News Column

RESPONSE GENETICS INC - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 14, 2014

Special Note Regarding Forward-Looking Statements

Certain information included or incorporated by reference in this Quarterly Report on Form 10-Q for the period ended on June 30, 2014 contains or may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995, as may be amended from time to time. Statements that are not historical facts, including statements that use terms such as "anticipate," "believe," "should," "expect," "intend," "plan," "project," "seek" and "will" and that relate to our plans, objectives, strategy and intentions for future operations, future financial position, future revenues, projected costs and prospects are forward-looking statements but not all forward-looking statements contain these identifying words. Forward-looking statements relate to future periods and may, for example, include statements about our expectation that, for the foreseeable future, a significant amount of our revenues will be derived from ResponseDX® product sales or our expectations regarding revenues from ResponseDX®products; 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; the amount of future revenues that we may derive from Medicare patients; the potential or 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 maintain compliance with the listing requirements of Nasdaq; 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 belief that we have 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 significant inherent risks and uncertainties that could cause actual results to differ materially from those expected. For us, these risks and uncertainties include, but are not limited to, our ability to develop and commercialize new products without unanticipated delay; to continue to provide the ResponseDX: Tissue of OriginTM test, the TC/PC pathology partnering program, the ResponseDX: Comprehensive Lung Profile; 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. In light of the risks and uncertainties inherent in all forward-looking statements, including the above, the inclusion of such statements in this Quarterly Report on Form 10-Q for the period ended on June 30, 2014 should not be considered as a representation by us that our objectives, projections or plans will be achieved. These statements are based on current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements and therefore you should not place undue reliance on them. The forward-looking statements included in this Quarterly Report on Form 10-Q for the period ended on June 30, 2014 speak only as of the date hereof and we expressly disclaim any obligation or undertaking to publicly 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.

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes to the financial statements included elsewhere in this Quarterly Report on Form 10-Q for the period ended June 30, 2014 and our audited consolidated financial statements for the year ended December 31, 2013 included in our Annual Report on Form 10-K for the year ended December 31, 2013 previously filed with the Securities and Exchange Commission.

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 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.

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 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; • Broadening our offerings with the introduction of the former Pathwork Diagnostics Tissue of OriginTM test that was acquired when we purchased the Pathwork Diagnostics assets in August 2013 and moved the assets to our Los Angeles facility. We began selling the ResponseDX: Tissue of OriginTM test in February 2014; • Enhancing our capabilities in the way we deliver our services to oncologists and pathologists. In late 2013, the Company introduced its TC/PC system to competitively offer its services to pathologists; • Developing additional diagnostic tests for assessing the risk of cancer recurrence, prediction to therapy response and tumor classification in cancer patients; • Expanding our testing services business by pursuing new technologies through collaborations and in-licensing to expand our business; • Entered into an exclusive agreement with Knight Diagnostic Laboratories at Oregon Health & Science University for a proprietary next generation sequencing panel for lung cancer; and • Selectively building our pharmaceutical services business.



Our technologies enable us to reliably and consistently extract the nucleic acids ribonucleic acid ("RNA") and deoxyribonucleic acid ("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 formalin-fixed paraffin embedded ("FFPE") patient biopsies for the development of diagnostic tests.

23 ResponseDX®



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

Until recently, most cancer treatment regimens were administered without any pre-selection of patients on the basis of the particular genetics of their tumor. However, advances in molecular technologies have enabled researchers to identify and measure genetic factors in patients' tumors that may predict the probability of success or failure of many anti-cancer agents. In order to increase the chances of a better outcome for cancer patients, we offer and continue to expand our offering of tests for measuring predictive factors for therapy response in tumor tissue samples. We provide tests for non-small cell lung cancer ("NSCLC"), colorectal cancer ("CRC"), gastric and gastroesophageal cancer ("GE"), melanoma, thyroid cancer, and breast cancer patients' tumor tissue specimens through our ResponseDX: Lung® , ResponseDX: Colon® , ResponseDX: Gastric® , ResponseDX: Melanoma ® , ResponseDX: ThyroidTM and ResponseDX: BreastTMtest suites at our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 ("CLIA"). These tests serve to help oncologists make optimal therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among therapies to treat their cancer patients.

In August 2013, the Company acquired substantially all of the assets of Pathwork Diagnostics, Inc. including its FDA-cleared Tissue of OriginTM cancer test. This newly acquired test was launched commercially by the Company in February 2014 as the ResponseDX: Tissue of OriginTM test. The ResponseDX: Tissue of OriginTM test is a microarray-based gene expression test that aids in identifying challenging tumors, including metastatic, poorly differentiated, and undifferentiated cancers. The ResponseDX: Tissue of OriginTM test uses a proprietary microarray platform and proprietary software to compare the expression of 2,000 genes in a patient's tumor with a panel of 15 known tumor types that represent 90% of all cancers. The test received FDA clearance in June 2010.

As of June 30, 2014, our ResponseDX® sales team consisted of 18 members located in the West, Southeast, and Northeast areas of the United States.

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. In 2014, we plan to build out our product offering to include a ResponseDX®Glioma profile as well as additional tests in our existing panels.

Addition of Next-Generation Sequencing to our suite of technologies

The Company is utilizing mutational analysis by next-generation sequencing ("NGS") to complement our suite of molecular diagnostics platforms for the analysis of cancer specimens. The Company is using NGS to detect genomic changes from FFPE tissue samples and to provide physicians with reports that are comprehensive with respect to clinically actionable alterations. To this end, on April 15, 2014, the Company entered into an agreement with Knight Diagnostic Laboratories of the Oregon Health and Science University ("OHSU") to offer OHSU's proprietary next generation sequencing panel which provides full gene sequencing of the actionable genes for lung cancer rather than detection only of so-called hot spots as part of the Company's testing menu. The collaboration leverages the Company's national sales force.

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.

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 we will be able to develop and commercialize tests of other types of cancer; or that we 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 sales and marketing activities related to our ResponseDX® diagnostic tests, research and development to expand our series of diagnostic tests for cancer patients, and for other general corporate purposes.

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 represented 11.5% and 9.9% of our total operating expenses for the three months ended June 30, 2013 and 2014, respectively, and 9.6% and 9.7% of our total operating expenses for the six months ended June 30, 2013 and 2014, respectively. Major components of the $447,686 and $473,324 in research and development expenses for the three months ended June 30, 2013 and 2014, respectively, and of the $744,886 and $940,890 in research and development expenses for the six months ended June 30, 2013 and 2014, respectively, included supplies and reagents for our research activities, sample procurement costs, personnel costs and patent fees. 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.

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Critical Accounting Policies and Significant Judgments and Estimates

This discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). 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 completed. 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 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 analyzes historical payments from payors as a percentage of amounts billed by the Company to estimate expected collections for purposes of recording net revenue.

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. In January 2013, a Medicare fee schedule update was announced which included proposed changes to Medicare reimbursement rates that significantly reduced the reimbursement rates for certain of the testing services we provide. The Company participated with other impacted organizations to provide guidance to the local Medicare Administrative Contractor ("MAC") that resulted in the local MAC updating certain pricing through September 2013 which reflected an increase in many of the tests originally priced in January 2013. In addition, on October 1, 2013, the Centers for Medicare and Medicaid Services ("CMS") issued fees for some, but not all, of the CPT codes used by the Company. It is uncertain if continued guidance provided to Medicare and the local MAC by impacted organizations will result in additional fee increases or additional positive coverage determinations in 2014. If, however, the current level of reduction in reimbursement rates is adopted as is, it may have a material adverse effect on the Company's operations.

As a result of these CPT code changes and Medicare price changes, we have experienced a departure from our normal reimbursement patterns with Medicare and other payors. Specifically, we have experienced delays in certain reimbursements for services and an increase in initial denials of claims for certain services provided. Accordingly, we re-evaluated the assumptions employed in our model for estimating revenue to be recognized for ResponseDX® testing. We view the code and price changes described above as affecting only the assumptions we used in pricing our services. The nature of the testing we provide, the evidence we gather to establish the creditworthiness of our payors and the delivery method of our services have not changed from prior periods, and there are no indicators that these assumptions require change.

We performed analyses that considered our historical patterns of revenue by payor in conjunction with the fluctuations we experienced in the three and six months ended June 30, 2013 and 2014 to arrive at the revenue recorded during those periods. We believe that the changes in CPT codes and pricing that are causing confusion and erratic payment experience in the payor community will take some time to resolve. The time needed for resolution will depend upon Medicare and the local MAC releasing additional pricing changes and potentially, revisions to previously revised prices, and upon the private payor community adopting the new CPT codes and some level of revised pricing. Accordingly, our revenue recognition estimates could be materially affected in future periods as pricing and payments patterns change and develop, and we may be materially affected by future or retroactive price changes.

On July 8, 2013, CMS released a new proposed rulemaking entitled "Medicare Program; Revisions to Payment Policies under the Physician Fee Schedule, Clinical Laboratory Fee Schedule & Other Revisions to Part B for CY 2014". This proposed rule contains a number of provisions that may adversely impact the level of reimbursement for a variety of tests for which the Company receives reimbursement from the Medicare program beginning in 2014. Among other things, CMS has proposed examining approximately 1,200 laboratory tests that appear on the Clinical Lab Fee Schedule ("CLFS") over a period of five years to determine whether advances in technology may have reduced the cost of providing such tests and whether or not the level of reimbursement should be revised. The Company is currently performing molecular testing which is reimbursed using CPT codes that fall on the CLFS. CMS has also proposed changing the methodology used to determine reimbursement rates for the technical component of certain tests reimbursed off of the Physician Fee Schedule ("PFS"). Among other provisions, CMS has proposed limiting the Relative Value Units ("RVUs") ascribed to the Practice Expense component of their reimbursement formula for tests performed in "Non-Facilities" (which would include most clinical laboratories like the Company) to the RVUs that have been ascribed for the same procedures under the Hospital Outpatient Prospective Payment System, or the Ambulatory Payment Classification ("APC") system which are used to reimburse "Facilities" (such as hospitals and ambulatory surgery centers). The Company currently performs FISH testing, which may be impacted by this PFS rule change if it is enacted.

Additionally, CMS has as part of its regulatory structure the National Correct Coding Initiative ("NCCI"). Recent changes to NCCI guidance may reduce allowable quantities billed for FISH testing. These changes would lower reimbursement amounts for FISH tests, and there can be no assurance that CMS will make any modifications in the existing language of the NCCI documents.

A number of proposals for legislation or regulation continue to be under discussion which could have the effect of substantially reducing Medicare reimbursements for clinical laboratories or introducing cost sharing to beneficiaries. Depending upon the nature of regulatory action, if any, which is taken and the content of legislation, if any, which is adopted, the Company could experience a significant decrease in revenues from Medicare and Medicaid, which could have a material adverse effect on the Company. The Company is unable to predict, however, the extent to which such actions will be taken.

License Fees



We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from the University of Southern California ("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 with USC were $86,908 and $10,449 for the three months ended June 30, 2013 and 2014, respectively, and were $191,014 and $21,410 for the six months ended June 30, 2013 and 2014, respectively. We also maintain a non-exclusive license to use Roche Molecular Systems, Inc.'s ("Roche") 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 $84,362 and $113,704 for the three months ended June 30, 2013 and 2014, respectively, and were $174,507 and $158,077 for the six months ended June 30, 2013 and 2014, respectively.

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

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Accounts Receivable 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. Bad debts to date have been minimal and there is no allowance for doubtful accounts for our pharmaceutical revenue at December 31, 2013 and June 30, 2014.

We bill Medicare and private payors ("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, based on a detailed analysis, that accounts receivable associated with certain billings are unlikely to be collected. Therefore, we have recorded an allowance for doubtful accounts of $2,404,659 and $1,912,668 as of December 31, 2013 and June 30, 2014, respectively.

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



Quarters Ended June 30, 2014 and June 30, 2013

Revenue: Revenue was $4,281,235 for the quarter ended June 30, 2014, as compared to $5,313,914 for the quarter ended June 30, 2013, a decrease of $1,032,679 or 19.4%. The decrease was due solely to a decline in pharmaceutical revenue of $1,608,556 or 72.9% offset by an increase in ResponseDX® revenue of $575,876 or 18.5%. ResponseDX® revenue accounted for 86.0% of total revenue for the quarter ended June 30, 2014 compared to 58.5% for the quarter ended June 30, 2013. The decrease in pharmaceutical client revenue related to the completion of certain studies in earlier periods by pharmaceutical clients and the realization of a $500,000 milestone payment from GSK in the prior year quarter. The increase in ResponseDX® revenue primarily relates to our continued focus on marketing and sales activities, the introduction of new programs (where the Company performs the technical component of testing and the client physician performs the related professional interpretation), and the introduction of the Response DX: Tissue of OriginTM test.

Cost of Revenue: Cost of revenue for the quarter ended June 30, 2014 was $2,585,738 as compared to $2,707,966 for the quarter ended June 30, 2013, a decrease of $122,228 or 4.5%. Cost of revenue declined less than did revenue due to the fixed and semi-fixed nature of many of the cost items. The decrease in cost of revenue resulted primarily from lower laboratory supplies and reagents and royalties of $273,263 offset by higher depreciation of $52,106, rent of $36,452 and equipment maintenance, service and repair of $55,324. For items that increased, the higher costs resulted primarily from our expansion related to our new ResponseDX: Tissue of OriginTM test, which launched during the quarter ended March 31, 2014. Cost of revenue as a percentage of revenue was 60.4% for the quarter ended June 30, 2014, as compared to 51.0% for the quarter ended June 30, 2013.

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Sales and Marketing Expenses: Sales and marketing expenses were $1,283,080 for the quarter ended June 30, 2014, which was consistent with $1,321,760 for the quarter ended June 30, 2013. The major expenditures for sales and marketing activities in both periods were compensation and travel expenses.

General and Administrative Expenses: General and administrative expenses were $3,046,599 for the quarter ended June 30, 2014, as compared to $2,109,268 for the quarter ended June 30, 2013, an increase of $937,331 or 44.4%. This increase resulted primarily from higher bad debt expense of $1,017,855 offset by lower personnel costs of $119,875.

Research and Development Expenses: Research and development expenses were $473,324 for the quarter ended June 30, 2014, as compared to $447,686 for the quarter ended June 30, 2014, an increase of $25,638 or 5.7%. This increase resulted primarily from efforts to develop new tests and to enhance existing tests. The increase in expense was the result of higher legal fees of $149,046 offset by lower laboratory supplies and reagents costs of $77,969 and lower personnel costs of $54,599. We expect to continue to invest in research and development as we continue to work to develop additional aspects of our technology, introduce new tests and to study diagnostic indicators for various forms of cancer.

Other Income and Expense: Other income and expense primarily represents the interest expense we incur on our revolving credit facility with Silicon Valley Bank and equipment leases as well as realized and unrealized foreign currency exchange gains or losses on our Euro-denominated accounts receivable. Interest expense increased to $23,151 for the three months ended June 30, 2014 compared to $20,756 for the three months ended June 30, 2013. The increase was primarily due to new capital leases for equipment. Other expense increased to $8,260 for the three months ended June 30, 2014 compared to $3,634 for the three months ended June 30, 2013 due to higher realized foreign currency exchange losses.

Net Income/(Loss): As a result of the foregoing, our net loss increased by $1,841,761 to $3,138,915 for the three months ended June 30, 2014 as compared to a net loss of $1,297,154 for the three months ended June 30, 2013.

Six Months Ended June 30, 2014 and June 30, 2013

Revenue: Revenue was $8,176,169 for the six months ended June 30, 2014, as compared to $10,938,105 for the six months ended June 30, 2013, a decrease of $2,761,936 or 25.3%. The decline was solely the result of a decrease in pharmaceutical revenue of $3,472,868 or 74.7% offset by an increase in ResponseDX® revenue of $710,932 or 11.3%. The decrease in pharmaceutical client revenue related to the completion of certain studies by pharmaceutical clients. The increase in ResponseDX®revenue primarily relates to our continued focus on marketing and sales activities, the introduction of new programs (where the Company performs the technical component of testing and the client physician performs the related professional interpretation), and the introduction of the ResponseDX: Tissue of OriginTM test.

Cost of Revenue: Cost of revenue for the six months ended June 30, 2014 was $5,024,114 as compared to $5,241,688 for the six months ended June 30, 2013, a decrease of $217,574 or 4.2%. Cost of revenue declined less than did revenue due to the fixed and semi-fixed nature of many of the cost items and due to the launch of our ResponseDX: Tissue of OriginTM test in early 2014. The decrease resulted primarily from lower laboratory supplies and reagent costs of $599,369, royalties of $186,033 offset by higher depreciation of $102,694, personnel costs of $148,687, equipment maintenance, repair and service of $99,142, equipment operating leases of $56,979 and rent of $81,522. For items that increased, the higher costs resulted primarily from our expansion related to our new ResponseDX: Tissue of OriginTM test, which launched during the quarter ended March 31, 2014. Cost of revenue as a percentage of revenue was 61.4% for the six months ended June 30, 2014, as compared to 47.9% for the six months ended June 30, 2013.

Sales and Marketing Expenses: Sales and marketing expenses were $2,735,984 for the six months ended June 30, 2014, which was consistent with expenses of $2,763,995 for the six months ended June 30, 2013. The major expenditures for sales and marketing activities in both periods were compensation and travel expenses.

General and Administrative Expenses: General and administrative expenses were $6,060,556 for the six months ended June 30, 2014, as compared to $4,244,433 for the six months ended June 30, 2013, an increase of $1,816,123 or 42.8%. The increase resulted primarily from higher bad debt expense of $1,843,243.

Research and Development Expenses: Research and development expenses were $940,890 for the six months ended June 30, 2014, as compared to $744,886 for the six months ended June 30, 2013, an increase of $196,004 or 26.3%. This increase resulted primarily from higher laboratory supplies and reagents costs of $39,255 and higher legal expense of $141,291. We expect continued investment in research and development as we work to develop additional aspects of our technology, introduce new tests and to study diagnostic indicators for various forms of cancer.

Other Income and Expense: Other income and expense primarily represents the interest expense we incur on our revolving credit facility with Silicon Valley Bank and other equipment financing arrangements as well as our realized and unrealized foreign currency exchange gains or losses on our Euro-denominated receivables. Interest expense increased to $47,372 for the six months ended June 30, 2014 compared to $40,186 for the same period in 2013. The increase primarily relates to new capital leases for equipment. Realized and unrealized losses on currency exchange rate fluctuations decreased $13,753 for the six months ended June 30, 2014 to $10,667 compared to $24,420 for the same period in 2013. The decrease primarily relates to a decrease in unrealized foreign currency losses resulting from changes in the US dollar- Euro exchange rates.

Income Taxes: As of June 30, 2014 and 2013, we have incurred substantial losses and have generated no taxable income. Therefore, a full valuation allowance has been recorded for the deferred tax assets since we do not believe the recoverability of the deferred income tax assets in the near future is more likely than not.

Net Income/(Loss): As a result of the foregoing, our net loss increased by $4,521,953, or 213.2%, to $6,643,411 for the six months ended June 30, 2014 as compared to a net loss of $2,121,458 for the six months ended June 30, 2013.

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Liquidity and Capital Resources

We incurred a net loss of $6,643,411 during the six months ended June 30, 2014. Since our inception in September 1999, we have incurred cumulative losses and as of June 30, 2014, we had an accumulated deficit of $71,940,591. We have not yet achieved profitability and anticipate that we will likely incur additional losses. 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 intends to effectively manage cash flows in 2014 and 2015 and expects that cash and cash equivalents, as well as other available resources, 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, our line of credit, our credit facility and other financing opportunities. 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 which may have a material adverse effect on the Company.

On July 30, 2014, we entered into a credit agreement (the "SWK Credit Agreement") with SWK Funding LLC, as the agent (the "Agent"), and the lenders (including SWK Funding LLC) party thereto from time to time (the "Lenders"). The SWK Credit Agreement provides for a multi-draw term loan to the Company (the "Loan") for up to a maximum amount of $12,000,000 (the "Loan Commitment Amount"). On the Closing Date, the Lenders advanced the Company an amount equal to $8,500,000 which is due and payable on July 30, 2020 (the "Term Loan Maturity Date") or such earlier date on which the Loan Commitment Amount is terminated pursuant to the terms of the SWK Credit Agreement.

On July 14, 2011, the Company entered into a line of credit agreement with Silicon Valley Bank (the "Bank"), and on July 30, 2014, subsequent to the end of the quarter, the agreement was amended by the Waiver and Sixth Amendment to Loan and Security Agreement. The line of credit is collateralized by the Company's pharmaceutical, Private Payor and Medicare receivables. As of June 30, 2014, the amount the Company can draw from the line of credit was $2,000,000 calculated as the lesser of (i) the Company's calculated borrowing base, which was 80% of certain of the Company's accounts receivable, or (ii) the amount available under the credit line. As of June 30, 2014, the interest fees associated with this line of credit were set at the prime rate plus 1%. During the three and six months ended June 30, 2013 and 2014, the rate 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. As of December 31, 2013 and June 30, 2014, the Company had drawn $1,000,000 and $1,500,000, respectively, against the line of credit. The line of credit is subject to various financial covenants. As of June 30, 2014, the Company was in compliance with the covenants. Historically, however, the Company has been out of compliance with the covenants from time to time, and the Company has received waivers and forbearance agreements from the Bank.

As of December 31, 2013, the line of credit under the credit agreement with the Bank was classified as a non-current liability on the accompanying condensed consolidated balance sheets as the line of credit had a maturity date of March 7, 2015, which was greater than one year from the date of the balance sheet. As of June 30, 2014, the line of credit under the credit agreement was classified as a non-current liability because the Waiver and Sixth Amendment to Loan and Security Agreement (further described below) extended the maturity of the facility to July 25, 2016.

From time to time, the Company's calculated borrowing base under its Bank line of credit may decrease to a level where the Company is in an over-advance position in which case the Company will be required to repay any outstanding amounts greater than the calculated borrowing base for such covered period back to the Bank immediately. The Company will be able to draw down on the credit line again with respect to such paid back amount once the Company is in compliance with the borrowing base requirement.

On July 30, 2014, in connection with entering into SWK Credit Agreement, the Company and the Bank entered into a Waiver and Sixth Amendment to Loan and Security Agreement ("Sixth Amendment"). The Sixth Amendment waived previous defaults under the loan agreement, modified the financial covenants, extended the maturity of the loan to July 25, 2016, modified the interest rate to the prime rate published by the Wall Street Journal plus 2.25% per annum, and implemented a pre-payment fee of $40,000. The financial covenants under the Sixth Amendment include a revenue covenant and a liquidity covenant that conform with and are cross defaulted with the revenue covenant and liquidity covenant of the SWK Credit Agreement. The Company will pay a closing fee of $10,000 for the Sixth Amendment on July 18, 2015, approximately one year from the date of the closing.

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, the Company sold shares of its common stock during 2012 and 2013. In connection with certain of these offerings, the Company entered into registration rights agreements with the purchasers of the common shares which give such purchasers certain registration rights.

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February 2012 Private Placement

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

In connection with the February 2012 Private Placement, the Company also entered into registration rights agreements, each dated February 2, 2012, with the February Investors pursuant to which the Company agreed to file, within 90 days of the February Closing, a registration statement with the SEC to register the February Shares for resale, which registration statement was required to become effective within 180 days following the February Closing. The Company also granted the February 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 February Shares or the February Shares becoming eligible for sale under Rule 144(b)(1) without restriction.

Pursuant to the registration rights agreements dated February 2, 2012, the Company filed a registration statement with the SEC on April 30, 2012, to register the February Shares for resale. This registration statement became effective on May 17, 2012 and remained effective as of June 30, 2014.

September 2012 Private Placement

On September 13, 2012, the Company entered into a purchase agreement (the "Purchase Agreement") with Glaxo Group Limited, an affiliate of GSK (the "GSK Investor") and two existing investors, Swiftcurrent Partners, L.P. and Swiftcurrent Offshore, Ltd. (collectively with the GSK Investor, the "September Investors") for the private placement of an aggregate of 8,000,000 newly-issued shares of the Company's common stock (the "September Shares") at a purchase price of $1.10 per share (the "September 2012 Private Placement"). The Company raised gross cash proceeds of $8,800,000 in the September 2012 Private Placement, which closed on September 13, 2012 (the "Closing").

Pursuant to the Purchase Agreement, for so long as the GSK Investor or its affiliates own at least 50% of the September Shares it purchased pursuant to the Purchase Agreement, the GSK Investor has the right to designate one non-voting board observer (the "Board Observer"). The Board Observer, if appointed, has the right to attend all meetings of the Board of Directors of the Company and to receive all board meeting materials, subject to certain restrictions set forth in the Purchase Agreement. As of the date hereof, the GSK Investor has not exercised its right to designate the Board Observer.

In connection with the September 2012 Private Placement, the Company also entered into a registration rights agreement, dated September 13, 2012 (the "September Registration Rights Agreement"), with the September Investors pursuant to which the Company agreed to file, within 45 days of the Closing, a registration statement with the SEC to register the September Shares for resale, which registration statement was required to become effective within 180 days following the Closing. The Company also granted the September 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 stockholders until the earlier of the sale of all of the September Shares or the September Shares becoming eligible for sale under Rule 144(b)(1) without restriction.

Under the September Registration Rights Agreement, the Company is obligated to use commercially reasonable efforts to cause a registration statement to become effective and to remain continuously effective and to maintain the listing of the covered common stock on NASDAQ or other exchanges, as defined, for a period that will terminate upon the earlier of (i) the date on which all Registrable Securities covered by such Registration Statement as amended from time to time, have been sold, (ii) the date on which there are no longer any Registrable Securities outstanding or (iii) three years from the date of filing of such Registration Statement (the "Effectiveness Period") and advise each September Investor in writing when the Effectiveness Period has expired. "Registrable Securities" means (i) the September Shares and (ii) shares of capital stock or any other securities issued or issuable with respect to or in exchange for the September Shares; provided, that, a security shall cease to be a Registrable Security with respect to a September Investor upon (A) sale by such September Investor pursuant to a registration statement or Rule 144 under the Securities Act of 1933, or (B) such security becoming eligible for sale by such September Investor without restriction pursuant to Rule 144(b)(1). In the event the Company fails to satisfy its obligations under the September Registration Rights Agreement, the Company would be in breach of such agreement, in which event, the September Investors would be entitled to pursue all rights and remedies at law or equity including an injunction or other equitable relief. The September Registration Rights Agreement does not provide an explicitly stated or defined penalty due upon a breach. Because the potential penalty for any breach of the September 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, the Company was required to present the investment of approximately $8,800,000 in the Company's common stock as common stock outside of stockholders' equity in the accompanying consolidated balance sheet under ASC 480-10-S99-3, Classification and Measurement of Redeemable Securities.

Pursuant to the September Registration Rights Agreement, the Company filed a registration statement with the SEC on October 26, 2012, to register the September Shares for resale. This registration statement became effective on November 13, 2012 and remained effective as of June 30, 2014.

As of December 31, 2012, the Company had removed the restriction on 3,000,000 of the 8,000,000 September Shares and reclassified the shares to common stock from common stock classified outside of stockholders' equity. At June 30, 2014, the restriction was eligible for removal from the remaining 5,000,000 restricted September Shares. Therefore, as of December 31, 2013 and June 30, 2014, a total of $5,500,000 and $0, respectively, of common stock relating to restricted September Shares was classified outside of stockholders' equity related to this transaction.

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August 2013 Issuance of Registered Shares of Common Stock of the Company as Part of the Pathwork Assets Acquisition Purchase Price

On August 23, 2013, the Company entered into an asset purchase agreement (the "Pathwork Purchase Agreement") with Pathwork (assignment for the benefit of creditors), LLC ("Seller"), pursuant to which the Company acquired substantially all of the assets of Pathwork Diagnostics, Inc. ("Pathwork"), which had previously assigned all of its assets to Seller for the benefit of its creditors pursuant to a General Assignment, dated as of April 2, 2013. Pursuant to the Pathwork Purchase Agreement, the Company acquired the Pathwork assets for the following consideration: (i) an aggregate of 500,000 newly-issued registered shares of the Company's common stock valued at $1.96 per share, or $980,000, issued to two senior secured creditors of Pathwork which were designated by Seller in the Pathwork Purchase Agreement and (ii) a cash payment of $200,000 to Seller.

September 2013 Registered Direct Offering

On September 20, 2013, the Company entered into a definitive agreement with certain institutional investors for the sale of 932,805 shares of its common stock in a registered direct offering at a price of $2.05 per share (the "September 2013 Offering"). The September 2013 Offering was completed on September 25, 2013. Gross proceeds of the September 2013 Offering were $1,912,250. Net proceeds, after deducting the placement agent fee and the September 2013 Offering costs, were approximately $1.7 million.

December 2013 Underwritten Public Offering

On December 13, 2013, the Company entered into an underwriting agreement with National Securities Corporation (the "Underwriter"), pursuant to which the Underwriter agreed to purchase 4,464,443 shares of the Company's common stock (the "Shares") at the public offering price of $1.20 per share less an underwriting discount of 5%. The Shares were offered and sold by the Company pursuant to an effective registration statement on Form S-3 (File No. 333-171266) filed by the Company with the Securities and Exchange Commission on December 17, 2010, as amended, as supplemented by the prospectus supplement dated December 13, 2013 relating to the offering and the accompanying prospectus (the "December 2013 Offering"). The December 2013 Offering was completed on December 18, 2013. Gross proceeds of the December 2013 Offering were $5,357,332. Net proceeds, after deducting the placement agent fee and the December 2013 Offering costs, were approximately $4.8 million.

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Comparison of Cash Flows for the Six Months Ended June 30, 2013 and 2014

As of June 30, 2013, we had $8,148,599 in cash and cash equivalents, working capital of $9,693,565 and an accumulated deficit of $65,297,179. As of June 30, 2014, we had $2,136,623 in cash and cash equivalents, working capital of $4,199,139 and an accumulated deficit of $71,940,591.

Cash flows provided by operating activities

During the six months ended June 30, 2013, the Company used cash flows in operating activities of $2,832,754 compared to $6,279,368 used in the six months ended June 30, 2014. The increase in cash used in operating activities of $3,446,614 was due mainly to an increase in the net loss from $2,121,458 for the six months ended June 30, 2013 to $6,643,411 for the six months ended June 30, 2014. Other items that impacted cash flows from operating activities include increases in accounts receivable, prepaid expenses, royalties and payroll-related liabilities and decreases in accounts payable and accrued expenses.

The increase in accounts receivable related mainly to increases in Medicare and Private Payor receivables resulting from the recent changes to the molecular codes used for billing. It is anticipated that these billings will continue to take longer to collect in the short-term as a result of these recent changes.

Cash flows used in investing activities

Net cash used in investing activities was $236,803 for the six months ended June 30, 2013 and $135,023 for the six months ended June 30, 2014. The reduction in cash used in investing activities was primarily attributable to lower purchases of equipment and software.

Cash flows used in financing activities

Cash flows from financing activities for the six months ended June 30, 2013 used net cash of $88,104 for repayment of capital lease obligations. Cash flows from financing activities for the six months ended June 30, 2014 provided net cash of $425,616 as a result of drawing on the line of credit and receiving proceeds from stock option exercises net of repayment of capital lease obligations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which modifies how all entities recognize revenue, and consolidates into one Accounting Standards Codification ("ASC") Topic (ASC Topic 606, Revenue from Contracts with Customers) the current guidance found in ASC Topic 605, Revenue Recognition, and various other revenue accounting standards for specialized transactions and industries. The core principle of the guidance is that "an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services." In achieving this objective, an entity must perform five steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations of the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 also clarifies how an entity should account for costs of obtaining or fulfilling a contract in a new ASC Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers.

ASU 2014-09 is effective for public companies for annual periods beginning after December 15, 2016 and interim periods within those annual periods, and early adoption is not permitted. ASU 2014-09 may be applied using either a full retrospective approach, in which all years included in the financial statements are presented under the revised guidance, or a modified retrospective approach. Under the modified retrospective approach, financial statements will be prepared using the new standard for the year of adoption, but not for prior years. Under this method, entities will recognize a cumulative catch-up adjustment to the opening balance of retained earnings at the effective date for contracts that still require performance by the company and disclose all line items in the year of adoption as if they were prepared under the old revenue guidance. We will adopt ASU 2014-09 on January 1, 2017 and are currently evaluating the impact that this adoption will have on our consolidated financial statements. At this time, we have not determined the transition method that will be used.

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