over 15% are directed at the areas of leukemia/lymphoma. We have focused our core capabilities on these five solid tumor cancers and leukemia/lymphoma.

As the compounds that represent targeted therapies are released to the market, the way that cancer is managed will change dramatically. The result will be a clinical need for quantitative or semi-quantitative measurement of the relevant targeted proteins within a cancer cell. An example of a targeted therapy that uses a companion diagnostic test is Genentech, Inc.’s Herceptin^®, which specifically targets breast tumors that over express Her2/neu protein on the cell membrane. The National Comprehensive Cancer Network (NCCN), a not-for-profit alliance of 21 of the world’s leading cancer centers, currently mandates that all new breast tumors be tested for Her2/neu expression levels.

Anatomic pathologists specialize in diagnosing abnormal changes in tissue. When using traditional methods only, pathologists often have difficulty determining which patients are most likely to benefit from new therapies. We believe that today’s pathologists need to be empowered with the most advanced resources and information available for the personalized treatment of the patient.

Operating Segment

We have one reportable operating segment that delivers oncology diagnostic testing services to community pathologists, oncologists, biopharmaceutical companies, and researchers. At December 31, 2009, all of our services were provided within the United States, and substantially all of our assets were located within the United States. We previously had an additional operating segment which consisted of a business sold on March 8, 2007. That business developed, manufactured, and marketed certain instrument systems — see Note 4 to the Consolidated Financial Statements.

Our Services

Overview

We provide a wide range of oncology diagnostic testing and consultative services which include technical laboratory services and professional interpretation of laboratory test results by licensed physicians that specialize in pathology; such reports and analyses primarily are provided to our customers through our Internet-based portal, PATHSiTE^®.

Our services are focused on the most common types of solid tumors: breast, ovarian, prostate, lung, and colon, representing over 80% of annual diagnosed cases in the United States. We also offer an extensive menu of hematopathology testing for leukemia and lymphoma. In addition, we provide a complete complement of commercial services to biopharmaceutical companies and other research organizations, ranging from diagnostic testing services to the development of directed diagnostics through clinical trials.

New Tests Launched in 2009

Clarient Insight^® Dx Breast Cancer Profile

During the second quarter of 2009, we launched the Clarient Insight^® Dx Breast Cancer Profile, a prognostic test which has been clinically validated for women with early-stage, hormone-receptor-positive breast cancer. Clarient Insight^® Dx Breast Cancer Profile uses a combination of pathology risk factors and molecular markers to categorize patients as either high-risk or low-risk for recurrence of breast cancer, utilizing a non-linear mathematical algorithm incorporating clinical and key pathologic variables into a continuous risk score. The main prognostic factors associated with breast cancer are the number of lymph nodes affected, tumor size, histological grade, and hormone receptor status, though some patients have a recurrence despite having a tumor with good prognostic features. We believe the Clarient Insight^® Dx Breast Cancer Profile provides physicians with meaningful data to help stratify a patient’s risk of cancer recurrence into high risk or low risk, based upon their patient’s tumor characteristics, previous treatment, and performance status.

We are currently in the process of evaluating reimbursement options for our Clarient Insight^® Dx Breast Cancer Profile and completing additional validation studies. Accordingly, we have not billed or recognized revenue in 2009 for any of our services which incorporate its use.

EGFR Mutation Test

During the second quarter of 2009, we launched a new gene mutation test (“EGFR Mutation Test”) that can help physicians select the proper therapy for patients with non-small cell lung cancer (“NSCLC”). There are a number of drugs used for the treatment of NSCLC. We expect that our EGFR Mutation Test will provide pathologists and oncologists with the necessary data to best treat their patients, ensuring that unnecessary toxicities and treatment delays are avoided, and reduce the overall cost of therapy.

BRAF Mutation Test

From late December 2008 through January 2009, we launched a new predictive biomarker for colorectal cancer which detects mutations in the BRAF gene. Patients who have this mutation will not respond to anti-EGFR therapies. We expect that this test, which complements our KRAS testing, will help pathologists and oncologists in determining which therapies will be the most effective for their patients with colon cancer, sparing unnecessary toxicities, treatment delays, and cost.

Methodologies Employed in Our Laboratory Services

Our extensive menu of over 350 diagnostic tests used to assess and characterize cancer includes various methodologies which incorporate the latest laboratory technologies: IHC, flow cytometry, PCR, FISH, cytogenetics, and histology, which are briefly described below:

•

IHC refers to the process of localizing proteins in cells of a tissue section and relies on the principle of antibodies binding specifically to antigens in biological tissues. IHC is widely used in the diagnosis of abnormal cells such as those found in cancerous tumors. Specific molecular markers are characteristic of particular cellular events such as proliferation or cell death (apoptosis). IHC is also used to understand the distribution and localization of biomarkers and differentially expressed proteins in various parts of biological tissue.

•

Flow cytometry is a technology that measures and analyzes multiple physical characteristics of single particles, usually cells, as they flow in a fluid stream through a beam of light. The properties measured include a particle’s relative size, relative granularity or internal complexity, and relative fluorescence intensity. The use of flow cytometry assists a pathologist in diagnosing a wide variety of leukemia and lymphoma neoplasms. Flow cytometry is also used to monitor patients through therapy to determine whether the disease burden is increasing or decreasing, otherwise known as minimal residual disease monitoring.

•

PCR is a molecular biology technique that uses small DNA probes to target and amplify specific gene sequences for further analysis. The amplification occurs through the use of the polymerase chain reaction which consists of repeated cycles of heating and cooling the specimen in the presence of specific reagents. The technique is extremely sensitive and rapid, and offers direct detection and visualization of gene sequences.

•

FISH is a molecular technique that can be used to detect and localize the presence or absence of specific DNA sequences on chromosomes. The technique uses fluorescent probes that bind to only those parts of the chromosome with which they show a high degree of sequence similarity. Fluorescence microscopy is used to visualize the fluorescent probes bound to the chromosomes. FISH is often used for finding specific features of the genome for use in genetic counseling, medicine, and species identification. FISH can be used to help identify a number of gene alternations, such as amplification, deletions, and translocations.

•

Histology is the study of the microscopic structure of tissues. Through histology services, a pathologist attempts to determine the diagnosis of disease. Through structural and other changes in cells, tissues, and organs, pathologists can use a number of tools to establish a diagnosis of the type of disease suffered by the patient, a prognosis on the likely progression of the disease, and a determination as to which therapies are most likely to be effective in treating the patient. In addition to histology service, a number of molecular studies can now be run on these samples to gain further insight on prognostic and predictive indicators.

•

Cytogenetics involves genetic testing in cancer to assess a variety of genetic disorders and hematologic malignancies. It involves looking at the chromosome structure to identify changes from patterns seen in normal chromosomes.

Billing

Overview

Our net revenue is predominately derived from performing oncology diagnostic testing services which are billed to third parties (Medicare and private health insurers), clients (pathologists, hospitals, clinics, and biopharmaceutical companies), and patients. Our laboratory diagnostic services are eligible for third-party reimbursement under well-established medical billing codes. These billing codes are known as Healthcare Common Procedure Coding Systems and incorporate Medicare’s Common Procedural Terminology (“CPT”) codes, providing the means by which Medicare/Medicaid and private health insurers identify certain medical services that are eligible for reimbursement. The Medicare/Medicaid reimbursement amounts are based on the relative value of medical services with associated CPT codes, as established by the Centers for Medicare & Medicaid Services (“CMS”) with recommendations from the American Medical Association’s Relative Value Update Committee.

Medicare reimbursement rates, which provide the basis for substantially all of our billings, are dictated by CPT codes under two distinct reimbursement schedules: a Physician Fee Schedule and a Clinical Fee Schedule. We have the requisite Medicare provider numbers for both schedules, though the vast majority of our billings fall under the Physician Fee Schedule. The relevant CPT billing codes under the Physician Fee Schedule further distinguishes between “Technical” diagnostic services (the performance of a diagnostic test), “Professional” services (the professional interpretation of a diagnostic test, typically performed by a licensed physician), and “Global” services (the combination of Technical and Professional services).

The amount that we are able to be reimbursed from private health insurers is based on several factors, including the type of health insurance coverage (for example, health maintenance organization or preferred provider organization), whether the services are considered to be in network or out of network by the health insurance provider, and the amount of any co-pays or deductibles for which the patient is responsible.

Payor Classes

Third-party billing. The majority of our net revenue is generated from patients who use health insurance coverage through Medicare or private health insurers.

Client billing. We generally establish arrangements with our clients that allow us to bill them an agreed-upon amount for each type of service provided, though our client pricing is generally based upon the effective CPT code rate. It is generally our clients’ responsibility to seek reimbursement from their patients’ health insurance companies and/or the patients themselves.

Patient billing. We bill patients with health insurance co-payment obligations and deductibles (indirect billings), as well as patients without health insurance coverage (direct billings).

We do not rely on any single customer, or subset of customers, for a significant portion of our net revenue and we therefore have minimal risk of customer concentration. We, however, are dependent upon reimbursement from Medicare and its designated administrator for a substantial portion of our services, and any significant delay in payment or reductions in the published Medicare fee schedules could impact our operating results, cash flows, and/or financial condition.

CPT Code Summary — 2009, 2008, and 2007

The following table summarizes the Medicare reimbursement rates under the Physician Fee Schedule for the most common CPT codes used in our laboratory services. The “TC” modifier denotes Technical services, “26” modifier denotes Professional services, and no modifier denotes Global services. The below CPT codes, which provide the basis for our reimbursement rates per test, were associated with a substantial portion of our net revenue for the years ended December 31, 2009, 2008, and 2007:

				2009				2008				2009 Change				2007				2008 Change
CPT Code		General Description of Service		(1/1/09 – 12/31/09)				(1/1/08 – 12/31/08)				From 2008				(1/1/07 – 12/31/07)				from 2007
88185		Flow cytometry (cell surface, cytoplasmic, or nuclear marker)		$	59			$	52				13.5	%		$	41				26.8	%
88342 — TC		IHC (including tissue immunoperoxidase)		$	72			$	69				4.3	%		$	60				15.0	%
88342 — 26		IHC (including tissue immunoperoxidase)		$	44			$	44				—			$	46				(4.3	)%
88342		IHC (including tissue immunoperoxidase)		$	116			$	113				2.7	%		$	107				5.6	%
88361 — TC		IHC (computer assisted)		$	116			$	123				(5.7	)%		$	120				2.5	%
88361 — 26		IHC (computer assisted)		$	62			$	62				—			$	65				(4.6	)%
88361		IHC (computer assisted)		$	178			$	186				(4.3	)%		$	186				—
88368 — TC		FISH (manual)		$	182			$	158				15.2	%		$	112				41.1	%
88368 — 26		FISH (manual)		$	70			$	71				(1.4	)%		$	75				(5.3	)%
88368		FISH (manual)		$	251			$	229				9.6	%		$	193				18.7	%
88367 — TC		FISH (computer assisted)		$	222			$	204				8.8	%		$	183				11.5	%
88367 — 26		FISH (computer assisted)		$	66			$	65				1.5	%		$	70				(7.1	)%
88367		FISH (computer assisted)		$	288			$	269				7.1	%		$	252				6.7	%
83891		PCR - Isolation or extraction of highly purified NA		$	6			$	6				—			$	6				—
83896		PCR - NA probe		$	6			$	6				—			$	6				—
83898		PCR - Amp of patient NA, each NA sequence		$	24			$	23				4.4	%		$	23				—
83907		PCR - Lysis of cells prior to NA extraction (FFPE Only)		$	20			$	19				5.3	%		$	19				—
83914		PCR - Mutation identification		$	24			$	23				4.4	%		$	23				—
83912 — 26		PCR - Interpretation and report		$	19			$	19				—			$	19				—
88381		PCR - Microdissection, manual		$	257			$	257				—			Not applicable					Not applicable

We work with relevant medical societies and other constituents to encourage appropriate reimbursement levels from Medicare and other payors (which generally base their reimbursement levels upon Medicare rates) that fairly reflect the costs of developing specialized laboratory diagnostic services and their related benefits. Our services are widely recognized for providing net healthcare savings by empowering physicians with diagnostic and interpretive information to more responsively treat their patients.

Sales and Marketing

Our primary target market includes community pathology practices and hospitals. The process of selling diagnostic services for the assessment and characterization of cancer requires a knowledgeable and skilled sales force that can help pathologists and oncologists understand the mechanisms of targeted therapy and the value of the prognostic and predictive services which we offer. Our sales representatives generally have previous sales experience in the medical diagnostic services market, have strong technical knowledge, and have an extensive understanding of the community-based pathology practice. Our typical sales representative has a four-year bachelor’s degree, generally in the biological sciences. All of our sales representatives are kept current through our continuous and intensive training programs.

As of December 31, 2009, we had 58 people dedicated to our sales and marketing efforts. Our sales and marketing efforts are directly overseen by our Senior Vice President of Commercial Operations. Our Vice President of Sales and National Director of Sales are responsible for developing our sales representatives and identifying sales opportunities. We are organized into two regions and six districts. We have two Regional Sales Directors and six District Managers who identify and develop sales opportunities, and train and support the salespeople in their region/district. Within each district, each sales representative has a dedicated territory based on revenue potential and geographic reach. We use an Internet-based sales system to optimize customer and territory management. We will continue to expand our sales force as appropriate. Our sales strategy focuses on expanding the menu of services provided to our current customer base, while acquiring new customers. Our sales approach is designed to understand our current and potential customers’ needs and to provide the appropriate solutions from our expanding range of diagnostic services.

Our marketing efforts in 2009 continued to focus on establishing a strong and distinctive corporate brand identity, and distinguishing the diagnostic services that we offer. Our core commercial focus remains on community pathologists. We use our CONTiNUUM™ national and regional seminar and webcast programs to provide a collaborative environment between potential customers and our medical advisory board and medical staff.

Managed Care

During 2009, we strengthened our relationships with numerous managed care organizations (“MCO”) by adding experienced managed care personnel to our marketing team. Our MCO marketing team promotes our cancer diagnostic testing capabilities, and the value of our services, with the goal of selectively entering into contracts with MCOs. We believe that our comprehensive test menu and pathology expertise provides MCOs with a high quality and cost-effective solution for delivering cancer diagnostic services to their members.

Primary Market Segments

Our data indicate that there are approximately 4,000 hospitals or practice networks (the “Clinical Market”) in the United States that require cancer diagnostic or prognostic services. We approach the Clinical Market by dividing it into three market segments, as identified below. We also serve the biopharmaceutical market in providing diagnostic services associated with clinical validations of various therapies. Our services are designed to meet the specific needs of each market segment.

Clinical Market

Larger community hospitals and pathology groups. This market segment typically has the expertise to perform tests to assess and characterize cancer, though the resources required for the necessary laboratory equipment and staff are often cost and time prohibitive. Even if such resources were obtained, they would likely not yield an adequate return on investment due to the lack of sufficient testing volume. Accordingly, larger community hospitals and pathology groups typically choose to outsource many of their specialized oncology diagnostic services.

Smaller community hospitals and pathology groups. This market segment typically outsources all specialized oncology diagnostic services.

Regional reference laboratories, regional cancer centers, teaching hospitals and other large hospitals/multi-hospital systems, and associated large pathology practice groups. This market segment typically has comprehensive capabilities and performs most testing in-house. This market segment may require our specialized oncology diagnostic services for particularly complex cases.

Biopharmaceutical Market. We estimate that world-wide there are over 1,000 biopharmaceutical organizations that could benefit from our laboratory expertise and capabilities in the development of targeted therapeutics and companion diagnostics. We are in the early stages of reaching out to this market, though we are actively developing collaborative opportunities within this market. We are currently participating in a number of clinical trials with various leaders in biopharmaceutical industry in which we provide diagnostic testing services in connection with their validation of the related therapy.

Seasonality

Our business is subject to the impact of seasonality, particularly during the holiday season in the fourth quarter. Medical procedures, including surgeries, are not as frequently scheduled during such time. Consequently, the demand for our services, in general, could be subject to declines in the fourth quarter.

Patents, Trademarks, and Proprietary Technology

We are focused on developing an intellectual property portfolio for our laboratory service methodologies which use automated cellular instrumentation, rare event identification, and our proteomic mathematic capabilities. We hold patents and have patents pending to protect our intellectual property. We also hold trademarks to protect the names of our service offerings.

To protect our trade secrets and proprietary know-how, we typically enter into confidentiality agreements with our employees, consultants, customers, business partners, and other third parties. As a condition of employment, we require that all employees enter into an inventions assignment and non-disclosure agreement.

In December 2009, we acquired AGI through a merger of AGI with a wholly-owned subsidiary of our company (see Note 15 to the Consolidated Financial Statements). As of the effective date of the merger, AGI had developed 10 prognostic and predictive multivariate IHC biomarkers for use in assessing the recurrence rates of various cancers and related treatment options. Such biomarkers have associated patents and patent applications pending approval. We believe the intellectual property obtained through the AGI acquisition will broaden our test menu significantly, allow us to firmly enter the lung cancer market with a distinct identity in the marketplace, and provide content for our ongoing research and development efforts.

In March 2007, as part of the ACIS Sale, we transferred our then existing patent portfolio and other intellectual property relating to our Technology Business to Zeiss (see Note 4 to the Consolidated Financial Statements). We entered into a license agreement with Zeiss, pursuant to which Zeiss granted us a non-exclusive, perpetual, and royalty-free license to certain of the transferred patents, copyrights, and software code for use in connection with image applications (excluding the sales of imaging instruments) and our laboratory services business. This license allows us to develop new applications and analytical capabilities which incorporate proprietary imaging technologies.

Competition

Competition in the diagnostic services market is intense and has increased with the rapid pace of technological development. The oncology testing sector has been consolidating and is becoming increasingly competitive. Our industry is led by two national laboratories: Laboratory Corporation of America (also known as LabCorp) and Quest Diagnostics Incorporated. Both companies offer a wide test and product menu with significant financial, sales, and logistical resources, and have extensive contracts with a variety of payor groups. Our secondary competitors include laboratories that are affiliated with large medical centers or universities, such as Mayo Medical Laboratories and Associated Regional and University Pathologists (also known as ARUP). We also compete with specialized laboratories in specific areas of cancer such as Genoptix, Inc. (leukemia/lymphoma), Bostwick Laboratories, Inc. (prostate cancer), NeoGenomics, Inc. (breast cancer and leukemia/lymphoma), and Caris Life Sciences, Inc. (colon cancer). New competitors have heightened the competitive landscape. We anticipate that additional companies will enter our market and will aggressively compete for market share.

We believe that healthcare providers consider a number of factors when selecting a diagnostic services laboratory, including:

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Accuracy, quality, and timeliness in reporting test results;

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Menu of tests offered and volume capability;

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Reputation in the medical community;

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Ability to report test results within a secure Internet site;

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Customer service; and

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Pricing.

We believe that we are an effective competitor in each of the above areas.

Collaborations and Partnerships

Our goal is to position our company as the recognized industry leader within the cancer diagnostic testing market, which includes novel biomarker development and novel marker clinical validation services. Opportunities to differentiate our services exist through the development of novel biomarker diagnostic tests that provide clarity in assessing and characterizing cancer.

In January 2008, we announced a collaboration with Prediction Sciences, LLC to commercialize a novel breast cancer test. During the second quarter of 2009, we began offering the Clarient Insight^® Dx Breast Cancer Profile, a prognostic test which has been clinically validated for women with early-stage, hormone-receptor-positive breast cancer. Clarient Insight^® Dx Breast Cancer Profile uses a combination of pathology risk factors and molecular markers to categorize patients as either high-risk or low-risk for recurrence of breast cancer, utilizing a non-linear mathematical algorithm incorporating clinical and key pathologic variables into a continuous risk score. The main prognostic factors associated with breast cancer are the number of lymph nodes affected, tumor size, histological grade, and hormone receptor status, though some patients have a recurrence despite having a tumor with good prognostic features. We believe the Clarient Insight^® Dx Breast Cancer Profile provides physicians with meaningful data to choose a therapy based upon their patient’s tumor characteristics, previous treatment, and performance status in order to improve the probability of survival, without unnecessarily compromising the patient’s quality of life.

We also work with a variety of biopharmaceutical companies through supporting their therapy development. This includes projects in preclinical, Phase II, and Phase III clinical trials. We provide a full suite of biomarker assay development, validation services, and biomarker testing services. Our laboratory allows for a fully-integrated approach to biomarker assay development services using our core IHC, flow cytometry, FISH, and PCR technologies.

Research & Development

Our research and development activities primarily relate to the development and validation of diagnostic tests in connection with our specialized oncology diagnostic services and the development of technology to electronically deliver such services to our clients. Our quality procedures and regulatory staff ensure that every developed test and application meets stringent regulatory guidelines.

Quality Assurance

The quality of our diagnostic testing services is of critical importance to us, our customers, and the patient being treated. We have established a comprehensive quality assurance program for our laboratory operations. Our quality assurance program is designed to deliver accurate and timely diagnostic test results and a consistent level of high quality. We have developed a variety of internal systems and procedures to emphasize, monitor, and continuously improve the quality of our laboratory operations, in addition to the compulsory requirements of CMS and other regulatory agencies.

External Proficiency and Accreditations

We participate in numerous externally-administered quality surveillance programs, and our laboratory is accredited by the College of American Pathologists (“CAP”). The CAP accreditation program involves both unannounced on-site inspections of our laboratory, and participation in CAP’s ongoing proficiency testing program for all testing categories. CAP is an independent, non-governmental organization of board-certified pathologists which accredits, on a voluntary basis, laboratories nationwide. CAP has been deemed by CMS as an accrediting agency to inspect clinical laboratories to determine adherence to the standards of the Clinical Laboratory Improvement Amendments of 1988 (“CLIA”). A laboratory’s receipt of accreditation by CAP satisfies the Medicare requirement for participation in proficiency testing programs administered by an external source, one of Medicare’s primary requirements for reimbursement eligibility. Our most recent CAP inspection was successfully completed in November 2009.

Internal Quality Control

We maintain internal quality control through documentation and review of daily key quality processes, rigorous validation and optimization practices, training and competency of staff involved in performing laboratory testing, and internal audits by our Quality Assurance department to ensure compliance with internal and external standards. Our quality assurance team, which is comprised of representative members involved in all aspects of patient testing and reporting, meets regularly to review various performance and quality metrics and to discuss methods to further improve the quality of our laboratory processes. On an annual basis, our Medical Director prepares an objective assessment of our quality management program, which is presented to our executive management team, and is utilized to guide our prospective focus on quality practices.

Information Systems

We have implemented information systems that support our laboratory operations and finance and administrative functions. We believe that our information systems strategically position us for long-term growth in our evolving market. We believe that our information systems are secure and robust. We maintain an off-site backup of all our critical data and e-mail systems on a regular basis. To electronically deliver services to our customers, PATHSiTE^® provides high resolution images and critical diagnostic test reports through an Internet-based portal, in a secure, HIPAA-compliant environment.

Legal and Regulatory Environment

Our business is subject to extensive laws and regulations, the most significant of which are summarized below.

Anti-Kickback Laws

Existing federal laws governing Medicare and Medicaid, and other similar state laws, impose a variety of broadly described restrictions on financial relationships among healthcare providers, including clinical laboratories. These laws include the federal “anti-kickback law”, which prohibits individuals or entities, including clinical laboratories, from making payment or furnishing other benefits intended to induce or influence the referral of patients for tests billed to Medicare, Medicaid, or certain other federally funded programs. The consequences of violation may include criminal penalties, civil sanctions, and/or exclusion from participating in Medicare, Medicaid, and other federal healthcare programs.

Stark Law

Self-referral prohibitions prevent us from accepting referrals from physicians with whom we have a compensation relationship. The federal law prohibiting physician self-referrals, commonly known as the “Stark Law”, prohibits, with certain exceptions, Medicare/Medicaid payments for laboratory tests referred by physicians who personally or through a family member have an investment interest in, or a compensation arrangement with, the testing laboratory. A person who engages in a scheme to circumvent the Stark Law’s prohibitions may be fined up to $100,000 for each such scheme. In addition, anyone who presents (or causes such presentation) of a claim to the Medicare program in violation of the Stark Law is subject to penalties of up to $15,000 per claim submitted, an assessment of several times the amount claimed, and possible exclusion from participation in federal healthcare programs. In addition, claims submitted in violation of the Stark Law may be alleged to be subject to liability under the federal False Claims Act and its “whistleblower” provisions.

Several states in which we operate have enacted legislation that prohibits physician self-referral arrangements and/or requires physicians to disclose to their patients any financial interest they may have with a healthcare provider when referring patients to that provider. Some of these statutes cover all patients and are not limited to beneficiaries of Medicare, Medicaid, and other federal healthcare programs. Possible sanctions for violating state physician self-referral laws vary, but may include loss of license and civil and criminal sanctions. State laws vary from jurisdiction to jurisdiction and in a few states are more restrictive than the Stark Law. Some states have indicated they will interpret their own self-referral statutes the same way that CMS interprets the Stark Law, but it is possible that states will interpret their own laws differently in the future.

Federal False Claims Act

There are other rules governing billing markups and direct billing rules that may apply to our relationships with our customers. Of particular importance to our operations are federal and state laws prohibiting fraudulent billing and providing for the recovery of non-fraudulent overpayments, as a large number of laboratories have been forced by the federal and state governments, as well as by private payors, to enter into substantial settlements under these laws. In particular, if an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties ranging from $6,000 to $11,000 for each separate false claim. While there are many potential bases for liability under the federal False Claims Act, such liability primarily arises when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. Submitting a claim with reckless disregard or deliberate ignorance of its validity could result in substantial civil liability. A current trend within the healthcare industry is the increased use of the federal False Claims Act and, in particular, actions under the False Claims Act’s “whistleblower” or “qui tam” provisions to challenge providers and suppliers. Those provisions allow a private individual standing to bring actions on behalf of the government, alleging that the defendant has submitted a fraudulent claim for payment to the federal government. The government may join in the lawsuit, but if the government declines to do so, the individual may choose to pursue the lawsuit alone. The government must be kept apprised of the progress of the lawsuit. Whether or not the federal government intervenes in the case, it will receive the majority of any recovery. In addition, various states have enacted laws modeled after the federal False Claims Act.

Health Insurance Portability and Accountability Act of 1996

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) created two general federal violations, healthcare fraud and false statements relating to healthcare matters, and protects the security and privacy of individually identifiable health information. We have implemented practices and procedures to meet the applicable requirements of HIPAA, as briefly described below.

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The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment, and/or exclusion from government sponsored programs.

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The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious, or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment.

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Standards govern the conduct of certain electronic transmission of health care information and to protect the security and privacy of individually identifiable health information maintained or transmitted by health care providers, health plans, and health care clearinghouses. These standards include: (i) Standards for Electronic Transactions and (ii) Standards for Privacy and Security of Individually Identifiable Information.

i)

The Standards for Electronic Transactions establishes standards for common health care transactions such as claims information, plan eligibility, and payment information. It also establishes standards for the use of electronic signatures, unique identifiers for providers, employers, health plans, and individuals.

ii)

The Standards for Privacy of Individually Identifiable Information restrict our use and disclosure of certain individually identifiable health information. The HIPAA privacy and security regulations establish a uniform federal “floor” and do not supersede state laws that are more stringent or provide individuals with greater rights with respect to the privacy or security of, and access to, their records containing patient/private health information (“PHI”). As a result, we are required to comply with both HIPAA privacy regulations and varying state privacy and security laws, which include physical and electronic safeguard requirements. These laws contain significant fines and other penalties for wrongful use or disclosure of PHI.

HITECH Act

The American Recovery and Reinvestment Act of 2009 (“ARRA”) became law on February 17, 2009. The ARRA includes provisions relating to Health Information Technology. Title XIII of ARRA, the Health Information Technology for Economic and Clinical Health Act (the “HITECH Act”), made significant changes to the privacy and security rules of HIPAA, extending their reach and imposing breach notification requirements on HIPAA-covered entities and their business associates. Additionally, the HITECH Act increased enforcement of, and penalties for, violations of privacy and security of PHI.

The HITECH Act’s security breach notification provisions require that covered entities notify individuals if their health information has been breached. The U.S. Department of Health and Human Services must be notified as well, and in some circumstances, the media. In determining whether or not notice is required, two questions are important: (1) did the event qualify as a defined “breach”? and (2) was the information protected by adequate encryption technology?

If we were in violation of the HITECH Act, a penalty determination would be based on the nature and extent of the violation and the nature and extent of the harm resulting from the violation. The penalties range from $100 — $50,000 per violation depending upon the violation category, subject to a $1.5 million cap for multiple violations of an identical requirement or prohibition in a calendar year.

Clinical Laboratory Improvement Amendments

Because we operate a clinical laboratory, many aspects of our business are subject to complex federal, state, and local regulations. In 1988, Congress passed CLIA, establishing quality standards for all laboratory testing to ensure the accuracy, reliability and timeliness of patient test results regardless of where the test was performed. Under CLIA, a laboratory is defined as any facility which performs laboratory testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease, or the impairment of, or assessment of health. CLIA is user-fee funded; therefore, all costs of administering the program must be covered by the regulated facilities, including certificate and survey costs. To enroll in the CLIA program, laboratories must register by completing an application, paying fees, being surveyed, if applicable, and becoming certified in the state in which they operate. We received our California state licensure with CLIA certification in the fourth quarter of 2004.

The final CLIA regulations were published on February 28, 1992, and updated on January 24, 2003. CLIA specifies quality standards for proficiency testing, patient test management, quality control, personnel qualifications and quality assurance for laboratories performing non-waived tests. Non-waived laboratories must enroll in CLIA, pay the applicable fees, and follow manufacturers’ instructions. Our laboratory service offerings now include tests in the non-waived category.

CMS is charged with the implementation of CLIA, including laboratory registration, fee collection, surveys, surveyor guidelines and training, enforcement, approvals of proficiency testing providers, and accrediting organizations. The Centers for Disease Control and Prevention is responsible for the CLIA studies, convening the Clinical Laboratory Improvement Amendments Committee and providing scientific and technical support/consultation to the Department of Health and Human Services and CMS. The FDA is responsible for test categorization and regulation of the medical devices used by clinical laboratories, including analyte specific reagents (“ASR”), in vitro diagnostic multivariate index assays (“IVDMIA”), general purpose reagents, laboratory equipment, instrumentation, and controls.

The State of California Department of Health and Human Services—Laboratory Field Services enforces the state’s requirements to apply for and maintain licensure, CLIA certification, and proficiency testing. CLIA accreditation is maintained through regular inspections by CAP. Our facilities have been inspected by these authorities and have been issued licenses to manufacture medical devices and provide laboratory diagnostic services in California. These licenses must be renewed every year. The State of California could prohibit our provision of laboratory services if we failed to maintain these licenses.

State Application and Provisional Requirements

We must also satisfy various other state application and provisional requirements. Our California laboratory is required to be licensed by the New York State Department of Health to receive specimens from New York State. We maintain such licensure for our laboratory under New York state laws and regulations, which establish standards for the day-to-day operation of a clinical laboratory, physical facilities requirements, equipment and quality control. New York law also mandates proficiency testing for laboratories licensed under New York state law, regardless of whether or not such laboratories are located in New York. We maintain a current license in good standing with the New York State Department of Health. Florida, Maryland, Pennsylvania and Rhode Island require out-of-state laboratories, which accept specimens from those states, to be licensed by such states. We have obtained licenses in such states and believe we are in compliance with applicable licensing laws. We may become aware from time to time of other states that require out-of-state laboratories to obtain licensure in order to accept specimens from the state, and it is possible that other states do have such requirements or will have such requirements in the future. If we identify any other state with such requirements or if we are contacted by any other state advising us of such requirements, we intend to follow instructions from the state regulators as to how we should comply with such requirements.

FDA Regulations

The FDA has stated that clinical laboratories which develop tests in-house are considered to be manufacturers of medical devices and are subject to the FDA’s jurisdiction under the federal Food, Drug, and Cosmetic Act (“FD&C Act”). We develop assays and intend to validate new markers as they become available to us. Many of the assays and new markers we intend to validate will be considered ASRs, commonly referred to as “home brews.” ASRs are reagents composed of chemicals or antibodies which are the active ingredients of tests used to identify one specific disease or condition. The FDA announced in November 1997 that it will exercise enforcement discretion over laboratory-developed ASRs, as well as laboratory-developed tests (“LDTs”) using commercially available and laboratory-developed ASRs.

The FDA announced (in draft guidance in July 2007) that IVDMIAs do not fall within the scope of LDTs over which the FDA has generally exercised enforcement discretion. The guidance document defines IVDMIAs as gene or protein-based tests (which include tests for breast and prostate cancer) that combine assays and algorithms to produce results tailored to a specific patient. In the draft guidance, the FDA stated that IVDMIAs must meet pre-market and post-market device requirements under the FD&C Act and FDA regulations, including pre-market review of class II and III devices.

We may decide to develop IVDMIAs in-house, which would then be subject to aforementioned regulations, should the FDA adopt these draft provisions. In such case, we would be required to obtain pre-market notification clearance, often referred to as a “510(k)” clearance or pre-market approval (“PMA”) of the test from the FDA. In order to market a device subject to the 510(k) clearance process, the FDA must determine that the proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device. Clinical and non-clinical data may be required to demonstrate substantial equivalence. The 510(k) clearance process usually takes from three to twelve months from the time of submission to the time that a company can begin to market and distribute such product in the United States. The process can take significantly longer and there can be no assurance that the FDA will issue such clearance. The PMA approval pathway requires an applicant to demonstrate that the device is safe and effective and such determination is based, in part, on data obtained in clinical trials. The PMA approval process is much more costly, lengthy, and uncertain and generally takes between one and three years from submission to PMA approval, but may take significantly longer and such approval may never be obtained. Once clearance or approval is obtained, ongoing compliance with FDA regulations, including those related to manufacturing operations, recordkeeping, reporting, marketing, and promotion, would increase the cost, time and complexity of conducting our business.

Clarient Pathology Services, Inc.

California prohibits general corporations from engaging in the practice of medicine, pursuant to both statutory and common law principles commonly known as the Corporate Practice of Medicine Doctrine (“CPMD”). In general, the CPMD prohibits non-professional corporations from employing physicians and certain other healthcare professionals who provide professional medical services. All of our pathology services, which require licensed physician sign-off, are provided by, or are under the supervision of, Clarient Pathology Services, Inc. (“CPS”) under a long-term, exclusive amended and restated professional services agreement by and between us (including Clarient Diagnostic Services, Inc. (“CDS”), a wholly-owned subsidiary) and CPS, entered into on September 1, 2009 (the “Professional Services Agreement”). Kenneth J. Bloom, M.D. is the sole shareholder and president of CPS. Dr. Bloom also serves as our Chief Medical Officer (“CMO”), a senior management function focused primarily on the technical oversight of our diagnostics services laboratory. In compliance with the CPMD, Dr. Bloom provides no pathology services, or any other medical services, while acting in his capacity as our CMO. As required under the Professional Services Agreement, we are responsible to perform a variety of non-medical administrative services for CPS. We bill and collect for the pathology services provided by CPS. We in turn pay CPS a monthly professional services fee equal to the aggregate of all estimated physician salaries and benefits and all other operating costs of CPS. The financial statements within this Annual Report on Form 10-K include the financial position, results of operations, and cash flows of us, and the accounts of CPS, which are consolidated as required by applicable accounting principles generally accepted in the United States (“GAAP”).

We refer to CPS and us collectively throughout this Annual Report on Form 10-K as “we”, “us”, and “our”, except in this paragraph, the next paragraph below, and the related risk factor in Item 1A. We are organized so that all physician services are offered by the physicians who are employed by CPS. We do not employ practicing physicians as practitioners, exert control over their decisions regarding medical care, or represent to the public we offer medical services. CPS also retains the authority to select the non-physician personnel, equipment, and supplies used to perform its medical services, as well as the authority to set its professional fees and approve all managed care contracts. Control and direction of licensed medical professionals rests with CPS. Under the Professional Services Agreement, CPS is responsible to appropriately staff its group with physicians who provide interpretative services and related reports us. We perform all non-medical management of CPS and have exclusive authority over all aspects of the business of CPS (other than those directly related to the provision of pathology or other medical services, or as otherwise prohibited by state law). The non-medical management provided by us under the Professional Services Agreement includes, among other functions, financial management and reporting, accounting, operating and capital budgeting, negotiating business agreements (in consultation with CPS), and all other administrative services. We, through CDS, bill for the services provided by CPS.

We believe that the services we provide to CPS do not constitute the practice of medicine under applicable laws. Because of the unique structure of the relationships described above, many aspects of our business operations have not been the subject of state or federal regulatory interpretation. We have no assurance that a review of our business by the courts or regulatory authorities will result in a determination that our operations comply with applicable law. Any determination that our relationship with CPS does not comply with applicable laws relating to the practice of medicine could have a material adverse affect on our operations.

Employees

As of December 31, 2009, we (inclusive of CPS) had 361 employees: 208 in laboratory diagnostics, research and development, and related support positions; 95 in executive, finance, information technology, billing, and administrative positions; and 58 in sales and marketing positions. We are not subject to any collective bargaining agreements, and we believe that our relationship with our employees is good. In addition to full-time employees, we use the services of various independent contractors, primarily for certain service development, marketing, and administrative activities.

Recent Acquisition

On December 21, 2009, we acquired AGI through a merger of AGI with a wholly-owned subsidiary of our company. The AGI acquisition provides us with proprietary IHC biomarkers and other related diagnostic tests for use in assessing the recurrence rates of various cancers, and the likelihood of a favorable response to certain therapy options. The AGI acquisition also provides us with content for our on-going research and development activities.

Consideration for the AGI acquisition included 4.4 million shares of our common stock and a maximum of an additional 3.2 million shares of our common stock, inclusive of exchanged stock option awards, upon the achievement of certain revenue and scientific publication milestones by December 31, 2012.

Two former executive officers of AGI joined us as our (i) Senior Vice President and Chief Scientific Officer and (ii) Senior Vice President, Technology Assessment, and General Manager, Huntsville Facility. Six other former employees of AGI have also joined us in business development, research and development, and laboratory services roles. See Note 15 to our Consolidated Financial Statements for further discussion of the AGI acquisition.

Available Information

All periodic and current reports, registration statements, and other filings that we are required to file with the Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act, are available free of charge from the SEC’s Internet site (http://www.sec.gov) or public reference room at 101 F Street NE, Washington, D.C. 20549, or through our Internet site at http://www.clarientinc.com. Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. Information on the operation of the SEC’s public reference room is available by calling the SEC at 1-800-SEC-0300. Copies of these reports (excluding exhibits) may also be obtained free of charge, upon written request to: Investor Relations, Clarient, Inc., 31 Columbia, Aliso Viejo, CA 92656-1460.

Our Internet website address is included in this report solely for identification purposes. Our Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. The following corporate governance documents are available free of charge on our website: the charters of our Audit, Compensation, and Corporate Governance Committees, our Statement on Corporate Governance, and our Code of Conduct. Copies of these corporate governance documents may also be obtained by any stockholder, free of charge, upon written request to: Corporate Secretary, Clarient, Inc., 31 Columbia, Aliso Viejo, CA 92656-1460.

Item 1A.		Risk Factors

Before deciding to invest in us, or to maintain or increase your investment, one should carefully consider the risks described below, in addition to the other information contained in this Annual Report on Form 10-K and other reports we have filed with the SEC. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also affect our business operations. If any of these risks are realized, our business, financial condition, or results of operations could be seriously harmed and in that event, the market price for our common stock could decline, and one may lose all or part of their investment.

Risks Related to Our Business

We have a history of operating losses, and future profitability is uncertain.

We have incurred operating losses in every year since inception. Our accumulated deficit as of December 31, 2009 was $165.0 million. Those operating losses are principally associated with the investments we have made, and expenses we have incurred, in our diagnostic services business, including bad debt expense, and to a lesser extent, the costs related to various activities associated with developing and commercializing our former ACIS technology, which we transferred to Zeiss as part of the ACIS Sale.

Although we have reduced our operating losses, we may continue to incur losses as a result of our laboratory services expansion. We may never become profitable. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to achieve and/or maintain profitability, the market value of our common stock will likely decline.

Third party billing is extremely complicated and could result in us incurring significant additional costs.

Billing for laboratory services is extremely complicated. The customer is the party that refers the tests and the payor is the party that pays for the tests, and the two are not always the same. Depending on the billing arrangement and/or applicable law, we need to bill various payors, including patients, health insurance companies, Medicare, Medicaid, doctors and employer groups, all of which have different billing requirements. Health insurance companies and governmental payors also generally require complete and correct billing information within certain filing deadlines. Additionally, our billing relationships require us to undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. Health insurance companies also impose routine external audits to evaluate payments made.

Additional factors complicating billing are:

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Pricing differences between our fee schedules and the reimbursement rates of the payors;

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Disputes with payors as to which party is responsible for payment; and

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Disparity in coverage and information requirements among various carriers.

We incur significant additional costs as a result of our participation in the Medicare and Medicaid programs, as billing and reimbursement for laboratory testing are subject to considerable and complex federal and state regulations. The additional costs we expect to incur as a result of our participation in the Medicare and Medicaid programs include costs related to, among other factors: (1) complexity added to our billing processes; (2) training and education of our employees and customers; (3) implementing compliance procedures and oversight; (4) collections and legal costs; (5) challenging coverage and payment denials; and (6) providing patients with information regarding claims processing and services, such as advanced beneficiary notices.

We previously outsourced responsibility for billing and collections for our laboratory services to a third-party. In order to improve the quality of our collection efforts and reduce processing costs, we established an internal billing and collection department during 2008, and staffed the department with experienced, knowledgeable, and licensed personnel. We, as a company, however, do not have previous experience in billing third parties or patients directly for our services, nor do we, as a company, have previous experience in collections activities. If our in-house billing and collection department is not able to bill and collect for services on a timely and accurate basis, including the compliance with filing deadlines required by certain payors, our operating results, cash flows, and financial condition may be negatively impacted.

Changes in federal payor regulations or policies may adversely affect coverage and reimbursement for our services and may have a material adverse effect upon our business.

Government payors, such as Medicare and Medicaid, have increased their efforts to control the cost, utilization, and delivery of health care services. On March 1, 2010, a 21.2% cut to Medicare payments to the Physician Fee Schedule was to take effect, though the reduction has been stayed for 30 days. We believe that the proposed cuts to the Physician Fee Schedule will ultimately not occur, though there can be no assurance of our expectation. If payment cuts to the Physician Fee Schedule were to take effect, reductions in the reimbursement rates applicable to other third-party payors would likely also occur, since many of our payors base their reimbursement on the published Medicare fee schedules. Accordingly, the 21.2% proposed rate cut to the Physician Fee Schedule would have a material adverse impact on our business if enacted. From time to time, Congress will consider and implement other reductions to the Medicare Physician Fee Schedule in conjunction with budgetary legislation which would similarly have a negative impact on our business if/when such reductions occur.

In addition, the 2010 extension of the technical component “grandfather clause” for Medicare billings has not yet occurred. We expect the grandfather clause to be extended in the near term, though there can be no assurance of our expectation. The grandfather clause permits us to directly bill Medicare for the technical laboratory services we provide to hospital inpatients and outpatients. Hospitals generally receive a bundled payment from Medicare for all services provided to Medicare patients. Absent the grandfather clause, when a hospital subcontracts out a cancer diagnostic test to us, the hospital would be responsible for paying us out of the bundled fee it receives from Medicare, since we would not be able to directly bill Medicare for technical laboratory services. This form of reimbursement would subject us to increased administrative costs and slower collections and would likely result in reduced reimbursement levels and pricing pressure.

Our net revenue will be diminished if payors do not adequately cover or reimburse us for our services.

There has been, and will likely continue to be, significant efforts by both federal and state agencies to reduce costs in government healthcare programs and to otherwise implement government control of healthcare costs. In addition, increasing emphasis on managed care in the United States may continue to put pressure on the pricing of healthcare services. Uncertainty exists as to the coverage and reimbursement status of new applications or services. Governmental payors and private payors are scrutinizing new medical products and services. Such third-parties may not cover, or may limit coverage and resulting reimbursement for our services. Additionally, third-party insurance coverage may not be available to patients for any of our existing assays or assays we may discover and develop in the future. A substantial portion of the testing for which we bill our hospital and laboratory clients is ultimately paid by third-party payors. Any pricing pressure exerted by these third-party payors on our customers may, in turn, be exerted by our customers on us. If governmental payors, including their contracted administrators, and other third-party payors do not provide adequate coverage and/or timely reimbursement for our services, our operating results, cash flows, or financial condition may decline.

Our cash flows and financial condition may decline if payors do not reimburse us for our services in a timely manner.

We depend on our payors to reimburse us for our services in timely manner. If our payors, particularly Medicare or Medicare’s designated administrator, do not reimburse us in a timely manner, our cash flows and financial condition may decline.

A majority of managed care organizations are using capitated payment contracts in an attempt to shift payment risks which may negatively impact our operating margins.

Managed care providers typically contract with a limited number of diagnostic laboratories and then designate the laboratory or laboratories to be used for tests ordered by participating physicians. The majority of managed care testing is negotiated on a fee-for-service basis at a discount. Such discounts have historically resulted in price erosion and we expect that they could negatively impact our operating margins as we continue to offer laboratory services to managed care organizations.

Our net revenue may be diminished from health care reform initiatives.

Health care reform has been identified as a priority by President Obama and other political leaders, business leaders, public advocates, policy experts, and candidates for office at the federal, state and local levels. Proposals include, among others: (1) establishing universal health care coverage or purchasing pools; (2) modifying how hospitals, physicians and other health care providers are paid; (3) evaluating hospitals, physicians and other health care providers on a variety of quality and efficacy standards to support pay-for-performance systems and (4) investing in health information technology and medical research. Congress and the Obama administration have indicated their desire to institute significant health care reform in the near term. The President’s budget for fiscal year 2010 proposes a health care reserve fund of over $600 billion to implement comprehensive health reforms over a ten-year period. Various reforms are also under consideration by Congress. Although health care reform may be financed in part by cuts in government health care payments, health care reform could be implemented in a way that is beneficial to healthcare providers if increased payments are available for more people who are currently uninsured or under insured. In order to pay for health reform initiatives, the Obama administration is considering to make significant cuts in Medicare payments. Our net revenue could be adversely affected by potential adjustments to Medicare reimbursement rates for our laboratory diagnostic services.

We are required to maintain compliance with financial and other restrictive covenants in our debt financing agreements which can restrict our ability to operate our business, and if we fail to comply with those covenants, our outstanding indebtedness may be accelerated.

In July 2008, we entered into a credit facility with Gemino. The Gemino Facility was amended in January 2009, February 2009, November 2009, and December 2009. The Gemino Facility, as amended, contains a financial covenant which requires us to meet a minimum “fixed charge coverage ratio” through January 2011.

The “fixed charge coverage ratio” covenant requires us to maintain a minimum ratio on a cumulative annualized basis of 1.00 for the three months ending March 31, 2010, 1.10 for six months ending June 30, 2010, 1.20 for the nine months ending September 30, 2010, and 1.20 for the twelve months ending December 31, 2010 and thereafter. The “fixed charge coverage ratio” is defined as the ratio of EBITDA (net income plus interest expense, tax expense, depreciation/ amortization expense, and stock-based compensation expense) to the sum of (i) interest expense paid in cash on the Gemino Facility, plus (ii) payments made under capital leases, plus (iii) unfinanced capital expenditures, plus (iv) taxes paid.

The Gemino Facility also contains covenants which, among other things, restrict our ability to:

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Incur additional debt;

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Pay dividends or make other distributions or payments on our capital stock;

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Make investments;

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Make capital expenditures;

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Incur (or permit to exist) liens;

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Enter into transactions with our affiliates;

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Change our business, legal name or state of incorporation;

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Guarantee the debt of other entities, including joint ventures;

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Merge or consolidate or otherwise combine with another company; and

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Transfer or sell our assets.

The above covenants could adversely affect our ability to finance our future operations or capital needs and pursue available business opportunities, including acquisitions. A breach of any of these covenants could result in a default under the Gemino Facility, and thus result in the indebtedness, together with accrued interests and other fees, to be immediately due and payable and could allow Gemino to proceed against collateral securing such indebtedness.

The minimum “fixed charge coverage ratio” required by the Gemino Facility through September 30, 2009 was 1.10. Our calculated “fixed charge coverage ratio” through September 30, 2009 was 0.83. Accordingly, we were not in compliance with the minimum “fixed charge coverage ratio” covenant as of September 30, 2009. On November 13, 2009, we obtained a waiver of non-compliance from Gemino. The “fixed charge coverage ratio” covenant was removed for the period through December 31, 2009 with an amendment to the Gemino Facility in November 2009.

We expect to be in compliance with all covenants contained within the Gemino Facility through January 2011, though such outcome is uncertain. If we were not able to maintain compliance through such date, our ability to receive a waiver of non-compliance from Gemino is also uncertain.

As of December 31, 2009, we had approximately $2.7 million of outstanding indebtedness under our facility with Gemino, and $10.9 million of cash and cash equivalents. In the event the facility with Gemino is accelerated, we may be able to repay our obligation to Gemino through our cash and cash equivalents, assuming our current cash burn rates remain consistent. In addition, we would likely seek alternative sources of financing to support our prospective working capital requirements, though we may be unable to secure such financing on commercially reasonable terms, if at all.

Our credit agreement with Gemino contains a material adverse change clause.

If our business encountered difficulties that would qualify as a material adverse change in our (i) operations, (ii) condition (financial or otherwise), or (iii) ability to repay our facility, our credit agreement with Gemino could be cancelled. Gemino could elect to declare the indebtedness under the facility, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing such indebtedness.

Disruption in credit markets and volatility in equity markets may affect our ability to access sufficient funding.

The global equity markets have been volatile and global credit markets have been disrupted, which has reduced the availability of investment capital and credit. If these conditions continue or worsen, we may be unable to access adequate funding to operate and grow our business. Our inability to access adequate funding or to generate sufficient cash from operations may require us to reconsider certain projects and capital expenditures. The extent of any impact will depend upon several factors, including our operating cash flows, the duration of tight credit conditions and volatile equity markets, our credit ratings and credit capacity, the cost of financing, and other general economic and business conditions.

We sold our Technology Business to Zeiss and we may incur indemnification obligations.

In March 2007, we sold our Technology Business to Zeiss for an aggregate purchase price of $12.5 million. In connection therewith, we made customary representations and warranties to Zeiss and we retained certain pre-closing liabilities relating to the Technology Business. As a result, we may have future indemnification obligations to Zeiss upon a breach of such representations and warranties and in connection with any related third party claims, surviving through the applicable statute of limitation, though we believe the value and likelihood of such obligations are minimal.

We may not successfully manage our growth, which may result in delays or unanticipated difficulties in implementing our business plan.

Our success will depend upon the expansion of our operations and the effective management of our growth. We expect to experience growth in the scope of our operations and services and the number of our employees. If we grow significantly, such growth will place a significant strain on our management, administrative, operational, and financial resources. To manage significant growth, we may need to expand our facilities, augment our operational, financial, and management systems, internal controls and infrastructure, and hire and train additional qualified personnel. Our future success is heavily dependent upon growth and acceptance of our future services. If we are unable to scale our business appropriately or otherwise adapt to anticipated growth and the introduction of new services, our business, operating results, cash flows, and financial condition may be harmed.

The diagnostic laboratory market is characterized by rapid technological change, frequent new product introductions, and evolving industry standards, and we may encounter difficulties keeping pace with changes in this market.

The introduction of diagnostic tests embodying new technologies and the emergence of new industry standards can render existing tests obsolete and unmarketable in short periods of time. We expect our competitors to introduce new products and services and enhancements to their existing products and services. Our future success will depend upon our ability to enhance our current tests, and to develop new tests, in a manner that keeps pace with emerging industry standards and achieves market acceptance. Our inability to accomplish any of these endeavors will likely have a material adverse effect on our business, operating results, cash flows, and financial condition.

We face substantial existing competition and potential new competition.

The laboratory business is intensely competitive both in terms of price and service. This industry is dominated by several national independent laboratories, but includes many smaller niche and regional independent laboratories as well. Large commercial enterprises, including Quest Diagnostics Incorporated and Laboratory Corporation of America (LabCorp), have substantially greater financial resources, larger research and development programs, and more sales and marketing channels than we do, enabling them to potentially develop and market competing products and services. These enterprises may also be able to achieve greater economies of scale or establish contracts with payor groups on more favorable terms. Academic and regional medical institutions generally lack the advantages of the larger commercial laboratories, but still compete with us on a limited basis. Smaller niche laboratories compete with us based on their reputation in specializing within a narrow test menu. Pricing of laboratory testing services is one of the significant factors often used by health care providers in selecting a laboratory. As a result, the laboratory industry is undergoing significant consolidation. Larger clinical laboratory providers are able to maximize cost efficiencies afforded by large-scale automated testing. This consolidation results in greater price competition. To meet such competition, we may be unable to improve our cost efficiencies sufficiently, if at all, and as a result, our operating results, cash flows, and our financial position could be negatively impacted.

Our current and developing competitors are actively conducting research and development in areas where we are also conducting such activities. The products and services these companies may develop could directly compete with our current or potential services, or may address other areas of diagnostic evaluation, making such companies compete more effectively against us. The diagnostic testing market is sensitive to the timing of product and service availability. A company that can quickly develop and achieve clinical study and regulatory success ahead of its competitors may hold a competitive advantage. If we are not able to effectively compete within our industry, our business and results of operations will be adversely affected.

If we fail to develop our proprietary biomarkers, we may not achieve an acceptable return on our research and development expenditures.

Our future success will depend, in part, on the timely development and introduction of biomarkers that address evolving market requirements for cancer diagnostic services. We are new to independently developing biomarkers and our future success will depend, in part, on our ability to internally develop and commercialize biomarkers. If we fail in this regard, we will not obtain an adequate return on our research and development expenditures, and will likely incur goodwill impairment charges, and lose valuable market share to our competitors, which may be difficult or impossible to regain.

Failure in our information technology systems could disrupt our operations.

Our success will depend, in part, on the continued and uninterrupted performance of our information technology systems. Information systems are used extensively in virtually all aspects of our business, including laboratory testing, billing, customer service, logistics, management of medical data, and dissemination of test results.

Our computer systems are vulnerable to damage from a variety of sources, including telecommunications failures, malicious human acts, and natural disasters. Moreover, despite reasonable security measures we have implemented, some of our information technology systems are potentially vulnerable to physical or electronic break-ins, computer viruses, and similar disruptive problems. In July 2009, we began utilizing a new Enterprise Resource Planning (“ERP”) system. The ERP has various modules which impact our internal control over financial reporting and the related business risks that could arise in connection therewith are uncertain.

We conduct business over the Internet and because certain of our information technology systems are located at third-party web hosting providers, we cannot control the maintenance and operation of the data centers by such third-parties. Despite the precautions we have taken, unanticipated problems affecting our systems could cause interruptions in our information technology systems, leading to lost revenue, deterioration of customer confidence, and significant business disruption. Our business, financial condition, results of operations, or cash flows could be materially and adversely affected by any problem that interrupts or delays our operations.

We may require additional financing for, among other things, general working capital, expansion of our laboratory operations, possible acquisitions, development of novel molecular tests, capital expenditures and other costs, and it is uncertain whether such financing will be available on favorable terms, if at all.

We will continue to expend funds for development of novel markers, clinical trials, and to expand our service offerings and will need additional capital if our current business initiatives are not successful or we fail to achieve the level of revenue and gross profit from our services within the time frame contemplated by our business plan.

Our present and future funding requirements will also depend on certain other external factors, including, among other things:

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The level of development investment required to maintain and improve our service offerings, including the development of novel molecular tests;

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Our need or decision to acquire or license complementary technologies or acquire complementary businesses;

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Competing technological and market developments;

	•		Changes in regulatory policies or laws that affect our operations; and
	•		Our ability to receive, in cash, the net revenue we have recognized and reported.

We do not know whether additional financing will be available to us as needed on commercially acceptable terms or at all. The current turmoil in the global credit markets adds to such uncertainty due to the more limited availability of credit. These conditions could also impair the ability of those with whom we do business, such as our customers, suppliers, and lenders, to satisfy their obligations to us. If adequate funds are not available, or are not available on commercially acceptable terms, we might be required to delay, scale back or eliminate some or all of our development activities or new business initiatives, or to license to third parties the right to commercialize products or technologies that we would otherwise seek to commercialize ourselves. If additional funds are raised through an equity or convertible debt financing, our stockholders may experience significant dilution.

If a catastrophe were to strike our facility, we would be unable to operate our business competitively.

Our facility may be affected by catastrophes such as fires or earthquakes. Although we have installed certain power back-up systems, we may also be affected by sustained interruptions in electrical service. Earthquakes and fires are of particular significance to us because our laboratory facility is located in southern California, an earthquake and fire prone area. In the event our existing facility or equipment is affected by man-made or natural disasters, we may be unable to process our customers’ samples in a timely manner and unable to operate our business in a commercially competitive manner.

Our ability to maintain our competitive position depends on our ability to attract and retain highly qualified managerial, technical, and sales and marketing personnel.

We believe that our continued success depends to a significant extent upon the efforts and abilities of our executive officers and our scientific and technical personnel, including the following individuals:

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Ronald A. Andrews, our Vice Chairman and Chief Executive Officer;

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Michael J. Pellini, M.D., our President and Chief Operating Officer;

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Michael R. Rodriguez, our Senior Vice President and Chief Financial Officer;

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Kenneth J. Bloom, M.D., our Chief Medical Officer;

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Todd S. Barry, M.D., Ph.D, our Medical Director;

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David J. Daly, our Senior Vice President of Commercial Operations;

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Douglas Ross, M.D., Ph.D, our Chief Scientific Officer;

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Robert Seitz, our Senior Vice President, Technology Assessment, and General Manager, Huntsville Facility;

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Ronald D. Collette, our Chief Information Officer; and

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Glen M. Fredenberg, our Vice President of Finance and Corporate Controller.

The loss of any of our executive officers, senior managers, or key scientific or technical personnel could have a material adverse effect on our business, operating results, cash flows, and financial condition. We do not maintain key-person life insurance on any of our officers, managers, scientific and technical personnel, or other employees. Furthermore, our anticipated growth and expansion will require the addition of highly skilled technical, management, financial, sales and marketing personnel. Competition for personnel is intense, and our failure to hire and retain talented personnel or the loss of one or more key employees could have a material adverse effect on our business. In particular, we may encounter difficulties in attracting and retaining a sufficient number of qualified California licensed laboratory scientists.

We are dependent on others for the development of products. The failure of our collaborations to successfully develop products could harm our business.

Our business strategy includes entering into agreements with clinical and commercial collaborators and other third parties for the development, clinical evaluation, and marketing of new services, including novel molecular tests. Research performed under a collaboration for which we receive or provide funding may not lead to the development of products in the timeframe expected, or at all. If these agreements are terminated earlier than expected, or if third parties do not perform their related obligations properly and on a timely basis, we may not be able to successfully develop new products as planned, or at all.

We may acquire other businesses, products or technologies in order to remain competitive in our market and our business could be adversely affected as a result of any of these future acquisitions.

We may make acquisitions of complementary businesses, products or technologies. If we identify any appropriate acquisition candidates, we may not be successful in negotiating acceptable terms of the acquisition, financing the acquisition, or integrating the acquired business, products or technologies into our existing business and operations. Further, completing an acquisition and integrating an acquired business will significantly divert management time and resources. The diversion of management attention and any difficulties encountered in the transition and integration process could harm our business. If we consummate any significant acquisitions using stock or other securities as consideration, our stockholders’ equity could be significantly diluted. If we make any significant acquisitions using cash consideration, we may be required to use a substantial portion of our available cash. Acquisition financing may not be available on favorable terms, if at all.

Clinicians or patients using our services may sue us, and our insurance may not sufficiently cover all claims brought against us, which will increase our expenses.

The development, marketing, sale, and performance of healthcare services expose us to the risk of litigation, including professional negligence. Damages assessed in connection with, and the costs of defending, any legal action could be substantial. We currently maintain numerous insurance policies, including a $10.0 million aggregate, $5.0 million per claim, medical professional liability insurance policy, with a deductible of $25,000. However, we may be faced with litigation claims which exceed our insurance coverage or are not covered under any of our insurance policies. In addition, litigation could have a material adverse effect on our business if it impacts our existing and potential customer relationships, creates adverse public relations, diverts management resources from the operation of the business, or hampers our ability to otherwise conduct our business.

If we use biological and hazardous materials in a manner that causes injury, we could be liable for damages.

Our development and clinical pathology activities sometimes involve the controlled use of potentially harmful biological materials, hazardous materials, chemicals, and various radioactive compounds. We cannot completely eliminate the risk of accidental contamination or injury to third parties from the use, storage, handling, or disposal of these materials. We currently maintain numerous casualty policies, including a $1.0 million per occurrence, $2.0 million aggregate general liability policy, and a $10.0 million umbrella liability policy. These policies have deductibles ranging from $5,000 to $50,000 and contain customary exclusions. However, in the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed our financial resources and/or any applicable insurance coverage we may have. Additionally, we are subject on an ongoing basis to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations is significant and could negatively affect our operations, cash flows, and financial condition if these costs substantially increase.

Any breakdown in the protection of our licensed proprietary technology, or any determination that our licensed proprietary technology infringes on the rights of others, could materially affect our business.

Our commercial success will depend in part on our ability to protect and maintain our proprietary technology. We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, and contractual provisions to protect our proprietary rights. However, obtaining, defending and enforcing intellectual property rights involve complex legal and factual questions. We may not be able to effectively maintain our technologies as unpatented trade secrets or otherwise obtain meaningful protection for our proprietary technology. Moreover, third parties may infringe, design around, or improve upon our proprietary technology or rights.

If the use of our technologies conflicts with the intellectual property rights of third parties, we may incur substantial liabilities and we may be unable to commercialize products based on these technologies in a profitable manner, if at all.

Our competitors and other third parties may have, or may acquire, patent rights that they could enforce against us. If they do so, we may be required to alter our technologies, pay licensing fees, or cease activities. Additionally, if our technologies conflict with patent rights of others, third parties could bring legal action against us or our licensees, suppliers, customers, or collaborators, claiming damages and seeking to enjoin manufacturing and marketing of the affected products. If these legal actions are successful, in addition to any potential liability for damages, we might have to obtain a royalty or licensing arrangement in order to continue to manufacture or market the affected products. A required license or royalty under the related patent or other intellectual property may not be available on acceptable terms, if at all.

Because patent applications can take many years to issue, there may be pending applications, unknown to us, that may later result in issued patents upon which our technologies may infringe. There could also be existing patents of which we are unaware upon which our technologies may infringe. In addition, if third parties file patent applications or obtain patents claiming technology also claimed by us in pending applications, we may have to participate in interference proceedings in the United States Patent and Trademark Office to determine priority of invention. If third parties file oppositions in foreign countries, we may also have to participate in opposition proceedings in foreign tribunals to defend filed foreign patent applications. Additionally, we may have to participate in interference proceedings involving our issued patents or our pending applications.

If a third party claims that we infringe upon its proprietary rights, any of the following may occur:

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We may become involved in time-consuming and expensive litigation, even if a claim is without merit;

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We may become liable for substantial damages for past infringement, including possible treble damages for allegations of willful infringement;

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A court may prohibit us from using a technology or providing a service without a license from the patent holder, which may not be available on commercially acceptable terms, if at all, or which may require us to pay substantial royalties or grant cross-licenses to our intellectual property; and

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We may have to redesign our services so that they do not infringe upon others’ patent rights, which may not be possible, or if possible, could require substantial funds or time.

If any of these events occur, our business, results of operation, cash flows, and financial condition will likely suffer and the market price of our common stock will likely decline.

Risks Related to Regulation of Our Industry

If we are not able to obtain all of the regulatory approvals and clearances required to conduct clinical trials if/when required and/or commercialize our services and underlying diagnostic applications, our business would be significantly harmed.

The industry in which we operate is highly regulated. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:

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

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Federal and state laboratory anti-mark-up laws;

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Federal and state anti-kickback laws;

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Federal and state false claims laws;

	•		Federal and state self-referral and financial inducement laws, including the federal physician anti-self-referral law, or the Stark Law;
	•		Coverage and reimbursement levels by Medicare, Medicaid, other governmental payors, and private insurers;

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Restrictions on reimbursements for our services;

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Federal and state laws governing laboratory testing, including CLIA;

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

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HIPAA and the HITECH Act;

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

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State laws regarding prohibitions on the corporate practice of medicine;

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State laws regarding prohibitions on fee-splitting;

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

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Occupational Safety and Health Administration (“OSHA”) rules and regulations.

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

We are subject to significant environmental, health and safety regulation.

We are subject to regulation under federal, state, and local laws and regulations relating to the protection of the environment, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste, and radioactive materials, as well as to the safety and health of our laboratory employees. OSHA has established extensive requirements relating to workplace safety for health care employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations, and other measures designed to minimize exposure to, and transmission of, blood-borne pathogens. In addition, the federally-enacted Needlestick Safety and Prevention Act requires, among other things, that we include in our safety programs the evaluation and use of engineering controls such as safety needles if found to be effective at reducing the risk of needlestick injuries in the workplace. Compliance with applicable environmental, health and safety regulations may be expensive, and current or future environmental laws and regulations may impair business efforts. If we do not comply with applicable regulations, we may be subject to fines and penalties.

We are subject to federal and state laws governing the financial relationship among healthcare providers, including Medicare & Medicaid laws, and our failure to comply with these laws could result in significant penalties and other adverse consequences.

Our reimbursement from Medicare accounted for approximately 33.5% of our net revenue for the year ended December 31, 2009. The Medicare program is administered by CMS, and similar to state Medicaid programs, imposes extensive and detailed requirements on diagnostic services providers, including, but not limited to, rules that govern how we structure our relationships with physicians, how and when we submit reimbursement claims, and how we provide our specialized diagnostic services. Our failure to comply with applicable Medicare, Medicaid, and other governmental payor rules could result in our inability to participate in a governmental payor program, our returning of funds already paid to us, civil monetary penalties, criminal penalties, and/or limitations on the operational function of our laboratory. If we were unable to receive reimbursement under a governmental payor program, a substantial portion of our net revenue would be lost, which would adversely affect our results of operations and financial condition.

Our business is subject to stringent laws and regulations governing the privacy, security and transmission of medical information, and our failure to comply could subject us to criminal penalties and civil sanctions.

Governmental laws and regulations affect the privacy, security and transmission of medical information. Such laws and regulations restrict our ability to use or disclose patient identifiable laboratory data, without patient authorization, for purposes other than payment, treatment or healthcare operations (as defined by HIPAA), except for disclosures for various public policy purposes and other permitted purposes outlined in the privacy regulations of HIPAA. Such privacy and security regulations provide for significant fines and other penalties for wrongful use or disclosure of PHI, including potential civil and criminal fines and penalties. Although HIPAA does not expressly provide for a private right of damages, we also could incur damages under state laws to private parties for the wrongful use or disclosure of confidential health information, or other private personal information.

Federal law and the laws of many states generally specify who may practice medicine and limit the scope of relationships between medical practitioners and other parties.

Because of the unique structure of the relationships between CPS and us, as described in Item 1, “Clarient Pathology Services, Inc.,” many aspects of our business operations have not been the subject of state or federal regulatory interpretation. A review of our business by the courts or regulatory authorities could result in a determination that our operations do not comply with applicable law. In addition, the health care regulatory environment may change in a manner that restricts our existing operations or future expansion.

Risks Related to Ownership of Our Common Stock

We have never paid cash dividends on our common stock and do not anticipate paying dividends on our common stock, which may cause you to rely on capital appreciation for a return on your investment.

We currently intend to retain future earnings for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will also depend on our financial condition, results of operations, capital requirements, and other factors and will be at the discretion of our board of directors. In addition, we are restricted from paying a dividend under our credit facilities without our lenders’ consent. Accordingly, one will have to rely on capital appreciation, if any, to earn a return on their investment in our common stock.

If we raise additional funds, you may suffer dilution or subordination, and we may grant rights in our technology or products to third parties.

If we raise additional funds by issuing equity securities, further dilution to our stockholders could result, and new investors could have rights superior to those of holders of our common stock. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. If we raise additional funds by issuing debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our developed technologies or products, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we may have to delay or may be unable to continue to develop our products.

Our stock price is likely to continue to be volatile, which could result in substantial losses for investors.

The market price of our common stock has in the past been, and in the future is likely to be, highly volatile. These fluctuations could result in substantial losses for investors. Our stock price may fluctuate for a number of reasons, including, but not limited to:

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Our operating performance;

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Media reports and publications and announcements about cancer or diagnostic products or treatments or new innovations;

	•		Developments or disputes regarding patent or other proprietary rights;
	•		Announcements regarding clinical trials or other technological or competitive developments by us and our competitors;

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The hiring and retention of key personnel;

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Announcements concerning our competitors or the biotechnology industry in general;

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Regulatory developments regarding us or our competitors;

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Changes in coverage and reimbursement policies concerning our services or competitors’ services;

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Changes in the current structure of the healthcare financing and payment systems;

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Stock market price and volume fluctuations, which have particularly affected the market prices for life sciences companies, and which have often been unrelated to the operating performance of such companies; and

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General economic, political, and market conditions.

Securities class action litigation is often brought against a company after a period of volatility in the market price of its stock. This type of litigation could be brought against us in the future, which could result in substantial expense and damage awards and divert management’s attention from running our business.

With the advent of the Internet, new avenues have been created for the dissemination of information. We do not have control over the information that is distributed and discussed on electronic bulletin boards and investment chat rooms. The motives of the people or organizations that distribute such information may not be in our best interest or in the interest of our stockholders. This, in addition to other forms of investment information, including newsletters and research publications, could result in a significant decline in the market price of our common stock.

Future sales of shares by existing stockholders could result in a decline in the market price of our stock.

Some of our current stockholders hold a substantial number of shares which they are currently able to sell in the public market, and our employees hold options to purchase a significant number of shares and/or have been issued shares of restricted stock that are covered by registration statements on Form S-8. If our common stockholders sell substantial amounts of common stock in the public market, or the market perceives that such sales may occur, the market price of our common stock could fall.

Two stockholders, in the aggregate, hold 48% of our outstanding voting shares. Those stockholders’ interests may differ from other stockholders’ interests and may adversely affect the trading price of our common stock.

Safeguard and Oak beneficially own approximately 28.0% and 20.0% of our outstanding voting shares, respectively. As a result, Safeguard and Oak will have significant influence in determining the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including mergers, consolidations, and the sale of all, or substantially all, of our assets. Safeguard and Oak are contractually able to appoint five of our nine directors, though their combined voting interest could result in their election of all of our directors through their combined support. As a result, Safeguard and Oak could dictate the management of our business and affairs, particularly if acting in concert. The interests of Safeguard and Oak may differ from other stockholders’ interests. In addition, this concentration of ownership may delay, prevent, or deter a change in control and could deprive other stockholders of an opportunity to receive a premium for their common stock as part of a sale of our business. This concentration of share ownership may adversely affect the trading price of our common stock because investors often perceive disadvantages in owning stock in companies with stockholders with significant voting interests.

Section 203 of Delaware General Corporation Law could inhibit a change in control and prevent a stockholder from receiving a favorable price for his or her shares.

Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by our board of directors. These provisions and others could make it difficult for a third party to acquire us, or for members of our board of directors to be replaced, even if doing so would be beneficial to our stockholders. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt to replace the current management team. If a change of control or change in management is delayed or prevented, one may lose an opportunity to realize a premium on their shares of common stock or the market price of our common stock could decline.

If we do not maintain compliance with the listing requirements of the NASDAQ Capital Market, or any other national securities exchange, our common stock could be delisted, and such delisting may negatively affect our business and the liquidity and price of our common stock.

Our common stock is listed on the NASDAQ Capital Market. We are required to satisfy various listing maintenance standards for our common stock to remain listed on the NASDAQ Capital Market. If we fail to meet such standards, our common stock would likely be delisted from the NASDAQ Capital Market and if we are unable to comply with the listing requirements of any other national securities exchange, our common stock would be traded on an over-the-counter market such as the OTC Bulletin Board or the “Pink Sheets.” The over-the-counter markets are generally considered to be less efficient markets and having our common stock quoted on an over-the-counter market would seriously impair the liquidity of our common stock and limit our potential to raise future capital through the sale of our common stock, which could materially harm our business, results of operations, cash flows, and financial position.

Securities analysts may not initiate coverage for our common stock, may cease coverage for our common stock or may issue negative reports, and this may have a negative impact on the market price of our common stock.

Securities analysts may elect not to provide research coverage of our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect the market price of our common stock. The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about us or our business. If one or more of the analysts who elect to cover us downgrades our stock, our stock price could decline. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.

Shares of our Series A convertible preferred stock are subject to anti-dilution rights that could increase the concentration of the ownership of our common stock.

Pursuant to our Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock, our Series A convertible preferred stock has certain anti-dilution protections. Pursuant to these protections, the number of shares of common stock that the Series A convertible preferred stock may convert into will increase in the event that we issue stock at a price lower than the original price of the Series A convertible preferred stock in certain circumstances. If the number of shares of common stock into which the Series A convertible preferred stock may convert increases, the holders of the Series A convertible preferred stock will control an increased percentage of our voting stock and will be in an even greater position to control significant corporate actions.

The holders of our Series A convertible preferred stock are entitled to receive liquidation payments in preference to the holders of our common stock.

Upon a change in control, liquidation, dissolution or winding up of the affairs of our business, whether voluntary or involuntary, the holders of our Series A convertible preferred stock are entitled to receive a liquidation payment prior to the payment of any amount with respect to shares of our common stock. The amount of this preferential liquidation payment per share of the Series A convertible preferred stock is the amount equal to the greater of (1) $7.60 per whole share of Series A convertible preferred stock (as adjusted for stock splits, reverse stock splits, stock dividends and similar transactions with respect to the Series A convertible preferred stock plus declared and unpaid dividends on such share of Series A convertible preferred stock or (2) such amount per share of Series A convertible preferred stock as would have been payable had each share of Series A convertible preferred stock which is convertible into common stock been so converted immediately prior to such change in control, liquidation, dissolution or winding up. Because of the liquidation preference to which the holders of shares of the Series A convertible preferred stock are entitled, the amount available to be distributed to the holders of shares of our common stock upon a liquidation, dissolution or winding up of the affairs of our business could be substantially limited or reduced. Each share of Series A convertible preferred stock is currently convertible into four shares of common stock.

Item 1B.		Unresolved Staff Comments

None.

Item 2.		Properties

We believe that our facilities are well maintained and adequate for our business requirements for the near-term, and that additional space, when needed, will be available on commercially reasonable terms. We have three facilities which are described below.

Corporate Headquarters and Diagnostic Services Laboratory

Our corporate headquarters and diagnostic services laboratory is located in Aliso Viejo, California, where we lease a facility with approximately 78,000 square feet. The initial ten-year term of our lease commenced on December 1, 2005, and we have an option to extend the lease term for up to two additional five-year periods.

Research and Development and Biopharmaceutical Services Centers

We lease our research and development and biopharmaceutical services centers in Huntsville, Alabama and Burlingame, California, comprising approximately 6,500 square feet. The Huntsville lease expires in January 2013. The Burlingame lease expires in March 2010 and will not be renewed.

Item 3.		Legal Proceedings

We are not a party to any material pending legal proceedings, the adverse outcome of which, individually or in the aggregate, management believes would have a material adverse affect on our business, financial condition, or results of operations. We may be subject to various claims and legal actions arising in the ordinary course of business from time to time.

Item 4.		[Reserved]

Item 4A.		Executive Officers of the Registrant

Name		Age				Position				Executive Officer Since
Ronald A. Andrews			50			Vice Chairman and Chief Executive Officer					2004
Michael J. Pellini, M.D.			44			President and Chief Operating Officer					2007
Michael R. Rodriguez			42			Senior Vice President and Chief Financial Officer					2009
David J. Daly			48			Senior Vice President of Commercial Operations					2005

Ronald A. Andrews, 50, has been our Chief Executive Officer since July 2004 and Vice Chairman since April 2008. He also served as our President from July 2004 through April 2008. Mr. Andrews was Senior Vice President of Global Marketing and Commercial Business Development at Pleasanton, California-based Roche Molecular Diagnostics from 2002 to 2004. In that role, he developed and led the strategic execution for all molecular diagnostic commercial operations. This included the oversight of five Business Sector Vice Presidents responsible for all aspects of global marketing and business development in the areas of blood screening, virology, women’s health, microbiology and automation/emerging diagnostics. Mr. Andrews was also responsible for executive direction of all marketing functions, directed the development of the 10-year Strategic Plan for the organization and completed the reorganization of commercial operations during that period. From 2000 to 2002, Mr. Andrews held two senior executive positions with Indianapolis-based Roche Diagnostics Corporation. As Vice President, U.S. Commercial Operations, Molecular Diagnostics, he directed sales, marketing, technical field support and product development activities and was responsible for United States commercial strategy development for the clinical laboratory market. Prior to that, as Vice President, Marketing, U.S. Commercial Operations, he was responsible for planning and directing all aspects of the Roche U.S. Laboratory Systems Commercial Operations Marketing which included the clinical chemistry, immunochemistry, hematology, near patient testing and molecular markets. From 1995 to 2000, Mr. Andrews was Vice President of Atlanta-based Immucor, Inc. where he helped lead the transition of that company from a reagent manufacturer to an instrument systems company. Prior to joining Immucor, Mr. Andrews spent almost 10 years in management positions of increasing responsibility at Chicago-based Abbott Diagnostics, culminating in the position of Senior Marketing Manager, Business Unit Operations. Mr. Andrews earned a B.S. degree in Biology and Chemistry from Spartanburg, South Carolina-based Wofford College in 1981 and participated extensively in the executive development programs at both Roche and Abbott Labs.

Michael J. Pellini, M.D., 44, has been our Chief Operating Officer since October 2007 and President since April 2008. From February 2007 to April 2008, Dr. Pellini also served as Vice President of Safeguard’s Life Sciences Group. Prior to joining Safeguard, Dr. Pellini was Executive Vice President and Chief Operating Officer at Lakewood Pathology Associates, Inc., a national anatomical pathology company that provides comprehensive molecular and pathology services tailored toward the outpatient needs of surgical sub-specialists, from April 2005 to December 2006. From September 2004 to April 2005, Dr. Pellini was an Entrepreneur in Residence at BioAdvance, where he was responsible for reviewing and evaluating seed stage investment proposals. From June 1999 to February 2004, Dr. Pellini served as President and Chief Executive Officer of Genomics Collaborative, Inc., a Boston-based biotech firm that was acquired by SeraCare Life Sciences, Inc. in 2004. Dr. Pellini is a native of the greater Philadelphia region. He trained as a primary care physician in the Thomas Jefferson University Health System. Before attending medical school, he worked in the investment banking industry in both Philadelphia and Sydney, Australia. Dr. Pellini earned a M.D. from Jefferson Medical College of Thomas Jefferson University in Philadelphia, an M.B.A. degree from Drexel University in Philadelphia and a B.A. degree in Economics from Boston College in Massachusetts.

Michael R. Rodriguez, 42, has been our Chief Financial Officer since December 2009. From August 2004 to July 2009, Mr. Rodriguez served as the Senior Vice President, Finance and Chief Financial Officer at Endocare, Inc., a publicly-traded medical device company focused on minimally invasive technologies for tissue and tumor ablation, which was acquired by HealthTronics, Inc. in July 2009. From January 2004 until August 2004, Mr. Rodriguez served as a consultant to Endocare, providing assistance on a variety of financial and operational projects and compliance with Section 404 of the Sarbanes-Oxley Act. Prior to joining Endocare as a consultant, Mr. Rodriguez served as Executive Vice President and Chief Financial Officer of Directfit, Inc., a privately-held provider of information technology staffing services, from June 2000 to November 2003. From September 1997 to June 2000, Mr. Rodriguez held a variety of positions, including Senior Vice President and Chief Financial Officer, with Tickets.com, Inc., a publicly-traded Internet-based provider of entertainment ticketing services and software. From June 1995 to September 1997, Mr. Rodriguez was Corporate Controller and Director of Finance at EDiX Corporation, a medical informatics company. Mr. Rodriguez began his career at Arthur Andersen LLP and was with that firm from 1989 to 1993. Mr. Rodriguez holds a B.S. degree in accounting from the University of Southern California and an M.B.A. degree from the Stanford University Graduate School of Business. Mr. Rodriguez is a Certified Public Accountant (inactive).

David J. Daly, 48, our Senior Vice President of Commercial Operations, joined us in February 2005 as Vice President of Sales. In 2006, Mr. Daly took over responsibility for both our marketing in addition to sales functions. In 2007, Mr. Daly became responsible for all of our commercial operations. Prior to joining us, Mr. Daly served as Area Marketing Manager for Roche Diagnostics, where he was responsible for the establishment of Molecular Centers of Excellence throughout the western region. Prior to Roche, Mr. Daly spent ten years with Abbott Laboratories, Diagnostic Division. He started his career as a territory sales representative and took on increasing levels of responsibility throughout his tenure. His roles included Worldwide Marketing, where he was responsible for the development and implementation of Abbott’s Global lab automation strategy and Sales Management where he served as District Manager for Hematology products. Mr. Daly completed his career at Abbott as Director of U.S. Sales, Animal Health division, where he was responsible for a $50 million annual sales plan and managed a 35 member sales organization. Mr. Daly earned an M.A. degree in Economics from the University of California, Santa Barbara and graduated cum laude with a B.A. degree in Economics from the University of California, Irvine.

Other Significant Employees

Kenneth J. Bloom, M.D., 52, has been our Medical Director since August 2004 and Chief Medical Officer since September 2004. Dr. Bloom is the President and sole shareholder of Clarient Pathology Services, Inc., which is discussed in Item 1. “Clarient Pathology Services, Inc.” Dr. Bloom joined us from Irvine, California-based U.S. Labs, where he served as Senior Medical Director since 2002. Prior to that, Dr. Bloom spent more than two decades serving in senior academic, consultative and clinical roles with leading hospitals and healthcare enterprises principally in the specialization of cancer care. Dr. Bloom’s academic posts have included over 10 years as Associate Professor of Pathology at Chicago-based Rush Medical College, as well as one year as a visiting Professor in the Department of Computer Science at DePaul University. Over the past 15 years, Dr. Bloom has held more than 10 appointed positions at Chicago-based Rush Presbyterian — St. Luke’s Medical Center, one of the leading cancer research hospitals in the United States. Those positions included Director of Laboratory Operations, Director of Immunohistochemistry, and Director of the Breast Service in the Department of Pathology, Consultant to the Rush Breast Cancer Center, and Director of Information Services for the Rush Cancer Institute. Dr. Bloom has, for more than three decades, been a prolific researcher and lecturer in the fields of pathology and, specifically, cancer related topics. He has been a member of the College of American Pathologists (CAP) since 1987 and currently serves as a member of the Immunohistochemistry and Technology Assessment Committees for that organization. In addition to the roles mentioned above, Dr. Bloom has served the industry off and on for the past 20 years in both advisory and operational roles. Those appointments include Board of Directors seats, consulting roles and executive posts including executive level positions at both diagnostics technology and information technology firms. Dr. Bloom earned his earned a M.D. from Rush Medical College and a B.A. degree from Grinnell College.

Todd S. Barry, M.D., Ph.D., 47, has been our Medical Director since September 2008. Prior to joining us, Dr. Barry was employed by PhenoPath Laboratories, in Seattle, WA, from July 2002 through August 2008, where he served as the Director of Molecular and Hematopathology. During his tenure with PhenoPath, Dr. Barry gained extensive experience in the use of morphologic, immunophenotypic, and molecular tools used in the diagnosis and prognosis of hematologic and non-hematologic malignancies. Dr. Barry’s expertise includes: immunohistochemistry, molecular diagnostic testing, flow cytometry, leukemias, lymphomas, cutaneous lymphoid disorders, breast pathology, and prognostic and predictive breast cancer biomarkers. Dr. Barry has lectured on these topics in numerous courses for the USCAP, ASCP, CAP, as well as, state and international pathologic societies. Dr. Barry received an M.D. degree and a Ph.D. degree in Immunology from Duke University in Durham, N.C., under the direct supervision of Dr. Barton Haynes (Hanes Professor of Medicine) in 1995. Dr. Barry then completed his residency training in Anatomic and Clinical Pathology at the University of Washington Medical Center in Seattle, WA in 1999. Following his residency training, Dr. Barry finished a one year Surgical Pathology/ Immunohistochemistry Fellowship at the University of Washington Medical Center. Additionally, Dr. Barry completed two more years of Hematopathology Fellowship training at the National Cancer Institute within the National Institutes of Health in Bethesda, Maryland.

Robert S. Seitz, 46, joined us in December 2009 as our Senior Vice President and General Manager, Huntsville Facility, and Technology Assessment. Previously, Mr. Seitz was Chief Executive Officer and co-founder of AGI. Mr. Seitz founded the antibody department at Research Genetics, Inc. and had been its director for the eight years before founding AGI. Mr. Seitz has extensive expertise in creating and marketing an antibody business and related services. As director of the antibody department of Research Genetics, Mr. Seitz managed numerous collaborations with both academic and pharmaceutical development teams. Mr. Seitz has a B.S. degree in Chemistry from the University of South Alabama and a M. Div. degree from Fuller Theological Seminary.

Douglas T. Ross, M.D., Ph.D, 50, joined us in December 2009 as our Chief Scientific Officer. Previously, Dr. Ross was Chief Scientific Officer and co-founder of AGI. Dr. Ross was a postdoctoral fellow with Patrick O. Brown and David Botstein at Stanford University. Dr. Ross was instrumental in the initiation and scale-up of the Stanford human microarray project, and for developing strategies for large-scale analysis of gene expression in human cancer. Dr. Ross earned an M.D. degree and a Ph.D. degree in Pathology from the University of Washington while studying at the Fred Hutchinson Cancer Research Center in Seattle, Washington. Dr. Ross completed two years of clinical pathology training including serving as Chief Resident at the University of California at San Francisco before joining the microarray project at Stanford University in 1996.

Ronald D. Collette, 46, became our Chief Information Officer in January of 2009, taking on the responsibility for directing and managing information technologies for our company. Mr. Collette is a well respected professional in the field of information technologies with over 25 years of experience working for various Fortune-500 organizations such as Fluor Corporation, Pacific Life, Countrywide Mortgage, and the Resolution Trust Corporation. Mr. Collette was a founding partner of Traxx Consulting Inc., a boutique consultancy focused on information security, team development, and technical architecture. He is a regular speaker at a number of security and IT related events such as International Standards Organization (ISO) conference, SecureWorld Expo, and InfoSeCon. Mr. Collette is also a regular columnist and research analyst for Computer Economics. Mr. Collette has also co-authored two books on information security “The CISO Handbook: A Practical Guide to Securing Your Company” and the companion publication ”CISO Soft Skills: Securing Organizations Impaired by Employee Politics, Apathy, and Intolerant Perspectives.” Both of these books are used as course material for numerous advanced education and university masters programs on security leadership. Mr. Collette’s contribution to the information yechnology industry is represented by numerous publications, papers, and presentations. Mr. Collette holds a B.S. degree in Economics with minors in Accounting and Business Administration from Arizona State University, and has completed post graduate work in Software Engineering.

Glen M. Fredenberg, 45, has served as our Vice President of Finance and Corporate Controller since August 2009. From April 2007 to August 2009, Mr. Fredenberg served as Vice President and Divisional Controller for Laboratory Corporation of America, or LabCorp. From February 2005 to April 2007, Mr. Fredenberg served as Associate Vice President and Divisional Controller for LabCorp’s Esoteric Businesses Division. From April 1998 to February 2005, Mr. Fredenberg served in a variety of senior financial roles at US LABS (acquired by LabCorp in February 2005), including Corporate Controller, Interim Chief Financial Officer, and Vice President of Finance. While at US LABS, Mr. Fredenberg was responsible for the Billing and Collections function which included a conversion from an in-house billing system to the XIFIN system. Mr. Fredenberg holds a B.S. degree in Business Administration with a concentration in Accounting from California State University, Fullerton. Mr. Fredenberg is a Certified Public Accountant (inactive).

PART II

Item 5.		Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Our common stock trades on the NASDAQ Capital Market under the symbol “CLRT”. The table below sets forth the high and low sales prices of our common stock for the periods indicated:

		High				Low
2009
First Quarter		$	2.25			$	1.20
Second Quarter			3.81				2.16
Third Quarter			4.39				3.23
Fourth Quarter			4.30				2.26
2008
First Quarter		$	2.43			$	1.34
Second Quarter			2.19				1.35
Third Quarter			2.31				1.69
Fourth Quarter			1.77				0.86

As of March 8, 2010, we had outstanding 84,103,031 shares of common stock held by approximately 9,300 stockholders, including beneficial owners of the common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers, and other fiduciaries.

We have not paid cash dividends during the two most recent years and do not intend on paying cash dividends in the foreseeable future. Furthermore, the declaration and payment of dividends is completely restricted by a covenant in our credit facility with Gemino. We expect to use any future earnings to finance our operations. The actual amount of any dividends that may be paid in the future will be subject to the discretion of our board of directors and will depend on our operations, financial, and business requirements, and other factors.

Item 12 provides information as of December 31, 2009 with respect to all of our compensation plans, agreements and arrangements under which our equity securities were authorized for issuance. Additionally, more detailed information with respect to our stock-based compensation is included in Note 11 to the Consolidated Financial Statements.

The following chart compares the yearly percentage change in the cumulative total stockholder return on Clarient common stock for the period from December 31, 2004 through December 31, 2009, with the cumulative total return on the Nasdaq Composite Index and the peer group index for the same period. The peer group consists of SIC Code 8071 Services- Medical Laboratories. The comparison assumes that $100 was invested on December 31, 2004 in our common stock at the then closing price of $2.16 per share.

Item 6.		Selected Financial Data

The following table presents selected financial data for the last five years of the operation of our business and has been adjusted for the effects of discontinued operations. The following information should be read in conjunction with the Consolidated Financial Statements and Notes thereto in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

		Years ended December 31,
		2009				2008				2007(a)				2006				2005
Consolidated Statement of Operations Data:
Net revenue		$	91,599			$	73,736			$	42,995			$	27,723			$	11,439
Cost of services			39,107				32,936				26,807				19,777				10,948
Gross profit			52,492				40,800				16,188				7,946				491
Operating expenses			55,613				42,290				27,985				20,563				16,118
Interest expense, net			4,431				8,149				2,349				920				212
Loss from continuing operations before income taxes			(7,552	)			(9,639	)			(14,146	)			(13,537	)			(15,839	)
Income tax (expense) benefit			599				(6	)			2,088				(24	)			—
Loss from continuing operations, net of income taxes			(6,953	)			(9,645	)			(12,058	)			(13,561	)			(15,839	)
Income (loss) from discontinued operations, net of income taxes			901				—				3,301				(2,574	)			1,037
Net loss		$	(6,052	)		$	(9,645	)		$	(8,757	)		$	(16,135	)		$	(14,802	)
Series A preferred stock beneficial conversion feature			(4,290	)			—				—				—				—
Net loss applicable to common stockholders		$	(10,342	)		$	(9,645	)		$	(8,757	)		$	(16,135	)		$	(14,802	)
Basic and diluted net loss per share applicable to common stockholders:
Loss from continuing operations		$	(0.14	)		$	(0.13	)		$	(0.17	)		$	(0.20	)		$	(0.29	)
Income (loss) from discontinued operations			0.01				—				0.05				(0.04	)			0.02
Net loss applicable to common stockholders		$	(0.13	)		$	(0.13	)		$	(0.12	)		$	(0.24	)		$	(0.27	)

		As of December 31,
		2009				2008				2007				2006				2005
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	10,903			$	1,838			$	1,516			$	448			$	9,333
Accounts receivable, net			21,568				20,315				12,020				9,165				4,786
Total assets			66,947				35,509				26,618				27,344				25,249
Current liabilities of discontinued operations			—				—				—				1,327				1,223
Total current liabilities			14,175				35,934				26,402				14,246				8,958
Capital lease obligations			604				345				906				7,439				2,073
Deferred rent and other non-current liabilities			3,055				3,970				4,099				3,651				1,756
Contingently issuable common stock			2,650				—				—				—				—
Accumulated deficit			(165,164	)			(154,822	)			(145,177	)			(136,420	)			(120,285	)
Total stockholders’ (deficit) equity			7,877				(4,740	)			(4,789	)			951				12,462

***

		Year Ended
		December 31, 2007
		Previously				As
		Reported				Adjusted
Condensed Consolidated Statements of Operations:
Income tax (expense) benefit		$	(23	)		$	2,088
Loss from continuing operations, net of income taxes			(14,169	)			(12,058	)
Income from discontinued operations, net of income taxes			5,412				3,301
Net income (loss) per share applicable to common stockholders — basic and diluted:
Loss from continuing operations		$	(0.20	)		$	(0.17	)
Income from discontinued operations			0.08				0.05

Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following management’s discussion and analysis of financial condition and results of operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risks and uncertainties, including those set forth in Item 1A of this report under the caption “Risks Relating to Our Business,” and other reports we file with the SEC. Our actual results could differ materially from those anticipated in these forward-looking statements.

Overview and Outlook

We are an advanced oncology diagnostics services company. Our mission is to combine innovative technologies, clinically meaningful test results, and world-class pathology expertise to improve the lives of those affected by cancer by bringing clarity to a complex disease. Our vision is to be the leader in cancer diagnostics by dedicating ourselves to collaborative relationships with the health care community as we translate cancer discovery and information into better patient care.

Our focus is on identifying high-quality opportunities to increase our profitability and differentiate our service offerings in a highly competitive market. An important aspect of our strategy is to develop high-value, revenue generating opportunities by combining our medical expertise and our intellectual property to develop and commercialize novel diagnostic tests (also referred to as “novel markers” or “biomarkers”) through our highly developed commercial channels. Novel diagnostic tests on which we focus detect characteristics of an individual’s tumor or disease that, once identified and qualified, allow for more accurate prognosis, diagnosis, and treatment.

In addition, we work to identify specific partners and technologies where we can assist in the commercialization of novel diagnostic tests developed by third-parties. We believe that broader discovery and use of novel diagnostic tests will clarify and simplify decisions for healthcare providers and the biopharmaceutical industry. The growing demand for personalized medicine has generated a need for these novel diagnostic tests, creating a new market for such novel diagnostic tests, widely expected by analysts to grow between $1.5 billion and $3.0 billion over today’s market size within the next five years, based upon industry analyst data and management’s internal estimates.

In 2010, we will focus on four primary objectives:

•

Maintain net revenue growth by reaching new customers and increasing “same store sales” to our existing customers with our new services;

•

Maintain financial discipline to achieve profitability;

•

Leverage our industry-leading commercial channel and successfully launch new proprietary diagnostic tests; and

•

Maximize the effectiveness of our billing and collection function.

Characteristics of our Revenue and Expenses

Net revenue

Net revenue is derived from billing governmental and private health insurers, clients, and patients for the services that we provide. We report revenue net of “contractual allowances” which is defined and discussed within the “Critical Accounting Policies and Estimates” section below. Bad debt expense is recorded as an operating expense, and is a key component of our overall operating performance.

Cost of services

Cost of services includes compensation (including stock-based compensation) and benefits of laboratory personnel, laboratory support personnel, and pathology personnel. Cost of services also includes depreciation expense for laboratory equipment, laboratory supplies expense, allocated facilities-related expenses, and certain direct costs such as shipping.

Sales and marketing

Sales and marketing expenses primarily consist of the compensation and benefits of our sales force, sales support, and marketing personnel. It also includes costs attributable to marketing our services to our customers and prospective customers.

General and administrative

General and administrative expenses primarily include compensation (including stock-based compensation) and benefits for personnel that support our general operations such as: information technology, executive management, billing and collection, client services, financial accounting, purchasing, and human resources. General and administrative expenses also include allocated facilities-related expenses, insurance, recruiting, legal, audit, and other professional services.

Bad debt

Bad debt consists of estimated uncollectible accounts, or portions thereof, recorded during the period. The process of establishing a reasonable allowance for doubtful accounts, and resulting bad debt expense, at each period end involves the combination of an objective evaluation of our historical collection experience, and a subjective evaluation to identify certain at risk receivable balances. Our allowance for doubtful accounts model is designed to consider the age of the receivable balance and associated payor class. In addition, we use a significant degree of judgment in determining the receivables we believe are unlikely to be collected.

Research and development

Research and development expenses consist of compensation and benefits for research and development personnel, certain laboratory supplies, certain information technology personnel, research and development consultants, and allocated facility-related costs. Our research and development activities primarily relate to the development and validation of diagnostic tests in connection with our specialized oncology diagnostic services, as well as the development of technology to electronically deliver such services to our customers.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of net revenue and expenses during the reported periods. While management believes these estimates are reasonable and consistent, they are by their very nature, estimates of amounts that will depend on future events. Accordingly, actual results could differ from these estimates. Our Audit Committee of the Board of Directors periodically reviews our significant accounting policies. Our critical accounting policies arise in conjunction with the following:

•

Revenue recognition

•

Allowance for doubtful accounts and bad debt expense

•

Stock-based compensation

•

Income taxes

Revenue recognition

Net revenue for our diagnostic services is recognized on an accrual basis at the time discreet diagnostic tests are completed. Each test performed relates to a specimen encounter derived from a patient, and received by us on a specific date (such encounter is commonly referred to as an “accession”). Our services are billed to various payors, including Medicare, private health insurance companies, healthcare institutions, biopharmaceutical companies, and patients. We use published fee schedules from CMS for recognized revenue for amounts billed to Medicare for our services. We report net revenue for our services from contracted payors, including certain private health insurance companies and healthcare institutions, based on the contracted rate (which is generally based on the CMS published fee schedule) or in certain instances, our estimate of such rate, based upon our historical collection experience.

The difference between the amount billed and the amount recognized as net revenue is the result of standard discounts (commonly referred to as “contractual allowances”). We report net revenue from non-contracted payors, including certain private health insurance companies, based on the amount expected to be approved for payment for our services. Additional revenue adjustments are recorded for non-contracted payors in the period that the additional information becomes known to us. Patient revenue is divided into two classes: direct bill and indirect bill. The amount recognized as net revenue for direct bill patients is based on a standard multiple of the CMS published fee schedule. The amount recognized as net revenue for indirect bill patients is based on their co-pay or deductible obligation with their primary insurance payor.

Allowance for doubtful accounts and bad debt expense

An allowance for doubtful accounts is recorded for estimated uncollectible amounts due from our various payor groups. The process for estimating the allowance for doubtful accounts involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically, and is principally based upon an evaluation of historical collection experience of accounts receivable by age for our various payor classes. After appropriate collection efforts, accounts receivable are written off and deducted from the allowance for doubtful accounts. Additions to the allowance for doubtful accounts are charged to bad debt expense. The payment realization cycle for certain governmental and managed care payors can be lengthy, involving denial, appeal, and adjudication processes, and is subject to periodic adjustments that may be significant.

During the third quarter of 2009, we refined our model for estimating an appropriate allowance for doubtful accounts at each period end, utilizing historical payment information by payor class and receivable age, which was not previously available to us in sufficient form and content. Nonetheless, due to a combination of objective and subjective factors in our previous model for estimating an appropriate allowance for doubtful accounts, our reported net accounts receivable of $21.6 million as of December 31, 2009, would not have been materially different had the previous model been applied in the third or fourth quarter of 2009.

Stock-based compensation

We record compensation expense related to stock-based awards, including stock options and restricted stock, based on the fair value of the award using the Black-Scholes option-pricing model (see Note 11 to the Consolidated Financial Statements). Stock-based compensation expense recognized during the period is based on the value of the portion of the stock-based awards that are ultimately expected to vest, and thus, the gross expense is reduced for estimated forfeitures. We recognize stock-based compensation expense over the vesting period using the straight-line method for employees and ratably for non-employees. We classify compensation expense related to these awards in the Consolidated Statements of Operations based on the department to which the recipient reports.

Income taxes

We account for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We do not recognize a tax benefit, unless we conclude that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, we recognize a tax benefit measured at the largest amount of the tax benefit that we believe is greater than 50 percent likely to be realized. Due to both historical and recent changes in our capitalization structure, the utilization of net operating losses may be limited pursuant to Section 382 of the Internal Revenue Code. As of December 31, 2009 our gross deferred tax asset of $60.2 million has a full valuation allowance, so that our net deferred tax assets are recorded at zero. In the event of future successive quarters of profitability, the valuation allowance may be reversed through the recording of an income tax benefit.

Strategy and Key Metrics

Our strategic focus is centered on identifying high-value opportunities that enable the expansion and differentiation of our cancer diagnostic services within the highly competitive medical laboratories sector in which we operate. We commercialize our services through our highly developed channels with community pathologists, oncologists, universities, hospitals, and pharmaceutical researchers. Our primary objective is to grow market share and increase net revenue, while efficiently running our business to maximize stockholder value. There are high fixed and semi-variable costs associated with operating a licensed medical services laboratory. Our business requires requisite test volume and associated net revenue to offset such costs and realize positive income from operations. We began offering cancer diagnostic services in late 2004. Our net revenue has grown substantially in each annual period through 2009.

We continued to make significant progress in growing our business in 2009 by expanding the breadth and depth of our cancer diagnostic menu and expanding our commercial reach, while judiciously managing costs, and operating our laboratory in a highly efficient manner. In 2010, achieving full year profitability will be a top priority of our management team, and is planned to be achieved as a result of: (i) our forecasted test volume and associated net revenue in 2010 and (ii) the efficient management of our business to contain expenses in 2010 and beyond. The aforementioned forward looking statements are inherently uncertain and are subject to a high degree of risk, as further discussed in our Cautionary Note Concerning Forward-Looking Statements within this Annual Report on Form 10-K.

The below tables within Continuing Operations Overview — 2009, 2008, and 2007 represent the key metrics we review in measuring our annual financial and operating success.

Results of Operations

Continuing Operations Overview — 2009, 2008, and 2007

The following table presents our results of continuing operations and the percentage of the years’ net revenue (in thousands):

		2009								2008								2007(a)
Net revenue		$	91,599				100.0	%		$	73,736				100.0	%		$	42,995				100.0	%
Cost of services			39,107				42.7	%			32,936				44.7	%			26,807				62.3	%
Gross profit			52,492				57.3	%			40,800				55.3	%			16,188				37.7	%
Operating expenses:
Sales and marketing			17,380				19.0	%			10,941				14.8	%			8,630				20.1	%
General and administrative			23,587				25.8	%			18,729				25.4	%			15,278				35.5	%
Bad debt			12,927				14.1	%			12,199				16.5	%			3,558				8.3	%
Research and development			1,719				1.9	%			421				0.6	%			519				1.2	%
Total operating expenses			55,613				60.7	%			42,290				57.4	%			27,985				65.1	%
Loss from operations			(3,121	)			(3.4	)%			(1,490	)			(2.0	)%			(11,797	)			(27.4	)%
Interest expense, net			4,431				4.8	%			8,149				11.1	%			2,349				5.5	%
Income tax benefit (expense)			599				0.7	%			(6	)			—				2,088				4.9	%
Loss from continuing operations, net of income taxes		$	(6,953	)			(7.6	)%		$	(9,645	)			(13.1	)%		$	(12,058	)			(28.0	)%

Each test we perform relates to a specimen encounter derived from a patient, and received by us on a specific date. Such specimen encounter is commonly referred to as an “accession”. The following table presents the total number of our accessions in 2009, 2008, and 2007.

		Year Ended December 31,
		2009				2008				2007
		(in thousands)
Total Accessions			135				109				74

The following table presents our test volumes by general test type in 2009, 2008, and 2007. Our diagnostic services incorporate a variety of testing methodologies for each of the below categories, as discussed in Item 1, Our Services.

		Year Ended December 31,
		2009				2008				2007
		(in thousands)
Test Volume by:
Solid tumor, including breast prognostics			332				298				232
Leukemia / Lymphoma			589				479				284
Molecular diagnostics			22				9				3
Total test volume			943				786				519

The following table presents our average net revenue and average cost of services per accession in 2009, 2008, and 2007:

		Year Ended December 31,
		2009				2008				2007
Average net revenue per accession		$	679			$	676			$	581
Average cost of services per accession			290				302				362
Gross profit per accession		$	389			$	374			$	219

The following table presents our average net revenue and average cost of services per test in 2009, 2008, and 2007:

		Year Ended December 31,
		2009				2008				2007
Average net revenue per test		$	97			$	94			$	83
Average cost of services per test			41				42				52
Gross profit per test		$	56			$	52			$	31

The following table presents our net revenue by payor class in 2009, 2008, and 2007:

		Year Ended December 31,
		2009								2008								2007
Governmental health insurance (Medicare, Medicaid)		$	33,493				36.7	%		$	26,062				35.4	%		$	16,860				39.2	%
Private health insurance			37,600				41.0	%			30,017				40.7	%			15,595				36.3	%
Clients (pathologists, hospitals, clinics, and biopharmaceutical companies)			15,713				17.2	%			12,365				16.8	%			7,156				16.6	%
Patients			4,793				5.1	%			5,292				7.1	%			3,384				7.9	%
Total		$	91,599				100	%		$	73,736				100	%		$	42,995				100	%

The following table presents our estimated active customer count, as defined as any customer that has ordered our services within six months prior to December 31, 2009, 2008, and 2007, respectively:

		As of December 31,
		2009				2008				2007
Active Customers			1,125				865				675

The following table presents average net revenue per full time equivalent (“FTE”) employee (a), including the employees of CPS, for the years ended December 31, 2009, 2008, and 2007:

		Year Ended December 31,
		2009				2008				2007
		(in thousands)
Net revenue per FTE employee		$	284			$	328			$	231

The decrease in net revenue per FTE employee in 2009 as compared to 2008 is primarily due to the average net increase of 98 FTE employees in 2009 versus 2008. In anticipation of the growth in our business, and to facilitate such growth, we hired additional personnel throughout 2009 in various company departments. We expect that in 2010, our net revenue per FTE employee will exceed $0.3 million.

Year Ended December 31, 2009 versus December 31, 2008

Net Revenue

		Years Ended December 31,												Percent
		2009				2008				Variance				change
		(in thousands)
Net revenue		$	91,599			$	73,736			$	17,863				24.2	%

Our 24.2% net revenue increase resulted from a 20.0% increase in diagnostic services test volume, increased Medicare reimbursement rates, and a favorable mix of higher-value services performed in the current period, partially offset by certain pricing reductions based on a 2009 analysis of historical cash collections by payor class. See the above Billing section for a table of Medicare reimbursement rates under the Physician Fee Schedule for the most common CPT codes associated with our laboratory services in 2009 and 2008.

Our menu of oncology diagnostic testing services expanded in the first quarter of 2008 to include markers for tumors of the colon, prostate, and lung. We expect to continue to expand our services menu to include markers for additional tumor types, and to deepen our market penetration for the diagnostic services that we currently provide. We have also steadily increased the depth of our diagnostic services for certain cancer types, including lymphoma/leukemia.

Net revenue growth in the year ended December 31, 2009, as compared to 2008, was enabled by our expanded capabilities and service offerings which utilize the test methodologies of IHC, flow cytometry, FISH, and molecular/PCR, and our accompanying sales and marketing efforts. We anticipate that net revenue will continue to increase as we further execute our commercial operation strategy of expanding the breadth and depth of our oncology diagnostic services and our sales and marketing efforts for such services.

Cost of Services, Gross Profit, and Gross Margin

		Years Ended December 31,												Percent
		2009				2008				Variance				change
		(in thousands)
Cost of services		$	39,107			$	32,936			$	6,171				18.7	%
Gross profit			52,492				40,800				11,692				28.7	%
Gross margin percentage (gross profit as a percent of net revenue)			57.3	%			55.3	%			2.1	%

The $6.2 million increase in cost of services was driven by a 20.0% increase in test volume, and was primarily related to: additional laboratory personnel costs of $2.1 million, increased lab supplies of $1.3 million, additional courier expenses of $0.7 million, and increased cost of tests performed on our behalf by other laboratories of $1.2 million.

Gross margin for the year ended December 31, 2009 improved to 57.3%, and was primarily due to increased test volumes and the related economies of scale in our operations. We anticipate that gross margins will gradually improve as our testing volumes increase and we continue to improve the efficiency and effectiveness of our laboratory operations. Laboratory employee productivity continues to improve based on metrics of specimens prepared and tested by month per FTE laboratory employee. Gross margins could be adversely affected, however, if Medicare reimbursement rates are decreased in 2010 or beyond.

Operating Expenses and Interest Expense, net

		Years Ended December 31,												Percent
		2009				2008				Variance				change
		(in thousands)
Sales and marketing		$	17,380			$	10,941			$	6,439				58.9	%
General and administrative			23,587				18,729				4,858				25.9	%
Bad debt			12,927				12,199				728				6.0	%
Research and development			1,719				421				1,298				308.3	%
Interest expense, net			4,431				8,149				(3,718	)			(45.6	)%

Sales and marketing. The $6.4 million increase for the year ended December 31, 2009 as compared to 2008 was primarily related to $5.1 million of additional sales and marketing personnel related costs, including sales commissions. During the first quarter of 2009, we hired 16 new sales representatives to deepen our market penetration across the U.S. The remaining $1.3 million increase was related to a $0.7 million increase in travel-related expenses and increased tradeshow, advertising, sales conferences, and consulting fees of $0.3 million.

General and administrative. The $4.9 million increase is related to several factors which include: (i) a $3.1 million increase in personnel expenses (including relocation & recruiting), particularly within our billing and collection, human resources, and information technology departments to support our growth, (ii) a $0.4 million increase in stock based compensation, (iii) a $0.6 million increase in depreciation expense on recently deployed capital assets, (iv) a $0.4 million increase in consulting expenses related to certain corporate initiatives, (v) a $0.4 million increase in facilities expenses associated with expansion at our current facility in Aliso Viejo, and (vi) increased general insurance fees of $0.5 million. These increases were partially offset by a reduction in third party collection fees of $0.6 million resulting from bringing our billing function in-house during the second half of 2008.

Bad debt. During the third quarter of 2009, we refined our model of estimating our allowance for doubtful accounts, based upon historical collection information not previously available to us in sufficient form and content. Our process involved a detailed analysis of historical collections by each payor class since we began performing the billing and collection function in-house in June 2008. Due to a combination of objective and subjective factors in our previous model for estimating an appropriate allowance for doubtful accounts and resulting bad debt expense, our reported bad debt expense of $12.9 million for the year ended December 31, 2009 would not have been materially different had the previous model been applied.

We expect that bad debt expense will gradually decrease to below 10% of net revenue over the next four to six quarters, as we more effectively manage our billing and collection function and continue to improve our billing and collection processes.

Research and development. The $1.3 million increase in research and development expenses was primarily driven by $0.3 million of increased compensation and benefits costs for recently hired research and development personnel, and $0.8 million of increased costs associated with third parties who assist us in developing novel diagnostic tests.

Interest expense, net. Interest expense includes stated interest and fees on our credit facilities, plus the amortization of the fair value of issued common stock warrants in connection with borrowings under our former credit facility with Safeguard and certain other lenders. The $3.7 million decrease in interest expense is primarily related to lower average outstanding short-term borrowings due to the repayment and retirement of our revolving credit facilities with Comerica and Safeguard as discussed in Note 7 to the Consolidated Financial Statements.

Income Taxes

		Years Ended December 31,
		2009				2008				Variance
		(in thousands)
Income tax benefit (expense)		$	599			$	(6	)		$	(605	)

The $0.6 million tax benefit in 2009 relates to the tax effect, through continuing operations, of a $1.5 million payment received in April 2009 from Zeiss, the acquirer in the ACIS Sale. The proceeds were in connection with the satisfaction of certain post-closing conditions from the ACIS Sale in 2007. The nominal tax expense in 2008 represents certain minimum payments due in various states.

Year Ended December 31, 2008 versus December 31, 2007

Net Revenue

		Years Ended December 31,												Percent
		2008				2007				Variance				change
		(in thousands)
Net revenue		$	73,736			$	42,995			$	30,741				71.5	%

Our 71.5% net revenue increase resulted from our increase in diagnostic services test volume of 51.4%, and increased Medicare reimbursement rates. See the above Billing section for a table of Medicare reimbursement rates under the Physician Fee Schedule for the most common CPT codes associated with our laboratory services in 2008 and 2007.

We expanded our menu of oncology diagnostic testing services in the first quarter of 2008 to include markers for tumors of the colon, prostate, and lung. Our expanded capabilities in the test methodologies of IHC, flow cytometry, FISH, and molecular/PCR, and our accompanying sales and marketing efforts, have driven net revenue growth in the year ended December 31, 2008, as compared to 2007.

Cost of Services, Gross Profit, and Gross Margin

		Years Ended December 31,												Percent
		2008				2007				Variance				change
		(in thousands)
Cost of services		$	32,936			$	26,807			$	6,129				22.9	%
Gross profit			40,800				16,188				24,612				152.0	%
Gross margin (gross profit as a percent of net revenue)			55.3	%			37.7	%			17.6	%

The $6.1 million increase in cost of services was driven by an overall increase in net revenue, and was primarily related to: (i) additional laboratory personnel costs of $2.1 million, (ii) increased laboratory reagents and other supplies expense of $1.4 million, (iii) increased allocated facilities expense of $0.4 million, (iv) increased cost of tests performed on our behalf by other laboratories of $1.7 million, and (v) an increase in shipping expense of $1.2 million.

Gross margin for the year ended December 31, 2008 was 55.3% compared to 37.7% in the prior year. The increase in gross margin was primarily driven by an overall increase in net revenue including higher value oncology diagnostic services. In addition, laboratory employee productivity improved based on metrics of specimens prepared and tested per month per FTE laboratory employee. Gross margin, however, does not include the bad debt expense that impacts our overall results. See our bad debt discussion below.

Operating Expenses and Interest Expense, net

		Years Ended December 31,												Percent
		2008				2007				Variance				change
		(in thousands)
Sales and marketing		$	10,941			$	8,630			$	2,311				26.8	%
General and administrative			18,729				15,278				3,451				22.6	%
Bad debt			12,199				3,558				8,641				242.9	%
Research and development			421				519				(98	)			(18.9	)%
Interest expense, net			8,149				2,349				5,800				247.0	%

Sales and marketing. The $2.3 million increase for the year ended December 31, 2008 as compared to 2007 was primarily related to additional sales and marketing personnel costs of $1.7 million which included increased sales commission expense of $0.6 million, a $0.3 million increase in travel-related expenses, and increased tradeshow, advertising, and consulting fees of $0.2 million.

General and administrative. The $3.5 million increase is related to several factors which include additional personnel costs of $2.6 million to support our business growth and to establish an in-house billing and collection department, and severance expenses of approximately $0.3 million, partially offset by a $1.0 million decrease in third-party billing and collection fees. As compared to the prior year, accounting and legal fees increased by $0.8 million and $0.6 million, respectively. The increase in accounting fees was primarily associated with the testing of internal controls over financial reporting. The increase in legal fees was primarily associated with SEC compliance, corporate governance, financing arrangements, and executive compensation review.

Bad debt. We recorded bad debt expense at a rate of approximately 16.5% and 8.3% of revenue for 2008 and 2007, respectively. The increase in bad debt expense is primarily related to our 71.5% increase in net revenue as compared to the prior year and the impact on cash collections due to delays in our internal billing and collection efforts. Bad debt expense was also impacted by higher loss experience, including significant uncollectible accounts identified during the second half of 2008 which were previously serviced by our former third-party billing and collection service provider.

Research and development. Research and development expenses in 2008 remained consistent with 2007. Our research and development costs in both years primarily included compensation and benefits for research and development personnel, laboratory supplies, and allocated facility-related costs.

Interest expense, net. The increase in interest expense is primarily related to higher average outstanding short-term borrowings in the year ended December 31, 2008, as compared to 2007, in order to support our growing operations and the recognition, through interest expense, of the fair value of common stock warrants issued to Safeguard in March 2008 through November 2008 in connection with the New Mezzanine Facility, as discussed in Note 7 to the Consolidated Financial Statements.

Income Taxes

		Years Ended December 31,
		2008				2007				Variance
		(in thousands)
Income tax (expense) benefit		$	(6	)		$	2,088			$	2,094

The ACIS Sale occurred in March 2007. Reported income from discontinued operations for the year ended December 31, 2007 was $5.4 million. The associated income tax benefit is reported within continuing operations. The nominal tax expense in 2008 represents certain minimum payments due in various states.

Liquidity and Capital Resources

The below chart summarizes selected liquidity data and metrics as of December 31, 2009 and 2008:

		December 31,				December 31,
		2009				2008
		(in thousands, except financial
		metrics data)
Cash and cash equivalents		$	10,903			$	1,838
Accounts receivable, net			21,568				20,315
Total current liabilities			14,175				35,934
Working capital surplus (deficit) (a)			21,287				(12,480	)
Days sales outstanding (“DSO”) (b)		86 days				85 days
Current ratio (c)			2.50				(0.65	)

Operating Activities

Cash used in operating activities was $3.1 million for the year ended December 31, 2009, as compared to cash used in operating activities of $4.5 million in the prior year period. The decrease in cash used in operating activities is primarily a function of the general improvements in our billing and collection processes, specifically within the area of monitoring and follow-up of significant accounts receivable balances. We hired additional billing and collection personnel in 2009 in order to improve the completeness and accuracy of the bills we send, and to minimize the time between our completed service date and our billing date. During the years ended December 31, 2009 and 2008, our cash collections from customers totaled $77.9 million and $53.2 million, respectively, representing 85.1% and 72.2% of net revenue reported for the same periods, respectively.

Investing Activities

Cash used in investing activities for the year ended December 31, 2009 of $5.1 million consisted of (i) $4.6 million of capital expenditures related to purchases of new laboratory equipment and information technology system enhancements, and (ii) security deposits into two restricted cash accounts totaling $2.1 million for a standby letter of credit related to the lease of our Aliso Viejo facility and a capital lease of computer hardware. These expenditures were partially offset by our $1.5 million receipt upon escrow period expiration in connection with the sale of our former equipment business (see Note 4 to the Consolidated Financial Statements).

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2009 was $17.3 million, an increase of $8.8 million as compared to the prior year, which we used to support our working capital needs. The $17.3 million in cash provided by financing activities was primarily attributable to $40.0 million in gross proceeds from the sale of our Series A convertible preferred stock to Oak on March 26, 2009 and May 14, 2009 (see Note 12 to the Consolidated Financial Statements), partially offset by 2009 net repayments of $23.5 million, against our now-retired revolving credit facilities with Safeguard and Comerica, and our active Gemino Facility (see Note 7 to the Consolidated Financial Statements).

Credit Arrangements

The following table summarizes our outstanding balance under our credit arrangement (excluding capital lease obligations) and our remaining credit availability as of December 31, 2009 (in thousands):

Outstanding

Credit Availability

December 31, 2009

December 31, 2009

Earliest Stated Maturity

Gemino Facility

$

2,678

$

5,322

January 31, 2011

As discussed in Note 12 to the Consolidated Financial Statements, on March 25, 2009 we entered into a Stock Purchase Agreement with Oak (the “Oak Purchase Agreement”), pursuant to which we agreed to sell and issue to Oak, up to an aggregate of 6.6 million shares of our Series A convertible preferred stock in two or more tranches for aggregate consideration of up to $50.0 million (the “Oak Private Placement”). The initial closing of the Oak Private Placement occurred on March 26, 2009, at which time we issued and sold Oak an aggregate of 3.8 million preferred shares for aggregate consideration of $29.1 million. After paying investment banking fees and legal expenses, we used the remaining proceeds to repay in full the outstanding balance of $9.8 million on our revolving credit facility with Comerica Bank, to support a $2.3 million standby letter of credit with Comerica Bank (subsequently reduced to $1.5 million in December 2009) through opening a restricted cash account with Comerica Bank in the same amount, and to repay $14.0 million of our mezzanine facility with Safeguard.

The second closing of the Oak Private Placement occurred on May 14, 2009, at which time we issued and sold Oak an aggregate of 1.4 million Series A preferred shares (the “Second Oak Closing Shares”) for aggregate consideration of $10.9 million. Of the $10.9 million of proceeds from the second closing of the Oak Private Placement, $5.7 million was used to repay in full and terminate the mezzanine facility with Safeguard. The remaining amount of $4.8 million, net of legal fees and investment banking fees, was used to support our working capital requirements. Though our Comerica and Safeguard facilities have been repaid and retired, we continue to maintain our credit facility (the “Gemino Facility”) with Gemino Healthcare Finance, LLC (“Gemino”).

The Gemino Facility contains certain financial and non-financial covenants which require our compliance, as described within Note 7 to the Consolidated Financial Statements. Failure to maintain compliance would constitute an event of default. The Gemino Facility also contains a material adverse change (“MAC”) clause. If we encountered difficulties that would qualify as a MAC in our (i) operations, (ii) condition (financial or otherwise), or (iii) ability to repay the amount outstanding, our credit agreement could be cancelled at Gemino’s sole discretion. Gemino could then elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing such indebtedness. We believe, though we can provide no assurance, that we will be able to meet the financial covenants, as amended (see below), and will not encounter a MAC triggering event associated with the Gemino Facility.

On November 13, 2009, we executed the November 2009 Gemino Amendment. The November 2009 Gemino Amendment (i) extended the maturity date of the Gemino Facility from January 31, 2010 to January 31, 2011, (ii) removed the “excess liquidity” covenant, (iii) increased the facility’s “advance rate” from 75% to 85%, (iv) eliminated the minimum “fixed charge coverage ratio” covenant through December 31, 2009, (v) includes a “maximum loan turnover ratio” (average monthly loan balance divided by average monthly cash collections multiplied by 30 days) of 35 days only for the three months ending December 31, 2009, (vi) requires a minimum annualized “fixed charge coverage ratio” covenant of 1.00 for the three months ending March 31, 2010, 1.10 for six months ending June 30, 2010, 1.20 for the nine months ending September 30, 2010, and 1.20 for the twelve months ending December 31, 2010 and thereafter, and (vii) reduced the commitment fee from 0.75% to 0.50% per year on the daily average of unused credit availability.

In-House Billing and Collection

On June 1, 2008, our in-house billing and collection department began operations, using licensed third-party billing and collection software. During the fourth quarter of 2008 we ceased utilizing the services of our former billing and collection service provider. We did not have adequate internal resources to address the unanticipated issues that arose during the establishment of our internal billing and collection department, and as a result, our cash collections in 2008 did not increase at the same rate as our net revenue increased. Certain of such issues continued through December 31, 2008 and into early 2009. Consequently, our collection efforts were also negatively impacted in the first and second quarters of 2009, and to a lesser extent, for the second half of 2009.

We continue to improve the overall effectiveness of our billing and collection processes. In the second half of 2009, we experienced improved collection results (measured by aggregate cash collections and cash collections as a percentage of net revenue) as compared to the first half of 2009, and second half of 2008. As we rely on our cash collections to support our general working capital needs, it is critical that we continue to improve the overall effectiveness of our billing and collection department in 2010 and beyond.

Contractual Obligations

The following table summarizes our contractual obligations and commercial commitments at December 31, 2009:

		Payment due by period at December 31, 2009
						Less
						than 1												After
		Total				Year				1 - 3 Years				3 - 5 Years				5 Years
		(in thousands)
Gemino Facility		$	2,678			$	2,678			$	—			$	—			$	—
Capital lease obligations			1,249				645				604				—				—
Operating leases			10,526				1,784				5,473				3,269				—
Minimum purchase commitments			1,191				432				759				—				—
Total contractual obligations and commercial commitments		$	15,644			$	5,539			$	6,836			$	3,269			$	—

The table does not include our reserves for unrecognized tax benefits. We had a $3.2 million reserve for unrecognized tax benefits, including interest and penalties, at December 31, 2009 and 2008, respectively, as discussed in Note 14 to Consolidated Financial Statements. In addition, this table does not include potential severance benefits due under various employment agreements with certain employees if such employee(s) was terminated without cause, the timing and total amount of which are not practicable to estimate.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that provide financing, liquidity, market or credit risk support, or involve leasing, hedging for our business, except for operating lease arrangements. In addition, we have no arrangements that may expose us to liability that is not expressly reflected in the Consolidated Financial Statements, except for potential indemnification obligations associated with the ACIS Sale.

As of December 31, 2009, we did not have any relationships with unconsolidated entities or financial partnerships, often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes, except our relationship with CPS, described in Note 1 to the Consolidated Financial Statements. As such, we are not subject to any material financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Recent Accounting Pronouncements

Several new accounting standards have been issued and adopted recently. None of these standards had or expected to have a material impact on our financial position, results of operations, or liquidity. See Note 5 to the Consolidated Financial Statements.

Item 7A.		Quantitative and Qualitative Disclosures About Market Risk

Our cash and cash equivalents are not subject to significant interest rate risk due to the short term maturities of these investments. As of December 31, 2009 the carrying value of our cash and cash equivalents approximates fair value.

We had $2.7 million of variable interest rate debt outstanding at December 31, 2009 under our Gemino Facility. Borrowings bear interest at an annual rate equal to 30-day LIBOR (subject to a minimum annual rate of 2.50% at all times) plus an applicable margin of 6.0% through its maturity date of January 31, 2011. The variable interest rate applicable of our Gemino Facility may therefore expose us to market risk due to changes in interest rates of 30-day LIBOR. A hypothetical 10% increase in the applicable interest rate on our Gemino Facility would negatively affect our pre-tax results of operations and cash flows by approximately $0.3 million on an annualized basis, assuming our average outstanding borrowings remained at $2.7 million.

Item 8.		Financial Statements and Supplementary Data