UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
  FORM
10-Q
  xQuarterly Report Pursuant
to Section 13 or 15(d) of the Securities Exchange Act of
1934
  For the
quarterly period ended March 31, 2010
   ̈ Transition Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934
  For the
transition period from ____________ to ____________
  Commission
File No. 0-21537
  Pacific
Biomarkers, Inc.
 (Exact
name of registrant as specified in its charter)
 Delaware
              93-1211114(State
      or other jurisdiction of incorporation
                or
      organization)
              (I.R.S.
      Employer Identification No.)
 
 220
      West Harrison Street
                Seattle,
      Washington
              98119(Address
      of principal executive offices)
              (Zip
      Code)(206)
      298-0068
                (Registrant’s
      telephone number, including area
code)
 
 Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file for such reports), and (2) has been subject to
such filing requirements for the past 90 days.
 Yes  x  No   ̈
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 or Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
 Yes  x  No   ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large
      accelerated filer  ̈
              Accelerated
      filer  ̈Non-accelerated
      filer  ̈
              Smaller
      reporting company x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes   ̈  No  x
 
 As of May
10, 2010, there were 16,645,972 shares of the registrant’s common stock, $0.01
par value per share, outstanding.
  
 PACIFIC
BIOMARKERS, INC.





INDEX TO
FORM 10-Q





PagePART
      I - FINANCIAL INFORMATIONITEM
      1 - FINANCIAL STATEMENTSConsolidated
      Balance Sheets as of March 31, 2010 (unaudited) and June 30,
      2009
            4Consolidated
      Statements of Operations for the three- and nine-month periods ended March
      31, 2010 and March 31, 2009 (unaudited)
            5Consolidated
      Statements of Cash Flows for the nine-month periods ended March 31, 2010
      and March 31, 2009 (unaudited)
            6Notes
      to Consolidated Financial Statements (unaudited)
            7ITEM
      2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS
            14ITEM
      4T - CONTROLS AND PROCEDURES
            21PART
      II - OTHER INFORMATIONITEM
      5 - OTHER INFORMATION
            22ITEM
      6 - EXHIBITS
            22






- 2
-




EXPLANATORY
NOTE





Unless
otherwise indicated or the context otherwise requires, all references in this
Report to “we,” “us,” “our,” and the “Company” are to Pacific Biomarkers, Inc.
and our wholly-owned subsidiaries Pacific Biomarkers, Inc., PBI Technology,
Inc., and BioQuant, Inc.





CAUTIONARY
NOTE REGARDING FORWARD LOOKING STATEMENTS





This
Quarterly Report on Form 10-Q may contain a number of forward-looking
statements, including statements regarding:





·
            our
      working capital and cash flows and our estimates as to how long these
      funds will be sufficient to fund our
operations,


·
            our
      business development efforts and our expectations for future work orders
      for laboratory services and revenue
generation,


·
            our
      intentions for the expansion of the market for our services and products,
      including our expectations for our novel biomarker
    services,


·
            our
      goals for implementing aspects of our business plan and strategies,
      and


·
            our
      financing goals and plans





The
forward-looking statements in this Report reflect management’s current views and
expectations with respect to our business, strategies, services, future results
and financial performance. All statements other than statements of historical
fact, including statements addressing projected results of operations or our
future financial position, made in this Quarterly Report on Form 10-Q are
forward looking statements. In particular, the words “expect,” “anticipate,”
“estimate”, “desire”, “goal”, “ believe”, “may”, “will”, “should”, “could”,
“intend”, “objective”, “seek”, “plan”, “strive”, variations of such words, or
similar expressions, or the negatives of these words, are intended to identify
forward-looking statements, but are not the exclusive means of identifying
forward-looking statements. The absence of these words does not mean that any
particular statement is not a forward-looking statement.





These
forward-looking statements are subject to risks and uncertainties. Our actual
results, performance or achievements could differ materially from historical
results as well as those expressed in, anticipated or implied by these
forward-looking statements. We expressly disclaim any obligation or undertaking
to release publicly any updates or revisions to any forward-looking statements
contained in this Report to reflect any change in management’s expectations with
regard thereto or any change in events, conditions or circumstances on which any
such statement is based.





For a
discussion of some of the factors that may affect our business, results and
prospects, see the Risk Factors discussed in our Annual Report on Form 10-K for
the fiscal year ended June 30, 2009. These risks and uncertainties include, but
are not limited to, the concentration of our business with large clients, our
ability to develop new technology and introduce new products, competition,
fluctuations in general economic conditions, and changes in policies by
regulatory agencies. Readers are urged to carefully review and consider the
various disclosures made by us in this Report and in our other reports
previously filed with the Securities and Exchange Commission, including our
periodic reports on Forms 10-K, 10-Q and 8-K, and those described from time to
time in our press releases and other communications.




- 3
-




PACIFIC
      BIOMARKERS, INC.CONSOLIDATED
      BALANCE SHEETS
  March
      31,
                
                
                June
      30,ASSETS
                
                2010
                
                
                2009(unaudited)Current
      assets:Cash
      and cash equivalents
                
                $
                3,310,961
                
                
                $
                1,365,406Accounts
      receivable, net
                
                
                1,203,052
                
                
                
                2,238,912Inventory
                
                
                279,231
                
                
                
                171,885Prepaid
      expenses and other assets
                
                
                257,449
                
                
                
                239,974Total
      current assets
                
                
                5,050,693
                
                
                
                4,016,177Property
      and equipment, net
                
                
                1,135,372
                
                
                
                813,258Total
      assets
                
                $
                6,186,065
                
                
                $
                4,829,435LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                
                $
                664,156
                
                
                $
                678,818Accrued
      liabilities
                
                
                387,077
                
                
                
                660,284Advances
      from customers - current portion
                
                
                201,961
                
                
                
                155,471Capital
      lease obligation - current portion
                
                
                174,101
                
                
                
                62,709Secured
      note - current portion
                
                
                906,464
                
                
                
                —Total
      current liabilities
                
                
                2,333,759
                
                
                
                1,557,282Advances
      from customers - long - term portion
                
                
                272,032
                
                
                
                272,032Capital
      lease obligations - long - term portion
                
                
                396,373
                
                
                
                156,309Secured
      note - long - term portion
                
                
                2,924,657
                
                
                
                —Total
      liabilities
                
                
                5,926,821
                
                
                
                1,985,623Commitments
      and contingencies
                
                
                —
                
                
                
                —Stockholders'
      equity:Common
      stock, $0.01 par value, 30,000,000 shares authorized, 16,645,972 shares
      issued andoutstanding
      at March 31, 2010, 19,099,539  shares issued and
      outstandingat
      June 30, 2009
                
                
                166,459
                
                
                
                190,995Additional
      paid-in capital
                
                
                27,685,340
                
                
                
                29,121,334Accumulated
      deficit
                
                
                (27,592,555
                )
                
                
                (26,468,517
                )Total
      stockholders' equity
                
                
                259,244
                
                
                
                2,843,812Total
      liabilities and stockholders' equity
                
                $
                6,186,065
                
                
                $
                4,829,435
  The
accompanying condensed notes are an integral part of these consolidated
financial statements.
  - 4
-





PACIFIC
      BIOMARKERS, INC.CONSOLIDATED
      STATEMENTS OF OPERATIONS(unaudited)
  Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              
              
              March
      31,2010
              
              
              2009
              
              
              2010
              
              
              2009Revenues
              
              $
              2,233,698
              
              
              $
              2,853,222
              
              
              $
              6,648,868
              
              
              $
              7,889,177Laboratory
      expenses and cost of sales
              
              
              1,381,248
              
              
              
              1,638,950
              
              
              
              4,155,405
              
              
              
              4,312,554Gross
      profit
              
              
              852,450
              
              
              
              1,214,272
              
              
              
              2,493,463
              
              
              
              3,576,623Operating
      expenses:Selling,
      general and administrative
              
              
              1,090,497
              
              
              
              1,007,581
              
              
              
              3,252,255
              
              
              
              3,028,799Operating
      income (loss)
              
              
              (238,047
              )
              
              
              206,691
              
              
              
              (758,792
              )
              
              
              547,824Other
      income (expense):Interest
      expense
              
              
              (146,204
              )
              
              
              (10,503
              )
              
              
              (338,155
              )
              
              
              (150,189
              )Gain
      on adjustment of embedded and freestanding derivatives to fair
      value
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              675,691Amortization
      of deferred financing costs - secured convertible debt
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (18,447
              )Amortization
      of discount on debt
              
              
              (18,756
              )
              
              
              —
              
              
              
              (36,846
              )
              
              
              —Other
      income
              
              
              9,748
              
              
              
              1,620
              
              
              
              9,755
              
              
              
              113,863Total
      other income (expense)
              
              
              (155,212
              )
              
              
              (8,883
              )
              
              
              (365,246
              )
              
              
              620,918Net
      income (loss) before tax expense
              
              
              (393,259
              )
              
              
              197,808
              
              
              
              (1,124,038
              )
              
              
              1,168,742Tax
      expense
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Net
      income (loss)
              
              $
              (393,259
              )
              
              $
              197,808
              
              
              $
              (1,124,038
              )
              
              $
              1,168,742Net
      income (loss) per share:Basic
      income (loss) per share
              
              $
              (0.02
              )
              
              $
              0.01
              
              
              $
              (0.06
              )
              
              $
              0.06Diluted
      income (loss) per share
              
              $
              (0.02
              )
              
              $
              0.01
              
              
              $
              (0.06
              )
              
              $
              0.06Weighted
      average common shares outstanding:Basic
              
              
              16,628,576
              
              
              
              19,099,539
              
              
              
              17,742,801
              
              
              
              18,993,693Diluted
              
              
              16,628,576
              
              
              
              19,700,811
              
              
              
              17,742,801
              
              
              
              19,594,965
  The
accompanying condensed notes are an integral part of these consolidated
financial statements.




- 5
-




PACIFIC
      BIOMARKERS, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWS(unaudited)
  Nine
      Months EndedMarch
      312010
              
              
              2009Cash
      flows from operating activities:Net
      income (loss)
              
              $
              (1,124,038
              )
              
              $
              1,168,742Reconciliation
      of net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
              
              
              243,447
              
              
              
              192,000Accretion
      of fair value assigned to conversion feature and warrants
              
              
              —
              
              
              
              88,134Amortization
      of deferred financing costs on  secured convertible
      note
              
              
              —
              
              
              
              18,447Gain
      from embedded and freestanding derivative liabilities relating to
      secured  convertible note
              
              
              —
              
              
              
              (675,691
              )Amortization
      of fair value assigned to repurchased shares of common
    stock
              
              
              36,846
              
              
              
              —Discount
      accretion and premium amortization of held-to-maturity
      securities
              
              
              6,710
              
              
              
              —Warrant
      expense for equipment lease and financing
              
              
              —
              
              
              
              3,940Compensation
      expense from restricted shares and options
              
              
              73,694
              
              
              
              101,218Changes in assets and
      liabilities:Accounts
      receivable
              
              
              1,035,860
              
              
              
              363,064Other
      receivable
              
              
              2,500
              
              
              
              444,791Inventory
              
              
              (107,346
              )
              
              
              34,418Prepaid
      expenses and other assets
              
              
              (19,975
              )
              
              
              (35,134
              )Advances
      from customers
              
              
              46,490
              
              
              
              (72,380
              )Accounts
      payable
              
              
              (14,662
              )
              
              
              (221,355
              )Accrued
      liabilities
              
              
              (273,207
              )
              
              
              (61,060
              )Net
      cash  provided by (used in) operating activities
              
              
              (93,681
              )
              
              
              1,349,134Cash
      flows from investing activities:Purchases
      of capital equipment
              
              
              (95,103
              )
              
              
              (42,159
              )Purchases
      of investments
              
              
              (506,710
              )
              
              
              —Maturities
      of investments
              
              
              500,000
              
              
              
              —Net
      cash used in investing activities
              
              
              (101,813
              )
              
              
              (42,159
              )Cash
      flows from financing activities:Payments
      on notes payable
              
              
              —
              
              
              
              (869,136
              )Proceeds
      from loan
              
              
              4,000,000
              
              
              
              —Repurchases
      of common stock
              
              
              (1,674,335
              )
              
              
              —Restricted
      stock transferred for employee withholding tax liability
              
              
              (65,614
              )
              
              
              —Payments
      on capital lease obligations
              
              
              (119,002
              )
              
              
              (32,291
              )Net
      cash provided by (used in) financing activities
              
              
              2,141,049
              
              
              
              (901,427
              )Net
      increase in cash and cash equivalents
              
              
              1,945,555
              
              
              
              405,548Cash
      and cash equivalents, beginning of period
              
              
              1,365,406
              
              
              
              1,196,310Cash
      and cash equivalents, end of period
              
              $
              3,310,961
              
              
              $
              1,601,858Supplemental
      Information:Cash
      paid during the period for interest
              
              $
              264,850
              
              
              $
              61,993Cash
      paid during the period for income taxes
              
              $
              —
              
              
              $
              —Non-cash
      investing and financing activities:Capital
      expenditures funded by capital lease borrowings
              
              $
              470,458
              
              
              $
              142,058




- 6
-




PACIFIC
BIOMARKERS, INC.




CONDENSED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




1.
            Organization
      and Basis of Presentation





We
provide specialty reference laboratory services to the pharmaceutical,
biotechnology, and diagnostics industries. Our company was incorporated in
Delaware in May 1996. We conduct our business primarily through our wholly-owned
subsidiary, Pacific Biomarkers, Inc., a Washington corporation. Our two other
wholly-owned subsidiaries are PBI Technology, Inc., a Washington corporation,
and BioQuant, Inc., a Michigan corporation. All material intercompany balances
and transactions have been eliminated in the accompanying consolidated unaudited
interim financial statements.





Unaudited
interim financial statements include all adjustments such as normal recurring
accruals that are, in the opinion of management, necessary for a fair statement
of results of interim periods. Operating results for the three- and nine-month
periods ended March 31, 2010 are not necessarily indicative of the results that
may be expected for any future period. The accompanying unaudited financial
statements and related condensed notes should be read in conjunction with the
audited financial statements and notes thereto, for our fiscal year ended June
30, 2009, as previously reported in our annual report on Form 10-K.





2.
            Summary
      of Significant Accounting Policies





There
have been no significant changes in our significant accounting policies during
the nine-month period ended March 31, 2010 compared to what was previously
disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30,
2009.





Principles
of Consolidation





These
consolidated financial statements include our consolidated financial position,
results of operations, and cash flows. All material intercompany balances and
transactions have been eliminated in the accompanying consolidated financial
statements.





Cash
and Cash Equivalents





Cash and
cash equivalents consist of highly liquid investments with an original maturity
of three months or less when purchased.





Accounts
Receivable





Trade
accounts receivable are stated at amounts billed to and due from clients, net of
an allowance for doubtful accounts. Credit is extended based on evaluation of a
client’s financial condition, and collateral is not required. In determining the
adequacy of the allowance, management identifies specific receivables for which
collection is not certain and estimates the potentially uncollectible amount
based on the most recently available information. We write off accounts
receivable when they are determined to be uncollectible, and payments
subsequently received on such receivables are credited to the allowance for
doubtful accounts. At March 31, 2010, we deemed no account receivable
uncollectible.





Inventory





Inventory
is stated the lower of cost or market. Cost is determined on a first in, first
out (FIFO) basis. Our inventory consists of reagent chemicals used in our
laboratory testing.




- 7
-




Long
–Lived Assets





Property
and equipment are recorded at cost. Depreciation is provided using the
straight-line method over the useful lives of the related assets, which range
from three to five years. Leasehold improvements are amortized over the shorter
of the estimated useful life of the improvements or the remaining term of the
lease. The cost and related accumulated depreciation of property or equipment
sold or otherwise disposed of are removed from the accounts and the resulting
gains or losses are included in the statement of operations.





In
accordance with the guidance of the Financial Accounting Standards Board, all of
our long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate the carrying amount may not be recovered. If the sum of
the expected future cash flows is less than the carrying amount of the asset, a
loss is recognized. As of March 31, 2010 and 2009, no impairment was deemed
necessary.





Client
Advances





We
receive advances from certain clients to perform consulting, laboratory
services, and clinical studies. We apply these advances as payments to invoices
as work is completed until the amounts advanced are exhausted. Advances are also
applied to invoices for setup and administrative fees, billed upon contract
approval. These setup and administrative fees are deferred as unearned income
when billed and amortized over the life of the project.





Income
Taxes





We
recognize deferred tax assets and liabilities based on differences between the
financial reporting and tax bases of assets and liabilities using the enacted
tax laws and rates that are expected to be in effect when the differences are
expected to be recovered. We provide a valuation allowance for deferred tax
assets due to the uncertainty of realization.




Revenue
Recognition





We
recognize revenue in the period when the related services are performed and
collectability is reasonably assured.  Currently, we derive
substantially all of our revenues from laboratory services. Service contracts
generally take the form of fixed-price contracts. Under fixed-price contracts,
revenue is recognized as services are performed, with performance generally
assessed using output measures, such as units-of-work performed to date as
compared to the total units-of-work contracted. Changes in the scope of work
generally result in a renegotiation of contract pricing terms and/or a contract
amendment. Renegotiated amounts are not included in net revenues until earned,
and realization is assured. Advance payments on service contracts are treated as
a deposit and applied to periodic billing during the contract period. Setup and
administrative fees are billed upon contract approval. Revenues from setup and
administrative fees are amortized over the life of the contract. Historically,
costs are not deferred in anticipation of work on contracts after they are
awarded, but instead are expensed as incurred. All out-of-pocket costs are
included in expenses.




Net
Income (Loss) per Share





Basic
income (loss) per share is based upon the weighted average number of our
outstanding common shares. Diluted income (loss) per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options and warrants using the “treasury stock”
method, which excludes treasury shares. There were no treasury shares at March
31, 2010 or 2009.





For the
three- and nine-month periods ended March 31, 2010, we did not include common
stock equivalents related to our (i) in-the-money, vested options and (ii)
in-the-money warrants in the computation of diluted (loss) per share because we
had net losses in these periods and the effect would be anti-dilutive. For the
three- and nine-month periods ended March 31, 2009, we included common stock
equivalents related to our (i) in-the-money, vested options and (ii)
in-the-money warrants in our computation of diluted earnings per share. We
included these items because we had net income in each of these
periods.
  - 8
-




Components
of basic and diluted income (loss) per share were as follows for the three- and
nine-month periods ended March 31:




Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              
              
              March
      31,2010
              
              
              2009
              
              
              2010
              
              
              2009Net
      income (loss) (A)
              
              $
              (393,259
              )
              
              $
              197,808
              
              
              $
              (1,124,038
              )
              
              $
              1,168,742Net
      income (loss) applicable to common stockholders (B)
              
              $
              (393,259
              )
              
              $
              197,808
              
              
              $
              (1,124,038
              )
              
              $
              1,168,742Weighted
      average number of outstandingshares
      of common stock (C)
              
              
              16,628,576
              
              
              
              19,099,539
              
              
              
              17,742,801
              
              
              
              18,993,693Weighted
      average number of outstandingshares
      of common stock and common stock equivalents (D)
              
              
              16,628,576
              
              
              
              19,700,811
              
              
              
              17,742,801
              
              
              
              19,594,965Income
      (loss) per share:Basic     (B/C)
              
              $
              (0.02
              )
              
              $
              0.01
              
              
              $
              (0.06
              )
              
              $
              0.06Diluted 
      (A/D)
              
              $
              (0.02
              )
              
              $
              0.01
              
              
              $
              (0.06
              )
              
              $
              0.06


During
the nine-month period ended March 31, 2010, we repurchased 2,391,906 shares and
acquired 91,132 employee-owned shares, increasing our treasury stock to
2,483,038 shares. In December 2009 we retired all our treasury stock and this
stock is no longer considered treasury stock, but returned to authorized and
unissued stock. As most of the shares were repurchased during the quarter
endedSeptember 30,
2009, the weighted average number of common shares outstanding for the three-
and nine-month periods ended March 31, 2010 is significantly lower than the
weighted average number of common shares outstanding for the three- and
nine-month periods ended March 31, 2009.





Comprehensive
Income





We have
adopted current accounting standards for reporting comprehensive income and its
components in the financial statements.  Comprehensive income consists
of net income and other gains and losses affecting stockholders’ equity that,
under generally accepted accounting principles, are excluded from net income.
For the three- and nine-month period ended March 31, 2010, our comprehensive
loss equaled our net loss. Accordingly, a statement of comprehensive loss is not
presented.  For the three- and nine-month period ended March 31, 2009,
our comprehensive income equaled our net income. Accordingly, a statement of
comprehensive income is not presented.





Use
of Estimates





In
preparing financial statements in conformity with U.S. GAAP, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.





Accounting
Changes and Recent Accounting Pronouncements




Initial Application of
Accounting Standards





As of
March 31, 2010, we adopted the following accounting standards, none of which had
a material impact on our financial position, results of operations or cash
flows:





The
update issued by the Financial Accounting Standards Board (“FASB”) that revises
accounting and reporting requirements for arrangements with multiple
deliverables. This update allows the use of an estimated selling price to
determine the selling price of a deliverable in cases where neither
vendor-specific objective evidence nor third-party evidence is available, which
is expected to increase the ability for entities to separate deliverables in
multiple-deliverable arrangements and, accordingly, to decrease the amount of
revenue deferred in these cases. Additionally, this update requires the total
selling price of a multiple-deliverable arrangement to be allocated at the
inception of the arrangement to all deliverables based on relative selling
prices.




- 9
-





The
update issued by the FASB that clarifies which revenue allocation and
measurement guidance should be used for arrangements that contain both tangible
products and software, in cases where the software is more than incidental to
the tangible product as a whole. More specifically, if the software sold with or
embedded within the tangible product is essential to the functionality of the
tangible product, then this software, as well as undelivered related software
elements are excluded from the scope of existing software revenue guidance,
which is expected to decrease the amount of revenue deferred in these
cases.





The
update issued by the FASB that clarifies which entities are required to evaluate
subsequent events through the issuance of financial statements and the scope of
the disclosure requirements related to subsequent events. This amendment will
become effective for us with the annual reporting period ending June 30,
2010.





In April
2010, the FASB issued ASU No. 2010-17 which establishes authoritative guidance
permitting use of the milestone method of revenue recognition for research or
development arrangements that contain payment provisions or consideration
contingent on the achievement of specified events. This guidance is effective
for milestones achieved in fiscal years beginning on or after June 15, 2010 and
allows for either prospective or retrospective application, with early adoption
permitted. Management is currently evaluating the impact that adoption of this
guidance will have on the Company’s consolidated Financial
Statements.




Accounting Standards Issued
But Not Yet Effective





In
December 2009, the Financial Accounting Standards Board (“FASB”) issued an
accounting standard update, Transfers and Servicing (Topic 860) Accounting for
Transfers of Financial Assets. The amendments in this update to the Accounting
Standards Codification are the result of FASB Statement No. 166, Accounting for
Transfers of Financial Assets. We believe adoption of this new guidance will not
have a material impact on our financial statements.





In
December 2009, the Financial Accounting Standards Board (“FASB”) issued an
accounting standard update for improvements to financial reporting by
enterprises involved with Variable Interest Entities. The new guidance includes
revised evaluations of whether entities represent variable interest entities and
additional disclosures for variable interests. We believe adoption of this new
guidance will not have a material impact on our financial
statements.





In
January 2010, the Financial Accounting Standards Board (“FASB”) issued an
accounting standard update, Fair Value Measurements and Disclosures (Topic 820),
Improving Disclosures about Fair Value Measurements. The Update would affect all
entities that are required to make disclosures about recurring and nonrecurring
fair value measurements. The Board concluded that users will benefit from
improved disclosures in this Update and that the benefits of the increased
transparency in financial reporting will outweigh the costs of complying with
the new requirements. The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures about purchases, sales,
issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. Those disclosures are effective for fiscal years beginning after
December 30, 2010, and for interim periods within those fiscal years. We are
currently evaluating the impact this update will have on our consolidated
financial statements.





In
January 2010,  the Financial Accounting Standards Board (“FASB”)
issued an accounting standard update to address implementation issues related to
the changes in ownership provisions in the Consolidation—Overall Subtopic
(Subtopic 810-10) of the FASB
Accounting Standards CodificationTM, originally issued as FASB Statement
No. 160, Noncontrolling
Interests in Consolidated Financial Statements.Subtopic 810-10
establishes the accounting and reporting guidance for noncontrolling interests
and changes in ownership interests of a subsidiary. The
amendments in this update are effective beginning in the period that an entity
adopts Statement 160 (now included in Subtopic 810-10).  If an entity
has previously adopted Statement 160 as of the date of the amendments in this
update are included in the Accounting Standards Codification, the amendments in
this update are effective beginning in the interim or annual reporting period
ending on or after December 31, 2009. The amendments in this update should be
applied retrospectively to the first period that an entity adopted 160. We are
currently evaluating the impact this update will have on our consolidated
financial statements.




- 10
-





Other
recent accounting pronouncements issued by the FASB, the American Institute of
Certified Public Accountants ("AICPA"), and the SEC did not or are not believed
by management to have a material impact on our present condensed consolidated
financial statements.





3.
            Concentration
      of Credit Risk





Our
largest client in the quarter ended March 31, 2010 accounted for approximately
34% of our total revenues, while our largest client in the quarter ended March
31, 2009 accounted for approximately 21% of our total revenues. As of March 31,
2010 and 2009, approximately 40% and 18% of our accounts receivable balance was
from the two largest clients at that time. The first largest client was the same
in each fiscal period and the second largest client was different. Component
clients included in the largest client calculation may vary from period to
period.





The
majority of our clients are pharmaceutical companies, many of which are on the
list of Fortune 1000 companies. For our revenue calculations, we aggregate
revenues we receive from several divisions within a pharmaceutical company
client as one single client.  For the quarter ended March 31, 2010,
71% of our revenue was derived from Fortune 1000 clients compared to 70% for the
quarter ended March 31, 2009. We believe that our exposure to concentration of
credit risk is very low considering the financial strength of our
clients.





We
maintain cash in three insured commercial accounts and one uninsured investment
account at major financial institutions. Although the financial institutions are
considered creditworthy and have not experienced any losses on client deposits,
our cash balance exceeded Federal Deposit Insurance Corporation (FDIC) limits
by $2,810,961 at March 31, 2010 and by $1,101,858 at March 31, 2009.
Management will continue to monitor the creditworthiness of the financial
institutions holding our deposits. FDIC limits were increased from $100,000 per
insured account to $250,000 per insured account effective October 10, 2008. The
new FDIC limits expire on December 31, 2013.





4.
            Fair
      Value Measurements





We follow
ASC Topic 820 and 825, (SFAS 157, Fair Value Measurements) which clarify a
number of considerations with respect to fair value measurement objectives for
financial reporting and expand disclosures about the use of fair value
measurements. The guidance regarding fair value measurements is intended to
increase consistency and comparability among fair value estimates used in
financial reporting. The disclosure requirements are intended to provide users
of financial statements with the ability to assess the reliability of an
entity's fair value measurements.




Definition of Fair
Value





Fair
value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date and, therefore, represents an exit price, not an entry price.
We hold or have held fixed maturities, equity securities, derivatives, and
embedded derivatives, which are carried at fair value.





The
degree of judgment utilized in measuring the fair value of financial instruments
is largely dependent on the level to which pricing is based on observable
inputs. Observable inputs reflect market data obtained from independent sources,
while unobservable inputs reflect our view of market assumptions in the absence
of observable market information. Financial instruments with readily available
active quoted prices would be considered to have fair values based on the
highest level of observable inputs, and little judgment would be utilized in
measuring fair value. Financial instruments that rarely trade would be
considered to have fair value based on a lower level of observable
inputs, and more judgment would be utilized in measuring fair
value.




Debt Financing – Fair Value
of Repurchased Shares





We
applied ASC Topic 820 and 825 (SFAS 157, Fair Value Measurements) to assess the
fair value of 2,391,906 shares of common stock that we repurchased during the
first quarter of fiscal 2010.  On September 1, 2009, we obtained
$4,000,000 in debt financing, and pursuant to the terms of the loan agreement,
we were required to use a portion of the loan proceeds to repurchase 2,391,906
shares of common stock at an aggregate price of $1,674,334 ($0.70 per
share).




- 11
-





We
recorded the repurchased shares on our balance sheet as treasury stock having a
fair value of $1,468,609.  We determined fair value using a bid-ask
regression model which uses Level 2 inputs for the determination of fair value,
which take into account the quoted market price of the common stock. We recorded
$205,725 on our balance sheet as a discount on the secured note, representing
the difference between the fair value of the common stock repurchased
($1,468,609) and the repurchase price ($1,674,334). The discount on the Note is
being amortized as interest expense using the effective interest method over the
48-month term of the Note (approximately $13,000 per quarter, currently;
declining with principal payments over time). At March 31, 2010, the
unamortized discount on the Note was approximately $169,000.





5.
            Stock
      Based Compensation





We
granted 87,500 restricted shares to directors under our stock incentive plan
during the three-month period ended March 31, 2010. We did not grant any
equity-based payment awards during the three-month period ended March 31, 2009.
For the comparable nine-month periods, we granted to certain officers, directors
and employees 293,000 restricted shares and 351,700 stock options in the
nine-month period ended March 31, 2010, compared to 179,392 restricted shares
and 192,000 stock options in the nine-month period ended March 31,
2009.





Stock
Options





We use
the Black-Scholes option-pricing model to estimate the calculated value of our
share-based payments. Stock options are valued as of the date of grant. The
volatility assumption used in the Black-Scholes formula is based on the
volatility of our common stock. We used the following assumptions to compute the
fair value of option grants for the nine-month periods ended March
31:




2010
              
              
              2009Expected
      volatility
              
              
              132-148
              %
              
              
              108.76
              %Expected
      dividend yield
              
              
              0.00
              %
              
              
              0.00
              %Risk-free
      interest rate
              
              
              3.21-3.85
              %
              
              
              3.85
              %Expected
      life
              
              10
      years
              
              
              10
      years


The
weighted average fair value on the date of the option grant was $74,796 for the
options granted in July 2009 and $174,000 for the options granted in October
2009. The total weighted average fair value for the nine-month period ended
March 31, 2010 was $248,796. The total unrecognized share-based compensation
costs related to non-vested stock options outstanding at March 31, 2010 was
$226,261 and is expected to be recognized over a weighted average period of
approximately 2.1 years.




A summary
of option activity from July 1, 2009 through March 31, 2010 is presented
below:




Number
      of
              Options
            
            
            Weighted
              Average
      Exercise
              Price
      per shareOptions
      outstanding at July 1, 2009
            
            
            1,549,815
            
            
            $
            0.76Granted
            
            
            351,700
            
            
            
            0.76Forfeited
            
            
            (14,359
            )
            
            
            0.72Exercised
            
            
            —
            
            
            
            —Options
      outstanding at March 31, 2010
            
            
            1,887,156
            
            
            
            0.76Exercisable
      outstanding at March 31, 2010
            
            
            1,515,614
            
            
            $
            0.78







- 12
-




Restricted
Stock





We
granted Restricted Stock, which we refer to as RS, to certain officers and
employees under our stock incentive plan. All RSs vest on the three- or
five-year anniversary of the date of grant. Our Board of Directors approved RS
agreement amendment extending certain existing and new RS grants from three-year
to five-year vesting effective March 29, 2010. The fair value of our RS is based
on the grant-date fair market value of the common stock, which equals the grant
date market price. As of March 31, 2010, we had $166,547 of unrecognized
compensation cost related to nonvested RS awards and it is expected to be
recognized over a weighted average period of approximately 2.5
years.





A summary
of RS activity from July 1, 2009 through March 31, 2010 is presented
below:





Number
      of
              RS
      awards
            
            
            Weighted
              Average
      Grant
              Date
      Fair Value
              per
      shareRS
      nonvested at July 1, 2009
            
            
            —
            
            
            
            —Granted
            
            
            293,000
            
            
            
            0.63Vested
            
            
            29,471
            
            
            
            0.67Forfeited
            
            
            —
            
            
            
            —RS
      nonvested at March 31, 2010
            
            
            263,529
            
            
            $
            0.63




Compensation
expense for share-based awards for the three- and nine-month periods ended March
31, 2010 and 2009 was included in our consolidated statements of operations as
follows:




Three
      months ended
            
            
            Nine
      months endedMarch
      31, 2010
            
            
            March
      31, 2009
            
            
            March
      31, 2010
            
            
            March
      31, 2009Cost
      of sales
            
            $
            1,344
            
            
            $
            2,791
            
            
            $
            4,872
            
            
            $
            10,222Selling
      and administrative expenses
            
            
            22,760
            
            
            
            7,942
            
            
            
            68,822
            
            
            
            90,996Total
      compensation expense
            
            $
            24,104
            
            
            $
            10,733
            
            
            $
            73,694
            
            
            $
            101,218











- 13
-




ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.





Investors
should read the following discussion and analysis in conjunction with our
consolidated financial statements and related notes in this Form 10-Q and our
audited financial statements and related notes for the year ended June 30, 2009,
included in our Annual Report on Form 10-K.





Overview





We
provide specialty laboratory services to support pharmaceutical, biotechnology
and laboratory diagnostic manufacturers in the conduct of human clinical
research, for use in their drug and diagnostic product development efforts. Our
clients include a number of the world’s largest multi-national pharmaceutical,
biotechnology and diagnostic companies. Our well-recognized specialty areas
include cardiovascular disease (dyslipidemia, atherosclerosis, and coronary
heart disease), diabetes (and obesity), and bone and joint diseases
(osteoporosis as well as osteo and rheumatoid arthritis). Coupled with our
specialty testing, we have central laboratory capability and provide
full-service central laboratory support for multi-center clinical trials. We
also provide clinical biomarker services to our pharmaceutical and biotechnology
clients, including assay development services for novel biomarkers and custom
assay services for immunogenicity testing and multiplex testing.





Management
has reviewed recent developments in the drug development market. These changes
–
specifically, continued consolidation, cost reductions and the use of adaptive
clinical trials have impacted current and have the potential to significantly
impact future revenues. We have observed a number of current studies being
postponed, suspended or terminated. We believe that there will be continued
uncertainty about the significance of these developments, potential effects on
our future business and revenue, driven by the drug development activities by
pharmaceutical, biotechnology and diagnostic companies.  The move to
adaptive clinical trials has reduced the total dollar value of our backlog of
signed contracts by aggregating shorter term and lower dollar
contracts.  Reduction in revenue is a trend reported by most of the
major Contract Research Organizations (CRO’s) since the economic downturn began
in 2008. This trend is the primary reason for the reduction in our third quarter
revenue. Nevertheless, we believe that we are well positioned in the lab
services and biomarker development market to take advantage of new compounds
coming into the drug development pipeline that may mitigate these
changes.  Indeed, we are involved with many top pharmaceutical
companies in providing testing services and biomarker development for their new
drugs due to a by-product of these changes:  increased out-sourcing of
assay development and testing services.





Our
company is a Delaware corporation, incorporated in May 1996, and we conduct our
operations primarily through our wholly-owned subsidiary, Pacific Biomarkers,
Inc., a Washington corporation.





Critical
Accounting Policies and Estimates





There
have been no material changes to our critical accounting policies and estimates
since the end of our 2009 fiscal year. For detailed information on our critical
accounting policies and estimates, see our financial statements and notes
thereto included in this Report and our Annual Report on Form 10-Kfor the fiscal year
ended June 30, 2009.





The
discussion and analysis of our financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with U.S. GAAP. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenue and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our estimates
including, among others, those affecting revenue, the allowance for doubtful
accounts, and the useful lives of tangible and intangible assets. The discussion
below is intended as a brief discussion of some of the judgments and
uncertainties that can impact the application of these policies and the specific
dollar amounts reported on our financial statements. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form our basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources.  Actual results may differ
from these estimates under different assumptions or conditions, or if management
made different judgments or utilized different estimates. Many of our estimates
or judgments are based on anticipated future events or performance, and as such
are forward-looking in nature, and are subject to many risks and uncertainties,
including those discussed below and elsewhere in this Report. We do not
undertake any obligation to update or revise this discussion to reflect any
future events or circumstances.




- 14
-





We have
identified below some of our accounting policies that we consider critical to
our business operations and the understanding of our results of operations. This
is neither a complete list of all of our accounting policies, nor does it
include all the details surrounding the accounting policies we have identified.
There are other accounting policies that are significant to us. For a more
detailed discussion on the application of these and our other accounting
policies, see Note 2 to our Consolidated Financial Statements included in this
Report and Note 2 to our Consolidated Financial Statements included in our
Annual Report on Form 10-K for the fiscal year ended June 30, 2009.





Revenue
Recognition





Under
fixed-price contracts, we recognize revenue as services are performed, with
performance generally assessed using output measures, such as units-of-work
performed to date compared to the total units-of-work contracted. Our client
contracts may be delayed or cancelled at any time. Uncertainty surrounding
continuation of existing revenues during any period is high. We believe that
recognizing revenue as services are performed is the most appropriate method for
our business as it directly reflects services performed in the laboratory. We
would expect material differences in reporting of our revenues to occur if we
changed our assumptions for revenue recognition from services performed to other
methods such as percent complete or completed contract methods. While both other
methods are allowed under GAAP, they would introduce more variables and
estimates into our revenue recognition process. The percent complete method
introduces estimated costs early in the process that may drive revenues higher
in early periods, and in the event that the study is terminated early,
previously recognized revenue would be reversed, net of a cancellation fee, if
applicable. The completed contract method may recognize revenues in future
contract periods, such as the first quarter after a fiscal year close and
subsequent to completion of the services rendered.




Fair
Value Measurements - Debt Financing





We follow
ASC Topic 820 and 825, (SFAS 157, Fair Value Measurements) in determining the
fair value in our recent repurchase of shares of common stock. SFAS 157
clarifies a number of considerations with respect to fair value measurement
objectives for financial reporting and expands disclosures about the use of fair
value measurements. The degree of judgment utilized in measuring the fair value
of financial instruments is largely dependent on the level to which pricing is
based on observable inputs. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect our view of market
assumptions in the absence of observable market information. See Note 4 to our
Consolidated Financial Statements. In valuing the repurchased shares from our $4
million debt financing in September 2009, we chose a bid-ask regression model as
the most appropriate method to determine the fair value of these shares. We
would expect material differences in reporting of the fair value of these
shares, had we chosen other methods in determining the fair value. The discount
to the Note derived from the fair value of the shares and interest expense
derived from the discount may have been a higher or lower amount. For example, a
regression model based on restricted share regression analysis would produce a
higher discount amount. Alternatively, had we chosen the market closing price
for fair value, the discount would have been zero. However, due to the thin
trading characteristics of our stock within the OTCBB market, the number of
shares repurchased, other observable and unobservable inputs, it was our
judgment that the method utilized in estimating the fair value of these shares
was appropriate for this transaction.




Stock-Based
Compensation Expense





Effective
January 1, 2006, we adopted the provisions of ASC Topic 718 (SFAS No. 123(R),
Share-Based Payment), using the modified prospective transition method. This
requires companies to estimate the fair value of equity-based payment awards on
the date of grant using an option-priced model. The value of the portion of the
award that is ultimately expected to vest is recognized as an expense over the
requisite service periods in our consolidated income statements. Determining the
fair value of equity-based awards at the grant date requires judgment. In
addition, judgment is also required in estimating the amount of equity-based
awards that are expected to be forfeited.  If actual results differ
significantly from these estimates, equity-based compensation expense and our
results of operations could be materially impacted.




- 15
-




Results
of Operations for Three- and Nine-Month Periods Ended March 31, 2010 and
2009





Revenue:




Dollars
      in thousands, rounded to nearest thousand
              Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              $
              %
              March
      31,
              $
              %2010
              2009
              Change
              Change
              2010
              2009
              Change
              ChangeRevenue
              $2,234
              $2,853
              (619)
              (22)
              $6,649
              $7,889
              (1,240)
              (16)


We
generate the majority of our revenue from clinical pharmaceutical trials testing
(“traditional biomarker services”) and novel biomarker development
services.  We also provide diagnostic services, which historically
have represented less than 1% of our total revenue.





Our
revenue decreased approximately 22% to $2,234,000 from $2,853,000 between the
comparable quarters ended March 31, 2010 and 2009. For the quarter ended March
31, 2010, our revenue was negatively impacted by delays and cancellations of
testing in the diabetes and rheumatoid arthritis therapeutic areas. In contrast,
during the quarter ended March 31, 2009, we benefited from strong levels of
testing revenue in the diabetes and rheumatoid arthritis therapeutic areas in
both the second and third quarters of that fiscal year. Our revenue fluctuates
due to the variability in the volume of testing services we perform, and by the
timing between our testing work and open work orders, and prior work orders
having been completed or terminated.





For the
nine-month periods ended March 31, 2010 and 2009, our revenue decreased
approximately 16% to $6,649,000 from $7,889,000 between the comparable
periods.  While the first quarter this year was well above the
comparable quarter during fiscal 2009, the second and third quarters have been
below fiscal 2009 results.  During the second and third quarters of
fiscal 2010, we did not sign any new contracts such as we did late in the
quarter in December 2008, instead we saw a number of studies being postponed,
suspended or terminated.





We
perform services for pharmaceutical and biotech companies, which include our
traditional biomarker services (consisting of direct trials testing and referral
trials testing for other large clinical laboratories that refer specialty
laboratory testing to us) and our novel biomarker development services. The
following table provides a breakdown of the percentage of our total revenue
generated from these service areas for the comparable three- and nine- month
periods ended March 31, 2010 and 2009:





Traditional
      Biomarker Services
            Novel
      BiomarkerDirect
      Trials
              Testing
            Referral
      Trials
              Testing
            Development
              ServicesThree
      months EndedMarch
      31, 2010
            49%
            41%
            10%March
      31, 2009
            61%
            35%
            4%Nine
      months EndedMarch
      31, 2010
            50%
            37%
            13%March
      31, 2009
            53%
            41%
            6%





We
believe that the overall decrease in revenue for the periods ended March 31,
2010 reflects ongoing changes in the drug development marketplace, including
cancellations and delays. We have continued to increase our investments in
business development initiatives over several fiscal years and will continue
this strategy, particularly directed towards direct trials testing and novel
biomarker development services. We have seen growth in our biomarker services
area and we expect to see our biomarker services represent a larger portion of
our revenue during fiscal 2010. As discussed in our Annual Report on Form 10-K
for the 2009 fiscal year, we are continuing to monitor and evaluate the shift in
the industry to “adaptive clinical trials” and how this change is impacting us
now as well as going forward.




- 16
-





Our
revenues tend to fluctuate from quarter to quarter, and at times these
fluctuations are significant. These fluctuations are typically explained by the
timing of entering into new contracts for clinical studies and our work on
testing and open work orders, and the completion of prior work orders or early
cancellation of studies by our clients.  The studies that we bid on
are uncertain until we have a signed contract. Once our work on a study
commences, the client may cancel the study at any time during the testing phase.
Clients may terminate, delay, or change the scope of a project for a variety of
reasons including unexpected or undesirable clinical results or a decision to
forego a particular study.  Accordingly, our revenues may be
significantly affected by the success or failure of the testing phase and other
factors outside of our control, including a large number of pharmaceutical
companies’ cost reduction announcements and continuing consolidation in the
biopharmaceutical market.





Laboratory
Expense and Cost of Goods Sold:




Dollars
      in thousands, rounded to nearest thousand
              Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              $
              %
              March
      31,
              $
              %2010
              2009
              Change
              Change
              2010
              2009
              Change
              ChangeLaboratory
      Expenses and Cost of Goods Sold
              $1,381
              $1,639
              (258)
              (16)
              $4,155
              $4,313
              (158)
              (4)Percentage
      of Revenue
              62%
              57%
              
              
              62%
              55%


Laboratory
expense and cost of goods sold consist primarily of salaries and related
benefits to employees performing analysis of clinical trial samples and the cost
of chemical reagents and supplies for analysis ofclinical trialsamples, and
secondarily, of payments to subcontractors for laboratory services, rent,
insurance, business and occupation taxes. We consider rent, insurance and
certain taxes as “fixed” costs, in that they are generally a constant expense
regardless of the level of our services.  In contrast, salaries and
benefits, reagent costs and other similar expenses are “variable” costs in that
they fluctuate depending on the mix of services we provide in any given period,
the overall volume of tests performed, the use of new and highly complex assays
and the volume of subcontracted laboratory services.





For the
comparable quarters ended March 31, 2010 and 2009, laboratory expense and cost
of goods sold decreased by approximately $258,000, or 16%, to $1,381,000, down
from $1,639,000. Laboratory expense and cost of goods sold as a percentage of
revenue was approximately 62% for the quarter ended March 31, 2010 and 57% for
2009. This is reflective of our decrease in revenue, increases in salaries and
related benefits and fixed costs; including an increase in rent from our lease
for laboratory space for biomarker development. The dollar decrease in
laboratory expense and cost of goods sold was due to a decrease in variable
costs of laboratory reagents and other variable costs.





For the
nine-month periods ended March 31, 2010 and 2009, laboratory expense and cost of
goods sold decreased by approximately $158,000 or 4%, to $4,155,000, down from
$4,313,000. Laboratory expense and cost of goods sold as a percentage of revenue
was approximately 62% for the nine-months ended March 31, 2010 and 55% for 2009.
While we had a decrease in variable costs of laboratory reagents and other
variable costs for the nine-month period ended March 31, 2010, our salaries and
related benefits and fixed costs increased due to increased staffing and
laboratory expansion for biomarker development work.




- 17
-





The
following tables illustrate changes in laboratory expense and cost of goods sold
in fixed and variable expense categories for the comparable three- and
nine-month periods:




Dollars
      in thousands, rounded to nearest thousand
            Three
      Months EndedMarch
      31,
            $
            %2010
            %
      of revenue
            2009
            %
      of revenue
            Change
            ChangeFixed
      Cost DetailRent,
      Utilities, Certain Taxes
            $        174
            8%
            $        141
            5%
            $          33
            23%Variable
      Cost DetailWages,
      Taxes, Benefits
            667
            30%
            639
            22%
            28
            4%Reagent
      Chemicals
            426
            19%
            626
            22%
            (200)
            (32)%Other
      Variable Costs
            114
            5%
            233
            8%
            (119)
            (51)%Total
            1,207
            54%
            1,498
            52%
            (291)
            (19)%Total
      Cost of Goods Sold
            $     1,381
            62%
            $     1,639
            57%
            $      (258)
            (16)%






Dollars
      in thousands, rounded to nearest thousand
              Nine
      Months EndedMarch
      31,
              $
              %2010
              %
      of revenue
              2009
              %
      of revenue
              Change
              ChangeFixed
      Cost DetailRent,
      Utilities, Certain Taxes
              $        510
              8%
              $        388
              5%
              $        122
              31%Variable
      Cost DetailWages,
      Taxes, Benefits
              1,949
              29%
              1,739
              22%
              210
              12%Reagent
      Chemicals
              1,287
              19%
              1,689
              21%
              (402)
              (24)%Other
      Variable Costs
              409
              6%
              497
              7%
              (88)
              (18)%Total
              3,645
              54%
              3,925
              50%
              (280)
              (7)%Total
      Cost of Goods Sold
              $     4,155
              62%
              $     4,313
              55%
              $      (158)
              (4)%


The
largest component of laboratory expense for the quarter and nine-month period
ended March 31, 2010 was salaries and related benefits. Laboratory salaries and
related benefits increased in the quarter and nine-month period ended March 31,
2010 compared to the comparable periods in fiscal 2009. In order to accommodate
increases in the complexity of tests performed and biomarker development, we
increased our laboratory staff from 45 FTE to 49 FTE. Laboratory salaries and
related benefits increased 4% to approximately $667,000 from $639,000 for the
quarters ended March 31, 2010 and 2009. These expenses represented approximately
30% and 22%, respectively, as a percentage of revenue for the comparable
periods. For the nine-month periods ended March 31, 2010 and 2009, our
laboratory salaries and related benefits increased 12% to approximately
$1,949,000 from $1,739,000. These expenses represented approximately 29% and
22%, respectively, as a percentage of revenue for the comparable
periods.





The other
major component of laboratory expense for the quarter and nine-month period
ended March 31, 2010 was the cost of laboratory reagents and supplies for
analysis of clinical trial samples. Over the last three fiscal years, reagent
chemicals used in our laboratory testing have averaged approximately 20% in cost
as a percentage of revenue, but may vary considerably depending on the type of
lab testing we perform, and constitute a significant expense item for our
business. Laboratory reagent expense decreased in the quarter and nine-month
period ended March 31, 2010 compared to the comparable periods in fiscal 2009 as
a result of a decrease in the number of tests performed. During the comparable
quarters ended March 31, 2010 and 2009, laboratory reagents and supplies
decreased by 32% to approximately $426,000 from $626,000. This reduction is also
driven down somewhat by the biomarker development business as
it requires less laboratory reagents and supplies to operate. The cost
of laboratory reagents and supplies as a percentage of revenue was approximately
19% and 22% for the comparable quarters ended March 31, 2010 and 2009. For the
nine-month periods ended March 31, 2010 and 2009, laboratory reagents and
supplies decreased by 24% to approximately $1,287,000 from $1,689,000. The cost
of laboratory reagents and supplies as a percentage of revenue was approximately
19% and 21% for the comparable nine-month periods ended March 31, 2010 and
2009.




- 18
-





Other
variable costs decreased 51% for the comparable quarters ended March 31, 2010
and 2009, to $114,000 from $233,000. Other variable costs decreased 18% for the
comparable nine-month periods ended March 31, 2010 and 2009, to $409,000 from
$497,000. The decrease was primarily due to decreases in outside service costs.





Fixed
costs for the quarter ended March 31, 2010 increased 24% compared to the quarter
ended March 31, 2009, to approximately $174,000 from $141,000. Fixed costs for
the nine-month period ended March 31, 2010 increased 32% compared to the
nine-month period ended March 31, 2009, to approximately $510,000 from $388,000.
This increase was mainly due to increases in depreciation expense, rent and
insurance liability.





Selling,
General and Administrative Expense:




Dollars
      in thousands, rounded to nearest thousand
              Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              $
              %
              March
      31,
              $
              %2010
              2009
              Change
              Change
              2010
              2009
              Change
              ChangeSelling,
      General and Administrative Expense
              $1,090
              $1,008
              82
              8
              $3,252
              $3,029
              223
              7Percentage
      of Revenue
              49%
              35%
              
              
              49%
              38%


Our
selling, general and administrative expense consists primarily of compensation
for our executive officers, board members and other selling, general and
administrative personnel (including those in business development, laboratory
administration, and our science and technology department), and secondarily of
share-based compensation, business development expenses, legal, accounting and
public company expenses.





For the
comparable quarters ended March 31, 2010 and 2009, our selling, general and
administrative expense increased 8% to approximately $1,090,000, up from
$1,008,000. As a percentage of revenue, selling, general and administrative
expense was 49% and 35%, respectively, for the quarters ended March 31, 2010 and
2009. The increase in selling, general and administrative expense as a
percentage of revenue was the result of the significant decrease in our revenues
between the comparable periods, while our SG&A expense increased mainly due
to increases in salaries and related benefits.





For the
nine-month periods ended March 31, 2010 and 2009, our selling, general and
administrative expense increased 7% to approximately $3,252,000, up from
$3,029,000. As a percentage of revenue, selling, general and administrative
expense was 49% and 38%. The dollar increase in our selling, general and
administrative expenses for the comparable three- and nine-month periods is due
in large part to increases in salaries and related benefits, due to the addition
of one FTE in the administration area and two FTEs in our Science and Technology
team to support our clinical biomarkers area.Other
SG&A increases occurred in consulting expense, legal and other public
company expense, including expenses and legal fees for our debt financing, and
increases in our insurance premiums.  These increases were offset somewhat
by decreases in bonus expense, travel expense and advertising and marketing
expense.





Other
Income (Expense):




Dollars
      in thousands, rounded to nearest thousand
              Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              $
              %
              March
      31,
              $
              %2010
              2009
              Change
              Change
              2010
              2009
              Change
              ChangeOther
      Income (Expense)
              ($155)
              ($9)
              (146)
              1647
              ($365)
              $621
              (986)
              (159)Percentage
      of Revenue
              (7)%
              (0)%
              
              
              (5)%
              8
      %
   - 19
-


We had
other expense of approximately $155,000 for the three-month period ended March
31, 2010, compared to other income of approximately $9,000 for the three-month
period ended March 31, 2009. The main component of other income (expense) for
the three-month period ended March 31, 2010 was interest expense of
approximately $146,000 compared to approximately $11,000 interest expense in the
comparable fiscal period last year. For the three-month period ended March 31,
2010, interest expense included $120,000 of interest related to our debt
financing, and we also recorded approximately $19,000 of expense related to the
amortization of the discount on the debt. We had no comparable debt, interest or
amortization expense for the comparable fiscal period last year.





Total
other expense for the nine-month period ended March 31, 2010 was approximately
$365,000, compared to other income of approximately $621,000 for the nine-month
period ended March 31, 2009. The main component of other income (expense) for
the nine-month period ended March 31, 2010 was interest expense of approximately
$338,000 compared to approximately $150,000 interest expense in the comparable
fiscal period last year. For the nine-month period ended March 31, 2010,
interest expense included $240,000 of interest related to our debt financing,
and we also recorded approximately $37,000 of expense related to the
amortization of the discount on the debt. We had no comparable amortization
expense for the comparable fiscal period last year.





A
significant change between the comparable nine-month periods is attributable to
the net gain we recognized in fiscal 2009 due to the accounting treatment on the
Laurus convertible notes, which were paid in full as of December 31, 2008. For
the nine-month period ended March 31, 2009, we incurred net gain of
approximately $676,000, attributable to the Laurus convertible notes and an
expense of $18,000 for amortization of deferred financing costs. We had no
comparable gain or amortization costs in current fiscal year.





Net
Income (Loss):




Dollars
      in thousands, rounded to nearest thousand
              Three
      Months Ended
              
              
              Nine
      Months EndedMarch
      31,
              $
              %
              March
      31,
              $
              %2010
              2009
              Change
              Change
              2010
              2009
              Change
              ChangeNet
      Income (Loss)
              ($393)
              $198
              (591)
              (299)
              ($1,124)
              $1,169
              (2,293)
              (196)Percentage
      of Revenue
              (18)%
              7
      %
              
              
              (17)%
              15
      %


We had a
net loss of approximately $(393,000) for the quarter ended March 31, 2010
compared to net income of approximately $198,000 for the quarter ended March 31,
2009. We had a net loss of approximately $(1,124,000) for the nine-month period
ended March 31, 2010, compared to net income of approximately $1,169,000 for the
nine-month period ended March 31, 2009. This decrease from net income, to net
loss, is equally attributable to our reduced operating income and the gain
derived from the Laurus convertible notes (as described above in “Other Income
(Expense)”), whereas we had no similar non-cash gain in the first three quarters
of fiscal 2010. Other changes, such as increases in expense, affecting our net
loss, are described above under “Laboratory Expense and Cost of Goods Sold” and
“Selling, General and Administrative Expense.”




Liquidity
and Capital Resources:




At March
31, 2010, our cash and cash equivalents were approximately $3,311,000, compared
to approximately $1,365,000 at June 30, 2009. At March 31, 2010 we had
approximately $1,203,000 in accounts receivable, compared to approximately
$2,239,000 as of June 30, 2009, reflecting timing of revenues billed and
collected. Our accounts receivable generally reflect our billings, and may
include one or several individually large customer receivables from time to
time. We generally have a high collectibility rate on our accounts receivable,
and our allowance for doubtful trade accounts is approximately $34,000, which we
believe is reasonable based on our past experience.





Total
liabilities recorded on our balance sheet as of March 31, 2010 were
approximately $5,927,000 compared to approximately $1,986,000 as of June 30,
2009. This significant increase in liabilities was the result of our $4 million
debt financing in September 2009. The loan is due and payable over 48 months,
with the first 8 months being interest only ($40,000 per month) beginning
September 30, 2009, and thereafter (beginning May 31, 2010) 40 monthly payments
of principal and interest ($121,822 each).  During the first 12 months
of the term of the loan, we have the right, in our sole discretion, to obtain an
additional $500,000 loan from the lender on the same terms. As of May 13, 2010,
we have not exercised this additional loan right. Other than this term loan with
the lender, we do not have a bank line of credit or other general borrowing
facility.




- 20
-





At March
31, 2010, we had working capital of approximately $2,717,000, compared to
approximately $2,459,000 at June 30, 2009, for an increase of approximately
$258,000.  Although we had a significant increase (approximately
$1,946,000) in our cash and cash equivalents, this positive impact on our
working capital was offset by current portion (approximately $906,000) of our $4
million debt financing and by a decrease (approximately $1,036,000) in our
accounts receivable. Other changes providing a positive impact in working
capital included increases in inventory and prepaid expenses and decreases in
accrued liabilities. Changes providing a negative impact included increases in
advances from customers, capital lease obligations and our secured note
obligation.




Net cash
used by operating activities was approximately $94,000 for the nine-month period
ended March 31, 2010 and included the effect of approximately $243,000 in
depreciation and amortization, $74,000 in expense from share-based compensation
and $37,000 in amortization of fair value assigned to repurchased shares of
common stock, related to the debt financing. Our investing activities used cash
of approximately $102,000 for the nine-month period ended March 31, 2010 for the
purchase of capital equipment and investments. Cash flow provided by or used in
financing activities included $4,000,000 provided by gross loan proceeds,
approximately $1,674,000 used in common stock repurchase, $66,000 used in
payment of employee withholding taxes from transferred restricted stock and
$119,000 used in payments on capital lease obligations.




We
believe that our cash, current assets and cash flows from operations will be
sufficient to fund current operations through fiscal 2011.




During
the remaining portion of fiscal 2010 and
continuing into fiscal 2011, we will continue to actively pursue
business development and marketing activities to broaden our client and revenue
base. In particular, we anticipate making additional capital investments for our
clinical biomarker services. We may also invest from time to time in our
technology infrastructure, operations and other areas of our business. These
efforts will use significant amounts of time, effort and funding.




We will
also continue to explore other strategic alternatives, which may include a
merger, acquisition, asset sale, joint venture or other similar transaction with
one or more strategic partners to provide additional capital resources to fund
operations and growth opportunities.




Off-Balance
Sheet Arrangements




We have
no off-balance sheet financing arrangements.




ITEM
4T.  CONTROLS AND PROCEDURES




We
maintain disclosure controls and procedures designed to ensure that information
required to be disclosed in our reports filed or submitted under the Securities
Exchange Act of 1934 is (a) recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission’s rules and
forms and (b) accumulated and communicated to management, including our
Chief Executive Officer and Vice President and Controller, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues if any, within a company have been detected.





As of the
end of the period covered by this Report on Form 10-Q, we carried out an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-15. This evaluation
was carried out under the supervision and with the participation of management,
including our Chief Executive Officer and Vice President and Controller. Based
upon that evaluation, our Chief Executive Officer and Vice President and
Controller concluded that our disclosure controls and procedures are effective
at March 31, 2010.




- 21
-





During
the quarterly period covered by this report, there were no changes in our
internal controls or in other factors that have materially affected, or are
reasonably likely to materially affect our internal controls over financial
reporting.





PART
II – OTHER INFORMATION




ITEM
5.  OTHER INFORMATION





On
January 15, 2010, we awarded a total of 87,500 shares of restricted stock
pursuant to our 2005 Stock Incentive Plan to non-management directors on our
Board of Directors. On March 15, 2010, our Board of Directors amended the
vesting on these and other outstanding restricted stock awards from three years
to five years.  The restricted shares fully vest on the fifth
anniversary of the grant date and are subject to forfeiture under certain
conditions if director appointment is terminated prior to the vesting date. The
terms of the awards are materially consistent with the form of restricted stock
purchase agreement under our 2005 Stock Incentive Plan. The restricted stock
awards are detailed on the following table:





No.
      of SharesMario
      Ehlers
            
            Director
            
            
            17,500Paul
      G. Kanan
            
            Director
            
            
            17,500Richard
      W. Palfreyman
            
            Director
            
            
            17,500Curtis
      J. Scheel
            
            Director
            
            
            17,500Stanley
      L. Schloz
            
            Director
            
            
            17,500TOTAL
            
            
            
            
            87,500




ITEM
6.  EXHIBITS




31.1
            Certification
      of Ronald R. Helm, Chief Executive Officer31.2
            Certification
      of John P. Jensen, Vice President and Controller32.1
            Certification
      of Ronald R. Helm, Chief Executive Officer and John P. Jensen, Vice
      President and Controller, of Pacific Biomarkers, Inc., pursuant to 18
      U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
      of 2002.






- 22
-




SIGNATURES





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





Dated:  May
13, 2010






/s/ Ronald R. Helm
              
              Ronald
      R. Helm
              Chief
      Executive Officer
              (principal
      executive officer)
              
              
              
              /s/ John P. Jensen
              John
      P. Jensen
              Vice
      President and Controller
              (principal
      financial and accounting officer)