UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION




WASHINGTON,
D.C. 20549




FORM
10-Q




x  Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934




For the
quarterly period ended March 31, 2009




oTransition 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
Biometrics, 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
              (Address
      of principal executive offices)
            
            98119
              (Zip
      Code)




(206)
      298-0068
              (Issuer’s
      telephone number, including area
code)





Indicate
by check mark whether the issuer: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 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 xNo o





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 or Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes xNo o





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





Large accelerated filer o                                                                         Accelerated
filer o


Non-accelerated
filer o                                                                           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 oNo x





As of May
13, 2009, there were 19,099,539 shares of the registrant’s common stock, $0.01
par value per share, issued and outstanding.












PACIFIC
BIOMETRICS, INC.





INDEX TO
FORM 10-Q





PagePART
      I - FINANCIAL INFORMATIONITEM
      1 - FINANCIAL STATEMENTSConsolidated
      Balance Sheets as of March 31, 2009 (unaudited) and June 30, 2008
      (audited)
            
            
            4Consolidated
      Statements of Operations for the three- and nine-month periods ended March
      31, 2009 and March 31, 2008 (unaudited)
            
            
            5Consolidated
      Statements of Cash Flows for the nine-month periods ended March 31, 2009
      and March 31, 2008 (unaudited)
            
            
            6Condensed
      Notes to the Consolidated Financial Statements (unaudited)
            
            
            7ITEM
      2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS
            
            
            11ITEM
      4T - CONTROLS AND PROCEDURES
            
            
            19PART
      II - OTHER INFORMATIONITEM
      6 - EXHIBITS
            
            
            19SIGNATURES
            
            
            19




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 Biometrics, Inc.
and our wholly-owned subsidiaries Pacific Biometrics, Inc., a Washington
corporation, 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
      estimates for future revenues and cost of revenues, including sources of
      revenue and anticipated revenue;


·
            our
      expectations regarding future expenses, including laboratory, research,
      business development, sales and marketing expenses;


·
            our
      estimates regarding the adequacy of our capital resources, working capital
      and cash flows, as well as 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, referral laboratory services and biomarker
      services;


·
            our
      intentions for the development of new services and products and the
      expansion of the market for our current services and products, and our
      expectations for our clinical biomarker
  services;


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


·
            our
      capital requirements, financing goals and plans, including our prospects
      of raising of additional capital through future equity and debt
      financings, as necessary, or entering into other strategic
      transactions.





The
forward-looking statements in this Report reflect management’s current views and
expectations with respect to our business, strategies, products, 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, 2008. 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, the risk of
bankruptcy, 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
BIOMETRICS, INC.
 CONSOLIDATED
BALANCE SHEETS




March
      31,
            
            
            June
      30,ASSETS
            
            2009
            
            
            2008(unaudited)
            
            
            (audited)Current
      assets:Cash
      and cash equivalents
            
            $
            1,601,858
            
            
            $
            1,196,310Accounts
      receivable, net
            
            
            1,783,016
            
            
            
            2,146,080Other
      receivable, net
            
            
            6,500
            
            
            
            451,291Inventory
            
            
            163,038
            
            
            
            197,456Prepaid
      expenses and other assets
            
            
            136,003
            
            
            
            100,869Deferred
      financing cost on secured convertible note - current
    portion
            
            
            -
            
            
            
            18,447Total
      current assets
            
            
            3,690,415
            
            
            
            4,110,453Property
      and equipment, net
            
            
            876,738
            
            
            
            884,521Total
      assets
            
            $
            4,567,153
            
            
            $
            4,994,974LIABILITIES
      AND STOCKHOLDERS’
      EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            596,869
            
            
            $
            818,224Accrued
      liabilities
            
            
            389,728
            
            
            
            450,788Advances
      from customers
            
            
            570,911
            
            
            
            643,291Capital
      lease obligation - current portion
            
            
            66,219
            
            
            
            32,530Secured
      convertible note, net of unaccreted fair value assigned to conversion
      feature and warrants of $0 and $214,771, respectively
            
            
            -
            
            
            
            678,535Embedded
      derivative liability
            
            
            -
            
            
            
            642,470Freestanding
      derivative liability
            
            
            -
            
            
            
            411,545Other
      notes payable - current portion
            
            
            -
            
            
            
            102,467Total
      current liabilities
            
            
            1,623,727
            
            
            
            3,779,850Capital
      lease obligations - long - term portion
            
            
            167,187
            
            
            
            91,109Total
      liabilities
            
            
            1,790,914
            
            
            
            3,870,959Commitments
      and contingencies
            
            
            -
            
            
            
            -Stockholders’
equity:Preferred
      stock, Series A convertible $0.01 par value, 5,000,000
    sharesauthorized,
      0 shares issued and outstanding for 2009 and 2008
            
            
            -
            
            
            
            -Common
      stock, $0.01 par value, 30,000,000 shares authorized,19,099,539
      and 18,720,147 shares issued and outstanding, respectively
            
            
            190,995
            
            
            
            187,201Additional
      paid-in capital
            
            
            29,120,966
            
            
            
            28,641,278Accumulated
      deficit
            
            
            (26,535,722
            )
            
            
            (27,704,464
            )Total
      stockholders’
      equity
            
            
            2,776,239
            
            
            
            1,124,015Total
      liabilities and stockholders’ equity
            
            $
            4,567,153
            
            
            $
            4,994,974




The
accompanying condensed notes are an integral part of these consolidated
financial statements.
  4
  PACIFIC
BIOMETRICS, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (unaudited)




Three
      Months Ended
              March
      31,
            
            
            Nine
      Months Ended
              March
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Revenues
            
            $
            2,853,222
            
            
            $
            2,296,310
            
            
            $
            7,889,177
            
            
            $
            6,025,507Laboratory
      expenses and cost of sales
            
            
            1,638,950
            
            
            
            1,200,107
            
            
            
            4,312,554
            
            
            
            3,567,790Gross
      profit
            
            
            1,214,272
            
            
            
            1,096,203
            
            
            
            3,576,623
            
            
            
            2,457,717Operating
      expenses:Selling,
      general and administrative
            
            
            1,007,581
            
            
            
            859,723
            
            
            
            3,028,799
            
            
            
            3,005,873Operating
      income (loss)
            
            
            206,691
            
            
            
            236,480
            
            
            
            547,824
            
            
            
            (548,156
            )Other
      income (expense):Interest
      expense
            
            
            (10,503
            )
            
            
            (210,241
            )
            
            
            (150,189
            )
            
            
            (733,553
            )Gain
      on adjustment of embedded and freestanding derivatives to fair
      value
            
            
            -
            
            
            
            274,066
            
            
            
            675,691
            
            
            
            606,926Amortization
      of deferred financing costs - secured convertible debt
            
            
            -
            
            
            
            (26,793
            )
            
            
            (18,447
            )
            
            
            (80,378
            )Other
      income
            
            
            1,620
            
            
            
            8,763
            
            
            
            113,863
            
            
            
            70,652Total
      other income (expense)
            
            
            (8,883
            )
            
            
            45,795
            
            
            
            620,918
            
            
            
            (136,353
            )Net
      income (loss) before tax expense
            
            
            197,808
            
            
            
            282,275
            
            
            
            1,168,742
            
            
            
            (684,509
            )Tax
      expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      income (loss)
            
            $
            197,808
            
            
            $
            282,275
            
            
            $
            1,168,742
            
            
            $
            (684,509
            )Net
      income (loss) per share:Basic
      income (loss) per share
            
            $
            0.01
            
            
            $
            0.02
            
            
            $
            0.06
            
            
            $
            (0.04
            )Diluted
      income (loss) per share
            
            $
            0.01
            
            
            $
            0.01
            
            
            $
            0.06
            
            
            $
            (0.04
            )Weighted
      average common shares outstanding:Basic
            
            
            19,099,539
            
            
            
            18,720,147
            
            
            
            18,993,693
            
            
            
            18,786,668Diluted
            
            
            19,700,811
            
            
            
            19,221,689
            
            
            
            19,594,965
            
            
            
            18,786,668




The
accompanying condensed notes are an integral part of these consolidated
financial statements.
  5




PACIFIC
BIOMETRICS, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (unaudited)




Nine
      Months Ended
                        March
      312009
                      
                      
                      2008Cash
      flows from operating activities:Net
      income (loss)
                      
                      $
                      1,168,742
                      
                      
                      $
                      (684,509
                      )Reconciliation
      of net loss to net cash provided by operating activities:Depreciation
      and amortization
                      
                      
                      192,000
                      
                      
                      
                      182,845Accretion
      of fair value assigned to conversion feature and warrants
                      
                      
                      88,134
                      
                      
                      
                      547,135Amortization
      of deferred financing costs on  secured convertible
      note
                      
                      
                      18,447
                      
                      
                      
                      80,378Gain
      from embedded and freestanding derivative liabilities relating to
      secured  convertible note
                      
                      
                      (675,691
                      )
                      
                      
                      (606,926
                      )Warrant
      expense for equipment lease and financing
                      
                      
                      3,940
                      
                      
                      
                      8,866Compensation
      expense from restricted shares and options
                      
                      
                      101,218
                      
                      
                      
                      164,603Changes in assets and
      liabilities:Accounts
      receivable
                      
                      
                      363,064
                      
                      
                      
                      (100,438
                      )Other
      receivable
                      
                      
                      444,791
                      
                      
                      
                      -Inventory
                      
                      
                      34,418
                      
                      
                      
                      (33,331
                      )Prepaid
      expenses and other assets
                      
                      
                      (35,134
                      )
                      
                      
                      (126,550
                      )Advances
      from customers
                      
                      
                      (72,380
                      )
                      
                      
                      (240,673
                      )Accounts
      payable
                      
                      
                      (221,355
                      )
                      
                      
                      18,469Accrued
      liabilities
                      
                      
                      (61,060
                      )
                      
                      
                      (34,643
                      )Net
      cash  provided by (used in) operating activities
                      
                      
                      1,349,134
                      
                      
                      
                      (824,774
                      )Cash
      flows from investing activities:Purchases
      of capital equipment
                      
                      
                      (42,159
                      )
                      
                      
                      (20,609
                      )Net
      cash used in investing activities
                      
                      
                      (42,159
                      )
                      
                      
                      (20,609
                      )Cash
      flows from financing activities:Payments
      on notes payable
                      
                      
                      (869,136
                      )
                      
                      
                      (1,283,116
                      )Payments
      on capital lease obligations
                      
                      
                      (32,291
                      )
                      
                      
                      (55,305
                      )Net
      cash used in financing activities
                      
                      
                      (901,427
                      )
                      
                      
                      (1,338,421
                      )Net
      increase (decrease) in cash and cash equivalents
                      
                      
                      405,548
                      
                      
                      
                      (2,183,804
                      )Cash
      and cash equivalents, beginning of period
                      
                      
                      1,196,310
                      
                      
                      
                      4,219,926Cash
      and cash equivalents, end of period
                      
                      $
                      1,601,858
                      
                      
                      $
                      2,036,122Supplemental
      Information:Cash
      paid during the period for interest
                      
                      $
                      61,993
                      
                      
                      $
                      185,520Non-cash
      investing and financing activities:Capital
      expenditures funded by capital lease borrowings
                      
                      $
                      142,058
                      
                      
                      $
                      65,667




The
accompanying condensed notes are an integral part of these consolidated
financial statements.
  6




PACIFIC
BIOMETRICS, INC.





CONDENSED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





1.    Organization
and Basis of Presentation





We
provide specialty reference laboratory services to the pharmaceutical, biotech,
and diagnostics industries.  Our company was incorporated in Delaware
in May 1996.  We conduct our business primarily through our
wholly-owned subsidiary, Pacific Biometrics, Inc., a Washington
corporation.  Our three other wholly-owned subsidiaries are Pacific
Biomarkers, Inc., a Washington corporation, 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, 2009 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, 2008, as previously reported in our annual report on Form
10-K.





2.
            Summary
      of Significant Accounting Policies





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, 2009, we deemed one client account receivable to
be uncollectible in an amount of approximately $16,000.





Other
accounts receivable consist of non-trade receivables such as state business and
occupation tax refunds, notes receivable and employee advances. These
receivables are stated at amounts per invoice or agreement and due from other
parties, net of an allowance for doubtful accounts. They are evaluated with the
same methods as utilized for trade accounts receivable.  At March 31,
2009, we had approximately $7,000 in other receivables.





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 Financial Accounting Standards Board’s Statements of
Financial Accounting Standards Statement No. 144 – “Accounting for the Impairment or
Disposal of Long-Lived Assets” (“SFAS 144”), 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, 2009 and 2008, 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. We follow SFAS 109, as amended, to
prepare our income tax reporting.





Financial
Instruments





The
carrying amounts of cash, cash equivalents, and accounts receivable approximate
fair value due to the short-term maturities of these instruments. The carrying
value of our secured convertible note is recorded net of the unamortized fair
value assigned to the conversion feature and warrants, representing its
estimated fair value. The carrying value of our other debt approximates their
estimated fair values due to the rates of interest on the debt approximate
current interest rates for similar obligations with like
maturities.





Financial
Derivatives – Embedded Features





Embedded
conversion and other features embedded in convertible notes are accounted for in
accordance with Statement of Financial  Accounting Standard (“SFAS)
No. 133 “Accounting for
Derivative Instruments and Hedging Activities” (“SFAS 133”) and EITF
00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in a
Company’s Own Stock” (“EITF 00-19”). SFAS 133 generally requires
companies to bifurcate conversion features embedded in convertible notes from
their host instruments and to account for them as freestanding derivative
financial instruments in accordance with EITF 00-19.





Our
convertible notes host conversion features and other features that are deemed to
be embedded derivatives financial instruments or beneficial conversion features
based on the commitment date fair value of the underlying common stock. These
notes meet the definition of derivative financial instruments and have, where
applicable, been bifurcated from host instruments and are carried at fair value.
We record the value allocated to warrants issued with the convertible notes,
measured at fair value and recognized by allocating a portion of the proceeds to
derivative liabilities with an offset to discount on the convertible note. The
recorded discount is accreted as interest expense using the effective interest
method over the life of the debt.





8




Common
Stock Purchase Warrants and Other Derivative Financial Instruments





We
generally do not use derivative financial instruments to hedge exposures to cash
flow or market risks. We account for the issuance of common stock purchase
warrants issued and other free standing derivative financial instruments in
accordance with the provisions of EITF 00-19. Based on the provisions of EITF
00-19, we classify as equity any contracts that (i) require physical settlement
or net-share settlement or (ii) give us a choice of net-cash settlement or
settlement in its own shares (physical settlement or net-share settlement). We
classify as assets or liabilities any contracts that (i) require net-cash
settlement (including a requirement to net cash settle the contract if an event
occurs and if that event is outside our control) (ii) give the counterparty a
choice of net-cash settlement or settlement in shares (physical settlement or
net-share settlement). As of December 31, 2008, we paid the secured convertible
notes in full.





Deferred
Debt Issue Cost





The costs
relating to obtaining and securing debt financing are capitalized and expensed
over the term of the debt instrument. In the event of settlement in part or
whole of such debt in advance of the maturity date, an expense is recognized for
the remaining unamortized deferred debt issue cost.





As of
March 31, 2009 and March 31, 2008, there were unamortized balances of zero and
$45,239, respectively.





Stock-Based
Compensation





Effective
January 1, 2006, we adopted the provisions of SFAS No. 123(R), “Share-Based Payment”,using
the modified prospective transition method. SFAS No. 123(R) 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.





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:




2009
            
            
            2008Expected
      volatility
            
            
            108.76
            %
            
            
            108.42
            %Expected
      dividend yield
            
            
            0.00
            %
            
            
            0.00
            %Risk-free interest rate
            
            
            3.85
            %
            
            
            4.04
            %Expected
      life
            
            10
      years
            
            
            10
      years





We
granted 371,392 equity-based payment awards under our incentive compensation
plan during the nine-month period ended March 31, 2009 and 200,000 equity-based
payment awards for the comparable period of fiscal 2008. We did not grant any
equity-based payment awards under our incentive compensation plans during either
of the three-month periods ended March 31, 2009 and March 31, 2008.




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.




9




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. All per share calculations exclude treasury shares.





For the
three- and nine-month periods ended March 31, 2009 and for the three-month
period ended March 31, 2008, 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. For the nine-month period ended March
31, 2008, 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 this period and the
effect would be anti-dilutive.





As of
March 31, 2009, our common stock equivalents included:  (i)
in-the-money, vested options to purchase 207,167 shares of common stock and (ii)
in-the-money warrants to purchase 394,105 shares of common stock. As of March
31, 2008, our common stock equivalents included:  (i) in-the-money,
vested options to purchase 183,917 shares of common stock and (ii) in-the-money
warrants to purchase 117,625 shares of common stock.





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
      31,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      income (loss) (A)
            
            $
            197,808
            
            
            $
            282,275
            
            
            $
            1,168,742
            
            
            $
            (684,509
            )Net
      income (loss) applicable to common stockholders (B)
            
            $
            197,808
            
            
            $
            282,275
            
            
            $
            1,168,742
            
            
            $
            (684,509
            )Weighted
      average number of outstandingshares
      of common stock (C)
            
            
            19,099,539
            
            
            
            18,720,147
            
            
            
            18,993,693
            
            
            
            18,786,668Weighted
      average number of outstandingshares
      of common stock and common stock equivalents (D)
            
            
            19,700,811
            
            
            
            19,221,689
            
            
            
            19,594,965
            
            
            
            18,786,668Income
      (loss) per share:Basic
      (B/C)
            
            $
            0.01
            
            
            $
            0.02
            
            
            $
            0.06
            
            
            $
            (0.04
            )Diluted (A/D)
            
            $
            0.01
            
            
            $
            0.01
            
            
            $
            0.06
            
            
            $
            (0.04
            )





Comprehensive
Income





We have
adopted Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive
Income,” which establishes 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 quarters and nine month periods ended March 31, 2009 and 2008,
our comprehensive income (loss) equaled our net income (loss). Accordingly, a
statement of comprehensive income (loss) 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.





10




3.  Concentration
of Credit Risk





Our
largest client in the quarter ended March 31, 2009 accounted for approximately
21% of our total revenues, while our largest client in the quarter ended March
31, 2008 accounted for approximately 23% of our total revenues. As of March 31,
2009 and 2008, respectively, approximately 18% and 31% of our accounts
receivable balance were from our two largest clients. These were different
clients in each fiscal period. 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, 2009,
70% of our revenue was derived from Fortune 1000 clients compared to 41% for the
quarter ended March 31, 2008. 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 $1,101,858 at March 31, 2009 and by $896,310 at June 30, 2008.
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, 2009.




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, our prior
reports on Form 10-Q for the fiscal quarters ended December 31, 2008 and
September 30, 2008, and our audited financial statements and related notes for
the fiscal year ended June 30, 2008, included in our Annual Report on Form
10-K.





Overview





We
provide specialty central laboratory services to support pharmaceutical 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 also have central laboratory capability and provide
full-service central laboratory support for multi-center clinical trials,
including routine safety lab tests (general chemistry, hematology, and
urinalysis). We also provide clinical biomarker services for novel biomarkers,
as well as custom assay services, to our pharmaceutical and biotech
clients.Our company
is a Delaware corporation, incorporated in May 1996, and we conduct our
operations primarily through our wholly-owned subsidiary, Pacific Biometrics,
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 2008 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, 2008.





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.





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 our company. For a
more detailed discussion on the application of these and our other accounting
policies, see “Note 2 to the Consolidated Financial Statements” included in this
Report and “Note 2 to Consolidated Financial Statements” included in our Annual
Report on Form 10-K for the fiscal year ended June 30, 2008.





11




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.





Financial
Derivatives – Conversion, Other Features and Warrants





With
respect to our convertible notes with Laurus Master Fund Ltd, which we paid in
full in December 2008, embedded conversion and other features that met the
definition of derivative financial instruments had, where applicable, been
bifurcated from host instruments (See Note 2. Summary of significant accounting
policies) and were carried at fair value.





We record
the value allocated to warrants issued with the convertible notes, measured at
fair value and recognized by allocating a portion of the proceeds to derivative
liabilities with an offset to discount on the convertible notes. The recorded
discount was accreted as interest expense using the effective interest method
over the term of the debt.





Stock-Based
Compensation Expense





Effective
January 1, 2006, we adopted the provisions of 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.





Results
of Operations for Three- and Nine-Month Periods Ended March 31, 2009 and
2008





Revenue:




Dollars in
      thousands,
            
            Three
Months
              Ended
            
            
            
            
            
            
            
            
            Nine Months
              Endedrounded to nearest
            
            March
      31,
            
            
            $
            
            
            %
            
            
            March
      31,
            
            
            $
            
            
            %thousand
            
            2009
            
            
            2008
            
            
            Change
            
            
            Change
            
            
            2009
            
            
            2008
            
            
            Change
            
            
            ChangeRevenue
            
            $
            2,853
            
            
            $
            2,296
            
            
            $
            557
            
            
            
            24
            
            
            $
            7,889
            
            
            $
            6,026
            
            
            $
            1,863
            
            
            
            31





We
generate the majority of our revenue from clinical pharmaceutical trials
testing, clinical biomarker services and diagnostic services. Our revenue
increased approximately 24% to $2,853,000 from $2,296,000 between the comparable
quarters ended March 31, 2009 and 2008. Our revenue increased approximately 31%
to $7,889,000 from $6,026,000 between the comparable nine-month periods ended
March 31, 2009 and 2008. Our revenue fluctuations are due to the variability in
the volume of testing services we perform, and by the timing between our work on
testing and open work orders, and prior work orders having been completed or
terminated.  In the fiscal 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.


12





We
perform services for pharmaceutical and biotech companies (“Direct Clinical
Services”) as well as with other large clinical laboratories that refer
specialty laboratory testing to us (“Referral Laboratories”). We experience
significant uncertainty regarding our existing revenues and estimates of future
revenues during any period. The studies we bid on are uncertain until we have a
signed contract. Once our work on a study commences, the study may be cancelled
by the client at any time during the testing phase. Accordingly, our revenues
may be significantly affected by the success or failure of the testing phase and
other factors outside of our control. In addition, several factors may adversely
affect our future revenues, including a large number of pharmaceutical
companies’ cost reduction announcements and continuing consolidation in the
pharmaceutical market.





During
the quarter ended March 31, 2009, revenue generated from Direct Clinical
Services, services for Referral Laboratories and diagnostic services accounted
for approximately 64%, 35% and 1% of our total revenue. During the nine-month
period ended March 31, 2009, revenue generated from Direct Clinical Services and
services for Referral Laboratories accounted for approximately 59% and 41% of
our total revenue. There were no diagnostic services revenues for the nine-month
period ended March 31, 2009. In contrast, during the quarter ended March 31,
2008, revenue generated from Direct Clinical Services, services for Referral
Laboratories and diagnostic services accounted for approximately 75%, 20% and
5%, respectively, of our total revenue.  During the nine-month period
ended March 31, 2008, revenue generated from Direct Clinical Services, services
for Referral Laboratories and diagnostic services accounted for approximately
70%, 27% and 3%, respectively, of our total revenue.





We
believe that the overall significant increase in revenue for both the quarter
and nine-month period ended March 31, 2009 reflects our significant investments
in business development initiatives over the last two fiscal
years. The primary component of our business development efforts has
been directed towards Direct Clinical Services and we have also seen
increase in revenues from Referral Laboratories in fiscal 2009. These revenues
represented a larger percentage of total revenue for the quarter and nine-month
period ended March 31, 2009 compared to the quarter and nine-month period ended
March 31, 2008.





Laboratory
Expense and Cost of Goods Sold:




Dollars
      in thousands,
              
              Three
Months
                Ended
              
              
              
              
              
              
              
              
              Nine Months
                Endedrounded
      to nearest
              
              March
      31,
              
              
              $
              
              
              %
              
              
              March
      31,
              
              
              $
              
              
              %thousand
              
              2009
              
              
              2008
              
              
              Change
              
              
              Change
              
              
              2009
              
              
              2008
              
              
              Change
              
              
              ChangeLaboratory
      Expenses and Cost of Goods Sold
              
              $
              1,639
              
              
              $
              1,200
              
              
              
              439
              
              
              
              37
              
              
              $
              4,313
              
              
              $
              3,568
              
              
              
              745
              
              
              
              21Percentage
      of Revenue
              
              
              57
              %
              
              
              52
              %
              
              
              
              
              
              
              
              
              
              
              55
              %
              
              
              59
              %





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 reagents and supplies for analysis ofclinical trialsamples, and
secondarily, of payments to subcontractors for laboratory services, rent,
insurance, business and occupation taxes. The relative increase in our
laboratory expense and cost of goods sold as a percentage of our revenue was the
result of variable cost increases that exceeded our increase in revenues in the
three- and nine-month periods ended March 31, 2009. The primary expense
increases for the three- and nine-month periods ended March 31, 2009 were from
reagents, salaries and employee benefits and outside services.





Generally,
laboratory and cost of goods sold expense items are highly variable due to 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.




13





The
following table illustrates changes in Laboratory Expense and Cost of Goods Sold
in fixed and variable expense categories:




Three
      months Ended
              March
      31,
            
            
            $
            
            
            
            %Dollars in thousands,
                rounded
      to nearest thousand
            
            2009
            
            
            %
      of revenue
            
            
            2008
            
            
            %
      of revenue
            
            
            Change
            
            
            
            ChangeFixed
      Cost DetailRent,
      Utilities, Certain Taxes
            
            $
            141
            
            
            
            5
            %
            
            $
            106
            
            
            
            5
            %
            
            $
            35
            
            
            
            33Variable
      Cost DetailWages,
      Taxes, Benefits
            
            
            639
            
            
            
            22
            %
            
            
            478
            
            
            
            21
            %
            
            
            161
            
            
            
            34Reagent
      Chemicals
            
            
            626
            
            
            
            22
            %
            
            
            439
            
            
            
            19
            %
            
            
            187
            
            
            
            43Other
      Variable Costs
            
            
            233
            
            
            
            8
            %
            
            
            177
            
            
            
            8
            %
            
            
            56
            
            
            
            32Total
            
            
            1,498
            
            
            
            52
            %
            
            
            1,094
            
            
            
            48
            %
            
            
            404
            
            
            
            37Total
      Cost of Goods Sold
            
            $
            1,639
            
            
            
            57
            %
            
            $
            1,200
            
            
            
            53
            %
            
            $
            439
            
            
            
            37




Nine
      months Ended
              March
      31,
            
            
            $
            
            
            %Dollars in
      thousands,
                  rounded
      to nearest thousand
            
            2009
            
            
            %
      of revenue
            
            
            2008
            
            
            %
      of revenue
            
            
            Change
            
            
            ChangeFixed
      Cost DetailRent,
      Utilities, Certain Taxes
            
            $
            388
            
            
            
            5
            %
            
            $
            365
            
            
            
            6
            %
            
            $
            23
            
            
            
            6Variable
      Cost DetailWages,
      Taxes, Benefits
            
            
            1,739
            
            
            
            22
            %
            
            
            1,404
            
            
            
            23
            %
            
            
            335
            
            
            
            24Reagent
      Chemicals
            
            
            1,689
            
            
            
            21
            %
            
            
            1,263
            
            
            
            21
            %
            
            
            426
            
            
            
            34Other
      Variable Costs
            
            
            497
            
            
            
            7
            %
            
            
            536
            
            
            
            9
            %
            
            
            (39
            )
            
            
            (7
            )Total
            
            
            3,925
            
            
            
            50
            %
            
            
            3,203
            
            
            
            53
            %
            
            
            722
            
            
            
            23Total
      Cost of Goods Sold
            
            $
            4,313
            
            
            
            55
            %
            
            $
            3,568
            
            
            
            59
            %
            
            $
            745
            
            
            
            21





For the
comparable quarters ended March 31, 2009 and 2008, laboratory expense and cost
of goods sold increased by approximately $439,000, or 37%, to $1,639,000, up
from $1,200,000. Laboratory expense and cost of goods sold as a percentage of
revenue increased to approximately 57%, up from approximately
53%.  Our relative increase in laboratory expense and cost of goods
sold were due to increases in salaries and related benefits, laboratory
reagents, depreciation expense and outside services expense.





The
largest component of laboratory expense for the quarter ended March 31, 2009 was
salaries and related benefits.  Laboratory salaries and related
benefits increased 34% to approximately $639,000 from $478,000 for the quarters
ended March 31, 2009 and 2008. These expenses represented approximately 22% and
21%, respectively, as a percentage of revenue for the comparable periods. The
expense increase was due primarily to an increase in laboratory staff by 6 FTE
to perform many new and more complex assays than were performed in the
comparable fiscal period last year.  We have also setup a separate
facility for a new class of assays in our biomarker services
area.  These new assays have yet to produce revenue.





This
increase in laboratory expense was partially offset by a decrease in contract
labor to $29,000 from $106,000 for the comparable quarters. This decrease is
attributatable to the fact that we hired lab technicians from our contract labor
provider as employees, as discussed above.





In
addition, we accrued approximately $46,000 of bonuses in the quarter ended March
31, 2009 based on our quarterly results for that period.  We did not
accrue or pay any bonuses in the comparable period in the prior fiscal
year.





14




The other
major component of laboratory expense for the quarter ended March 31, 2009 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 are
asked to perform, and constitute a significant expense item for our
business.  During the comparable quarters ended March 31, 2009 and
2008, laboratory reagents and supplies increased by 43% to approximately
$626,000 from $439,000 as a result of an increase in the number of tests
performed. The cost of laboratory reagents and supplies as a percentage of
revenue was approximately 22% and 19% for the comparable quarters ended March
31, 2009 and 2008.





These
reagents and supply costs are highly variable depending on the type of tests
performed. During the first three quarters of fiscal 2009,  we have
been involved in more complex assays and testing methods and lower volume phase
I studies, both of which result in an increased cost of reagents and higher per
test labor cost. We experienced cost increases from several reagent suppliers
commencing on January 1, 2009. We expect these cost increases to continue
through calendar 2009.





Another
component of laboratory expense for the quarter ended March 31, 2009 that showed
a major increase was the cost of outside services. Laboratory outside services
increased 813% to approximately $86,000 from $9,000 for the quarters ended March
31, 2009 and 2008, representing approximately 3% and 0.4%, respectively, as a
percentage of revenue. These outside service costs are highly variable depending
on the type of tests performed as requested by the client or study
sponsor.





Fixed
costs for the quarter ended March 31, 2009 increased by 33%, to $141,000 from
approximately $106,000 as compared to the quarter ended March 31, 2008. The
increase was attributable to increase in laboratory depreciation, insurance
expense and training expenses.





For the
comparable nine-month periods ended March 31, 2009 and 2008, laboratory expense
and cost of goods sold increased approximately 21% to $4,313,000 from
$3,568,000. The increase in laboratory expense and cost of goods sold was mainly
due to increases in reagent costs and salaries and related benefits. As a
percentage of revenue, laboratory expense and cost of goods sold decreased to
approximately 55% from approximately 59%.





Laboratory
salaries and related benefits increased 24% to approximately $1,739,000 from
$1,404,000 for the nine-month periods ended March 31, 2009 and 2008,
respectively, including approximately $87,000 for accrued bonuses for the period
ended March 31, 2009. Salaries and related benefits accounted for approximately
40% and 39% of total laboratory expense and cost of goods sold for the
nine-month periods ended March 31, 2009 and 2008, respectively. As a percentage
of revenue, salaries and related benefits decreased to approximately 22% from
approximately 33%. On March 31, 2009, we had 42 FTE performing laboratory
services. This compares to 36 FTE on March 31, 2008.





Laboratory
reagents and supplies expense increased 34% to approximately $1,689,000 from
$1,263,000 for the nine-month periods ended March 31, 2009 and 2008 due to the
significant increase in our testing volume. During each of the comparable nine
month periods ended March 31, 2009 and 2008, the cost of laboratory reagents and
supplies accounted for approximately 21% as a percentage of
revenue.





Other
variable costs decreased 7% for the nine-month period ended March 31, 2009
compared to the nine-month period ended March 31, 2008. The major reason for
this decrease was a decrease in our use of laboratory contract labor as well as
a decrease in our licensing and maintenance expenses.





Fixed
costs for the nine-month period ended March 31, 2009 increased 6% to $388,000
from approximately $365,000 compared to the nine-month period ended March 31,
2008. The increase was attributable to increases in laboratory depreciation,
insurance expense and training expenses.





15




Selling,
General and Administrative Expense:




Dollars in
      thousands,
              
              Three Months
      Ended
              
              
              
              
              
              
              
              
              Nine Months
      Endedrounded to nearest
              
              March
      31,
              
              
              $
              
              
              %
              
              
              March
      31,
              
              
              $
              
              
              %thousand
              
              2009
              
              
              2008
              
              
              Change
              
              
              Change
              
              
              2009
              
              
              2008
              
              
              Change
              
              
              ChangeSelling,
      General and Administrative Expense
              
              $
              1,008
              
              
              $
              860
              
              
              
              148
              
              
              
              17
              
              
              $
              3,029
              
              
              $
              3,006
              
              
              
              23
              
              
              
              1Percentage
      of Revenue
              
              
              35
              %
              
              
              37
              %
              
              
              
              
              
              
              
              
              
              
              38
              %
              
              
              50
              %





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), as well as a major
portion of company share-based compensation, business development expenses, and
legal and accounting fees.





For the
comparable quarters ended March 31, 2009 and 2008, respectively, our selling,
general and administrative expense increased 17% to approximately $1,008,000, up
from $860,000. As a percentage of revenue, selling, general and administrative
expense was 35% and 37%, respectively, for the quarters ended March 31, 2009 and
2008. The decrease in selling, general and administrative expense as a
percentage of revenue was the result of the significant increase in our revenues
between the comparable periods.





For the
quarter ended March 31, 2009, our selling, general and administrative expense
increased primarily due to increases in public company expenses from investor
relations, bonuses to executive officers and other non-laboratory personnel,
rent for our new biomarker services facility, and salaries in our science and
technology department related to biomarker services. These increases were offset
by decreases in legal expense and consulting expense.





For the
nine-month periods ended March 31, 2009 and 2008, respectively, our selling,
general and administrative expense increased 1% to approximately $3,029,000, up
from $3,006,000. As a percentage of revenue, selling, general and administrative
expense was 38% and 50% for the nine-month periods ended March 31, 2009 and
2008. The decrease in selling, general and administrative expense as a
percentage of revenue was also the result of our significant increase in
revenues over the comparable periods.





For the
nine-month period ended March 31, 2009, our selling, general and administrative
expense increased primarily due to increases in salaries in our administrative,
laboratory management and science and technology departments, bonuses, public
company expense from  investor relations, rent for our new biomarker
services facility and advertising expense. These increases were offset by
decreases in salaries due to the resignation of our Chief Medical Officer in
August 2008 and decreases in legal expense, accounting expense and bad debt
expense. The decrease in bad debt reflects the collection of a $100,000 loan
that we previously classified as bad debt in December 2007.





Other
Income (Expense):




Dollars in thousands,
              
              Three Months
      Ended
              
              
              
              
              
              
              
              
              Nine
      Months Endedrounded to nearest
              
              March
      31,
              
              
              $
              
              
              %
              
              
              March
      31,
              
              
              $
              
              
              %thousand
              
              2009
              
              
              2008
              
              
              Change
              
              
              Change
              
              
              2009
              
              
              2008
              
              
              Change
              
              
              ChangeOther
      Income/(Expense)
              
              $
              (9
              )
              
              $
              46
              
              
              
              (55
              )
              
              
              (119
              )
              
              $
              621
              
              
              $
              (136
              )
              
              $
              757
              
              
              
              555Percentage
      of Revenue
              
              
              (0
              )%
              
              
              2
              %
              
              
              
              
              
              
              
              
              
              
              8
              %
              
              
              (2
              )%





We had
other expense of approximately $9,000 for the quarter ended March 31, 2009,
compared to other income of approximately $46,000 for the quarter ended March
31, 2008. This decrease in other income for the quarter was attributable to the
gain due to adjustments to the value of the embedded derivative for the quarter
ended March 31, 2008, whereas no comparable gain was recognized in the current
quarter as the convertible notes payable to Laurus Master Fund Ltd. were paid
off as of December 31, 2008. This improvement is primarily attributable to our
payment in full on the convertible notes payable to Laurus, reflecting a
decrease in interest expense paid, a decrease in amortization of deferred
financial costs, and gain due to adjustments to the value of the embedded
derivative.





16




Total
other income for the nine-month period ended March 31, 2009 was approximately
$621,000, compared to approximately $136,000 other expense for the nine-month
period ended March 31, 2008.  The reduction in the principal balance
of the Laurus notes is the primary reason that our interest expense decreased
80% to approximately $150,000 for the nine-month period ended March 31, 2009,
down from approximately $734,000 for the nine-month period ended March 31, 2008.
The gain from adjustment of embedded and freestanding derivatives to fair value
was approximately $676,000 for the nine-month period ended March 31, 2009
compared to $607,000 for the nine-month period ended March 31, 2008. Another
component of other expense for the nine-month period ended March 31, 2009 was
approximately $18,000 of amortization of deferred financing costs on our
secured convertible debt, compared to approximately $80,000 of such expense
recorded for nine-month period ended March 31, 2008.





We had
approximately $114,000 of other income for the nine-month periodended March 31, 2009
compared to approximately $71,000 of other income recorded for the nine-month
period ended March 31, 2008. This increase resulted mainly from the collection
of $104,000 that we previously classified as bad debt in December 2007. This
increase was partially offset by decrease in interest income to approximately
$15,000, down from approximately $79,000 for the nine-month periodended March 31,
2008.





Net
Income (Loss):




Dollars in
      thousands,
              
              Three Months
      Ended
              
              
              
              
              
              
              
              Nine Months
      Endedrounded to nearest
              
              March
      31,
              
              $
              
              
              %
              
              
              March
      31,
              
              
              $
              
              
              %thousand
              
              2009
              
              
              2008
              
              
              Change
              
              
              Change
              
              
              2009
              
              
              2008
              
              
              Change
              
              
              ChangeNet
      Income (Loss)
              
              $
              198
              
              
              $
              282
              
              
              $
              (84
              )
              
              
              (30
              )
              
              $
              1,169
              
              
              $
              (685
              )
              
              $
              1,854
              
              
              
              271Percentage
      of Revenue
              
              
              7
              %
              
              
              12
              %
              
              
              
              
              
              
              
              
              
              
              15
              %
              
              
              (11
              )%





We had
net income of approximately $198,000 for the quarter ended March 31, 2009,
compared to a net income of approximately $282,000 for the quarter ended March
31, 2008. While our revenue increased 24% compared to the quarter ended March
31, 2008, our operating profit decreased by 13% and our net income decreased by
30%. This decrease is attributable to increased salaries, laboratory reagents
and supplies, other fixed and variable laboratory costs, increased selling,
general and administrative expense and changes in other income (expense), each
as described above.





We had
net income of approximately $1,169,000 for the nine-month period ended March 31,
2009, compared to a net loss of approximately $685,000 for the nine-month period
ended March 31, 2008. For the nine-months ended March 31, 2009, the increase to
net income, from net loss, is principally due to a significant increase in
revenue during fiscal 2009 and an increase in other income as described above.
Additionally, our net income position was favorably impacted by a reduction in
interest expense by approximately $583,000 due to final payment of the
outstanding Laurus Notes and the reduced amounts outstanding on our equipment
credit line with Franklin Funding.





Liquidity
and Capital Resources:





At March
31, 2009, our cash and cash equivalents were approximately $1,602,000 compared
to approximately $1,196,000 at June 30, 2008. At March 31, 2009 we had
approximately $1,783,000 in accounts receivable, compared to $2,146,000 as of
June 30, 2008, reflecting timing of revenues billed and collected. We had
approximately $7,000 in other accounts receivable for an employee travel
advance, compared to approximately $451,000 as of June 30, 2008 for a
Washington state tax refund, which we received in August
2008.





We had
significant improvement in revenues for both the quarter and nine-month period
ended March 31, 2009, as compared to the quarter and nine-month period ended
March 31, 2008. Additionally, our operating profit has shown a significant
increase for the nine-month period ended March 31, 2009 as compared to the
nine-month period ended March 31, 2008.





17





Total
liabilities recorded on our balance sheet as of March 31, 2009 were
approximately $1,791,000 compared to approximately $3,871,000 as of June 30,
2008. This significant decrease in liabilities was the result of retiring both
the Laurus debt and the outstanding note balance from Franklin Funding, which
were paid off in December 2008. We paid off the Laurus debt early, one month
prior to maturity, which required approximately $50,000 in addition to our
regular monthly payment. In connection with our payoff of the Laurus notes, we
reduced the remaining balance for embedded derivative liability to zero by
recording gain of approximately $300,000 for the remaining balance of the
derivative liability. We reclassified freestanding derivative liability by
crediting additional paid-in capital for approximately $378,000 for the
remaining balance of the warrants associated with both Laurus notes, which
remain in effect. This reclassification resulted in no changes to our
accumulated deficit or net loss presented.





Our
working capital increased to approximately $2,067,000, compared to working
capital of approximately $331,000 at June 30, 2008. The increase of
approximately $1,736,000 in our working capital is attributable to a significant
decrease in our current liabilities due to Laurus debt payoff and decrease in
other notes payable. Changes providing a positive impact included increases in
prepaid expenses, decreases in secured convertible debt and associated
derivative liability to the Laurus notes, accounts payable, accrued liabilities
and other notes payable. Changes providing a negative impact included decreases
in accounts receivable and other receivable and increases in capital leases
obligations. Our strong earnings have also improved our working capital
position.





Net cash
used provided by operating activities was approximately $1,349,000 for
the nine-month period ended March 31, 2009 and included the effect of
approximately $192,000 in depreciation and amortization, approximately $88,000
of amortization related to the Laurus notes, approximately $101,000 in expense
from share-based compensation and approximately $676,000 in income from
adjustment of the compound embedded derivative liability relating to the Laurus
notes. Our investing activities used cash of approximately $42,000 for the
nine-month period ended March 31, 2009 for the purchase of capital equipment.
Cash flows used in financing activities included approximately $901,000 in
payments on notes payable and payments on capital lease
obligations.





We
experienced an increase in our cash and working capital position from operations
during the nine months of fiscal 2009 and we believe that our current cash,
current assets and cash flows from operations will be sufficient to fund
operations into fiscal 2010. Importantly, we paid off the outstanding principal
balance on our convertible notes payable to Laurus and the outstanding principal
balance on our note payable to Franklin Funding at December 31, 2008. Aside from
capital leases, we have no other debt obligations as of March 31, 2009. We are
considering new debt financing for fiscal 2010; however, the amounts and terms
of that debt are unknown at this time.





In fiscal
2009, 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 and human resource investments for our
clinical biomarker services.  We may also invest and 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 and may
not be successful.





While our
revenues increased for the nine-month period ended March 31, 2009, we have been
impacted by significant volatility in our revenues over the past several years.
We experience significant uncertainty regarding existing revenues and estimates
of future revenues, during any period.  If our revenues decrease
significantly in future periods, we may experience significant losses and our
cash and working capital position will be adversely impacted. Our operations
historically have been funded through revenues generated from operations and
from debt and equity financings.





We are
exploring options for establishing a line of credit or other general borrowing
facility. We currently do not have available to us a bank line of credit or
other general borrowing facility. We have no additional amounts available to us
under our Franklin Funding credit facility and do not have any other credit
facility in place.





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





18




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 of Finance 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 of Finance and
Controller. Based upon that evaluation, our Chief Executive Officer and Vice
President of Finance and Controller concluded that our disclosure controls and
procedures are effective at March 31, 2009.





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
6.                      EXHIBITS





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




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
15, 2009




/s/
      Ronald R. HelmRonald
      R. HelmChief
      Executive Officer
                  (principal
      executive officer)
  /s/
      John P. JensenJohn
      P. JensenVice
      President of Finance and Controller
                  (principal financial and accounting
      officer)
 19