UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x

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

 

For the fiscal year ended December 31, 2011

 

¨

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

 

For the transition period from _____ to ______

 

Commission file number 0001124608

 

RESPONSE GENETICS, INC.

(Name of Small Business Issuer in Its Charter)

 

Delaware		2835		11-3525548
(State or Other Jurisdiction of Incorporation or Organization)		(Primary Standard Industrial Classification Code Number)		(I.R.S. Employer Identification No.)

 

1640 Marengo St., 6th Floor

Los Angeles, California 90033

(323) 224-3900

(Address and Telephone Number of Principal Executive Offices)

Securities registered under Section 12(b) of the Exchange Act:

Title of each class		Name of each exchange on which registered
Common Stock, par value 0.01 per share		Nasdaq Capital Market

Securities registered under Section 12(g) of the Exchange 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 x

 

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 x

 

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 report), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments 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 Rule12b-2 of the Exchange Act.

 

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

 

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

 

The aggregate market value of common stock held by non-affiliates of the registrant was $31,897,342.50 as of June 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter. Such aggregate market value was computed by reference to the closing price of the common stock of $2.50 per share as reported on the Nasdaq Capital Market on June 30, 2011.

 

The number of shares of the registrant’s common stock outstanding as of March 26, 2012 was 24,797,625.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Items 10 (as to directors and Section 16(a) Beneficial Ownership Reporting Compliance), 11, 12, 13 and 14 of Part III incorporate by reference information from the registrant’s proxy statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the registrant’s 2012 Annual Meeting of Stockholders. 

 

 

 

TABLE OF CONTENTS

 

		Page
Part I
Item 1.  Business.		3
Item 1B. Unresolved Staff Comments.		15
Item 2.  Properties.		15
Item 3.  Legal Proceedings.		16
Item 4.  Mine Safety Disclosures.		16
Part II
Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.		16
Item 6.  Selected Financial Data.		17
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.		18
Item 8.  Financial Statements and Supplementary Data.		29
Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.		29
Item 9A.  Controls and Procedures.		29
Item 9B.  Other Information.		30
Part III
Item 10.  Directors, Executive Officers, Promoters and Corporate Governance		30
Item 11.  Executive Compensation		30
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.		30
Item 13.  Certain Relationships and Related Transactions, and Director Independence.		31
Item 14.  Principal Accountant Fees and Services.		31
Part IV
Item 15.  Exhibits, Financial Statement Schedules.		61

 

  

 

Part I

 

FORWARD-LOOKING STATEMENTS

 

Except for the historical information contained herein, this Annual Report on Form 10-K contains or may contain, among other things, certain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. When used in this report, the words “expects,” “anticipates,” “intends,” “estimates,” “plans,” “may,” “will,” “believes,” and similar expressions are intended to identify forward-looking statements although not all forward-looking statements contain these identifying words. These are statements that relate to future periods and include statements about our expectation that, for the foreseeable future, a significant amount of our revenues will be derived from ResponseDX sales; our ability to maintain revenue from pharmaceutical clients; the factors that may impact our financial results; the extent of our net losses and our ability to achieve sustained profitability; our business strategy and our ability to achieve our strategic goals; our expectations regarding revenues from ResponseDX^® products; the amount of future revenues that we may derive from Medicare patients; the potential to intent to enter into distribution arrangements; our ability to sustain or increase demand for our tests; our sales forces’ capacity to sell our tests; plans for the development of additional tests; our expectation that our research and development, general and administrative and sales and marketing expenses will increase and our anticipated uses of those funds; our ability to comply with the requirements of a public company; our ability to attract and retain qualified employees; our compliance with federal and state regulatory requirements; the potential impact resulting from the regulation of our tests by the U.S. Food and Drug Administration; the impact of new or changing policies or regulation of our business; our believe that we’ve filed adequate patent and trademark applications to protect our intellectual property rights; the impact of accounting pronouncements and our accounting policies, estimates, assumptions or models on our financial results; and anticipated challenges to our business.

 

Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected. These risks and uncertainties include, but are not limited to, our ability to develop and commercialize new product without unanticipated delay; the risk that we may not maintain reimbursement for our existing tests or any future tests; the risk that reimbursement pricing may change; the risks and uncertainties associated with the regulation of our tests; our ability to compete;; our ability to obtain capital when needed; and our history of operating losses. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to update any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

Item 1.  Description of Business

Overview

 

Response Genetics, Inc. was formed as a Delaware corporation in September 1999. We are a life sciences company engaged in the research and development of clinical diagnostic tests for cancer. Our mission is to provide personalized genetic information that will help guide physicians and patients in choosing the treatment from which a given patient is most likely to benefit. We currently generate revenues primarily from sales of our ResponseDX^® diagnostic tests, which we launched in 2008 and by providing clinical trial testing services to pharmaceutical companies.

 

Our proprietary technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, or FFPE, specimens and thereby to analyze genetic information contained in these tissues. Our technologies also enable us to use the FFPE patient biopsies for the development of diagnostic tests.

 

We file our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other information with the Securities and Exchange Commission (the “SEC”). Copies of these reports are also available through our website at www.responsegenetics.com. We also post copies of our press releases on our corporate website.

 

Our Approach

 

Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide physicians and cancer patients with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues through the utilization of our proprietary technology as well as through the use of non-proprietary technology that could also benefit patients.

 

Our approach to achieving this goal is to provide a range of oncology diagnostic testing services, focusing on solid tumors, which include technical laboratory services and professional interpretation of laboratory test results by licensed pathologists. In addition, we provide extensive services to pharmaceutical companies and research organizations, including development of diagnostics and clinical trial testing services.

 

ResponseDX^®

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

 

Many chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic factors in patients’ tissues that can predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we have and continue to develop genetic tests that measure predictive factors for tumor response in tumor tissue samples. We offer tests for non-small cell lung cancer (NSCLC), colorectal cancer (CRC) and gastric and gastroesophageal (GE), and melanoma cancer patients’ tumor tissue specimens through our ResponseDX: Lung®, ResponseDX: Colon® and ResponseDX: Gastric^® test suites and ResponseDX: Melanoma™ .These test results may help doctors and patients decide the best course of treatment for patients.

 

Our ResponseDX^® tests are commercially available through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendment of 1988 (CLIA).

 

Tests Launched in 2011

 

PIK3 CA and NRAS Mutation Tests

 

During 2011, we added two additional mutational tests to our ResponseDX: Colon^® panel: PIK3 CA mutation testing and NRAS mutational testing. Some studies suggest PIK3 mutations in exon 20 are associated with low response to anti-EGFR therapies. The presence of mutations in codons 12, 13 or 61 of NRAS is indicative of a tumor that may respond to therapies targeted at genes downstream to NRAS in the mitogen activating protein kinase (MAPK) signaling cascade; mutations in this gene may also indicate metastatic colorectal cancer that may not respond to EGFR-targeted therapies.

 

MSI Test

 

We also began offering Microsatellite Instability (MSI) testing in colorectal cancers (CRCs). MSI is the mutational signature found in CRCs that evolve as a result of inactivation of the DNA mismatch repair system. Studies suggest that Stage II CRC patients with high levels of MSI may have good prognosis and do not benefit from 5-fluorouracil adjuvant therapy.

 

ALK Break Apart Test

 

In December of 2011, we added a new anaplastic lymphoma kinase (ALK) test.  Using fluorescence in situ hybridization (FISH)-based technology, which complements the Company’s current PCR-based EML4-ALK test, the Company can better detect gene variants in patients with non-small cell lung cancer (NSCLC), who may be candidates for crizotinib treatment.  Approximately 3 to 5 percent of NSCLC tumors have a rearrangement of the ALK gene.  We use the new ALK Break Apart FISH Probe Kit, which can detect rearrangements of the ALK gene on the 2p23 chromosome in tumors.  The ALK Break Apart FISH Probe Kit is the only available diagnostic assay clinically validated to predict response to the targeted therapy crizotinib.

 

Our Technology

 

Methodologies used in Our Testing Services

 

PCR

 

The majority of our tests are based on the polymerase chain reaction (PCR), which is a sensitive, precise and reliable technology that gives numerical values that are not dependent on subjective interpretations. We developed and extensively validated technology to perform quantitative PCR analysis of gene expressions in formalin-fixed paraffin embedded (FFPE) tumor tissues. We have used our technological expertise in many projects for the pharmaceutical industry and for many collaborative scientific studies. The benefit of our capability for patients is that in many cases, no tissue samples other than the pre-treatment diagnostic biopsy will be required for the biomarker analysis.

 

FISH

 

Our laboratory recently expanded its diagnostic menu to include Fluorescence in situ hybridization (FISH) technology tests, which may be used to determine whether specific genes, loci or regions are present or if deletions, duplications, amplifications or other structural rearrangements have occurred. This technology produces an accurate result in a more rapid turnaround time than other cytogenetic techniques, such as tissue culture cytogenetics.

 

Sequencing

 

Our laboratory now offers DNA sequencing, which is the process of determining the nucleotide order of a given DNA fragment. Currently, our validated methodology uses the chain termination method developed (Sanger Method), which uses sequence specific termination of a DNA synthesis reaction using modified nucleotide substrates. .

 

IHC

 

Immunohistochemistry, or ICH, is also utilized in our laboratory. IHC relies on detecting antigen (proteins) in cells of a tissue section and exploiting the principle of antibodies binding with specificity to antigens in tissues. This methodology is useful to understand the distribution of biomarkers and differentially expressed proteins in various tissues.

 

 

 

 Our Technologies

 

We have developed technologies for the extraction of RNA from FFPE tissues which enable us to reliably recover RNA suitable for a variety of applications, such as gene expression research, development of diagnostics, and microarray platforms. In addition, our technologies permit gene profiling analysis of current clinical trials, most of which use the paraffin embedding technique for tissue specimen storage.

 

The Company developed and patented extraction methodologies that allow reliable and consistent isolation of RNA and DNA from FFPE suitable for use in various types of analysis. We validated our methodology, which particularly addressed issues of recovery of RNA, accuracy, and precision. Further, our methodologies allow for rapid extraction of RNA with little or no DNA contamination, which makes it suitable for large-scale analysis.

 

• Micro-dissection of each specimen to separate tumor from non-tumor tissue. Most tumor biopsy specimens are mixtures of normal and tumor tissue. A specimen may include only a small percentage of tumor cells. The molecular biology of tumor and normal tissues may be considerably different and mixing the two may yield false results for gene expression profiling. To accurately measure gene expression and establish expression profiles of various pathologic lesions, it is important to analyze RNA from tumor cells. With the assistance of a pathologist, we can identify the tumor cells and isolate them, either manually or with laser-capture micro-dissection.

  

• Isolation of DNA from the same specimen used to obtain RNA. Alterations in DNA sequence that are inherited (polymorphisms) as well as acquired (mutations) are often associated with disease susceptibilities, treatment response, and survival. DNA polymorphisms and mutations may change the gene expression pattern of a cell in specific ways. Characterization of gene expression profiles associated with various DNA sequence alterations may lead to a better understanding of disease mechanisms and may suggest new and better treatments. Our technique for isolating DNA and RNA from the same specimen facilitates such efforts because in many cases the amount of available tissue may not be sufficient for separate isolation of DNA and RNA. In addition, measuring gene expressions and DNA sequence alteration in the same cells rather than in different areas of the tissue specimen is likely to give more valid data.

 

We believe these technologies may be used as a powerful tool to establish diagnostic gene sets for predicting a patient’s likelihood of survival under a particular treatment regimen. Such diagnostic tests will provide the opportunity for choosing the best treatment prior to therapy and thus enable application of personalized medicine based on each person’s unique genetics.

 

ResponseDX: Lung®, ResponseDX: Colon®, ResponseDX: Gastric™ and ResponseDX: Melanoma™

 

We developed ResponseDX^® in part by using our technology to extract genetic information from FFPE tumor specimens. Our technology provides gene expression information for each patient’s tumor tissue specimen. Our mission is to help doctors and patients choose the most effective cancer treatment options- the first time- based on genetic information from the patient’s tumor biopsy.

 

ResponseDX: Lung® comprises eight tests: ERCC1 expression, RRM1 expression, TS expression, KRAS mutational analysis, EGFR expression, EML4-ALK mutational analysis, ALK, and EGFR mutational analysis. ResponseDX: Colon™ comprises seven tests: ERCC1 expression, KRAS mutational analysis, TS expression, EGFR expression, PIK3 CA, NRAS and BRAF mutational analysis. We offer MSI mutation as a standalone test for colon cancer. ResponseDX: Gastric^® comprises three tests: ERCC1 expression, TS expression and HER2 expression. ResponseDX: Melanoma™ comprises BRAF mutational analysis. Furthermore, we have found that KRAS, BRAF and EGFR mutations can be analyzed in various other tumor types. Therefore, we are also offering these tests in other tumor types. Physicians are ordering our tests to determine whether patients may benefit from a clinical trial of a new agent.

We have developed assays for single genes comprising the ResponseDX^® panels for use in our CLIA lab. Assay development of these tests was done through appropriate validation procedures which determine the accuracy (sensitivity and specificity) of each test. Our experience in this area allows us to continue to develop additional tests for these and other ResponseDX^® panels.

 

Sales, Marketing and Client Services for ResponseDX^® tests

 

We offer our ResponseDX^® test services nationwide. Our primary sales [market] includes community based oncologists, pathologists, physician offices and hospitals. Selling diagnostic testing services of cancer requires a knowledgeable and skilled sales force that can help oncologist and pathologists understand the value of our testing services. Our sales representatives generally have previous sales experience in the oncology field, including pharmaceutical sales experience or medical diagnostic services market, and have an extensive knowledge of the community-based hospital and oncology practice. Our sales force is compensated through a combination of salaries, commissions based upon actual sales performance and incentives from time to time, all at levels commensurate with each individual’s qualifications, performance and responsibilities.

 

As of December 31, 2011, our sales force was comprised of 21 people. Our sales and marketing efforts are directly overseen by our National Sales Director. Our sales force is organized into two regions. We have a Western Regional Sales Director and a National Sales Training Director, who train, develop sales territories and support the sales managers in their region. We will continue to expand our sales force as appropriate. Our sales strategy focuses on expanding the ResponseDX^® test services 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.

 

We have developed a set of marketing materials to support our sales efforts. Our marketing materials provide a summary of our tests along with practical information regarding how to order our tests. When creating our marketing materials we have focused on establishing a distinctive corporate brand and plan on continuing to build upon our strong ResponseDX^® brand.

 

We compete largely on the basis of the quality of our tests, our turnaround time, the convenience of ordering our tests and the innovation of our services.

 

Our Strategy

 

Research & Development

 

Research and development is crucial to the Company’s development as we seek to expand our series of diagnostic tests for cancer patients. Our research and development expenses were $1,611,582 and $1,321,897 for the years ended December 31, 2010 and 2011, respectively, representing 6.2% and 4.7% of our total operating expenses for the years ended December 31, 2010 and 2011, respectively. Major components of our research and development expenses include supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, insurance, business consulting and sample procurement costs. We expect research and development expenses to increase as we work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer. The following section contains further information regarding our research and development strategy and goals.

 

Expansion of our ResponseDX^® diagnostic test panels

 

Our research and development activities primarily relate to the development and validation of diagnostic tests in connection with our ResponseDX^® diagnostic services. Our quality procedures ensure that our tests and applications meet regulatory guidelines.

 

Increasing uptake of our RepsonseDX® diagnostic tests through continued prospective clinical trials with co-operative oncology groups and key opinion leaders from the oncology community: towards acceptance in clinical practice guidelines

 

• ERCC1, a platin sensitivity gene, is contained three of our ResponseDX® panels: Colon, Gastric and Lung. Upon completion of a retrospective trial with the Southwest Oncology Group (SWOG) showing a statistically association of ERCC1 gene expression with clinical benefit from platin chemotherapy in gastric (GE Junction) tumors, a clinical trial testing the results by patient selection for platin or non-platin therapy with ERCC1 was proposed and approved by SWOG. Similarly, trials selecting patients for platinum adjuvant therapy in non-small cell lung cancer was approved by the Eastern Co-Operative Oncology Group (ECOG).

 

 

 

• Develop a bladder cancer chemotherapy response test. We expect to develop a test to determine responsiveness to adjuvant chemotherapy treatment for advanced bladder cancer. We have analyzed a series of bladder tumors from patients enrolled for adjuvant therapy in the AUO-AB 05/95 phase III trial. In May 2010, at the ASCO meeting, the results of this study, which investigated the relationship between multidrug-resistance 1 (MDR1) gene expression and ERCC1 gene expression to outcome were announced. This study provided the foundation for development of a diagnostic test for improving chemotherapy in the treatment of bladder cancer. We plan to further analyze additional specimens to develop a gene set and development of the diagnostic test will be similar to the lung test

 

Pursue Additional Collaborations and In-licensing to Expand Our Business

We intend to pursue additional collaborations with pharmaceutical companies or in-licensing of products or technologies that will enable us to accelerate the implementation of our plans to expand the services we provide to oncologists and pathologists. We expect to implement this plan by way of licensing of technology and know-how, investments in other companies, strategic collaborations, and other similar transactions. We expect these collaborations to provide us with early access to new technologies available for commercialization. We expect annual revenues from these collaborations to be less than approximately 1% of our total annual revenues in 2012.

 

Providing Accurate and High Quality Results - Quality Assurance Program

 

The quality of our diagnostic testing services is important to us and our clients. In order to deliver accurate and high quality results, we have established a quality assurance program for our laboratory operations. This program is designed to utilize both external and internal systems and procedures to monitor the quality of our laboratory operations. For example, we participate in external quality surveillance programs, including ongoing proficiency testing programs administered by the College of American Pathologists (CAP). CAP is an independent, non-governmental organization of board-certified pathologists which accredits, on a voluntary basis, laboratories. 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. Our most recent CAP inspection was successfully completed in October of 2010.  

 

 

 

License Agreement with the University of Southern California

 

In April 2000, as amended in June 2002 and April 2005, we entered into a license agreement with USC, pursuant to which USC granted us a worldwide, exclusive license with the right to sublicense, the patents for nucleic acid extraction methodologies and related technology, for use in human and veterinary diagnostic laboratory services, the sale of clinical diagnostic products, and the sale of research products to the research community. We are obligated under the agreement to use best efforts to work toward the commercialization of the licensed technology. In consideration for this license, we are obligated to pay royalties to USC, as a percentage of net sales of products or services using the technology, and to meet a certain minimum in royalty payments. Royalty expense, included in the cost in revenue section of the accompanying consolidated statement of operations, for the years ended December 31, 2010 and 2011 was $439,540 and $516,746, respectively. USC retains the right under the agreement to use the technology for research and educational purposes.

 

Upon authorization from us, USC has the obligation to undertake all responsibilities for the filing, prosecution and maintenance of all patents covered under the license; however, we have agreed to reimburse USC for all associated costs. If we elect not to pursue a particular patent, the rights to that patent revert to USC, if USC takes the necessary steps to prosecute and maintain the patent; if USC does not undertake such actions, the exclusive license rights to the patent remain with us. We bear full responsibility for enforcement of patent rights against all claims of infringement by third parties and the right, but not the obligation to bring action against any alleged infringement of the licensed patents by third parties, bearing all costs. USC has the right to pursue any offensive enforcement we chose not to pursue at its own expense and we may agree with USC to pursue such action jointly, sharing all related costs.

 

This agreement terminates on the first to occur of: (i) the date of the expiration of the last to expire of the patents issued in any country, or (ii) if no patents issue, the date on which any decision or determination to reject or deny the last remaining patent application or claim becomes final. Either party may terminate this agreement for uncured material breach or default upon written notice to the other party. We may terminate the agreement for any reason, upon written notice to USC. USC may terminate the agreement, upon written notice, in the event that we transfer or assign our rights and obligations under the agreement to a third party, in any manner contrary to the terms of the agreement or in derogation of USC’s proprietary rights; and immediately if we fail to obtain or maintain insurance coverage and for other specified causes. We are obligated to indemnify USC against all liabilities to third parties, from claims arising in connection with the agreement and our use, sale or other distribution of services and products involving the licensed technology. We also are required to maintain comprehensive general liability insurance, appropriately covering the full scope and range of activities we pursue with the licensed technology.

 

 

Patent License Agreement with Roche Molecular Systems, Inc.

 

In November 2004, we entered into an agreement with Roche pursuant to which we obtained a royalty-bearing, non-exclusive, personal, non-transferable license to use certain licensed technology, including specified nucleic acid amplification processes, to perform certain human invitro clinical laboratory services.

 

Roche retains all proprietary rights to the licensed technologies and our non-exclusive license is limited to the use of the technology as described above. Under this agreement, neither party is obligated to defend any proprietary rights against third parties for infringement.

 

In consideration for this license, we are obligated to pay royalties to Roche, as a certain percentage of revenues we receive from performing services using the licensed technology. Royalty expense for the years ended December 31, 2010 and 2011 was $426,366 and $552,113, respectively.

 

This agreement terminates on the date of expiration of the last to expire of the patents included in the licensed technology. Roche may immediately terminate the agreement upon written notice in the event of any material change in our ownership or control, or in the event that we breach certain non-assignability provisions of the agreement. Roche may also terminate the agreement upon prior written notice in the event of any breach or default by us of a material term under the agreement. The agreement will automatically terminate upon our entry into bankruptcy or similar proceedings.

 

Services Agreement with Taiho Pharmaceutical Co., Ltd.

 

In July of 2001, we entered into an agreement with Taiho pursuant to which we will provide Taiho with molecular-based tumor analyses for use in its business development and marketing of pharmaceutical and diagnostic products for use against cancer. Pursuant to the agreement, we appointed Taiho as the exclusive purchaser in Japan of tests and testing services based upon RGI-1 using gene expression through 2011 for: (i) any one or the combination of specified molecular markers, (ii) the therapeutic use of specified compounds, or (iii) the diagnosis or therapeutic treatment of specified precancerous and cancerous diseases. We also granted Taiho the right to be a non-exclusive purchaser in Japan of tests and testing services based upon RGI-1 using gene expression, other than those for which Taiho has exclusivity, for: (i) any one or combination of molecular markers, (ii) the therapeutic use of any compound or biological product against cancer, or (iii) the diagnosis or therapeutic treatment of precancerous and cancerous diseases.

 

We are obligated to notify Taiho of new molecular markers, therapeutic compounds and diseases for which RGI-1 may be useful and to offer Taiho the option of including those within its exclusivity. Taiho must perform all testing services pursuant to our instructions and we retain the right to process some or all of the testing services for Taiho internally, or through any other designated and licensed laboratory; provided that such other laboratory is under an appropriate obligation of confidentiality with respect to this agreement.

 

In consideration for the testing services provided, Taiho made a fixed amount advanced payment to us and is obligated to pay regular testing fees, covering the specific services performed on a monthly basis which was initially recorded as deferred revenue and has subsequently been fully recognized. Taiho is obligated to purchase a minimum amount of testing services from us during each calendar quarter through 2011. Revenue recognized under this agreement for the years ended December 31, 2010 and 2011 was $1,864,175, and $1,022,900, respectively. We obtained a non-exclusive sublicense from the University of Southern California for Taiho for distribution of the testing services in Japan. We retain all intellectual property rights to our proprietary testing services and materials, other than specimens provided by Taiho, and all related patent applications provided that, however, Taiho retains all intellectual property rights to the results of the testing services performed under the agreement.

 

Taiho has agreed to indemnify us against any damages claims brought by third parties based on the distribution of the testing services; any claims related to false advertising or unfair competition; and any regulatory challenges. We have agreed to indemnify Taiho against claims of intellectual property infringement related to the testing services. Both parties have agreed to indemnify one another against any breaches of warranties or failures to perform obligations under the agreement. We have agreed to maintain comprehensive general liability insurance for the term of the agreement and for a specified period thereafter. Either party has the right to terminate the agreement in the event of an uncured material breach by the other party, upon written notice, or for cause, as defined under the agreement. Since we do not hold a patent for RGI-1 in Japan, we have agreed to negotiate to adjust Taiho’s fee obligations in the event that a third party obtains a patent for similar testing services in Japan and offers those services at a competitive rate. In the event that we cannot reach an agreement Taiho has the right to terminate the agreement upon fulfilling certain notice obligations. In addition, should Taiho terminate the agreement for cause, Taiho retains the right to have Dr. Peter Danenberg and/or Kathleen Danenberg provide the testing services in the same manner as we provide them under the agreement. In January 2011, this agreement with Taiho was renewed for an additional three years. According to the terms of the renewal, Taiho’s appointment as an exclusive purchaser in Japan of certain tests and testing services and its minimum purchasing obligations ended December 31, 2011.

 

 

Services Agreement with SmithKline Beecham Corporation (d.b.a. GlaxoSmithKline) (“GSK”) and Amended and Restated Service Agreement with GSK

 

In January 2006, the Company entered into a Master Services agreement with GSK, a leading pharmaceutical manufacturer, pursuant to which the Company provides services in connection with profiling the expression of various genes from a range of human cancers. Under the agreement, the Company will provide GSK with testing services as described in individual protocols and GSK will pay the Company for such services based on the pricing schedule established for each particular protocol. GSK is obligated to make minimum annual payments to the Company under the agreement and also was obligated to make a non-refundable upfront payment to the Company, to be credited against work undertaken pursuant to the agreement. In January 2006, the Company received an upfront payment of $2,000,000, which was initially recorded as deferred revenue. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. There was no remaining deferred revenue balance associated with this agreement for the periods ended December 31, 2010 or December 31, 2011.

 

In December 2008, the Company amended and restated its master service agreement with GSK. Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000, which was received on January 5, 2010. There is no balance for deferred revenue for this agreement at December 31, 2011.

 

In March 2010, the Company entered into a non-exclusive license agreement with GSK. Under the agreement, the Company granted GSK a non-exclusive, sublicenseable license to its proprietary PCR analysis technology and diagnostic expertise to assess BRAF gene mutations in human tumor samples. As part of the agreement, the Company received a non-refundable technology access fee in consideration for the transfer of the Company’s technology to GSK. The agreement also contains milestone provisions which would allow the Company to earn further payments from GSK. The Company had not earned any milestone payments from GSK as of December 31, 2011.

 

The Company recognized revenue of $1,636,518 and $3,387,442 relating to all of the GSK agreements for the years ended December 31, 2010 and 2011, respectively.

 

Amended and Restated Master Laboratory Test Services Agreement with GlaxoSmithKline Biologicals (“GSK Bio”) and Amended and Restated Service Agreement with GSK Bio

 

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

 

For each calendar quarter of 2010 and the first two quarters of 2011, €200,000 of the existing credit shall apply to all services rendered to GSK Bio during such calendar quarter. Pursuant to the Amended and Restated Agreement, GSK Bio has extended the term of the agreement for an additional one-year period through March 30, 2012, or until certain clinical trial testing services have been completed, whichever is later. As provided in the Amended and Restated Agreement, the remaining balance of the existing credit of approximately €1,357,800 was divided into six equal quarterly amounts and will be applied to all services rendered to GSK Bio in each of the last two quarters of 2010 and the four calendar quarters of 2011. Beginning in the third quarter of 2010, the amount of the credit to be applied to all services rendered to GSK Bio is €226,300. In all cases, GSK Bio shall remit payment to the Company for all services rendered to GSK Bio in any such calendar quarter that is in excess of the applicable credit amount. In the event the amount of services rendered to GSK Bio in a calendar quarter does not exceed the applicable credit amount, the existing credit for the following calendar quarter shall be increased by such unused amount.

 

The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products. The amount of deferred revenue for this agreement at December 31, 2010 was $1,333,186, as of December 31, 2011 there was no remaining balance classified as deferred revenue. The timing of the recognition of these amounts is dependent upon when GSK Bio submits the specimens for testing. The Company recognized revenue of $5,805,951 and $5,185,302 relating to the GSK Bio agreement for the years ended December 31, 2010, and 2011, respectively, which includes for 2010 and 2011 of $1,255,710 and $1,333,186 of previously recorded deferred revenue.

 

 

Agreement with Shanghai BioChip

 

In March 2007, we entered into a collaboration agreement with Shanghai BioChip Company, Ltd. (“SBC”) pursuant to which SBC provides pharmacogenomic testing services in China using our extraction technology. Under this agreement, we work with SBC pursuant to a formal statement of work (SOW) arrangement. This agreement greatly expands our ability to provide our services globally, particularly in China. Specifically, this agreement allows us to collaborate with some of our current clients in the pharmaceutical industry as we can now process specimens collected during clinical trials that are based in China. Additionally, this agreement allows us to offer our services to companies within China.

 

Pursuant to the agreement, we have granted SBC an exclusive license in China to provide services in China using our RNA extraction technology. Subject to consent from the University of Southern California, we will grant SBC an exclusive sublicense to patents licensed from the University of Southern California for distribution of testing services in China. In turn, SBC will perform RNA extraction from FFPE tissue specimens exclusively for us during the term of the agreement. SBC must perform all testing services pursuant to our instructions and we retain the right to generate and report all final results. All proposed contracts from SBC using our testing services must be explicitly approved in writing by us. We have also retained the rights to any intellectual property which result from the performance of this collaboration agreement.

 

Outside of certain shared costs, as specified in the agreement, we and SBC each are individually and separately responsible for our own costs. Specifically, we are responsible for costs related to royalty payments to third parties under existing licensing agreements, license fees for our intellectual property, costs associated with the analysis of raw data from test results, costs associated with generating final reports to customers, costs of responding to customer inquiries regarding the results of analysis the data and the report of test results, and costs associated with providing training and assistance with laboratory setup.

 

 

 

 

SBC is responsible for expenses related to the initial cost of laboratory equipment, as well as the cost of any additional equipment necessary as a result of increases in volume of business; maintenance or service fees and expenses for the existing testing equipment; the cost of reagents; the cost of qualified laboratory space, including any rent for such space; expenses and salaries associated with laboratory personnel, including the Vice-General Manager and necessary FTE personnel to perform collaboration services; the costs of responding to customer inquiries regarding the performance of the testing, storage of the samples and other record keeping; and the costs associated with training and commencement of operations.

 

Our agreement with SBC has an initial term of five years, with an automatic renewal for an additional three-year term unless either party gives 90 day’s notice in advance of the renewal date of its intent not to renew. We may terminate the agreement on the occurrence of: (i) errors in SBC’s processing of samples that exceeds levels in our other facilities; (ii) the inability to achieve laboratory qualifications within 12 months; (iii) the failure to adequately address quality concerns raised by two or more customers; and (iv) refusal by SBC to agree on a reasonable request for a SOW. Either party may terminate this agreement for uncured material breach, insolvency or bankruptcy, or substantial use of the name of the other party without consent. For the years ended December 31, 2010 and 2011, testing services totaled $169,400 and $306,675, respectively.

 

Agreement with Hitachi Chemical Co., Ltd.

 

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

 

This Agreement had an initial term expiring on March 31, 2010, with an automatic renewal for one year at the end of the original period under the same terms and conditions. Pursuant to the agreement, Hitachi performs certain testing services and receives a percentage of the revenue collected from the Company's clients in the Territory which totaled $1,395,688 and $560,211 for the years ended December 31, 2010 and 2011, respectively. Following the Great East Japan Earthquake and Fukushima nuclear disaster that occurred in March of 2011, the processing of certain samples in Japan under our collaboration agreement with Hitachi was temporarily suspended. During the second and third quarters of 2011, these samples were processed in our Los Angeles laboratory. As such, we were not required to make payments to Hitachi under our agreement during that period. The financial impact was that our cost of revenue was reduced and our net loss for the quarters was reduced. Hitachi resumed processing certain samples beginning in the third quarter of 2011. 

 

Hitachi is responsible for expenses related to the cost of laboratory equipment and modification to the laboratory facilities, as well as the cost of reagents.

 

Intellectual Property

 

We rely on a combination of patents, trade secret, copyright and trademark laws, license agreements, nondisclosure and other contractual provisions and technical measures to protect our intellectual property rights in our products, technology and processes. We have proprietary rights in three areas.

 

First, we exclusively license from USC the use of the extraction methodologies, which has been patented in the United States. Currently, this exclusive license includes four United States patents related to this technology. We also have proprietary rights in additional variations on our extraction technology, for which patent applications are pending in the United States and in select critical countries. We also use these proprietary methods when meeting our contractual obligations with various clients and when developing diagnostic tests for cancer.

 

Next, we have identified and are in the process of identifying tumor response markers, which provide an indication of an anti-cancer drug’s effectiveness or ineffectiveness based upon the level of such determinant in a particular tumor. We intend to protect these proprietary developments to the extent allowable under current law. We have patented and have patent applications pending related to certain tumor response markers in the United States and in select critical countries. For example, we have patented methods of quantifying expression of response markers from tumor tissue, which provide guidance in determining appropriate chemotherapeutic regimens for patients that are candidates for treatment with particular chemotherapies. Currently, we have eleven United States patents that relate to certain tumor markers. Such markers include thymidylate synthase (TS), dihydropyrimidine dehydrogenase (DPD), excision repair gene CC1 (ERCC1), glutathione-s transferase pi (GST-π), epidermal growth factor receptor (EGFR) and HER2/neu gene. We use some of these patented methods as part of our contractual obligations with various clients. We have also licensed the use of certain markers and technology know-how to GSK.

 

 

 

Finally, we have proprietary rights and know-how in the factors which allow us to standardize the quantitative gene expression levels used in our database, and the computation of such values from the readings provided by the laboratory equipment used in the analysis of the mRNA extracted from a patient’s tumor, using our proprietary conversion factors.

 

We have and will continue to pursue the registration of our trademarks in the United States and internationally. Response Genetics, Danenberg Tumor Profile, Man in Circle Design, DTP, Kras is Only Half the Equation, ResponseDX, ResponseDX:Lung, ResponseDX:Colon, and The Right Therapy for each Patient the First Time are registered trademarks in the United States. We have pursued additional marks by filing trademark applications in the United States and abroad. We currently hold the domain names www.responsegenetics.com and www.responsedx.com.

 

We intend to broaden the scope of our intellectual property and consider our technologies and proprietary know-how to be critical to our future success.

 

Regulations and Legal Environment

 

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

 

 Clinical Laboratory Improvement Amendments

 

The Clinical Laboratory Improvement Amendments of 1988, or CLIA, provide for the regulation of clinical laboratories by the United States Department of Health and Human Services (DHHS). This law requires the certification of clinical laboratories that conduct tests on human subjects and imposes specific conditions for certification. CLIA is intended to ensure the accuracy, reliability and timeliness of patient test results performed in clinical laboratories in the United States by mandating specific standards in the areas of personnel qualification, administration participation in proficiency testing, patient test management, quality control, quality assurance and inspections. CLIA regulations also contain guidelines for the qualification, responsibilities, training, working conditions and oversight of clinical laboratory employees. In addition, specific standards are imposed for each type of test that is performed in a laboratory. The categorization of commercially marketed in vitro diagnostic tests under CLIA is the responsibility of the FDA. The FDA will assign commercially marketed test systems into one of three CLIA regulatory categories based on their potential risk to public health. Tests will be designated as waived, of moderate complexity or of high complexity. CLIA and the regulations promulgated there under are enforced through quality inspections of test methods, equipment, instrumentation, materials and supplies on a periodic basis.

 

CLIA regulations are enforced through biennial surveys and inspections. Moreover, CLIA inspectors may make random inspections of our laboratory. Since April 21, 2008, we have been CLIA certified and any loss of CLIA certification, change in CLIA or CLIA regulations or in the interpretation thereof, could have a material adverse effect on our business.

 

Other Laboratory Regulations

 

CLIA does not preempt more stringent state clinical laboratory laws. Since March 26, 2007, we have been a licensed clinical laboratory in California. California laws establish standards for day-to-day operation of our clinical laboratory, including the training and skills required of personnel and quality control. Moreover, several states require that we hold licenses to test specimens from patients residing in those states. Accordingly, we are also licensed in Florida, Pennsylvania, Maryland and Rhode Island. We have a license application pending in New York. Other states in which we chose to operate may have similar requirements or may adopt similar requirements in the future. Finally, we may be subject to regulation in foreign jurisdictions if we seek to expand offering our tests or distribution of our tests internationally.

 

If we lose our California license, we would not be able to sell tests for prospective clinical trials which would limit our revenues and harm our business. If we were unable to obtain or lost necessary licenses in other states, we would not be able to test specimens in those states.

 

 

 

HIPAA Compliance and Privacy Protection and the HITECH Act

 

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) established comprehensive federal protection for the privacy and security of health information. The HIPAA standards apply to three types of organizations, or “Covered Entities:” health plans, health care clearing houses, and health care providers who conduct certain health care transactions electronically (Standard Transactions). Covered Entities must have in place administrative, physical and technical safeguards to protect against the misuse of individually identifiable health information, or PHI. Additionally, some state laws impose privacy protections more stringent than HIPAA’s and some states impose privacy obligations specifically applicable to clinical laboratories.  Additionally, many states have implemented data breach laws requiring additional security measures for certain types of PHI and also public notification of the theft, breach or other loss of personal information. There are also international privacy laws, such as the European Data Directive and various national laws implementing the Data Directive, that impose restrictions on the access, use, and disclosure of health information and other types of identifiable personal information. All of these laws may impact our business. As of December 31, 2008, we became a Covered Entity subject to HIPAA privacy and security standards because our testing services became reimbursable by insurance payors and we began conducting Standard Transactions. We formed an active program designed to address HIPAA regulatory compliance.  This program will likely require periodic updating to comply with amendments to HIPAA. Regardless of our own Covered Entity status, HIPAA presently applies to many of the facilities and physicians with whom we do business and controls the ways in which we may obtain tissue specimens and associated clinical information from those facilities and physicians. We believe we have taken the steps required for us to comply with applicable health information privacy and confidentiality statutes and regulations under both federal and applicable state jurisdictions. However, we may not be able to maintain compliance in all jurisdictions where we do business. Our failure to comply with these privacy laws or significant changes in the laws restricting our ability to obtain tissue specimens and associated patient information could significantly impact our business and our future business plans.

 

Additionally, the HITECH Act requires HIPAA covered entities, including clinical laboratories, to provide notification to affected individuals and to the Secretary of Health and Human Services, following discovery of a breach of unsecured PHI. In some cases, the HITECH Act requires covered entities to provide notification to the media of breaches. In the case of a breach of unsecured PHI at or by a business associate of a covered entity, the Act requires the business associate to notify the covered entity of the breach. The HITECH Act requires the Secretary to post on the Department of Health and Human Services’ website a list of covered entities that experience breaches of unsecured PHI involving more than 500 individuals. The HITECH Act made other changes relating to the HIPAA privacy and security rules, including, among others, establishing that, effective February 17, 2010, the security and privacy rules apply directly to business associates and, consequently, that a business associate’s violation of the rules may result in government enforcement action directly against the business associate.

 

Federal and State Physician Self-referral Prohibitions

 

We are subject to the federal physician self-referral prohibitions (the Stark Law) and restrictions under California’s Physician Ownership and Referral Act (PORA). These restrictions prohibit us from billing a patient or any governmental or private payor for any test when the physician ordering the test, or any member of such physician’s immediate family, has an investment interest in or compensation arrangement with us, unless the arrangement meets an exception to the prohibition.

 

Both the Stark Law and PORA contain an exception for referrals made by physicians who hold investment interests in a publicly traded company that has stockholders’ equity exceeding $75 million at the end of its most recent fiscal year or on average during the previous three fiscal years, and which satisfies certain other requirements. In addition, both the Stark Law and PORA contain an exception for compensation paid to a physician for personal services rendered by the physician. We have compensation arrangements with a number of physicians for personal services, such as speaking engagements and specimen tissue preparation. We have structured these arrangements with terms intended to comply with the requirements of the personal services exception to Stark and PORA.

 

However, we cannot be certain that regulators would find these arrangements to be in compliance with Stark, PORA or similar state laws. We would be required to refund any payments we receive pursuant to a referral prohibited by these laws to the patient, the payor or the Medicare program, as applicable.

 

Penalties for a violation of the Stark Law include: refunds of amounts collected by an entity in violation of the Start Law, denial of payment for the services provided in violation of the prohibition, and civil penalties of up to $15,000 per service arising out of the prohibited referral. Additionally a person who engages in a scheme to circumvent the Stark Law’s prohibition may be subject to a civil penalty of up to $100,000. A violation of PORA is a misdemeanor and could result in civil penalties and criminal fines

 

Other states have self-referral restrictions with which we have to comply that differ from those imposed by federal and California law. While we have attempted to comply with these laws, it is possible that some of our financial arrangements with pathologist and physicians could be subject to regulatory scrutiny at some point in the future, and we cannot provide assurance that we will be found to be in compliance with these laws following any such regulatory review.

 

Federal False Claims Act

 

There 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.

 

Food and Drug Administration

 

The U.S. Food and Drug Administration, or the FDA, regulates the sale or distribution in interstate commerce, of medical devices, including in vitro diagnostic test kits. The information that must be submitted to the FDA in order to obtain clearance or approval to market a new medical device varies depending on how the medical device is classified by the FDA. Medical devices are classified into one of three classes on the basis of the controls deemed by the FDA to be necessary to reasonably ensure their safety and effectiveness. Class I devices are subject to general controls, including labeling, listing, registration, and reporting.  It may also include pre-market notification and adherence to the FDA’s quality system regulation, which are device-specific good manufacturing practices. Class II devices are subject to general controls and special controls, such as performance standards and post-market surveillance. Class III devices are subject to most of the previously identified requirements as well as to pre-market approval. Most in vitro diagnostic kits are regulated as Class I or Class II devices. Entities that fail to comply with FDA requirements can be liable for criminal or civil penalties, recalls, seizures, orders to cease manufacturing and restrictions on labeling and promotion.

 

The FDA presently requires clearance or approval of diagnostic test kits that are sold to labs, hospitals and doctors, considering them to be medical devices. However, diagnostic tests that are developed and performed by a CLIA-certified reference laboratory, known as “home-brew,” “in-house” or “laboratory-developed” tests, have been generally not regulated by FDA to date. The FDA has stated that it has the power to regulate laboratory-developed tests such as the ones that we hope to develop. Nevertheless, it has exercised enforcement discretion and not regulated most laboratory-developed tests performed by high complexity CLIA certified laboratories.

 

The FDA has stated that it intends to regulate some laboratory-developed tests as devices.  The FDA has said it will develop guidelines describing which tests would need to comply with device requirements.  The degree to which in-house tests are regulated by the FDA has also been the focus of recent Congressional attention, and Congress is considering the introduction of legislation that would subject at least some such tests  to premarket review or approval by the FDA.

 

The diagnostic and chemotherapy response tests being developed by Response Genetics include the use of gene sets involving multiple genes and algorithms to determine whether a patient falls into a high or low risk for recurrence of response to a particular chemotherapy. Response Genetics plans to continue to develop and offer these tests as “in house” tests unless it becomes clearer that these tests are subject to regulation by the FDA. We will continue to monitor both the FDA and Congress and we intend to comply with any new requirements that may apply.

 

Good Laboratory Practice (GLP)

 

We are subject to various regulatory requirements designed to ensure the quality and integrity of our non-clinical testing processes. Our standard operating procedures are written in accordance with applicable regulations and guidelines for operating in the United States. The industry standards for conducting preclinical laboratory testing are embodied in Good Laboratory Practice regulations, or GLP, regulations promulgated by the FDA. In the United States, non-clinical studies intended for FDA submission must be conducted in accordance with GLP; foreign governments may require our North American clients to comply with certain regulatory requirements of other countries (in order to gain approval within these countries), such as regulations promulgated by the Japanese Ministry of Health, Labor and Welfare and Ministry of Agriculture, Forestry and Fisheries, and in Europe, the Organization for Economic Co-operation and Development. GLP regulations specify requirements for facilities, equipment, and professional staff and standardized procedures for conducting studies, including procedures for recording and reporting data and for managing study materials and records. We have established a required quality assurance program that monitors ongoing compliance with GLP regulations by auditing test data and reporting and conducting inspections of testing procedures. 

 

 

 

 

Our business is also subject to regulation under state and federal laws regarding environmental protection and hazardous substances control, such as the Federal Occupational Safety and Health Act, the Environmental Protection Act, and Toxic Substances Control Act.  These regulations, among other things, require work practice controls, protective clothing and equipment, training and other measures designed to minimize exposure to chemicals and transmission of pathogens.  We believe that we are in compliance with these and other applicable laws and that the costs of our ongoing compliance will not have a material adverse effect on our business.  However, statutes and regulations applicable to our business may be adopted which impose substantial costs to assure compliance or otherwise materially adversely affect our operations.

 

Regulation of Reimbursement and Coverage

 

Revenues for clinical laboratory testing services come from a variety of sources and depend significantly on the availability of third-party reimbursement, including from Medicare and Medicaid programs, commercial insurers and managed care organizations. We are a Medicare laboratory services provider and intend to become a Medicaid laboratory services provider. We also receive reimbursement from third-party payors for our testing services. However, as is the case with health care services generally, the majority of payors pay for our testing services at varying levels that may be significantly lower or otherwise differ from our list prices. Obtaining reimbursement from third-party payors is both time consuming and expensive. Payment from third-payors may not be sufficient to allow us to sell our services on a profitable and competitive basis.

 

We derived approximately 21% and 23% of our net sales of ResponseDX^® testing services directly from the Medicare program in 2010 and 2011, respectively. Therefore, compliance with complex Medicare reimbursement rules is important to our operations. Once Medicare has determined that it will cover a particular test, or that a test will be provided as a benefit, payment is generally made under the Clinical Laboratory Fee Schedule with amounts assigned to specific procedure billing codes. Each Medicare carrier jurisdiction has a fee schedule that establishes the price for each specific laboratory billing code. This fee schedule is updated annually. As a Medicare-participating laboratory based in California, we bill the Medicare program's California contractors and will have to comply with this contractor's coverage and payment policies. In recent years, both government and private sector payers have made efforts to contain or reduce health care costs, including reimbursement for clinical laboratory services.

 

Manufacturing

 

We currently intend to rely on contract manufacturers or collaborative partners to produce materials necessary for our research and development efforts and to produce our diagnostic tests. We plan to continue to rely on these manufacturers and collaboration partners to manufacture these materials if any of our diagnostic tests is approved for marketing by the FDA or any foreign regulatory authority.  We do not have manufacturing experience.  We may not be able to identify or enter into satisfactory agreements with collaborative partners.

 

Information Technology

 

We have implemented an internally developed database system that is used to perform tracking, evaluation, and reporting of laboratory specimens as they are analyzed. The database system is maintained using application software consisting of a multi-tier MS SQL Server application using Thin Crystal reports for data reporting. Analysis results are imported from TaqMan® PCR instruments. The application platform consists of a 2003 server on the back end, with Windows XP Professional workstations as clients operating within the corporate Local Area Network (LAN). We also make use of commercial software applications that allow biostatistical analysis of data generated from chip array studies.

 

We employ a LAN configured as a switched Ethernet network over the TCP/IP protocol supporting the responsegenetics.com domain. This LAN hosts the basic business functions for us including office applications, electronic mail, general ledger/accounting software, internet connectivity etc.

 

Specimen storage equipment consists of lockable cabinets that are catalogued for the storage of paraffin-embedded specimens for our clients. Our database provides locator information in order to retrieve these archived specimens as needed. In addition, we maintain freezers to store frozen tissue specimens. These freezers are monitored via computerized probes on a continuous basis to ensure that temperatures are maintained at levels necessary to keep these specimens frozen. Should temperatures in any of the freezers move out of range due to mechanical failure an emergency alert is sent to us for response. These freezers are also supported by a freestanding emergency backup generator that will engage in the event of a general power outage to in order to maintain freezer temperatures at necessary levels. As we expand globally, similar storage systems will be developed at our facilities as necessary to safeguard tissue specimens.

 

 

 

Competition

 

We provide services in a segment of the healthcare industry that is highly fragmented and extremely competitive. Any failure to respond to technological advances and emerging industry standards could impair our ability to attract and retain clients. This industry is characterized by rapid technological change. The Company’s actual and potential competitors in the United States and abroad may include major clinical and pathology laboratories, such as Quest Diagnostics Inc., Laboratory Corporation of America, Clarient, Inc.(acquired by GE), and specialized laboratories such as Genoptixs Inc. (acquired by Novartis Pharmaceuticals), NeoGenomics, Inc., Caris Life Sciences, university laboratories and other research institutions. Many of our potential competitors have considerably greater financial, technical, marketing, research and other resources than we do, which may allow these competitors to discover important information and technology before we do. We anticipate increased competition with additional companies entering our maker to aggressively compete for market share. Our competitors may succeed in developing diagnostic products that circumvent our technologies or product candidates. Also, our competitors may succeed in developing technologies or products that are more effective than those that will be developed by us or that would render our technology or product candidates less competitive or obsolete.

 

In addition, we are developing our services and product candidates to impact certain methods for treating cancer. If those methods change, it is likely that the demand for our services and product candidates would significantly decline or cease altogether. The development of new or superior competing technologies or products, or a change in the methodology of treating cancer, could affect our competitive position and harm our business. Moreover, these competitors may offer broader product lines and have greater name recognition than us and may offer discounts as a competitive tactic.

 

Additionally, several development-stage companies are currently making or developing product candidates that compete with or will compete with our potential products. Competitors may succeed in developing, obtaining approval from the FDA or marketing technologies or products that are more effective or commercially attractive than our potential products or that render our technologies and current or potential products obsolete. Competitors may also develop proprietary positions that may prevent us from commercializing product candidates.

 

Employees

 

As of December 31, 2011, we had 105 employees, 100 full-time and 5 part-time employees. Our employees are not represented by any collective bargaining organizations and we consider our relations with our employees to be good.

 

Reports to Security Holders

 

We are a Delaware corporation with our principal executive offices located at 1640 Marengo Street, 6^th Floor, Los Angeles, California 90033. Our telephone number is (323) 224-3900 and our web site address is www.responsegenetics.com . We make available free of charge through the Investor Relations section of our web site our quarterly reports on Form 10-Q, our Annual Report on Form 10-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2.  Properties.

 

Our corporate headquarters are located at 1640 Marengo Street, 6^th Floor, Los Angeles, California, 90033. We sub-lease a total of 18,180 square feet of space, adjacent to the USC Health Science Campus, where research and development and administrative functions are performed. Our current lease expires on March 31, 2012. We are currently in negotiations to extend the lease of our current facility. We also sub-lease 1,460 square feet of space at 103 South Carroll Street, Suite 2b, Frederick, Maryland 21701, where administrative functions are performed. Our current lease expires on January 31, 2013.

 

 

Item 3. Legal Proceedings.

 

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

 

Item 4. Mine Safety Disclosures.

 

None.

 

Part II

 

Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Our Common Stock is traded on the NASDAQ Capital Market under the symbol "RGDX" and has been trading since our initial public offering on June 4, 2007. The following table sets forth the range of high and low sales prices of our Common Stock, based on the closing price of our Common Stock on a given day, in each quarter since our Common Stock began trading.

 

		2011
		First				Second				Third				Fourth
		Quarter				Quarter				Quarter				Quarter
Stock price - High		$	2.80			$	3.05			$	2.93			$	2.00
Stock price - Low		$	2.06			$	1.77			$	1.72			$	.81

		2010
		First				Second				Third				Fourth
		Quarter				Quarter				Quarter				Quarter
Stock price - High		$	1.81			$	2.84			$	3.07			$	2.50
Stock price - Low		$	1.15			$	1.86			$	2.27			$	2.08

 

Stockholders

 

As of March 26, 2012, there were approximately 42 stockholders of record of the 24,797,625 outstanding shares of Common Stock.

 

Dividends

 

The Company has not paid dividends to its stockholders since its inception and does not plan to pay cash dividends in the foreseeable future.

 

The Company currently intends to retain earnings, if any, to finance the growth of the Company.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The information required by this item regarding securities authorized for issuance under equity compensation plans is incorporated by reference from Item 12 of this Form 10-K.

 

Recent Sales of Unregistered Securities

 

 

On February 2, 2012, we entered into purchase agreements with various investors (collectively, the “Investors”) for the private placement of an aggregate of 5,257,267 newly-issued shares of our common stock (the “Shares”) at a purchase price of $1.50 per share (the “2012 Private Placement”). The Company raised $7,822,000, net of fees, in the 2012 Private Placement. The Investors participating in the 2012 Private Placement were various institutions and all officers and directors of the Company. The final closing of the 2012 Private Placement (the “Closing”) occurred on February 2, 2012.

 

In connection with the 2012 Private Placement, we also entered into registration rights agreements, each dated February 2, 2012, with the Investors pursuant to which we have agreed to file, within 90 days of the Closing, a registration statement with the SEC to register the Shares for resale, which registration statement is required to become effective within 180 days following the Closing. We also granted the Investors certain “piggyback” registration rights, which are triggered if we propose to file a registration statement for our own account or the account of one or more shareholders until the earlier of the sale of all of the Shares or the Shares becoming eligible for sale under Rule 144(b)(1) without restriction.

 

Purchases of Equity Securities

 

The Company made no purchases of its equity securities in the period covered by this annual report.

 

Item 6. Selected Financial Data.

 

The following selected consolidated statement of operations data for the years ended December 31, 2010 and 2011 and the balance sheet data at December 31, 2010 and 2011 have been derived from our audited consolidated financial statements, which are included elsewhere in this Annual Report on Form 10-K.  Historical results are not necessarily indicated of the results of operations for future periods.  The following data is qualified in its entirety and should be read in conjunction with the rest of the information contained in this section and our consolidated financial statements and related notes included elsewhere in this report.

 

Consolidated Statement of Operations Data:

 

		Year ended				Year ended
		December 31, 2010				December 31, 2011
Revenue		$	21,277,415			$	22,642,728
Operating expenses:
Cost of revenue		$	10,460,994			$	11,733,700
Selling and marketing		$	5,988,746			$	5,560,637
General and administrative		$	8,097,122			$	9,708,347
Research and development		$	1,611,582			$	1,321,897
Operating loss		$	(4,881,029	)		$	(5,681,853	)
Net loss		$	(4,670,379	)		$	(5,702,422	)
Net loss per common share:
Basic and diluted		$	(0.26	)		$	(0.30	)
Weighted average common shares outstanding:
Basic and diluted			17,791,584				19,124,806

 

 

 

 

Consolidated Balance Sheet data:

 

		December 31, 2010				December 31, 2011
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	4,120,074			$	1,700,295
Total assets		$	10,601,570			$	7,850,807
Common stock classified outside of stockholders’ equity (deficit)		$	7,854,682			$	7,854,682
Total stockholders’ equity (deficit)		$	(3,275,396	)		$	(6,137,844	)

 

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

 

Special Note Regarding Forward Looking Statements

 

The following discussion of our financial condition and results of operation should be read in conjunction with our audited consolidated financial statements and related notes to the consolidated financial statements included elsewhere in this annual report on Form 10-K for the year ended December 31, 2011. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward looking statements.

 

Overview

 

Response Genetics, Inc. (the Company) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin. In August 2000, we changed our name to Response Genetics, Inc.   

 

Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. We are focusing our efforts in the following areas:

 

•

Continued commercialization of our ResponseDX® tests;

 

•

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

 

•

Expanding our testing services business by pursuing new technologies through collaborations and in-licensing to expand our business.

 

 

Our technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, specimens and thereby to analyze genetic information contained in these tissues. This is significant because the majority of patients diagnosed with cancer have a tumor biopsy sample stored in paraffin, while only a small percentage of patients’ tumor specimens are frozen. Our technologies also enable us to use the FFPE patient biopsies for the development of diagnostic tests.

 

 

 

ResponseDX^®

 

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

 

At present most chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients’ tissues that may predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we have and continue to expand our development of genetic tests for measuring predictive factors for tumor response in tumor tissue samples. We have begun offering tests for non-small cell lung cancer (NSCLC) (ResponseDX: Lung^®), colorectal cancer (CRC) (ResponseDX: Colon^®), gastric and gastroesophageal (GE) cancer  (ResponseDX: Gastric™) and melanoma cancer (ResponseDX: Melanoma™) patients’ tumor tissue through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 (CLIA), and we anticipate offering additional tests for bladder and pancreatic cancer in the future. These tests are proprietary based tests which serve to help oncologists make optional therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among chemotherapy regimens to treat their cancer patients. As of December 31, 2011, our sales team had been expanded to 21 sales people located in the West Coast, Midwest, and East Coast areas of the United States.

 

 

 

Diagnostic Tests for Other Cancers

 

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

 

Pursue Additional Collaborations and In-licensing to Expand Our Business

 

We intend to pursue additional collaborations with pharmaceutical companies or in-licensing of products or technologies that will enable us to accelerate the implementation of our plans to expand the services we provide to oncologists and pathologists. We expect to implement this plan on by way of licensing of technology and know-how, investments in other companies, strategic collaborations, and other similar transactions. We expect these collaborations to provide us with early access to new technologies available for commercialization.

 

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

 

We anticipate that, over the next 12 months, a substantial portion of our capital resources and efforts will be focused on research and development to expand our series of diagnostic tests for cancer patients, sales and marketing activities related to our ResponseDX^® diagnostic tests, and for other general corporate purposes.

 

Research and development expenses represented 6.2% and 4.7% of our total operating expenses for the years ended December 31, 2010 and 2011, respectively. Major components of the $1,611,582 and $1,321,897 in research and development expenses for the years ended December 31, 2010 and 2011, respectively, included supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, insurance, business consulting and sample procurement costs.

 

 

 

 

Critical Accounting Policies and Significant Judgments and Estimates

 

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

 

Revenue Recognition

 

Pharmaceutical Revenue

 

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

 

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

 

ResponseDX Revenue

 

Net revenue for the Company’s 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 the Company on a specific date (such encounter is commonly referred to as an “accession”). The Company’s services are billed to various payors, including Medicare, private health insurance companies, healthcare institutions, and patients. The Company reports net revenue from contracted payors, including certain private health insurance companies, and healthcare institutions based on the contracted rate, or in certain instances, the Company’s estimate of the amount expected to be collected for the services provided. For billing to Medicare, the Company uses the published fee schedules, net of standard discounts (commonly referred to as “contractual allowances”). The Company reports net revenue from non-contracted payors, including certain private health insurance companies, based on the amount expected to be collected for the services provided.

 

The Company has its Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes. 

 

License Fees

 

We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from USC in exchange for royalty fees on revenue generated by use of this technology. These royalties are calculated as a fixed percentage of revenue that we generate from use of the technology licensed from USC. Total license fees expensed in cost of revenue under the royalty agreement to USC were $439,540 and $516,746 for the years ended December 31, 2010 and 2011, respectively. We also maintain a non-exclusive license to use Roche’s polymerase chain reaction (PCR), homogenous PCR, and reverse transcription PCR processes. We pay Roche a fixed percentage royalty fee for revenue that we generate through use of this technology. Royalties expensed in cost of revenue under this agreement totaled $426,366 and $552,113 for the years ended December 31, 2010 and 2011, respectively.

 

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

 

 

 

 

Accounts Receivable and Allowance for Doubtful Accounts

 

We invoice our pharmaceutical clients as specimens are processed and any other contractual obligations are met. Our contracts with pharmaceutical clients typically require payment within 45 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, our clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal and there is no allowance for doubtful accounts for our pharmaceutical revenue at December 31, 2010 and 2011.

 

We bill Medicare and Private Payors for ResponseDX^® upon completion of the required testing services. As such, we take assignment of benefits and the risk of collection with Medicare and Private Payors. We continue to monitor the collection history for Medicare and Private Payors.  Based on the historical experience for our Medicare and Private Payor accounts, we have determined that related accounts receivable associated with billings over one year old are unlikely to be collected.  Therefore, we have recorded an allowance for doubtful accounts of $113,838 and $838,750 as of December 31, 2010 and 2011. 

 

An allowance for doubtful accounts is recorded for estimated uncollectible amounts due from the Company’s 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 for the Company’s 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. 

 

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

 

Income Taxes

 

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

 

Results of Operations

 

Years Ended December 31, 2011 and December 31, 2010

 

Revenue.  Revenues were $22,642,728 for the year ended December 31, 2011, as compared to $21,277,415 for the year ended December 31, 2010, an increase of $1,365,313, or 6.4%. The increase was due to increases in ResponseDX^® revenue of $1,229,290 and pharmaceutical revenues of $136,091. ResponseDX^® revenue accounted for 55.4% of total revenue in the year ended December 31, 2011 compared to 53.1% for the year ended December 31, 2010.  ResponseDX^® revenues for the year ended December 31, 2011, increased 10.9% as compared to the year ended December 31, 2010.  This increase was primarily due to increased revenues following increased investments in our sales force and adding additional genes to our tests. We expect that our overall revenues will continue to increase, primarily due to expected increases in ResponseDX^® revenues as we add additional sales managers in 2012. For the year ended December 31, 2011, our two most significant pharmaceutical customers accounted for approximately 37.9% of our revenue, as compared to approximately 43.7% of our revenue for the year ended December 31, 2010.

 

Cost of Revenue.  Cost of revenues for the year ended December 31, 2011 was $11,733,700 as compared to $10,460,994 for the year ended December 31, 2010, an increase of $1,272,706 or 12.2%.   To support the increase in revenue and the anticipated growth the Company hopes to achieve, the Company hired additional lab personnel and temporary help, incurred additional costs for lab supplies, reagents and shipping costs. Specifically, the increase in cost of revenue resulted primarily from increases in personnel and temporary help costs of $840,411, lab supplies and reagent costs of $781,781, consulting costs of $514,649 and royalties of $228,347, offset by a decrease in costs from third party (Hitachi Chemical and Shanghai Bio) processing costs of $530,349 and legal expenses of $194,318. Cost of revenues as a percentage of revenues was 51.8% for the year ended December 31, 2011, as compared to 49.2% for the year ended December 31, 2010, an increase of 2.6%.

 

  

Research and Development Expenses.  Research and development expenses were $1,321,897 for the year ended December 31, 2011, as compared to $1,611,582 for the same period in 2010, a decrease of $289,685 or 18%. This decrease resulted primarily from decreases in laboratory supplies, reagents and microarray costs of $57,541, personnel related costs of $136,846, postage and shipping costs of $26,799 and legal services of $60,358. We expect research and development expenses to increase as we work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

 

General and Administrative Expenses.  General and administrative expenses totaled $9,708,347 for the year ended December 31, 2011, as compared to $8,097,122 for the year ended December 31, 2010, an increase of $1,611,225 or 19.9%. This increase resulted primarily from increases in personnel costs of $519,972, business tax of $166,548, business consulting costs of $187,729, billing service costs of $170,699, equipment maintenance of $121,128 and bad debt expense of $1,179,069, (see ResponseDX^® Revenue Accounts Receivable for an explanation of bad debt expense), offset by a decrease in asset impairments of $214,631, insurance expense of $64,293 and legal services of $195,625.

 

Sales and Marketing Expenses.   For the year ended December 31, 2011, our sales and marketing expenses totaled $5,560,637 compared to $5,988,746 for the year ended December 31, 2010, a decrease of $428,109 or 7.1%.  The decrease primarily resulted from decreased sales and marketing activities for ResponseDX^®, which included decreases in advertising of $490,462, speaker fees of $151,292, and travel and meeting costs of $91,005, offset by increases in personnel costs of $460,923.  We expect that sales and marketing costs will increase as we expand our sales and marketing activities in order to gain clinical acceptance of our ResponseDX^® assays.

 

Other Income.  In 2010, we applied for and received a one-time federal grant relating to qualified research and development activities.  The gross amount of the proceeds received was $244,479.  This amount, net of $22,677 of related direct costs, is shown as other income on the accompanying 2010 consolidated statement of operations. There was no comparable other income for the year ended December 31, 2011.

 

Interest Income and Expense.  Interest income was $149 for the year ended December 31, 2011, compared with $682 for the same period in 2010. Interest expense was $20,718 for the year ended December 31, 2011, compare with $10,578 for the same period in 2010.

 

Income Taxes. As of December 31, 2010 and 2011, since we have incurred substantial losses and have generated no taxable income a full valuation allowance has been recorded for the net deferred tax assets since we do not believe the recoverability of the net deferred income tax assets in the near future is more likely than not.

 

Liquidity and Capital Resources

 

We incurred net losses of $4,670,379 and $5,702,422 during the years ended December 31, 2010 and 2011, respectively. Since our inception in September 1999, we have incurred cumulative losses and as of December 31, 2011, we had an accumulated deficit of $49,519,585. We have not yet achieved profitability and anticipate that we will likely incur additional losses for the next year. We cannot provide assurance as to when we will achieve profitability. We expect that our cash and cash equivalents will be used to fund our selling and marketing activities primarily related to our ResponseDX^® tests, research and development, and general corporate purposes. As a result, we will need to generate significant revenues to achieve profitability.  Management plans to effectively manage cash flows in 2012 and expects that cash and cash equivalents will be sufficient to meet the Company’s working capital requirements through the next 12 months. Nevertheless, until we can generate and maintain sufficient revenues to finance our cash requirements, which we may never do, we expect to finance additional cash needs primarily through public or private equity offerings, strategic collaborations, and other financing opportunities as they may arise.  Please see note 16, Subsequent Events, regarding the Company has raised $7,822,000 on February 2, 2012. We do not know whether additional funding will be available on acceptable terms, if at all.  If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate selling and marketing activities or research and development programs.

 

 

 

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

 

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

 

 

 

Sales of Common Stock

 

Under the Company’s Articles of Incorporation, the Company has one class of common stock and its holders have no preemptive, subscription, redemption or conversion rights.  As described below and in Notes 12 and 15 in the Notes to Consolidated Financial Statement, the Company sold shares of its common stock during 2011 and during the first quarter of 2012.  In connection with certain of these offerings, the Company entered into registration rights agreements with the purchasers of the common shares.

 

May 2011 Registered Offering of Common Stock 

 

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

 

February 2012 Private Placement

 

On February 2, 2012, we entered into purchase agreements with various investors (collectively, the “Investors”) for the private placement of an aggregate of 5,257,267 newly-issued shares of our common stock (the “Shares”) at a purchase price of $1.50 per share (the “2012 Private Placement”). The Company raised $7,822,000, net of fees, in the 2012 Private Placement. The Investors participating in the Private Placement were various institutions and all officers and directors of the Company. The final closing of 2012 the Private Placement (the “Closing”) occurred on February 2, 2012.

 

In connection with the 2012 Private Placement, we also entered into registration rights agreements, each dated February 2, 2012, with the Investors pursuant to which we have agreed to file, within 90 days of the Closing, a registration statement with the SEC to register the Shares for resale, which registration statement is required to become effective within 180 days following the Closing. We also granted the Investors certain “piggyback” registration rights, which are triggered if we propose to file a registration statement for our own account or the account of one or more shareholders until the earlier of the sale of all of the Shares or the Shares becoming eligible for sale under Rule 144(b)(1) without restriction.

 

Common stock classified outside of stockholders’ equity (deficit)

 

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

 

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

 

Under the Lansdowne Registration Rights Agreement, the Company was required to have the registration statement declared effective within 120 days after the private placement closed.  In addition, the Company is obligated to use commercially reasonable efforts (i) to cause the registration statement described above to remain continuously effective and (ii) to maintain the listing of the Company’s common stock on Nasdaq or other exchanges, as defined, for a period that that will terminate on the earlier of July 22, 2012 or the date on which Lansdowne has sold all of its shares of common stock.  The Company is also required to file with the SEC in a timely manner all reports and other documents required of the Company under the 1934 Act. In the event the Company fails to satisfy its obligations under the Lansdowne Registration Rights Agreement, the Company would be in breach of said agreement, in which event Lansdowne would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief.  The Lansdowne Registration Rights Agreement does not provide an explicitly stated or defined penalty due upon a breach.  Because (i) the potential penalty for any breach of the Lansdowne Registration Rights Agreement is not explicitly stated or defined, which prohibits the Company from applying the guidance of ASC 825-20-15, Registration Payment Arrangements and (ii) complying will all filing requirements under the 1934 Act as described above is not solely within the Company’s control, the Company is required to present Lansdowne’s investment of $3,975,279 in the Company’s common stock as common stock outside of stockholders’ equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.

 

On March 5, 2010, we entered into a Purchase Agreement with certain affiliates of and funds managed by Lansdowne Partners Limited Partnership, Greenway Capital Partners and Paragon Associates for the private placement of 3,005,349 newly-issued shares of our common stock at a per share price of $1.31.  The closing of the sale of the shares occurred on Friday, March 5, 2010.  In connection with the acquisition of the shares, the purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of our capital stock, subject to various exceptions and limitations.  Lansdowne participated in the Private Placement by electing to exercise the preemptive rights granted to it pursuant to the Purchase Agreement by and between the Company and Lansdowne, dated July 22, 2009. Net proceeds received from this financing were approximately $3,879,403.

 

In connection with the Private Placement, we also entered into a Registration Rights Agreement, dated March 5, 2010, with the purchasers (the “Registration Rights Agreement”) pursuant to which it has agreed to file, within 45 days of the closing of the Private Placement, a registration statement with the SEC to register the shares for resale, which registration statement is required to become effective within 120 days following the closing.  We also granted certain "piggyback" registration rights to the purchasers which are triggered if we propose to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the shares or the shares become eligible for sale under Rule 144(b)(1) without restriction.

 

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

 

 

Comparison of years ended December 31, 2011 and 2010

 

As of December 31, 2011, we had $1,700,295 in cash and cash equivalents, working capital of $845,664 and an accumulated deficit of $49,519,585.

 

Cash flows provided by operating activities

 

During the year ended December 31, 2011, the Company used cash flows in operating activities of $5,084,304 compared to $6,491,671 used in the year ended December 31, 2010.  The reasons for the decrease in cash used in operating activities of $1,407,367 was due mainly to the increases in accounts payable, and accrued payroll and related liabilities, offset by the decreases in accounts receivable and prepaid expenses and other current assets, and the decrease in deferred revenue.

 

The decrease in accounts receivable related mainly to the increased efforts of collections and an increase in allowance for doubtful accounts.  The increase in accounts payable relates to the increase in recruiting costs associated with trying to increase critical headcount.  The decrease in deferred revenue related to the revenue recognition of deferred revenue totaling $1,618,766.

 

Cash flows used in investing activities

 

Net cash used in investing activities was $391,518 and $390,780 for the years ended December 31, 2010 and 2011, respectively. This was attributable to the need for property and equipment for our laboratory and new personnel.

 

Cash flows used in financing activities

 

Cash flows from financing activities for the years ended December 31, 2010 and 2011 provided net cash of $3,953,483 and $3,128,522, respectively, primarily relating to the sale of common stock and a draw on our business line of credit of $1,000,000.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

 

 

 

Recent Accounting Pronouncements

  

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

 

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

 

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

 

In July 2011, the FASB issued ASU 2011-7, Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities (ASU2011-7). In accordance with ASU 2011-7, the Company will be required to present its provision for doubtful accounts related to patient service revenue as a deduction from revenue, similar to contractual discounts. Accordingly, the Company’s revenues will be required to be reported net of both contractual discounts as well as its provision for doubtful accounts related to patient service revenues. Additionally, ASU 2011-7 will require the Company to make certain additional disclosures designed to help users understand how contractual discounts and bad debts affect recorded revenue in both interim and annual financial statements. ASU 2011-7 is required to be applied retrospectively and is effective for public companies for fiscal years beginning after December 15, 2011, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a material effect on our results of operation or financial position.

 

 

 

Item 8.  Financial Statements and Supplementary Data.

 

Our consolidated financial statements and related notes are included in this annual report beginning on page 37.

 

Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.  Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Under the supervision, and with the participation of our management, including the Principal Executive Officer and Principal Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 as of the end of the period covered by this report. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that these disclosure controls and procedures were effective such that the material information required to be filed in this report is recorded, processed, summarized and reported within the required time periods specified in the SEC rules and forms. This conclusion was based on the fact that the business operations to date have been limited and our Principal Executive Officer and Principal Financial Officer have had complete access to all records and financial information and have availed themselves of such access to ensure full disclosure.

 

It should be noted that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. As a result, there can be no assurance that a control system will succeed in preventing all possible instances of error and fraud. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and the conclusions of our Principal Executive Officer and the Principal Financial Officer are made at the “reasonable assurance” level. 

 

Management’s Annual Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements.

 

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.

 

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on its assessment, management believes that, as of December 31, 2011, our internal control over financial reporting was effective based on those criteria.

 

This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to an exemption for smaller companies under Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

  

 

 

Changes in Internal Control over Financial Reporting

 

For the year ended December 31, 2011, the Company created internal controls over cash posting as it relates to our additional responsibilities as a result of transitioning from our previous outside medical biller to our in-house solution, Xifin. Previously the Company did not post cash at an accession level detail. The Company designed the posting controls to comply with current HIPPA standards of patient confidentiality and sufficient internal controls to prevent misappropriation of funds. In addition to cash controls the Company also implemented controls over the billing process utilizing the Xifin billing system.

 

Item 9B.  Other Information.

 

None.

 

Part III

 

Certain information required by Part III is omitted from this Annual Report on Form 10-K since we intend to file our definitive proxy statement for our 2012 annual meeting of stockholders, pursuant to Regulation 14A of the Securities Exchange Act, not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and certain information to be included in the proxy statement (the Proxy Statement) is incorporated herein by reference.

 

Item 10.  Directors, Executive Officers, Promoters, Control Persons and Corporate Governance.

 

The information required by this item concerning the Company’s executive officers and directors, the code of ethics and corporate governance matters is incorporated herein by reference to the section entitled ”Management”, “Proposal One-Election of Directors,” “Board of Directors - Principles of Corporate Governance,” and “Director Independence, Board Meetings and Committee” in our Proxy Statement.

 

The information required by this item regarding delinquent filers pursuant to Item 405 of Regulation S-K is incorporated herein by reference to the section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement.

 

Code of Ethics

 

Our Code of Ethics, which applies to all of our employees and directors, including our principal executive officer and our principal financial officer is available on the investor relations page of our website at www.responsegenetics.com. The Board has not adopted a code of ethics that pertains specifically to the Board of Directors.

 

Item 11.  Executive Compensation.

 

The information required by this item concerning executive compensation is incorporated herein by reference to the sections entitled “Compensation of Directors” and “Executive Compensation” in our Proxy Statement.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The information required by this item pursuant to Item 403 of Regulation S-K is incorporated by reference to the sections entitled “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement. The information required by Item 201(d) of Regulation S-K is set forth below.

 

Equity Compensation Plan Information

 

The table below sets forth certain information as of December 31, 2011 about the Company’s Common Stock that may be issued upon the exercise of options and rights under all of our existing equity compensation plans (shares in thousands):

 

 

Securities Authorized For Issuance Under Equity Compensation Plans

 

Plan Category		Number of securities to be issued upon exercise of outstanding options,  warrants and rights (a)				Weighted-average exercise price of outstanding options, warrants and rights (b)				Number of securities  remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders			1,998,363			$	3.73				1,089,154
Equity compensation plans not approved by security holders			1,170,000				0.87 – 1.20				—
Total			3,168,363			$	0.87 – 3.73				1,089,154

 

 

Item 13.  Certain Relationships and Related Transactions, and Director Independence.

 

The information required by this item concerning related party transactions pursuant to Item 404 of Regulation S-K is incorporated herein by reference to the section entitled “Related Transactions” in our Proxy Statement.

 

The information required by this item concerning director independent pursuant to Item 407(a) of Regulation S-K is incorporated herein by reference to the section entitled “Director Independence, Board Meetings and Committees” in our Proxy Statement.

 

Item 14.  Principal Accountant Fees and Services.

 

Information required by this item will be set forth in our Proxy Statement.  Such information is incorporated herein by reference.

 

 

 

 

FINANCIAL STATEMENTS

 

INDEX

 

	Page
Report of Independent Registered Public Accounting Firm	36
Consolidated Balance Sheets as of December 31, 2010 and 2011	37
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2010 and 2011	38
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010 and 2011	39
Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2010 and 2011	40
Notes to Consolidated Financial Statements	41 - 63

 

 

 

 

Report of Independent Registered Public Accounting Firm

To the Board of Directors

Response Genetics, Inc.

Los Angeles, California

 

We have audited the accompanying consolidated balance sheets of Response Genetics, Inc. and subsidiary as of December 31, 2011 and 2010 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit), and cash flows for each of the two years in the period  ended December 31, 2011. These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Response Genetics, Inc. and subsidiary at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ BDO USA, LLP

 

BDO USA, LLP

Los Angeles, California

April 2, 2012

 

 

RESPONSE GENETICS, INC.

 

CONSOLIDATED BALANCE SHEETS

		As of December 31,
		2010				2011
ASSETS
Current assets:
Cash and cash equivalents		$	4,120,074			$	1,700,295
Accounts receivable, net of allowance for doubtful accounts of $113,868 and $838,750 at     December 31, 2010 and 2011, respectively			4,733,698				4,047,059
Prepaid expenses and other current assets			941,981				991,351
Total current assets			9,795,753				6,738,705
Property and equipment, net			805,817				1,067,679
Intangible assets			—				44,423
Total assets		$	10,601,570			$	7,850,807
LIABILITIES, COMMON STOCK CLASSIFIED OUTSIDE OF STOCKHOLDERS’ EQUITY (DEFICIT) AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable		$	1,247,151			$	1,492,526
Accrued expenses			1,075,636				1,149,741
Accrued royalties			809,694				738,832
Accrued payroll and related liabilities			1,271,037				1,362,689
Capital lease obligation current portion			—				149,253
Deferred revenue			1,518,696				—
Line of credit			—				1,000,000
Total current liabilities			5,922,214				5,893,041
Deferred revenue, net of current portion			100,070				—
Capital lease obligation, net of current portion			—				240,928
Total liabilities			6,022,284				6,133,969
Commitments and contingencies (Note 5)
Common stock classified outside of stockholders’ equity (deficit)  (Note 13)			7,854,682				7,854,682
Stockholders’ equity (deficit):
Common stock, $0.01 par value; 50,000,000 shares authorized; 18,357,406 and 19,540,358     shares issued and outstanding at December 31, 2010 and 2011, respectively			122,942				134,327
Additional paid-in capital			40,612,785				43,514,591
Accumulated deficit			(43,817,163	)			(49,519,585	)
Accumulated other comprehensive loss			(193,960	)			(267,177	)
Total stockholders’ equity (deficit)			(3,275,396	)			(6,137,844	)
Total liabilities, common stock classified outside of stockholders’ equity (deficit) and stockholders’ equity (deficit)		$	10,601,570			$	7,850,807

 

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

  

 

 

RESPONSE GENETICS, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

		Year Ended December 31,
		2010				2011
Net revenue		$	21,277,415			$	22,642,728
Operating expenses:
Cost of revenue			10,460,994				11,733,700
Selling and marketing			5,988,746				5,560,637
General and administrative			8,097,122				9,708,347
Research and development			1,611,582				1,321,897
Total operating expenses			26,158,444				28,324,581
Operating loss			(4,881,029	)			(5,681,853	)
Other income (expense):
Interest expense			(10,578	)			(20,718	)
Interest income			682				149
Other			221,802				—
Loss before income tax provision			(4,669,123	)			(5,702,422	)
Income tax provision			1,256				—
Net loss			(4,670,379	)			(5,702,422	)
Unrealized loss on foreign currency translation			(8,585	)			(73,217	)
Comprehensive loss		$	(4,678,964	)		$	(5,775,639	)
Net loss per share — basic and diluted		$	(0.26	)		$	(0.30	)
Weighted-average common shares — basic and diluted			17,791,584				19,124,806

  

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

 

 

 

RESPONSE GENETICS, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Year Ended December 31,
		2010				2011
Cash flows from operating activities:
Net loss		$	(4,670,379	)		$	(5,702,422	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			465,689				366,695
Bad debt expense			224,978				1,299,633
Share-based compensation			680,268				723,616
Loss (gain) on sale of property and equipment			1,854				11,793
Impairment of property and equipment			371,872				157,241
Changes in operating assets and liabilities:
Accounts receivable			(2,975,725	)			(612,994	)
Prepaid expenses and other assets			(444,037	)			(49,370	)
Accounts payable			518,051				245,375
Accrued expenses			572,024				74,105
Accrued royalties			353,699				(70,862	)
Accrued payroll and related liabilities			802,263				91,652
Deferred revenue			(2,392,228	)			(1,618,766	)
Net cash used in operating activities			(6,491,671	)			(5,084,304	)
Cash flows from investing activities:
Purchase of property and equipment and intangible assets			(391,518	)			(390,780	)
Net cash used in investing activities			(391,518	)			(390,780	)
Cash flows from financing activities:
Proceeds from issuance of common stock			3,879,403				2,179,535
Exercise of stock options			74,080				10,040
Proceeds from line of credit			—				1,000,000
Capital lease payments			—				(61,053	)
Net cash provided by financing activities			3,953,483				3,128,522
Effect of foreign exchange rates on cash and cash equivalents			(8,585	)			(73,217	)
Net decrease in cash and cash equivalents			(2,938,291	)			(2,419,779	)
Cash and cash equivalents:
Beginning of the year			7,058,365				4,120,074
End of the year		$	4,120,074			$	1,700,295
Cash paid during the period for:
Income taxes		$	1,256			$	1,256
Interest		$	10,578			$	20,718
Supplemental disclosure of non-cash financing activities
Property and equipment acquired by capital lease		$	—			$	451,234

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

 

 

 

 

RESPONSE GENETICS, INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)

 

		Common Stock
		Number of Shares				Amount				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Total Stockholders' Equity (Deficit)
Balances at December 31, 2009			15,297,183			$	122,393			$	39,858,986			$	(39,146,784	)		$	(185,375	)		$	649,220
Issuance of common stock			3,005,349				—				—				—				—				—
Exercise of stock options			54,874				549				73,531				—				—				74,080
Share-based compensation expense			—				—				680,268				—				—				680,268
Unrealized gain (loss) on foreign currency translation			—				—				—				—				(8,585	)			(8,585	)
Net loss			—				—				—				(4,670,379	)			—				(4,670,379	)
Balances at December 31, 2010			18,357,406				122,942				40,612,785				(43,817,163	)			(193,960	)			(3,275,396	)
Issuance of common stock			1,175,512				11,798				2,167,737				—				—				2,179,535
Exercise of stock options			7,440				(413	)			10,453				—				—				10,040
Share-based compensation expense			—				—				723,617				—				—				723,616
Unrealized gain (loss) on foreign currency translation			—				—				—				—				(73,217	)			(73,217	)
Net loss			—				—				—				(5,702,422	)			—				(5,702,422	)
Balances at December 31, 2011			19,540,358			$	134,327			$	43,514,591			$	(49,519,585	)		$	(267,177	)		$	(6,137,844	)

 

 

 

 

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

 

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization, Operations and Basis of Accounting

 

Response Genetics, Inc. (the “Company”) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin wax. In August 2000, the Company changed its name to Response Genetics, Inc. 

 

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

 

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

 

Since its inception, the Company has devoted substantial effort in developing its product and has incurred losses and negative cash flows from operations, and at December 31, 2011 has an accumulated deficit of $49,519,585. The Company is forecasting continued losses and negative cash flows as it funds its selling and marketing activities and research and development programs.

 

Based on the Company’s current operating plan which includes various assumptions concerning the level and timing of cash receipts from product sales and cash outlays for operating expenses and capital expenditures, management believes that existing cash and cash equivalents will be sufficient to meet the Company’s working capital requirements through the next twelve months.  The Company’s ability to successfully carry out its business plan is primarily dependent upon its ability to (1) obtain sufficient additional capital at acceptable costs, (2) attract and retain knowledgeable workers, and (3) generate significant revenues. The Company plans to seek additional financing and/or strategic investments; however, there can be no assurance that any additional financing or strategic investments will be available on acceptable terms, if at all. Please see note 16, Subsequent Events, regarding the Company’s sale of common stock for approximately, $7.8 million on February 2, 2012.

 

However, if events or circumstances occur such that the Company does not meet its operating plan as expected, in addition to seeking the additional capital in excess of the amount raised on February 2, 2012 as described above, the Company will most likely be required to reduce certain discretionary spending, which could have a material adverse effect on the Company’s ability to achieve its intended business objectives.  No adjustments have been made to the accompanying financial statements to reflect any of the matters discussed above.  The consolidated financial statements have been prepared on the basis that the Company will continue as a going concern.

  

2. Summary of Significant Accounting Policies

 

Basis of Consolidation

 

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

 

Cash and Cash Equivalents

 

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

 

Accounts Receivable

 

Pharmaceutical Accounts Receivable

 

The Company invoices its clients as specimens are processed and any other contractual obligations are met. The Company’s contracts with clients typically require payment within 45 days of the date of invoice. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its clients to make required payments. The Company specifically analyzes accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, the Company’s clients have primarily been large pharmaceutical companies. As a result, bad debts from clinical accounts receivable to date have been minimal. Pharmaceutical company accounts receivable as of December 31, 2010 and 2011 were $1,694,130 and $1,701,837, respectively.  There were no allowances for doubtful accounts recorded against these pharmaceutical accounts receivable at December 31, 2010 and 2011.

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

 

Accounts Receivable – (continued)

 

ResponseDX^® Accounts Receivable

 

ResponseDX^® accounts receivable are recorded from two primary payors: Medicare and third party and private payors (Private Payors).  ResponseDX^® accounts receivable are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors.  Management performs ongoing valuations of accounts receivable balances based on management’s evaluation of historical collection experience and industry trends.  Based on the historical experience for the Company’s Medicare and Private Payor accounts, management has determined that related accounts receivable associated with billings over one year are unlikely to be collected.  Any outstanding receivable balance that is over one year old is written off. During the fourth quarter of 2011, the Company reevaluated its model of estimating the allowance for doubtful accounts. Correspondingly, the Company’s bad debt expense for the fourth quarter and the year ended December 31, 2011 was $838,750 and $1,299,633, respectively.

 

ResponseDX^® accounts receivable as of December 31, 2010 and 2011, consisted of the following:

 

		December 31, 2010				December 31, 2011
Net Medicare receivable		$	1,092,386			$	506,308
Net Private Payor receivable			2,061,020				2,634,838
Other			—				42,827
			3,153,406				3,185,060
Allowance for doubtful accounts			(113,838	)			(838,750	)
Total		$	3,039,568			$	2,346,310

 

Property and Equipment and Intangible Assets

 

Property and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line and double declining balance methods over the estimated useful lives of the assets. The Company has determined the estimated useful lives of its property and equipment, as follows:

 

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

 

Maintenance and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the related accounts and the resulting gain or loss is reflected in the statements of operations. The Company has capitalized costs related to the development of database software development (see Note 3). As of December 31, 2011, the Company has placed a portion of this database into service and accordingly has started to amortize this software development cost in accordance with ASC 350-40, Internal-Use Software. The amortization period is three years using the straight-line method. During the years ended December 31, 2010 and 2011, the Company recorded an impairment loss of $371,872 and $157,241, respectively, relating to the abandonment of a portion of these software development costs because management had determined that it was no longer probable that the specific portion of the database in development will be completed and placed into service.

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2. Summary of Significant Accounting Policies - (continued)

 

Revenue Recognition

 

Pharmaceutical Revenue

 

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

 

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

 

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

 

ResponseDX^® Revenue

 

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

 

Revenues are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through our laboratory under a specified contractual protocol.

 

Starting July 1, 2011, the Company transitioned from its former billing provider to a new billing software, Xifin. This new software allows the Company to process the billing and cash receipts as opposed to outsourcing, as was the previous practice. The Company recognizes all product revenue from its ResponseDX^® tests on an accrual basis. ResponseDX^® Private Payor and Medicare revenue are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. The Company’s Medicare provider number allows it to invoice and collect from Medicare. The Company’s invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT).

 

The Company received its Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes. 

 

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

 

Revenue Recognition - (continued)

The following details ResponseDX^® revenue for the years ended December 31, 2010 and 2011:

		Year Ended December 31,
		2010				2011
Net Medicare revenue		$	4,483,316			$	5,274,749
Private Payor Revenue			6,612,741				7,335,455
NeoGenomics Laboratories revenue			185,064				—
Other			26,054				(73,739	)
Net ResponseDX® revenue		$	11,307,175			$	12,536,465

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Summary of Significant Accounting Policies - (continued)

 

Revenue Recognition - (continued)

 

Cost-Containment Measures

 

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

 

Regulatory Matters

 

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

 

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

 

Cost of Revenue

 

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

 

License Fees

 

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

 

Research and Development

 

The Company expenses costs associated with research and development activities as incurred. Research and development costs are allocated on a pro rata basis using an estimate of employee time as a percentage of total hours worked for which specific employees are conducting research and development. Research and development costs include employee costs (salaries, payroll taxes, benefits, and travel), equipment depreciation and warranties and maintenance, laboratory supplies, primers and probes, reagents, patent costs and occupancy costs.

 

 

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2. Summary of Significant Accounting Policies - (continued)

 

Line of Credit

 

On July 14, 2011, the Company entered into a line of credit agreement with Silicon Valley Bank (the Bank). The line of credit is collateralized by the Company’s pharmaceutical receivables. The maximum amount that can be borrowed from the credit line is $3,000,000. The amount the Company can draw from the loan is equal to the calculated borrowing base, which is 80% of the Company’s pharmaceutical accounts receivable that have not aged greater than 90 days. As of December 31, 2011, the amount available for the borrowing base is $1,100,000, as part of the line of credit the Bank shall issue letters of credit up to a maximum amount of $500,000. Any issued letters of credit reduce the amount available to borrow under the line of credit on a dollar for dollar basis. The interest fees associated with this line are set at the prime rate plus 1%. For the period ended December 31, 2011, the rate being charged to the Company was 5%. As needed from time to time, the Company may draw on this line for use for general corporate purposes and repay the funds when available. As of December 31, 2011, the Company has drawn $1,000,000 against the line of credit and no letters of credit were outstanding. The line of credit is subject to various financial covenants and, as of December 31, 2011, the Company was not in compliance with certain covenants. Effective March 23, 2012, the line of credit agreement was amended for various matters including the waiver of all covenant violations through the effective date of the amendment. Management has concluded that there exists a probability during 2012 that the Company may violate the debt covenants under the line of credit and accordingly has classified the amount due as of December 31, 2011 as a current liability on the accompanying consolidated balance sheet. Should the Company violate the covenants under the line of credit agreement, management will pursue a cure of the violation and or a waiver of the violation from the Bank. There is no guarantee that any violation could be cured or the Bank would agree to a waiver.

 

Income Taxes

 

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

 

ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. As of December 31, 2010 and 2011, the Company does not have a liability for unrecognized tax benefits. The Company recognizes interest and penalties associated with tax matters as part of the income tax provision and includes accrued interest and penalties with the related tax liability in the balance sheet. For the period ending December 31, 2011 there were no interest or penalties recorded on the Consolidated Statement of Operations.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation in accordance with ASC 718, Stock Compensation, Share-Based Payment. Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value estimated in accordance with the provisions of ASC 718.  The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting period.

 

The Company accounts for equity instruments issued to non-employees in accordance with ASC 505, Equity. Under ASC 505, stock option awards issued to non-employees are measured at fair value using the Black-Scholes option-pricing model and recognized pursuant to a performance model.

 

Management Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates in these consolidated financial statements have been made for revenue, accounts receivable, allowances for contractual and doubtful accounts, impairment of long-lived assets, depreciation for property and equipment and stock-based compensation. Actual results could differ materially from those estimates.

 

Long-lived Assets

 

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the asset with the estimated undiscounted future cash flows associated with the use of the asset and its eventual disposition. Should the review indicate that the assets cost is not recoverable, the carrying value of the asset would be reduced to its estimated fair value, which is measured by future discounted cash flows.  During the years ended December 31, 2010 and 2011, the Company recorded impairment losses of $371,872 and $157,241, respectively, relating to the abandonment of certain internally developed software (see Note 3).

 

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2. Summary of Significant Accounting Policies - (continued)

 

Foreign Currency Translation

 

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

 

Comprehensive Loss

 

The components of comprehensive loss are accumulated net loss and foreign currency translation adjustments for the years ended December 31, 2010 and 2011.

 

Fair Value of Financial Instruments

 

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

 

Sales and marketing costs

 

The Company markets its services through its advertising activities in trade publications and on line. Advertising costs are included in selling and marketing expenses on the statements of operations and are expensed as incurred.  Advertising costs for the years ended December 31, 2010 and 2011 were $657,697 and $97,971, respectively.

 

Reclassifications

 

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

 

 

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2. Summary of Significant Accounting Policies - (continued)

 

Concentration of Credit Risk Clients and Limited Suppliers

  

Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. The Company has never experienced any losses related to these balances. All of the Company’s non-interest bearing cash balances were fully insured at December 31, 2011 due to a temporary federal program in effect from December 31, 2011 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning in 2013, federal insurance coverage is scheduled to revert to $250,000 per depositor at each financial institution, and the Company’s non-interest bearing cash balances may again exceed federally insured limits. There were no funds in interest-bearing accounts that exceeded the federally insured limits as of December 31, 2011.  At December 31, 2011, $20,278 of cash was held outside of the United States and is uninsured.

 

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

 

		Year Ended December 31,
		2010								2011
		Revenue				Percent of Total Revenue				Revenue				Percent of Total Revenue
GlaxoSmithKline and GlaxoSmithKline Biologicals		$	7,442,469				35	%		$	8,572,744				37.8	%
Medicare		$	4,483,316				21	%		$	5,274,749				23.3	%

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

 

		As of December 31,
		2010								2011
		Receivable Balance				Percent of Total Receivables				Receivable Balance				Percent of Total Receivables
GlaxoSmithKline and GlaxoSmithKline Biologicals		$	1,305,829				28	%		$	1,556,096				31.8	%
Medicare		$	1,092,386				23	%		$	506,308				10.3	%

 

Many of the supplies and reagents used in the Company’s testing process are procured from a limited number of suppliers. Any supply interruption or an increase in demand beyond the suppliers’ capabilities could have an adverse impact on the Company’s business. Management believes it can identify alternative sources, if necessary, but it is possible such sources may not be identified in sufficient time to avoid an adverse impact on its business. Refer also to Note 6 for further discussion regarding these supply agreements. The Company purchases certain laboratory supplies and reagents primarily from two suppliers. Purchases from these two suppliers accounted for approximately 61% and 75% of the Company’s reagent purchases for the years ended December 31, 2010 and 2011, respectively.

 

 

RESPONSE GENETICS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2. Summary of Significant Accounting Policies - (continued)

 

Recent Accounting Pronouncements

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

 

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

 

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

 

In July 2011, the FASB issued ASU 2011-7, Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities (ASU2011-7). In accordance with ASU 2011-7, the Company will be required to present its provision for doubtful accounts related to patient service revenue as a deduction from revenue, similar to contractual discounts. Accordingly, the Company’s revenues will be required to be reported net of both contractual discounts as well as its provision for doubtful accounts related to patient service revenues. Additionally, ASU 2011-7 will require the Company to make certain additional disclosures designed to help users understand how contractual discounts and bad debts affect recorded revenue in both interim and annual financial statements. ASU 2011-7 is required to be applied retrospectively and is effective for public companies for fiscal years beginning after December 15, 2011, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a material effect on our results of operation or financial position.

 

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3. Property and Equipment and Intangible Assets

 

Property and equipment consists of the following:

 

		December 31, 2010				December 31, 2011
Laboratory equipment		$	2,389,339			$	3,036,274
Furniture and equipment			735,731				716,363
Leasehold improvements			194,899				194,899
			3,319,969				3,947,536
Less: Accumulated depreciation			(2,621,214	)			(2,879,858	)
Total property and equipment, net		$	698,755			$	1,067,679
Internally developed software		$	107,062			$	48,461
Less: Accumulated depreciation and amortization			—				(4,038	)
Total intangible assets, net		$	107,062			$	44,423

 

Depreciation expense, included in cost of revenue, general and administrative expenses, and research and development expenses for the years ended December 31, 2010 and 2011 was $465,689 and $366,695, respectively.  During the years ended December 31, 2010 and 2011, the Company recorded impairment losses of $371,872 and $157,241, respectively, relating to the abandonment of capitalized software development costs.

 

Capital Lease    The Company leases certain equipment that is recorded as capital leases. This equipment is included in property and equipment on the accompanying balance sheet as of December 31, 2011 as follows:

 

Capital leased equipment		$	451,234
Less: Accumulated amortization			(61,053	)
Capital leased equipment net		$	390,181

 

Future minimum lease payments under capital leases as of December 31, 2011 are as follows:

 

Years ending December 31,
2012		$	179,627
2013			175,548
2014			87,119
Total minimum lease payments			442,294
Less amount represented by interest			(52,113	)
Less current portion			(149,253	)
Capital lease obligation, net of current portion		$	240,928

 

4. Loss Per Share

 

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

 

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

		Year Ended December 31,
		2010				2011
Numerator:
Net loss		$	(4,670,379	)		$	(5,702,422	)
Numerator for basic and diluted earnings per share		$	(4,670,379	)		$	(5,702,422	)
Denominator:
Denominator for basic and diluted earnings per share — weighted-average shares outstanding			17,791,584				19,124,806
Basic and diluted loss per share		$	(0.26	)		$	(0.30	)

 

Outstanding stock options and warrants to purchase 2,095,280 shares and 1,970,846 shares for the years ended December 31, 2010 and 2011, respectively, including 100,000 warrants, which were excluded from the calculation of diluted loss per share as their effect would have been anti-dilutive.

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. Commitments and Contingencies

 

Operating Leases

 

The Company leases 18,180 square feet of office and laboratory space in Los Angeles, California, under a noncancelable operating lease that expires on March 31, 2012. The Company is currently in negotiations for a new lease. The Company also sub-leases 1,460 square feet of space in Frederick, Maryland, where administrative functions are performed. Our current lease expires on January 31, 2013.

 

Rent expense, which is classified in cost of revenue, general and administrative, and research and development expenses was $476,666 and $517,417 for the years ended December 31, 2010 and 2011, respectively.

 

Future minimum lease payments by year and in the aggregate, under the Company’s noncancelable operating leases, consist of the following at December 31, 2011:

Years Ending December 31,
2012		$	186,778
2013			2,000
Total		$	188,778

 

Systems and Services Agreement

 

The Company entered in to a Systems and Service agreement with Xifin, Inc. on December 21, 2011.  The term of this agreement is for 36 months, at a rate of $20,000 a month with automatic renewals thereafter for 12 months, unless termination notice is given by either party.  

 

Guarantees

 

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

 

Legal Matters

 

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

 

Employment Agreements

 

The Company has employment contracts with several individuals, which provide for annual base salaries and potential bonuses. These contracts contain certain change of control, termination and severance clauses that require the Company to make payments to certain of these employees if certain events occur as defined in their respective contracts.

 

 

  

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. License and Collaborative Agreements

 

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

 

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

 

In consideration for this license, the Company agreed to pay to USC royalties based on a percentage of the revenues generated by the use of RGI-1 and related technology.  Royalty expense relating to this agreement amounted to $439,540 and $516,746 for the years ended December 31, 2010 and 2011, respectively.  Such expense is included in cost of revenue in the accompanying statements of operations.

 

License Agreement with Roche Molecular Systems (“Roche”)

 

In July 2001, the Company entered into a diagnostic services agreement with Roche to provide the Company with access to Roche’s patented PCR technology. In November 2004, this agreement was replaced by a non-exclusive license to use Roche’s PCR, homogenous PCR, and reverse transcription PCR processes. In consideration for these rights, the Company is obligated to pay royalties to Roche, based on a percentage of net sales of products or services that make use of the PCR technology. Royalty expense included in cost of revenue relating to this agreement amounted to $426,366 and $552,113 for the years ended December 31, 2010 and 2011, respectively.

 

In November 2004, the Company entered into an agreement with Roche, pursuant to which the Company is collaborating with Roche to produce commercially viable assays used in the validation of genetic markers for pharmaceutical companies. Specifically, the Company has licensed the rights to Roche to use the pre-diagnostic assays the Company develops in the course of using its RNA-extraction technologies to provide testing services to pharmaceutical companies and to produce diagnostic kits that then can be sold commercially to those pharmaceutical companies. Roche is required to pay the Company royalties of a certain percentage of net sales of such diagnostic kits sold to pharmaceutical companies. Through December 31, 2011, Roche has not been required to pay any royalties to the Company pursuant to this agreement.

 

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

 

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

 

In consideration for the testing services provided, Taiho paid an upfront payment at the commencement of the agreement and is obligated to pay regular testing fees, covering the specific services performed on a monthly basis.  In January 2011, the Company amended its agreement with Taiho and the agreement was renewed for an additional three years. According to the terms of the renewal, Taiho’s appointment as an exclusive purchaser in Japan of certain tests and testing services and its minimum purchasing obligations ended on December 31, 2011.

 

Until its minimum purchasing obligations ended on December 31, 2011, Taiho was obligated to purchase a minimum amount of testing services from the Company each calendar quarter. Revenue recognized under this agreement was $1,864,175 and $1,022,900 for the years ended on December 31, 2010 and 2011, respectively.

 

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. License and Collaborative Agreements - (continued)

 

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

 

In January 2006, the Company entered into a Master Services agreement with GSK, a leading pharmaceutical manufacturer, pursuant to which the Company provides services in connection with profiling the expression of various genes from a range of human cancers. Under the agreement, the Company will provide GSK with testing services as described in individual protocols and GSK will pay the Company for such services based on the pricing schedule established for each particular protocol. GSK is obligated to make minimum annual payments to the Company under the agreement and also was obligated to make a non-refundable upfront payment to the Company, to be credited against work undertaken pursuant to the agreement. In January 2006, the Company received an upfront payment of $2,000,000, which was initially recorded as deferred revenue. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. There was no remaining deferred revenue balance associated with this agreement at December 31, 2010.  In the course of performing the year-end financial close procedures for the three months ended December 31, 2010, management identified a prior period error relating to the recognition of revenue pertaining to this agreement.  The error created an understatement of net revenues in the amount $322,469, which should have been recognized in 2008.  As described in Note 15, this revenue was not considered material to any prior period and has been recognized in the three months ended December 31, 2010.  See Note 15 for further details.

 

In December 2008, the Company amended and restated its master service agreement with GSK. Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000, which was received on January 5, 2010.  There was no amount of deferred revenue for this agreement at December 31, 2011.

 

In March 2011, the Company entered into a non-exclusive license agreement with GSK.  Under the agreement, the Company granted GSK a non-exclusive, sublicenseable license to its proprietary PCR analysis technology and diagnostic expertise to assess BRAF gene mutations in human tumor samples.  As part of the agreement, the Company received a non-refundable technology access fee in consideration for the transfer of the Company’s technology to GSK. The agreement also contains milestone provisions which would allow the Company to earn further payments from GSK.  The Company had not earned any milestone payments from GSK as of December 31, 2011.

 

The Company recognized revenue of $1,636,518 (including the $322,469 prior period adjustment noted above) and $3,387,442 relating to all of the GSK agreements for the years ended December 31, 2010 and 2011, respectively.

 

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

 

In December 2006, the Company entered into a Master Services agreement with GSK Bio, the vaccine division of GSK (see above), pursuant to which it will provide testing services, principally in relation to profiling the expression of various genes from a range of human cancers. The Company will conduct the testing services on tissue specimens provided by GSK Bio. The agreement required that GSK Bio make an upfront payment of €2,000,000, which was received by the Company in December 2006. The agreement further specified that GSK Bio  pay annual minimum payments in 2007, 2008 and 2009 and that the upfront payment made in December 2006 will be credited against the annual minimum payments in 2007 and 2008. The agreement also provided that any differences between the annual minimum payments made in 2007, 2008 or 2009 and the amounts due to the Company for testing services performed on specimens submitted by GSK Bio during the three years ended December 31, 2010 be credited towards services performed during the year ending December 31, 2011, the final year of the agreement. If the Company ceases to provide services under the agreement or any reason, the Company shall remit to GSK Bio payment of the then remaining balance of the existing credit within sixty days of the date on which the Company ceased to provide services to GSK Bio.

 

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

 

On September 7, 2009, the Company amended and restated its master service agreement with GSK Bio (the “Amended and Restated Agreement”).  The master service agreement has been extended through March 31, 2012. The Company is currently in negotiations for a new agreement. Pursuant to the Amended and Restated Agreement, the parties agreed that GSK Bio has accrued an aggregate credit under the terms, representing the balance of deferred revenue relating to this agreement at that date of the original agreement, which amount shall be allocated towards services rendered to GSK Bio during the remaining term of the agreement as described below.

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. License and Collaborative Agreements - (continued)

 

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

 

For each calendar quarter of 2009 and the first two quarters of 2010, €200,000 of the existing credit was applied to all services rendered to GSK Bio during such calendar quarter.  Pursuant to the Amended and Restated Agreement, GSK Bio has extended the term of the agreement for an additional one-year period through December 31, 2011.   As provided in the Amended and Restated Agreement, the remaining balance of the existing credit of approximately €1,357,800 was divided into six equal quarterly amounts and was applied to all services rendered to GSK Bio in each of the last two quarters of 2010 and the four calendar quarters of 2011.  

 

The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. The Company recognized revenue of $5,805,951 and $5,185,302 relating to the GSK Bio agreement for the years ended December 31, 2010, and 2011, respectively, which includes for 2010 and 2011 $1,255,710 and $1,333,186 of previously recorded deferred revenue. The amount of deferred revenue related to this agreement at December 31, 2010 was $1,333,186 and, as of December 31, 2011, there was no remaining balance classified as deferred revenue.

 

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

 

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

 

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

 

This agreement has an initial term of five years, with an automatic renewal for an additional three-year term unless either party gives 90 days’ notice in advance of the renewal date of its intent not to renew. As of December 31, 2011 neither party has given notice of intent not to renew, by default the agreement has been renewed. Pursuant to the agreement, SBC will receive a percentage of the gross margin, as defined in the agreement, collected from the Company’s clients in China as compensation for its testing services performed. For the year ended December 31, 2010, and December 31, 2011, testing services totaled $169,400 and $306,675.

 

Commission Agreement with Hitachi Chemical Co., Ltd.

 

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

 

This Agreement had an initial term expiring on March 31, 2010, with an automatic renewal for one year at the end of the original period under the same terms and conditions. Pursuant to the agreement, Hitachi performs certain testing services and receives a percentage of the revenue collected from the Company's clients in the Territory, which totaled $1,395,688 and $560,211 for the years ended December 31, 2010 and 2011, respectively. Following the Great East Japan Earthquake and Fukushima nuclear disaster that occurred in March 2011, the processing of samples in Japan under the collaboration agreement with Hitachi was temporarily suspended. During the second and third quarters of 2011, these samples were processed in the Company’s Los Angeles laboratory. As such, the Company was not required to make payments to Hitachi under the agreement during that period. The financial impact was that the Company’s cost of revenue was reduced and the Company’s net loss for the quarters was reduced. Hitachi resumed processing certain samples beginning in the third quarter of 2011.

 

Hitachi is responsible for expenses related to the cost of laboratory equipment and modification to the laboratory facilities, as well as the cost of reagents.

  

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. Stock Option Plans

 

In March 2000, the Company adopted a Stock Option Plan (the “2000 Plan”) as approved by its Board of Directors. Under the 2000 Plan, the Company may grant options to acquire up to 1,600,000 shares of common stock. In connection with the adoption of the 2006 Employee, Director and Consultant Stock Plan, as further discussed below, the Company is to grant no additional options under its 2000 Plan under which options to purchase 190,000 shares remained outstanding as of December 31, 2011. Although no more options may be granted under the 2000 Plan, the terms of the 2000 Plan continue to apply to all outstanding options. The Company also granted options to purchase 16,000 shares of common stock to two consultants which were granted under separate agreements outside of the 2000 Plan.

 

On October 26, 2006, the Board of Directors of the Company approved, and on May 1, 2007, reapproved the adoption of the 2006 Employee, Director and Consultant Stock Plan (the “2006 Stock Plan”). The stockholders approved the 2006 Stock Plan on June 1, 2007. The initial number of shares which may be issued from time to time pursuant to this Plan is 2,160,000 shares of common stock.  In addition, on the first day of each fiscal year of the Company during the period beginning in fiscal year 2008, and ending on the second day of fiscal year 2017, the number of shares that may be issued from time to time pursuant to the Plan shall be increased by 200,000 shares.  The initial number of shares available for issuance of 2,160,000 increased by 200,000 in 2008, 2009, 2010 and 2011, resulting in the total number of shares that may be issued as of January 1, 2011 to be 2,960,000.   As of December 31, 2011, there were 1,089,154 options available for grant under the 2006 Stock Plan.

 

Employee options vest according to the terms of the specific grant and expire 10 years from the date of grant. Non-employee option grants to date vest typically over a 2 to 3 year period. The Company had 1,870,845 options outstanding at a weighted average exercise price of $3.67 at December 31, 2011. There were 502,372 non-vested stock options with a weighted average grant date fair value of $1.85 outstanding at December 31, 2011.  As of December 31, 2011, there was $359,930 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 2.19 years.

 

Except for the certain grants of restricted common stock and common stock options containing market conditions as described below, the Company estimated share-based compensation expense for the years ended December 31, 2010 and 2011 using the Black-Scholes model with the following weighted average assumptions:

  

		Year Ended December 31,
		2010				2011
Risk free interest rate			1.64-3.0%				1.25-2.89%
Expected dividend yield			—				—
Expected volatility			77.6-82.0%				97.5-122.2%
Expected term **(in years)			5.5-6.25				43.0-6.25
Forfeiture rate			6.9	%			7.0	%

** Expected term is calculated using SAB 107 Simplified Formula. Management has concluded that the use of the simplified method for calculating the expected term of its common stock option grants is appropriate.

 

The following table summarizes the stock option activity for the 2000 Plan and the 2006 Stock Plan for the year ended December 31, 2011:

 

		Number of Shares				Weighted Average Exercise Price				Remaining Contractual Life (Years)				Aggregate Intrinsic Value
Outstanding, December 31, 2010			1,995,280			$	4.20				7.647			$	436,791
Granted			557,250				1.96
Exercised			(3,126	)			1.35
Expired			(170,375	)			7.64
Forfeited			(508,183	)			2.42
Outstanding, December 31, 2011			1,870,846			$	3.67				7.40			$	66,976
Exercisable, December 31, 2011			1,368,474			$	4.33				6.82			$	37,366

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. Stock Option Plan – (continued)

 

The weighted-average grant-date fair value of options granted during the years ended December 31, 2010 and 2011 was $1.80 and $1.47, respectively.  

 

The following table provides additional information in regards to options outstanding as of December 31, 2011:

 

				Options Outstanding								Options Exercisable
Exercise Price				Number of Options				WA Remaining Contractual Term				Number of Options				WA Remaining Contractual Term
$	1.32				80,000				9.9548				—				—
	1.35				278,755				7.4579				207,588				7.4579
	1.66				74,750				9.7851				—				0.0000
	1.67				107,500				9.8042				—				0.0000
	2.21				100,000				8.3422				25,000				8.3422
	2.25				135,000				9.2813				135,000				9.2813
	2.35				80,500				8.9293				80,500				8.9293
	2.71				192,126				8.5339				113,098				8.5339
	3.05				160,728				6.7132				147,231				6.7132
	3.15				43,132				6.4613				43,132				6.4613
	3.24				11,500				6.3737				10,785				6.3737
	3.80				11,500				6.2587				10,785				6.2587
	4.29				11,500				5.6482				11,500				5.6482
	7.00				583,855				5.4374				583,855				5.4374
					1,870,846				7.4025				1,368,474				6.8226

Stock-based compensation expense was classified in the results of operation as follows:

 

		Year Ended December 31,
		2010				2011
Cost of revenue		$	176,005			$	226,108
Selling and marketing expense			85,172				25,494
General and administrative expense			398,973				446,211
Research and development expense			20,118				25,403
Totals		$	680,268			$	723,616

 

Thomas Bologna was appointed Chief Executive Officer of the Company on December 21 of 2011 and in connection with his appointment, Mr. Bologna was awarded stock options outside of the 2006 Stock Plan. Pursuant to the employment agreement between the Company and Mr. Bologna, dated December 21, 2011, and in reliance on NASDAQ Listing Rule 5636(c), the Company granted Mr. Bologna (i) a stock option to purchase 600,000 shares of the Company’s common stock, which vests monthly over 36 months from the date of grant, subject to his continued employment with the Company, (ii) a stock option to purchase 300,000 shares of the Company’s common stock, which vests in two equal installments on the first day of the 18th and 36th calendar months from the date of grant, subject to his continued employment with the Company, or if earlier, the date on which the 30-day trailing average closing price of the Company’s common stock equals or exceeds $1.80, and (iii) 270,000 shares of restricted common stock of the Company, which vest on the date on which the 30-day trailing average closing price of the Company’s common stock equals or exceeds $2.40. The exercise price of the stock options is $1.20 per share, the closing price of the Company’s common stock on the day prior to the date of grant. The expense recognized in connection with these grants was approximately $12,000 for the year ended December 31, 2011.

 

Since the restricted common stock grant vests upon attainment of a target price for the Company’s common stock and each tranche of the 300,000 share common stock option grant can vest sooner than the stated vesting dates based upon attainment of a target price for the Company’s common stock, these awards are deemed to include market conditions for purposes of determining the valuation and accounting for the awards. Accordingly, the fair value of the restricted stock grant and each tranche of the 300,000 share common stock option grant that Mr. Bologna received was determined using a Monte-Carlo simulation model to simulate the Company’s stock prices in the future that would trigger or not trigger the market conditions. The model used the following significant assumptions: a risk free rate ranging from .1664% - .4152%, terms ranging from 1.45 – 1.95 years, starting price equal to the grant date fair value of the Company’s common stock of $1.20, exercise price equal to the market condition and volatility equal of 75%. The restricted common stock awards of 270,000 shares had a fair value per unit on grant date of $0.87 and a derived service period of .98 years. The options that vest in June 2013 had a fair value per unit on grant date of $.38 and a median service period of 1.45 years, the options that vest in December of 2014 had a fair value per unit on grant date of $.48 and a median service period of 2.95 years. The options that vest over three years that were priced using the Black-Scholes model had a volatility of 122.2% a discount rate of 1.18%, an exercise price of $1.20 a share and an expected term of 3 years. For these awards containing market conditions, the compensation amount will be attributed over the service date unless vesting occurs sooner due to achieving the market condition.

  

8. Common Stock Warrants

 

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

 

In June 2007, in conjunction with the initial public offering, the Company issued 100,000 warrants to purchase 100,000 shares of its common stock at an exercise price of $7.70 to the underwriters as part of the initial public offering. There were no warrants granted during the years ended December 31, 2010 and 2011.  As of December 31, 2011, all of the warrants were outstanding and exercisable and had a remaining contractual life of six months.

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. Income Taxes

The components of the income tax provision were as follows:

		Year Ended December 31,
		2010				2011
Current
Federal		$	—			$	—
Foreign			—				—
State			1,256				—
			1,256				—
Deferred
Federal			—				—
Foreign			—				—
State			—				—
			—				—
Income tax provision		$	1,256			$	—

 

For financial statement purposes, loss before income tax provision includes the following components:

		Year Ended December 31,
		2010				2011
Domestic		$	(4,644,914	)		$	(5,671,528	)
Foreign			(24,209	)			(30,894	)
		$	(4,669,123	)		$	(5,702,422	)

 

A reconciliation of the expected income tax benefit computed using the federal statutory income tax rate of 34% to the Company’s effective income tax rate is as follows:

		Year Ended December 31,
		2010				2011
Income tax benefit based on federal statutory rate		$	(1,588,000	)		$	(1,928,000	)
State income tax benefit, net of federal income tax			(311,000	)			(191,000	)
Change in deferred tax valuation allowance			1,783,000				1,367,000
Stock-based compensation			—				675,000
Other, net			117,256				77,000
Income tax provision		$	1,256			$	—

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. Income Taxes – (continued)

 

The tax effects of temporary differences that give rise to significant portions of the Company’s deferred tax assets and deferred tax liabilities are presented below: 

 

		December 31, 2010				December 31, 2011
Deferred tax assets:
Domestic net operating loss carryforwards		$	9,341,000			$	11,411,000
Foreign net operating loss carryforwards			1,572,000				1,581,000
Deferred revenue			550,000				—
Federal and state tax credit			240,000				297,000
Stock-based compensation			2,104,000				1,620,000
Capitalized costs			1,242,000				1,236,000
Other, net			541,000				724,000
Total gross deferred tax assets			15,590,000				16,869,000
Less valuation allowance on deferred tax assets			(15,502,000	)			(16,869,000	)
Net deferred tax assets			88,000				—
Deferred tax liabilities:
Plant and equipment, principally accelerated depreciation			(88,000	)			—
Total deferred tax liabilities			(88,000	)			—
Net deferred taxes		$	—			$	—

 

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

 

The Company files U.S. federal, U.S. state, and foreign tax returns. The Company’s major tax jurisdictions are U.S. federal and the State of California and are subject to tax examinations for the open years from 2002 through 2011.

 

As of December 31, 2011, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $29.3 million and $25.1 million, respectively. If not utilized, the federal net operating loss and tax credit carryforwards will expire beginning in 2020. If not utilized, the state net operating loss carryforward will expire beginning in 2012.

 

As of December 31, 2011, the Company had U.K. net operating loss carryforwards totaling approximately $5.6 million that may be carried forward indefinitely. A full valuation allowance has been provided against this asset.

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. Related Party Transactions

 

While employed at USC, Kathleen Danenberg, the Company’s chief executive officer through July 2011 and a member of the Company’s Board of Directors through October 2011, developed and patented (United States Patent 6,248,535; Danenberg, et al., Method For Isolation of RNA From Formalin-Fixed Paraffin-Embedded Tissue Specimens) an extraction method that allowed reliable and consistent isolation of RNA from FFPE suitable for RT-PCR. USC retains ownership of this patent but has exclusively licensed this technology to the Company. In consideration for this license, the Company is obligated to pay royalties to USC, as a percentage of net sales of products or services using the technology, and to meet a certain minimum in royalty payments. Pursuant to USC policy, the inventors of technology owned by the University and then licensed for commercialization are paid a portion of royalties received by the University from the licensed technology. USC Therefore, USC is to pay a portion of royalties received from the Company, which royalties amounted to $32,758 and $261,599 for the years ended December 31, 2010 and 2011, respectively, to Ms. Danenberg in recognition of her invention.

 

11. Segment Information

 

The Company operates in a single reporting segment, with operating facilities in the United States.

 

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

 

		Year Ended December 31,
Revenue:		2010				2011
United States		$	13,607,289			$	16,434,526
Europe			5,805,951				5,185,302
Japan			1,864,175				1,022,900
		$	21,277,415			$	22,642,728

 

		December 31,				December 31,
Long-lived assets:		2010				2011
United States		$	805,817			$	1,112,102
		$	805,817			$	1,112,102

.

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. Offerings of Common Stock

 

The Company sold shares of its common stock during 2009, 2010 and 2011 in three private placements and one registered offering, as described below.  In connection with the private placements, the Company entered into registration rights agreements with the purchasers of the common shares. Subsequently, in February 2012, the Company completed another private placement of common stock. For further information regarding the February 2012 private placement, please refer to Note 15 regarding Subsequent Events.

 

Common stock

 

On February 27, 2010, we entered into a Purchase Agreement with certain affiliates of Special Situations Funds for the private placement of 2,000,000 newly-issued shares of the Company's common stock at a per share price of $1.00. The closing of the sale of the Shares occurred on Monday, March 2, 2010 and we received net proceeds of $2,000,000 on the same date.

 

In connection with the Special Situations Funds Private Placement, we also entered into a Registration Rights Agreement, dated February 27, 2010, with the Purchasers (the “Registration Rights Agreement”) pursuant to which the Company filed a registration statement with the Securities and Exchange Commission (“SEC“) to register the 2,000,000 shares for resale, which registration statement became effective on June 30, 2010.

 

The Special Situations Registration Rights Agreement provides an explicitly stated or defined penalty due upon a breach, which allows the Company to apply the guidance of ASC 825-20-15, Registration Payment Arrangements, and compliance with all filing requirements under the 1934 Act as described above was solely within the Company’s control.  As such, it allowed the Company to include the $2,000,000 in the Company’s common stock as stockholders’ equity in the accompanying balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.

 

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

 

Common stock classified outside of stockholders’ equity (deficit)

 

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

 

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

 

Under the Lansdowne Registration Rights Agreement, the Company was required to have the registration statement declared effective within 120 days after the private placement closed.  In addition, the Company is obligated to use commercially reasonable efforts (i) to cause the registration statement described above to remain continuously effective and (ii) to maintain the listing of the Company’s common stock on Nasdaq or other exchanges, as defined, for a period that will terminate on the earlier of July 22, 2012 or the date on which Lansdowne has sold all of its shares of common stock.  The Company is also required to file with the SEC in a timely manner all reports and other documents required of the Company under the 1934 Act. In the event the Company fails to satisfy its obligations under the Lansdowne Registration Rights Agreement, the Company would be in breach of said agreement, in which event Lansdowne would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief.  The Lansdowne Registration Rights Agreement does not provide an explicitly stated or defined penalty due upon a breach.  Because (i) the potential penalty for any breach of the Lansdowne Registration Rights Agreement is not explicitly stated or defined, which prohibits the Company from applying the guidance of ASC 825-20-15, Registration Payment Arrangement, and (ii) complying will all filing requirements under the 1934 Act as described above is not solely within the Company’s control, the Company is required to present Lansdowne’s investment of $3,975,279 in the Company’s common stock as common stock outside of stockholders’ equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. Private Placements – (continued)

 

Common stock classified outside of stockholders’ equity (deficit) – (continued)

 

On March 5, 2010, the Company entered into a Purchase Agreement with certain affiliates of and funds managed by Lansdowne Partners Limited Partnership, Greenway Capital Partners and Paragon Associates for the private placement of 3,005,349 newly-issued shares of our common stock at a per share price of $1.31.  The closing of the sale of the shares occurred on Friday, March 5, 2010.  In connection with the acquisition of the shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of the Company’s capital stock, subject to various exceptions and limitations.  Lansdowne participated in the Private Placement by electing to exercise the preemptive rights granted to it pursuant to the Purchase Agreement by and between the Company and Lansdowne, dated July 22, 2009.  Net proceeds received from this financing were approximately $3,879,403.

 

In connection with the Private Placement, the Company also entered into a Registration Rights Agreement, dated March 5, 2010, with the Purchasers (the Registration Rights Agreement) pursuant to which it has agreed to file, within 45 days of the closing of the Private Placement, a registration statement with the SEC to register the shares for resale, which registration statement is required to become effective within 120 days following the closing.  The Company also granted certain "piggyback" registration rights to the Purchasers which are triggered if the Company proposes to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the shares or the shares become eligible for sale under Rule 144(b)(1) without restriction.

 

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

 

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

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. Fair Value Measurements

 

ASC 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.  ASC 820 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The first two inputs are considered observable and the last unobservable, that may be used to measure fair value and include the following:

 

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

 

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

 

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

 

As of December 31, 2011, the Company held certain assets that are required to be measured at fair value on a recurring basis, including its cash and cash equivalents. The fair value of these assets and liabilities was determined using the following inputs in accordance with ASC 820 at December 31, 2011:

 

		Fair Value Measurement as of December 31, 2011
		Total				Level 1				Level 2				Level 3
Description		$				$				$				$
Money market accounts (1)			10,000				10,000				—				—

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

 

 

 

RESPONSE GENETICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14.   Correction of an error

 

During the fourth quarter of 2011, management reevaluated the Company’s method for estimating the accounts receivable allowance for doubtful accounts associated with Medicare and Private Payor sales. Historically, the Company’s policy was to record a write-off of accounts receivable aged greater than one-year from the date of being billed. Management evaluated the historical collection patterns of receivables for Medicare and Private Payors and built a model to relate the collection of accounts receivables to the period of sale in order to establish an estimation of the amount of every accounts receivable dollar that was collected. Based upon this model, management concluded that an allowance for doubtful accounts was required for the 2011 and 2010 annual periods, and in each of the quarterly periods included therein.. Since an allowance for doubtful accounts was not originally recorded in each of these periods, management concluded there was an error and evaluated the effect of not recording an allowance for doubtful accounts in each of the annual periods, and the quarterly periods included therein in accordance with the SEC’s Staff Accounting Bulletin (SAB) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statement. Management evaluated the materiality of the errors from qualitative and quantitative perspectives and concluded that the error was not material to any prior periods.   The correction of the error in the current period was material to the 2011 fourth quarter financial statements but was not material to the results of operations for the year ended December 31, 2010 or 2011or the trend of financial results.  Accordingly, management corrected the error in the fourth quarter of 2011.  The impact of the adjustment to correct the error to the specific line items of the financial statements for the year ended December 31, 2011 was as follows:

 

		Increase
		(Decrease)
Statement of operations:
Operating loss		$	679,183
Net loss			679,183
Net loss per share – basic and diluted			0.04
Balance Sheet:
Accounts receivable, net of allowance for doubtful accounts			(679,183	)
Total current assets			(679,183	)
Accumulated deficit			679,183

  

In the course of performing our year-end financial close procedures for the year ended December 31, 2010, management identified a prior period error relating to the recognition of revenue relating to the GSK agreement (see Note 6).  The error related to an understatement of net revenue in the amount $322,469 in the year ended December 31, 2008.  In accordance with the SEC’s Staff Accounting Bulletin (SAB) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, management evaluated the materiality of the errors from qualitative and quantitative perspectives and concluded that the error was not material to any prior periods.   The correction of the error in the current period was material to the 2010 fourth quarter financial statements but was not material to the results of operations for the year ended December 31, 2010 or the trend of financial results.  Accordingly, management corrected the error in the fourth quarter of 2010.  The impact of the adjustment to correct the error to the specific line items of the financial statements for the year ended December 31, 2010 was as follows:

		Increase
		(Decrease)
Statement of operations:
Net revenue		$	322,469
Operating loss			(322,469	)
Net loss			(322,469	)
Net loss per share – basic and diluted			(0.02	)
Balance Sheet:
Deferred revenue		$	(322,469	)
Total liabilities			(322,469	)
Accumulated deficit			(322,469	)

 

15. Subsequent events

 

On February 2, 2012, the Company entered into purchase agreements with various investors (collectively, the “Investors”) for the private placement of an aggregate of 5,257,267 newly-issued shares of the Company’s common stock (the “Shares”) at a purchase price of $1.50 per share (the “2012 Private Placement”). The Company raised $7,822,000, net of fees, in the 2012 Private Placement. The Investors participating in the 2012 Private Placement were various institutions and all officers and directors of the Company. The final closing of the 2012 Private Placement (the “Closing”) occurred on February 2, 2012.

 

In connection with the 2012 Private Placement, the Company also entered into registration rights agreements, each dated February 2, 2012, with the Investors pursuant to which the Company agreed to file, within 90 days of the Closing, a registration statement with the SEC to register the Shares for resale, which registration statement is required to become effective within 180 days following the Closing. The Company also granted the Investors certain “piggyback” registration rights, which are triggered if the Company proposes to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the Shares or the Shares becoming eligible for sale under Rule 144(b)(1) without restriction.

 

 

Part IV.

 

Item 15.  Exhibits, Financial Statement Schedules.

 

3.1*		Amended and Restated Certificate of Incorporation, as amended.
3.2*◊		Amended and Restated Bylaws of the Company.
4.1*		Form of Common Stock Certificate.
10.1†^		Amended and Restated Master Agreement for the supply of Laboratory Test Services by and between SmithKline Beecham Corporation (a.b.a. GlaxoSmithKline) and the Company dated as of December 22, 2008
10.2†!		Amended and Restated Master Agreement for the Supply of Laboratory Services by and between GlaxoSmithKline Biologicals and the Company, dated as of September 7, 2010.
10.4*†		License Agreement by and between Roche Molecular Systems, Inc. and the Company, dated as of November 23, 2004.
10.5*†		Patent License Agreement by and between Roche Molecular Systems Inc. and the Company, dated as of November 16, 2004.
10.7*†		Option and License Agreement by and between the University of Southern California and the Company, as amended, dated as of April 19, 2000.
10.8*#
10.9*#
10.10*#		Employment Agreement by and between David O’Toole and the Company, dated as of May 3, 2011.
10.11▲ #
10.12 □#		Amended and Restated Employment Agreement by and between Denise McNairn and the Company, dated as of September 10, 2011.
10.13*#		Response Genetics, Inc. 2006 Employee, Director and Consultant Stock Plan.
10.14		Office Lease by and between Health Research Association and the Company, dated effective as of January 25, 2005, as amended on March 4, 2011.
10.15*†		Collaboration Agreement by and between the Company and Shanghai Biochip Company, Ltd., dated as of March 5, 2007
10.16*
10.17*#		Executive Officer Form of Incentive Stock Option Agreement.
10.18*#		Executive Officer Form of Non-Qualified Stock Option Agreement.
10.19@†		Commission Agreement by and between Hitachi Chemical Co., LTD. and the Company, dated as of July 26, 2007.
14*		Code of Ethics.
21*		Subsidiaries of the Small Business Issuer.
23		Consent of BDO USA, LLP.
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906

 

 

* Incorporated by reference to the Company’s Registration Statement on Form SB-2 (File No. 333-139534).

@ Incorporated by reference to the Company’s Quarterly Report on Form 10-QSB for the quarter ended September 30, 2007.

# Identifies a management contract or compensatory plan or agreement in which an executive officer or director of the Company participates.

† Confidential treatment requested as to certain portions, which portions have been filed separately with the Securities and Exchange Commission.

^ Incorporated by reference to the Company’s Annual Report on Form 10K for the fiscal year ended December 31, 2008.

! Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010.

◊ Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011.

∆ Incorporated by reference to the Company’s Current Report on Form 8-K dated May 5, 2011.

▲Incorporated by reference to the Company’s Current Report on Form 8-K dated June 16, 2011.

□ Incorporated by reference to the Company’s Current Report on Form 8-K dated September 16, 2011.

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

RESPONSE GENETICS, INC.

April 2, 2012	/s/ Thomas Bologna
Date	Thomas Bologna
	Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

 

		Signatures		Title		Date
By:		/s/ Thomas Bologna
		Thomas Bologna		Chief Executive Officer (principal executive officer) and Chairman of the Board of Directors		April 2, 2012
By:		/s/ David O’Toole
		David O’Toole		Vice President and Chief Financial Officer (principal financial and accounting officer)		April 2, 2012
By:		/s/ Kirk Calhoun
		Kirk Calhoun		Director		April 2, 2012
By:		/s/ Gary D. Nusbaum
		Gary D. Nusbaum		Director		April 2, 2012
By:		/s/ David Wurzer
		David Wurzer		Director		April 2, 2012
By:		/s/ Michael Serruya
		Michael Serruya		Director		April 2, 2012
By:		/s/ Michael Metzger
		Michael Metzger		Director		April 2, 2012

By:		/s/ Richard van den Broek
		Richard van den Broek		Director		April 2, 2012