UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-K
 
 x
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the fiscal year ended December 31, 2010
 
 o
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the transition period from _____ to ______
 
 Commission file number 0001124608
 
 RESPONSE GENETICS, INC.
 (Name of Small Business Issuer in Its Charter)
 
 Delaware

2835

11-3525548(State or Other Jurisdiction of

Incorporation or Organization)

(Primary Standard Industrial

Classification Code Number)

(I.R.S. Employer

Identification No.)
 
 1640 Marengo St., 6th Floor
 Los Angeles, California 90033
 (323) 224-3900
 (Address and Telephone Number of Principal Executive Offices)
 
 Securities registered under Section 12(b) of the Exchange Act:
 
 Title of each class

Name of each exchange on which registeredCommon Stock, par value 0.01 per share

Nasdaq Capital Market
 
 Securities registered under Section 12(g) of the Exchange Act:   None.
 
 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
 
 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o No x
 
 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o
 
 Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. o
 
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule12b-2 of the Exchange Act.
 Large accelerated filer   o
Accelerated filer   oNon-accelerated filer   o (Do not check if a smaller reporting Company)
Small reporting company   x
 
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
 
 The aggregate market value of common stock held by non-affiliates of the registrant was $31,897,342.50 as of June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter. Such aggregate market value was computed by reference to the closing price of the common stock of $2.50 per share as reported on the Nasdaq Capital Market on June 30, 2010.
 
 The number of shares of the registrant’s common stock outstanding as of March 28, 2011 was 18,361,720.
 
 DOCUMENTS INCORPORATED BY REFERENCE
 
 The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K: Certain portions of the Registrant’s definitive Proxy Statement for the 2011 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
  
 
  TABLE OF CONTENTS
 
 PagePart IItem 1.  Business.

3Item 1B. Unresolved Staff Comments.

18Item 2.  Properties.

18Item 3.  Legal Proceedings.

19Part IIItem 4.  Reserved.

19Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

19Item 6.  Selected Financial Data.

20Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

21Item 8.  Financial Statements and Supplementary Data.

32Item 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

32Item 9A.  Controls and Procedures.

32Item 9B.  Other Information.

33Part IIIItem 10.  Directors, Executive Officers, Promoters and Corporate Governance

33Item 11.  Executive Compensation

33Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

33Item 13.  Certain Relationships and Related Transactions, and Director Independence.

34Item 14.  Principal Accountant Fees and Services.

34Part IVItem 15.  Exhibits, Financial Statement Schedules.

64
 
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  Part I
 Item 1.  Business
 Overview
 
 Response Genetics, Inc. was formed as a Delaware corporation in September 1999. We are a life sciences company engaged in the research and development of innovative clinical diagnostic tests for cancer based on our proprietary technologies. Our mission is to provide personalized genetic information that will help guide physicians and patients in choosing the treatment from which a given patient is most likely to benefit. We currently generate revenues primarily from sales of our ResponseDX diagnostic tests, which we launched in 2008 and by providing pharmacogenomic testing services to pharmaceutical companies.
 
 Our patented technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, or FFPE, specimens and thereby to analyze genetic information contained in these tissues. This is significant because the majority of patients diagnosed with cancer have a tumor biopsy sample stored in paraffin, while only a small percentage of patients’ tumor specimens are frozen. Our technologies also enable us to use the FFPE patient biopsies for the development of diagnostic tests. To our knowledge, we are the first company to generate clinically relevant information regarding the risks of recurrence of cancer or chemotherapy response using approximately 30,000 genes available from microarray profiling of FFPE specimens.
 
 We file our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other information with the SEC. Copies of these reports are also available through our website at www.responsegenetics.com. We also post copies of our press releases on our corporate website.
 
 Our Approach
 
 Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide physicians and cancer patients with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues.
 
 Response DXTM
 
 The outcome of cancer chemotherapy is highly variable due to genetic differences among patients. Some patients respond well with tumor shrinkage and increase in life span. Other patients do not obtain benefit from the same therapy but may still experience toxic side effects as well as delay in effective treatment and psychological trauma.
 
 At present most chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients’ tissues that can predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we are developing genetic tests that will measure predictive factors for tumor response in tumor tissue samples. We offer tests for non-small cell lung cancer (NSCLC), colorectal cancer (CRC) and gastric and gastroesophageal (GE) cancer patients’ tumor tissue specimens through our ResponseDX: Lung, ResponseDX: Colon and ResponseDX: Gastric test suites. The test results may help doctors and patients decide the course of treatment for patients.
 
 Since February 2008, our ResponseDX tests are commercially available through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendment of 1988 (CLIA).
 
 Our Technology
 
 All of our tests are based on the polymerase chain reaction (PCR), which is a sensitive, precise and reliable technology that gives numerical values that are not dependent on subjective interpretation by pathologists, as are antibody-based tests. We developed and extensively validated technology to perform quantitative PCR analysis of gene expressions in formalin-fixed paraffin embedded (FFPE) tumor tissues. We have used our technological expertise in many projects for the pharmaceutical industry and for many collaborative scientific studies. The benefit of our capability for patients is that in many cases, no tissue samples other than the pre-treatment diagnostic biopsy will be required for the biomarker analysis.
 
 We developed ResponseDX in part by using our technology to extract genetic information from FFPE tumor specimens. Our technology provides gene expression information for each patient’s tumor tissue specimen. Our mission is to help doctors and patients choose the most effective cancer treatment options- the first time- based on genetic information from the patient’s tumor biopsy.
 
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 Except for the historical information contained herein, this Annual Report on Form 10-K contains or may contain, among other things, certain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve significant risks and uncertainties. Such statements may include, without limitation, statements with respect to the Company's plans, objectives, projections, expectations and intentions, such as the ability of the Company to analyze cancer samples, the potential for using the results of this research to develop diagnostic tests for cancer, the usefulness of genetic information to tailor treatment to patients, the ability of the Company to make its ResponseDX: Lung, ResponseDX: Colon and ResponseDX: Gastric tests available and other statements identified by words such as "projects," "may," "could," "would," "should," "believes," "expects," "anticipates," "estimates," "intends," "plans" or similar expressions.
 
 These statements are based upon the current beliefs and expectations of the Company's management and are subject to significant risks and uncertainties, including those detailed in this Annual Report on Form 10-K filed with the Securities and Exchange Commission. Actual results, including, without limitation, actual sales results, if any, or the application of funds, may differ from those set forth in the forward-looking statements. These forward-looking statements involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond the Company's control).
 
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 Our Technologies
 
 We have developed technologies for the extraction of RNA from FFPE tissues which enable us to reliably recover RNA suitable for a variety of applications, such as gene expression research, development of diagnostics, and microarray platforms. We believe our technologies for the first time can provide access to molecular information from the entire vast body of archival tissue specimens from past clinical trials for which clinical outcomes and results are documented. In addition, our technologies permit gene profiling analysis of current clinical trials, most of which are still using the paraffin embedding technique for tissue specimen storage.
 
 RGI-1
 
 Kathleen Danenberg, our President, Chief Executive Officer and director, co-developed and patented (U.S. Patent No. 6,248,535; Danenberg , et al., Method For Isolation of RNA From Formalin-Fixed Paraffin-Embedded Tissue Specimens), an extraction method (RGI-1) that allows reliable and consistent isolation of RNA and DNA from FFPE suitable for use in RT-PCR analysis, while she was employed at USC. Using RGI-1, successful RT-PCR quantitation of gene expressions is possible from as little as a single 10-micron section of a paraffin block with over 90% reliability and excellent reproducibility. We validated our methodology, which particularly addressed issues of recovery of RNA, accuracy, and precision. RGI-1 allows for rapid extraction of RNA with little or no DNA contamination, which makes it suitable for large-scale analysis. We have used RGI-1 successfully to quantify gene expressions in over 45,000 FFPE specimens received by us from various pharmaceutical companies since 2001 as well as in our own research projects. We and others have published over fifty papers and articles based on data generated using RGI-1. The data below demonstrates that gene expressions obtained by us from FFPE specimens using RGI-1 closely match those isolated from fresh-frozen tissue.
 
 RNA was isolated from FFPE tissues by RGI-1 and from matched sets of fresh-frozen tissues of the same tumor specimens. The expression of several genes was quantitated by RT-PCR. This experiment shows that if RT-PCR analysis is done within the guidelines and parameters established by RGI, very similar results are obtained from FFPE specimens when compared to frozen specimens data.
 
 RGI-2
 
 RNA isolated by RGI-1 is fragmented by the heating process, but may be analyzed by the PCR process. The PCR assay works by binding DNA primers, which are specific sequences of DNA, at various sites on the gene and copying these sequences through PCR. These sequences can be designed to bind closely together to accommodate short fragments of RNA. However, the microarray technology works best through binding of longer RNA sequences. A second technology developed by us, RGI-2, is designed to maximize the isolation of longer fragments of RNA. This technology does not replace RGI-1, since it is less rapid and may contain a small amount of genomic DNA. Using this technology, the average length of RNA fragments recovered from FFPE is substantially increased. The RNA preparations obtained with RGI-2 produced similar results on gene expression microarrays as RNA isolated from fresh-frozen tissues. Therefore, we believe that this new technology, which we are in the process of patenting, enables profiling of gene expression by microarray of archival FFPE specimens from clinical studies.
 
 The technologies we have developed for extracting RNA from FFPE provide RNA which is suitable for both RT-PCR and microarray analyses. These methods of RNA analysis are characterized by a high degree of reliability and reproducibility, with a success rate of over 90% if our guidelines are followed.
 
 ·Micro-dissection of each specimen to separate tumor from non-tumor tissue. Most tumor biopsy specimens are mixtures of normal and tumor tissue. A specimen may include only a small percentage of tumor cells. The molecular biology of tumor and normal tissues may be considerably different and mixing the two may yield false results for gene expression profiling. To accurately measure gene expression and establish expression profiles of various pathologic lesions, it is important to analyze RNA from tumor cells. With the assistance of a pathologist, we can identify the tumor cells and isolate them, either manually or with laser-capture micro-dissection. Since we are able to work with FFPE we can more accurately dissect out the tumor cells from the normal cells than would be possible with frozen tissue because the resolution in FFPE is better than in frozen tissue.
 
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 ·Isolation of DNA from the same specimen used to obtain RNA. Alterations in DNA sequence that are inherited (polymorphisms) as well as acquired (mutations) are often associated with disease susceptibilities, treatment response, and survival. DNA polymorphisms and mutations may change the gene expression pattern of a cell in specific ways. Characterization of gene expression profiles associated with various DNA sequence alterations may lead to a better understanding of disease mechanisms and may suggest new and better treatments. Our technique for isolating DNA and RNA from the same specimen facilitates such studies because in many cases the amount of available tissue may not be sufficient for separate isolation of DNA and RNA. In addition, measuring gene expressions and DNA sequence alteration in the same cells rather than in different areas of the tissue specimen is likely to give more valid data.
 
 We believe these technologies may be used as a powerful tool to establish diagnostic gene sets for predicting a patient’s likelihood of survival under a particular treatment regimen. Such diagnostic tests will provide the opportunity for choosing the best treatment prior to therapy and thus enable application of personalized medicine based on each person’s unique genetics.
  ResponseDX: LungTM, ResponseDX: ColonTM, and ResponseDX: GastricTM
  ResponseDX: LungTM comprises seven tests: ERCC1 expression, RRM1 expression, TS expression, KRAS mutational analysis, EGFR expression, EML4-ALK mutational analysis and EGFR mutational analysis. ResponseDX: ColonTM comprises six tests: ERCC1 expression, KRAS mutational analysis, TS expression, EGFR expression, and BRAF mutational analysis. ResponseDX: Gastric comprises three tests: The Response DX test measures the RNA expression of ERCC1, TS, EGFR, RRM1 and the presence of EML4-ALK translocations by RT-PCR from a patient's tumor tissue. PCR analysis of DNA from the patient's sample is used to determine BRAF, EGFR and KRAS mutational status.
  Furthermore, we have found that KRAS, BRAF and EGFR mutations can be analyzed in various other tumor types. Therefore, we are also offering these tests in other tumor types. For example, there are a number of pharmaceutical agents in clinical trials targeting BRAF in melanoma. Physicians are ordering our tests to determine whether patients may benefit from a clinical trial of a new agent.
 
 We have developed assays for single genes comprising the ResponseDX panels for use in our CLIA lab. Assay development of these tests was done through rigorous validation procedures which determine the accuracy (sensitivity and specificity) of each test. We believe our tests are among the most reliable that are currently available on the market. Our experience in this area allows us to continue to develop additional tests for these and other ResponseDX panels. In the near term we are developing additional tests for sensitivity to targeted therapy in colon and other cancers. Similarly, in bladder cancer, we are developing a test including ERCC1 and other genes associated with sensitivity to platinum, vinblastin and epirubicin containing regimens.
 
 Sales, Marketing and Client Services for ResponseDX tests
 
 We offer our ResponseDX test services nationwide through a specialized sales force focused on serving the specific needs of customers in the area of oncology. Our sales force currently operates out of eleven states and focuses on community based oncologists, hospitals and physician offices. Our sales force is compensated through a combination of salaries, commissions based upon actual sales performance and bonuses, all at levels commensurate with each individual’s qualifications, performance and responsibilities.
 
 We have developed a set of clear and effective marketing materials to support our sales efforts. Our materials are targeted to the oncologists and physician office staff. Our marketing materials provide a summary of our tests along with practical information regarding how to order our tests.
 
 We compete largely on the basis of the quality of our tests, the convenience of ordering our tests and the innovation of our services.
 
 Our Strategy
 
 Our goal is to provide cancer patients and their physicians with the means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. Using our two technologies for extraction of RNA from FFPE tissue, we can analyze specific RNAs rapidly by PCR or the entire genome by using microarray methods. Elements of our business strategy include:
 
 Increasing uptake of our RepsonseDX® diagnostic tests though continued prospective clinical trials with co-operative oncology groups and key opinion leaders from the oncology community: towards acceptance in clinical practice guidelines
 
 · ERCC1, a platin sensitivity gene, is contained in all three of our ResponseDX® panels: Colon, Gastric and Lung. Upon completion of a retrospective trial with the Southwest Oncology Group (SWOG) showing a statistically association of ERCC1 gene expression with clinical benefit from platin chemotherapy in gastric (GE Junction) tumors, a clinical trial testing the results by patient selection for platin or non-platin therapy with ERCC1 was proposed and approved by SWOG. Similarly, a trial selecting patients for platinum adjuvant therapy in non-small cell lung cancer was approved by the Eastern Co-Operative Oncology Group (ECOG). Finally, a colon cancer trial and an additional lung cancer trial using markers contained in our ResponseDX® panels are in the planning stages by key-oncology opinion leaders. We believe that positive outcomes from these trials may result in increased uptake of our testing for ERCC1 and other tests in our panels. The results of clinical trials are reviewed periodically for inclusion in the clinical practice guidelines (NCCN and ASCO) and it is these publications that physicians often use for treatment decisions for their patients.
 
 Developing diagnostic tests for assessing the risk of cancer recurrence, prediction of chemotherapy response and tumor classification in cancer patients based on our technologies.
 
 ·Develop a lung cancer recurrence test. To date, all studies involving microarray analysis could only be done using frozen tissues. Since frozen tissues from clinical trials are available on a very limited basis or often not available at all, this has severely limited the development of diagnostic tests. In contrast, for the reasons discussed above, nearly all patients diagnosed with cancer have a diagnostic tissue specimen stored in a paraffinized state. Therefore, there are a vast number of patient specimens available for the development of a diagnostic test using our technology.
 
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 We have developed preliminary gene sets for predicting risk of recurrence in early stage non-small cell lung cancer after surgery through analysis of 80 patient specimens by microarray. This “product candidate” must be validated in a larger set of patient specimens in the research setting. Since lung cancer is among the highest frequency cancers around the world, patient specimens are available from many sites. We have chosen to prioritize development of a diagnostic test to predict outcome for this cancer. Generally, Stage 1A and 1B lung cancer is not treated with chemotherapy even though these patients have a 50% risk of recurrence within five years. The patient is considered in remission unless and until the tumor recurs. At the time of recurrence chemotherapy is administered. However, if there were a test for high risk of recurrence, then the physician could treat the patient right away with chemotherapy rather than waiting for the recurrence.
 
 Our plan is to use our proprietary technologies to analyze these archived patient specimens and to correlate the data with clinical outcomes so that we can develop diagnostic tests to predict likelihood of recurrence and responsiveness to chemotherapy.
 
 After preliminary validation of the predictive gene set, a formal clinical trial will be designed to prove the ability of the gene set to accurately predict outcome in additional patients using reagents available from Affymetrix. Since RGI is able to analyze archived FFPE tissue, the patients included in this trial will have been treated years ago, but the outcome will be blinded to RGI by the clinical investigators until the end of the trial. The number of specimens required in this clinical trial will be determined by the accuracy in which the preliminary gene set can predict the first series of specimens in the research study. Based on the current predictability of our gene set, over 90% accuracy, we estimate that the clinical trial will require an additional 100-200 early stage lung cancer patients. Additional trials may then be launched at various sites to continue to refine the accuracy of our assay.
 
 The analysis of the first two series of patient specimens is complete and statistical analysis is being performed. Using these results, analysis of additional retrospective clinical trials may be performed. Our plan is to develop a CLIA compliant laboratory developed test using the outcome of this data. This process will take approximately one to two years. If compliance with additional regulatory agencies is required, it will add approximately two to three additional years.
 
 There are a number of diagnostic test developers available to partner with us during the clinical trial and test launch process. Roche, with whom we have a strategic alliance, is one of these providers.
 
 ·Develop a lung cancer chemotherapy response test. In addition to our tests for recurrence for various forms of cancer, we also intend to develop a test to determine responsiveness to chemotherapy treatment for lung cancer. Of the 169,000 newly diagnosed lung cancer patients in the United States, a majority will receive chemotherapy as an initial treatment. Of those who receive chemotherapy, greater than 90% are given the combination of Paclitaxel/Carboplatin as their first chemotherapy. Paclitaxel/Carboplatin is only effective in about 19% of the patients for whom it is prescribed. We intend to develop a pharmacogenomic test to determine whether an individual patient will be included in the 19% of NSCLC patients responding to Paclitaxel/Carboplatin or whether the patient should consider a different chemotherapy. Clinical trial specimens are available to us for development of this test, however, there can be no assurance that we will be successful in developing this test, or if developed, that such a test will be commercially viable.
 
 In June 2006, we presented at the American Society of Clinical Oncology (ASCO) meeting the first study demonstrating the possibility of a predictive molecular test derived by microarray analysis of patients’ FFPE tumor biopsies.
 
 These preliminary studies in lung cancer using our technologies for RNA extraction from FFPE have produced gene expression profiles which describe the probability of recurrence among patients with early stage lung cancer. Other expression profiles have been generated predicting the risk of metastases. By applying our technologies to early stage non-small cell lung cancer, we have:
 
 · demonstrated the feasibility of creating a preliminary genomic risk prediction model using FFPE tissue, and
 
 · identified the differential pathways indicated by the unique gene signatures between early stage patients surviving less or greater than two years for both adenocarcinomas and squamous cell carcinomas, and demonstrated the feasibility of generating differential pathways from FFPE specimens.
 
 We believe that this study represents the first “biologically significant” result using microarray analysis of FFPE specimens.
 
 The diagnostic test, when implemented, will involve extracting RNA from tumor biopsies using our technologies and measuring a series of genes (a gene set) either by microarray or RT-PCR that have been found to differentiate long and short-term survivors. Levels of expression of these genes will provide information regarding whether the patient is at a higher than normal risk of recurrence. We are currently in the process of refining and validating the predictive gene set for early stage lung cancer recurrence.
 
 In addition to our studies in lung cancer, we have developed similar preliminary predictive gene sets for cancer recurrence after surgery for pancreatic, colon and esophageal cancers. In each of these studies we analyzed patient specimens from early stage cancers and developed predictive gene sets by microarray analysis. We have analyzed an average of 40 specimens from each of these cancer types but will require more research to validate these gene sets. We have entered into an agreement with Duke University to obtain additional NSCLC specimens.
 
 · Develop a pancreatic cancer recurrence test. Similarly to the test for recurrence in lung cancer, we are in the research phase of developing a test for recurrence after surgery for pancreatic cancer. We have analyzed a series of twenty specimens by microarray from patients with pancreatic cancer who were at “high risk” and “low risk” of rapid recurrence after surgery. The patients at “high risk” had a median cancer-free survival of 150 days, where the patients at “low risk” had a median cancer-free survival of 1225 days. Development of a diagnostic tests is planned to determine the patients at “high risk” of rapid recurrence after surgery, so that physicians may choose to treat these patients with aggressive chemotherapy rather than an ineffective surgery at the time of diagnosis. We are in the early research phase of development of this test and will need to analyze more specimens before we test our initial gene set by validation. After the initial validation, a large clinical trial of patients with known outcome to surgery will be analyzed and the ability of our predictive gene set will be tested for accuracy. Development of the diagnostic test will be similar to that for the lung cancer test. We have entered into an agreement with University of California San Francisco and the University of Utah to obtain additional pancreatic cancer specimens and have begun to analyze these specimens.
 
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 ·Develop acolon cancer risk of metastasis test. We have analyzed a series of primary tumors in colon cancer and determined a preliminary gene set predictive of whether the patient tumor has spread beyond the colon into other sites (metastasized). If a colon cancer tumor has spread or invaded other organs or lymph nodes, the treatment may include earlier, more aggressive chemotherapy and not surgery at the time of diagnosis. It is not always possible for the physician to determine whether a cancer has spread before surgery has taken place. Therefore, we are developing a diagnostic test using microarray technology to predict whether the patient’s tumor is contained in the colon before surgery. We are in the research phase of development of this test. We have analyzed sixty patient specimens with metastatic and non-metastatic colon cancer and have developed a preliminary gene set predictive of metastatic cancer. We will validate this gene set in a larger group of specimens and proceed with development of the test in the same manner as the lung test.
  ·Develop an esophageal cancer risk of recurrence test. We have analyzed a series of esophageal tumors from patients with long and short survival after esophageal surgery. A preliminary gene set predictive of “high risk” patients was determined using the first 46 patients analyzed. An additional set of specimens will be used to validate this predictive gene set and development of the diagnostic test will be similar to the lung test.
 
 · Develop an ovarian cancer chemotherapy response test.We intend to develop a test to determine responsiveness to chemotherapy treatment for ovarian cancer. We have analyzed a series of ovarian tumors and plan to further analyze additional specimens to develop a gene set and development of the diagnostic test will be similar to the lung test.
 
 · Develop a bladder cancer chemotherapy response test.We intend to develop a test to determine responsiveness to adjuvant chemotherapy treatment for advanced bladder cancer. We have analyzed a series of bladder tumors from patients enrolled for adjuvant therapy in the AUO-AB 05/95 phase III trial. In May 2009, at the ASCO meeting, the results of this study, which investigated the relationship between multidrug-resistance 1 (MDR1) gene expression and ERCC1 gene expression to outcome was announced. This study provided the foundation for development of a diagnostic test for improving chemotherapy of bladder cancer. We plan to further analyze additional specimens to develop a gene set and development of the diagnostic test will be similar to the lung test
  ·Develop a cancers of unknown primary test. About 5% of patients suffer from cancer without knowing where the tumor originated. For example, the cancer may have invaded both the colon and the lungs. Treatments for lung cancer are quite different from treatments for colon cancer. Therefore, we are planning to develop a diagnostic test using microarray methods for determination of the origin of the cancer. We have collected patient specimens from a series of cancers that have been diagnosed as tumors of unknown origin. These include gallbladder, pancreas, gastric, kidney, breast, prostate cancer and others. We intend to analyze these specimens using microarray methodology and develop a gene set that will identify the origin of the tumor. We are in the early stages of planning our research analysis of these specimens. Development of a diagnostic test will be similar to the lung cancer test.
 
 We will validate these tests using clinical specimens available from our network of over a dozen clinical investigators. As we proceed from the research phase to the validation phase with respect to these tests, we will need to access additional specimens from larger institutions. We have identified these institutions and are in the process of negotiating the appropriate agreements with them. However, there can be no assurance that we will be able to enter into agreements with these institutions on terms favorable to us, or at all.
 
 ·Develop “in-house tests.”We intend to develop our diagnostic tests as “in-house tests.” Such in-house tests, which will be performed in our own CLIA-certified laboratory, are also called “home brew” tests. Current examples of in-house tests are those for estrogen receptor (ER) and progesterone receptor (PR) which are given to virtually every breast cancer patient. The results of these tests determine whether the patient should be prescribed a hormone antagonist such as Tamoxifen and provide information about the aggressiveness of the tumor. None of these tests is currently regulated by the FDA.
 
 After validation of the results and after obtaining any necessary regulatory approval, we intend to develop, market and sell these tests or license them to a diagnostic company, depending on the market potential of the particular test and the regulatory climate. For instance, we are currently working with clinicians who are members of the Cancer and Leukemia Group B (CALGB) research group, who have indicated a commitment to provide us with the requisite number of FFPE of early stage lung cancer, both for the discovery and validation phase and for the prospective testing phase. We are in the process of negotiating the appropriate agreements with them. However, there can be no assurance that we will be able to enter into agreements with these clinicians on terms favorable to us, or at all.
 
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 Growth Through Globalization of Our Service Business.
 
 We estimate based on our internal market research and experience to date that the addressable market opportunity for our testing services business in the area of analyzing tumor specimens in the course of clinical trials is between $400 and $500 million worldwide.
 
 Demand within the pharmaceutical industry requires us to offer “integrated” service throughout the world for analysis of their clinical trial specimens. It is important to the pharmaceutical industry and the regulatory agencies that the same analytical methods be used for each clinical trial sample around the world so that the data can be easily compared and used for global drug development. Also, export of clinical trial specimens to the United States is restricted from some areas of the world such as China. Finally, the enrollment of patients in clinical trials sometimes depends on analyzing the sample for a specific biomarker within five days, which may not provide sufficient time for shipping specimens to the United States.
 
 The pharmaceutical industry is moving a large percentage of their clinical trials to Asia to access and treat patients that are chemotherapy-naïve (patients who have not had previous chemotherapies), to carry out less expensive clinical trials and to generate “on site” chemotherapy response data to be used in conjunction with drug approval in these areas. The goal of our globalization plan is to offer a worldwide analysis of patient specimens and generate consistent data based on integrated common platforms and technology.
 
 · C hina. We offer our services in China through a collaboration arrangement with an established biotech company, Shanghai Biochip Company, Ltd. (“SBC”). This collaboration is necessary, since the Chinese government does not allow shipment of patient specimens outside of China for processing elsewhere. We believe that placement of a laboratory in China is important because several of our pharmaceutical clients have stated that they have clinical trial specimens stored in China that they have not been able to analyze. Additionally, prospective clinical trials are planned in China as part of an effort to get drugs approved in China. In the collaboration we provide the technology and training, and SBC provides the space, equipment and the staff.
 
 ·Japan and Asia (except China and India). We offer our services in Japan through a collaboration arrangement with Hitachi Chemical Co., Ltd. (“Hitachi”), a leading diagnostics manufacturer in Japan. Under this arrangement, Hitachi processes specimens collected throughout Asia, except China and India, and Australia using our technology. Pharmaceutical clients have requested analysis of patient specimens on site in Japan and surrounding countries for prospective clinical trials due to the need to analyze the patient sample within five days of surgery.
 
 ·Europe. We offered our pharmacogenomic testing at a site in Edinburgh, Scotland, which was associated with the University of Edinburgh and Edinburgh Royal Infirmary. We established a subsidiary, Response Genetics, Ltd. in November 2006 through which we managed the work at this site. As of March 2009, the laboratory in Edinburgh was consolidated with the laboratory in Los Angeles due to the ability to ship patient specimens to Los Angeles and to analyze these samples within five days of surgery, thus no longer necessitating a laboratory on site in Europe. We offer our services in Europe with the actual analysis being occurring in Los Angeles.
 
 We believe that growth in our pharmacogenomic testing services business will be enhanced by our ability to process specimens in various locations throughout the world. To our knowledge, we will be the only company offering this type of service with consistent results at various sites around the world to the industry.
 
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 Developing a Pharmacogenomic Test for Generic Drugs.
 
 · Generic drug tests. The majority of patients that require chemotherapy are given drugs, such as Tamoxifen, that are no longer under patent from the pharmaceutical company that developed the drug. Once a company that seeks to produce and commercialize a generic version of one of these drugs has obtained approval from the FDA, the typically lower-priced generic drug may be used in place of the brand name drug. Tests for generic drugs are not likely to be developed by the pharmaceutical industry because they no longer have a commercial interest in those drugs, therefore, they are appropriate targets for the development of associated in-house tests. We intend to develop a pharmacogenomic test to determine whether an individual patient will be included in the 19% of NSCLC patients responding to Paclitaxel/Carboplatin or whether the physician and patient should consider a different chemotherapy. Paclitaxel and Carboplatin are both sold as generic drugs. We intend to develop pharmacogenomic tests to determine response to other generic drugs, if the market potential of the test is similar to that for Paclitaxel and Carboplatin. However, there can be no assurance that we will be successful in developing these tests, or if developed, that such a test will be commercially viable.
 
 · Micro RNA Analysis. Our technology for extraction of nucleic acids from FFPE tissues delivers micro RNA as well as DNA and total RNA. We are developing a service to analyze specific micro RNAs from FFPE specimens for the pharmaceutical industry.
 
 License Agreement with the University of Southern California
 
 In April 2000, as amended in June 2002 and April 2005, we entered into a license agreement with USC, pursuant to which USC granted us a worldwide, exclusive license with the right to sublicense, the patents for RGI-1 and related technology, for use in human and veterinary diagnostic laboratory services, the sale of clinical diagnostic products, and the sale of research products to the research community. We are obligated under the agreement to use best efforts to work toward the commercialization of the licensed technology. In consideration for this license, we are obligated to pay royalties to USC, as a percentage of net sales of products or services using the technology, and to meet a certain minimum in royalty payments. Royalty expense for the years ended December 31, 2009 and 2010 was $227,958 and $439,540, respectively. USC retains the right under the agreement to use the technology for research and educational purposes.
 
 Upon authorization from us, USC has the obligation to undertake all responsibilities for the filing, prosecution and maintenance of all patents covered under the license; however, we have agreed to reimburse USC for all associated costs. If we elect not to pursue a particular patent, the rights to that patent revert to USC, if USC takes the necessary steps to prosecute and maintain the patent; if USC does not undertake such actions, the exclusive license rights to the patent remain with us. We bear full responsibility for enforcement of patent rights against all claims of infringement by third parties and the right, but not the obligation to bring action against any alleged infringement of the licensed patents by third parties, bearing all costs. USC has the right to pursue any offensive enforcement we chose not to pursue at its own expense and we may agree with USC to pursue such action jointly, sharing all related costs.
 
 This agreement terminates on the first to occur of: (i) the date of the expiration of the last to expire of the patents issued in any country, or (ii) if no patents issue, the date on which any decision or determination to reject or deny the last remaining patent application or claim becomes final. Either party may terminate this agreement for uncured material breach or default upon written notice to the other party. We may terminate the agreement for any reason, upon written notice to USC. USC may terminate the agreement, upon written notice, in the event that we transfer or assign our rights and obligations under the agreement to a third party, in any manner contrary to the terms of the agreement or in derogation of USC’s proprietary rights; and immediately if we fail to obtain or maintain insurance coverage and for other specified causes. We are obligated to indemnify USC against all liabilities to third parties, from claims arising in connection with the agreement and our use, sale or other distribution of services and products involving the licensed technology. We also are required to maintain comprehensive general liability insurance, appropriately covering the full scope and range of activities we pursue with the licensed technology.
 
 License Agreement with Roche Molecular Systems, Inc.
 
 In November 2004, we entered into a license agreement with Roche, pursuant to which we are collaborating with Roche to produce commercially viable assays related to the validation of genetic markers for pharmaceutical companies. Specifically, we have licensed the rights to Roche to use the pre-diagnostic assays we develop in the course of using our RNA-extraction technologies to provide testing services to pharmaceutical companies, to produce diagnostic kits that then can be sold commercially to those pharmaceutical companies. Roche is required to pay us royalties of a certain percentage of net sales of the diagnostic kits sold to pharmaceutical companies. For the years ended December 31, 2009 and 2010, there were no royalties received by us for this arrangement.
 
 Roche will own the rights to all improvements or modifications solely made by it to the assays or to the technologies we use to develop those assays. Roche has granted us a license to use the optimized assays that form the basis of the diagnostic kits for research purposes. Each party has the exclusive right to prosecute, maintain and defend against infringement, its own patents and applications for patents using counsel of its choice at its expense.
 
 The agreement will continue until the date on which each and every application for patent and claim of our patent rights has expired, been disclaimed, been cancelled, abandoned or terminated, or has been held invalid by a court of law. Either party may terminated the agreement for material breach or for cause, as defined in the agreement, upon prior written notice to the other party. Following the two year anniversary of the effective date of the agreement, either party may terminate the agreement by meeting certain notice obligations and provided that the term will be extended to the point necessary to meet the requirements of any third party pharmaceutical company collaboration transaction then subject to completion.
 
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 Patent License Agreement with Roche Molecular Systems, Inc.
 
 In November 2004, we entered into an agreement with Roche pursuant to which we obtained a royalty-bearing, non-exclusive, personal, non-transferable license to use certain licensed technology, including specified nucleic acid amplification processes, to perform certain polymerase chain reaction-based human in vitro clinical laboratory services.
 
 Roche retains all proprietary rights to the licensed technologies and our non-exclusive license is limited to the use of the technology as described above. Under this agreement, neither party is obligated to defend any proprietary rights against third parties for infringement.
 
 In consideration for this license, we are obligated to pay royalties to Roche, as a certain percentage of revenues we receive from performing services using the licensed technology. Royalty expense for the years ended December 31, 2009 and 2010 was $198,279 and $426,366, respectively.
 
 This agreement terminates on the date of expiration of the last to expire of the patents included in the licensed technology. Roche may immediately terminate the agreement upon written notice in the event of any material change in our ownership or control, or in the event that we breach certain non-assignability provisions of the agreement. Roche may also terminate the agreement upon prior written notice in the event of any breach or default by us of a material term under the agreement. The agreement will automatically terminate upon our entry into bankruptcy or similar proceedings.
 
 Services Agreement with Taiho Pharmaceutical Co., Ltd.
 
 In July of 2001, we entered into an agreement with Taiho pursuant to which we will provide Taiho with molecular-based tumor analyses for use in its business development and marketing of pharmaceutical and diagnostic products for use against cancer. Pursuant to the agreement, we appointed Taiho as the exclusive purchaser in Japan of tests and testing services based upon RGI-1 using gene expression through 2010 for: (i) any one or the combination of specified molecular markers, (ii) the therapeutic use of specified compounds, or (iii) the diagnosis or therapeutic treatment of specified precancerous and cancerous diseases. We also granted Taiho the right to be a non-exclusive purchaser in Japan of tests and testing services based upon RGI-1 using gene expression, other than those for which Taiho has exclusivity, for: (i) any one or combination of molecular markers, (ii) the therapeutic use of any compound or biological product against cancer, or (iii) the diagnosis or therapeutic treatment of precancerous and cancerous diseases.
 
 We are obligated to notify Taiho of new molecular markers, therapeutic compounds and diseases for which RGI-1 may be useful and to offer Taiho the option of including those within its exclusivity. Taiho must perform all testing services pursuant to our instructions and we retain the right to process some or all of the testing services for Taiho internally, or through any other designated and licensed laboratory; provided that such other laboratory is under an appropriate obligation of confidentiality with respect to this agreement.
 
 In consideration for the testing services provided, Taiho made a fixed amount advanced payment to us and is obligated to pay regular testing fees, covering the specific services performed on a monthly basis which was initially recorded as deferred revenue and has subsequently been fully recognized. Taiho is obligated to purchase a minimum amount of testing services from us during each calendar quarter through 2010. Revenue recognized under this agreement for the years ended December 31, 2009 and 2010 was $1,782,950, and $1,864,175, respectively. We obtained a non-exclusive sublicense from the University of Southern California for Taiho for distribution of the testing services in Japan. We retain all intellectual property rights to our proprietary testing services and materials, other than specimens provided by Taiho, and all related patent applications provided that, however, Taiho retains all intellectual property rights to the results of the testing services performed under the agreement.
 
 Taiho has agreed to indemnify us against any damages claims brought by third parties based on the distribution of the testing services; any claims related to false advertising or unfair competition; and any regulatory challenges. We have agreed to indemnify Taiho against claims of intellectual property infringement related to the testing services. Both parties have agreed to indemnify one another against any breaches of warranties or failures to perform obligations under the agreement. We have agreed to maintain comprehensive general liability insurance for the term of the agreement and for a specified period thereafter. Either party has the right to terminate the agreement in the event of an uncured material breach by the other party, upon written notice, or for cause, as defined under the agreement. Since we do not hold a patent for RGI-1 in Japan, we have agreed to negotiate to adjust Taiho’s fee obligations in the event that a third party obtains a patent for similar testing services in Japan and offers those services at a competitive rate. In the event that we cannot reach an agreement Taiho has the right to terminate the agreement upon fulfilling certain notice obligations. In addition, should Taiho terminate the agreement for cause, Taiho retains the right to have Dr. Peter Danenberg and/or Kathleen Danenberg provide the testing services in the same manner as we provide them under the agreement. In January 2010, this agreement with Taiho was renewed for an additional three years. According to the terms of the renewal, Taiho’s appointment as an exclusive purchaser of tests and testing services in Japan through 2010 and its minimum purchasing obligations were extended through 2010.
 
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 Services Agreement with SmithKline Beecham Corporation (d.b.a. GlaxoSmithKline) (“GSK”) and Amended and Restated Service Agreement with GSK
 
 In January 2006, the Company entered into a Master Services agreement with GSK, a leading pharmaceutical manufacturer, pursuant to which the Company provides services in connection with profiling the expression of various genes from a range of human cancers. Under the agreement, the Company will provide GSK with testing services as described in individual protocols and GSK will pay the Company for such services based on the pricing schedule established for each particular protocol. GSK is obligated to make minimum annual payments to the Company under the agreement and also was obligated to make a non-refundable upfront payment to the Company, to be credited against work undertaken pursuant to the agreement. In January 2006, the Company received an upfront payment of $2,000,000, which was initially recorded as deferred revenue. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. There was no remaining deferred revenue balance associated with this agreement at December 31, 2010. In the course of performing our year-end financial close procedures for the three months ended December 31, 2010, management identified a prior period error relating to the recognition of revenue pertaining to this agreement. The error created an understatement of net revenues in the amount $322,469, which should have been recognized in 2008. As described in Note 15 of the consolidated financial statements, this revenue was not considered material to any prior period and has been recognized in the three months ended December 31, 2010. See Note 15 for further details.
  In December 2008, the Company amended and restated its master service agreement with GSK. Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000, which was received on January 5, 2009. The balance of deferred revenue for this agreement at December 31, 2010 is $30,582. After the remaining balance of deferred revenue is used, GSK will make payments based on the amount of work performed each month in 2011.
  In March 2010, the Company entered into a non-exclusive license agreement with GSK. Under the agreement, the Company granted GSK a non-exclusive, sublicenseable license to its proprietary PCR analysis technology and diagnostic expertise to assess BRAF gene mutations in human tumor samples. As part of the agreement, the Company received a non-refundable technology access fee in consideration for the transfer of the Company’s technology to GSK. The agreement also contains milestone provisions which would allow the Company to earn further payments from GSK. The Company had not earned any milestone payments from GSK as of December 31, 2010.
  The Company recognized revenue of $190,935 and $1,636,518 relating to all of the GSK agreements for the years ended December 31, 2009 and 2010, respectively.
 
 Master Laboratory Test Services Agreement with GlaxoSmithKline Biologicals (“GSK Bio”) and Amended and Restated Service Agreement with GSKBio
 
 In December 2006, the Company entered into an agreement with GSK Bio, the vaccine division of GSK (see above), pursuant to which it will provide testing services, principally in relation to profiling the expression of various genes from a range of human cancers. The Company will conduct the testing services on tissue specimens provided by GSK Bio. The agreement required that GSK Bio make an upfront payment of €2,000,000 (approximately $2,620,000), which was received by the Company in December 2006. The agreement further specified that GSK Bio pay annual minimum payments in 2007, 2008 and 2009 and that the upfront payment made in December 2006 will be credited against the annual minimum payments in 2007 and 2008. The agreement also provided that any differences between the annual minimum payments made in 2007, 2008 or 2009 and the amounts due to the Company for testing services performed on specimens submitted by GSK Bio during the three years ended December 31, 2009 be credited towards services performed during the year ending December 31, 2010, the final year of the agreement. If the Company ceases to provide services under the agreement or any reason, the Company shall remit to GSK Bio payment of the then remaining balance of the existing credit within sixty days of the date on which the Company ceased to provide services to GSK Bio.
  In December 2007, the Company amended its agreement with GSK Bio, whereby GSK Bio would make the remaining minimum payments under the agreement in one lump sum. This payment of approximately $2,722,000 was received in January 2008.
  On September 7, 2009, the Company amended and restated its master service agreement with GSK Bio (the “Amended and Restated Agreement”). Pursuant to the Amended and Restated Agreement, the parties agreed that GSK Bio has accrued an aggregate credit under the terms, representing the balance of deferred revenue relating to this agreement at that date of the original agreement, which amount shall be allocated towards services rendered to GSK Bio during the remaining term of the agreement as described below.
  For each calendar quarter of 2009 and the first two quarters of 2010, €200,000 of the existing credit shall apply to all services rendered to GSK Bio during such calendar quarter. Pursuant to the Amended and Restated Agreement, GSK Bio has extended the term of the agreement for an additional one-year period through December 31, 2011. As provided in the Amended and Restated Agreement, the remaining balance of the existing credit of approximately €1,357,800 was divided into six equal quarterly amounts and will be applied to all services rendered to GSK Bio in each of the last two quarters of 2010 and the four calendar quarters of 2011. Beginning in the third quarter of 2010, the amount of the credit to be applied to all services rendered to GSK Bio is €226,300. In all cases, GSK Bio shall remit payment to the Company for all services rendered to GSK Bio in any such calendar quarter that is in excess of the applicable credit amount. In the event the amount of services rendered to GSK Bio in a calendar quarter does not exceed the applicable credit amount, the existing credit for the following calendar quarter shall be increased by such unused amount.
 
 The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products. The amount of deferred revenue for this agreement at December 31, 2009 and December 31, 2010 is $2,588,896 and $1,333,186, respectively. The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. The Company recognized revenue of $3,420,748 and $5,805,951 relating to the GSK Bio agreement for the years ended December 31, 2009, and 2010, respectively, which includes for 2010 $1,255,710 of previously recorded deferred revenue.
 
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 Agreement with Shanghai BioChip
 
 In March 2007, we entered into a collaboration agreement with Shanghai BioChip Company, Ltd. (“SBC”) pursuant to which SBC will provide pharmacogenomic testing services in China using our RGI-1 extraction technology. Under this agreement, we work with SBC pursuant to a formal statement of work (“SOW”) arrangement. This agreement greatly expands our ability to provide our services globally, particularly in China. Specifically, this agreement allows us to collaborate with some of our current clients in the pharmaceutical industry as we can now process specimens collected during clinical trials that are based in China. Additionally, this agreement allows us to offer our services to companies within China.
 
 Pursuant to the agreement, we have granted SBC an exclusive license in China to provide services in China using our proprietary RGI-1 RNA extraction technology. Subject to consent from the University of Southern California, we will grant SBC an exclusive sublicense to patents licensed from the University of Southern California for distribution of testing services in China. In turn, SBC will perform RNA extraction from FFPE tissue specimens exclusively for us during the term of the agreement. SBC must perform all testing services pursuant to our instructions and we retain the right to generate and report all final results. All proposed contracts from SBC using our testing services must be explicitly approved in writing by us. We have also retained the rights to any intellectual property which result from the performance of this collaboration agreement.
 
 Outside of certain shared costs, as specified in the agreement, we and SBC each are individually and separately responsible for our own costs. Specifically, we are responsible for costs related to royalty payments to third parties under existing licensing agreements, license fees for our intellectual property and the salary of the General Manager of the facility, costs associated with the analysis of raw data from test results, costs associated with generating final reports to customers, costs of responding to customer inquiries regarding the results of analysis the data and the report of test results, and costs associated with providing training and assistance with laboratory setup.
 
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 SBC is responsible for expenses related to the initial cost of laboratory equipment, as well as the cost of any additional equipment necessary as a result of increases in volume of business; maintenance or service fees and expenses for the existing testing equipment; the cost of reagents; the cost of qualified laboratory space, including any rent for such space; expenses and salaries associated with laboratory personnel, including the Vice-General Manager and necessary FTE personnel to perform collaboration services; the costs of responding to customer inquiries regarding the performance of the testing, storage of the samples and other record keeping; and the costs associated with training and commencement of operations.
  Our agreement with SBC has an initial term of five years, with an automatic renewal for an additional three-year term unless either party gives 90 days notice in advance of the renewal date of its intent not to renew. We may terminate the agreement on the occurrence of: (i) errors in SBC’s processing of samples that exceeds levels in our other facilities; (ii) the inability to achieve laboratory qualifications within 12 months; (iii) the failure to adequately address quality concerns raised by two or more customers; and (iv) refusal by SBC to agree on a reasonable request for a SOW. Either party may terminate this agreement for uncured material breach, insolvency or bankruptcy, or substantial use of the name of the other party without consent. For the year ended December 31, 2009, no testing services were performed. For the year ended December 31, 2010, testing services totaled $169,400.
 
 Agreement with Hitachi Chemical Co., Ltd.
  On July 26, 2007, the Company entered into a collaboration agreement with Hitachi Chemical Co., Ltd. (“Hitachi”), a leading diagnostics manufacturer in Japan (the “Hitachi Agreement”). Under the terms of this agreement, Hitachi will begin using the Company's proprietary and patented techniques to extract genetic information from formalin-fixed paraffin-embedded (“FFPE”) tissue samples collected in Southeast Asia, Australia and New Zealand. As part of this collaboration agreement, the Company will provide Hitachi with the technical information and assistance necessary to perform the testing services. Hitachi also plans to introduce the Company to potential new testing services customers in the region to expand the testing of FFPE clinical samples in Asia. The Southeast Asian countries covered under this agreement include Japan, North Korea, South Korea, Taiwan, Mongolia, Pakistan, Bangladesh, Sri Lanka, Nepal, Singapore, Malaysia, Indonesia, Brunei, Thailand, Myanmar, Laos, Cambodia, Vietnam and the Philippines (the “Territory”).
  This Agreement has an initial term expiring on March 31, 2010, with an automatic renewal for one year at the end of the original period under the same terms and conditions. Pursuant to the agreement, Hitachi will receive a percentage of the revenue, as provided in the agreement, collected from the Company's clients in the Territory, for its testing services performed which totaled $1,369,794 and $1,395,688 for the years ended December 31, 2009 and 2010, respectively.
 
 Hitachi is responsible for expenses related to the cost of laboratory equipment and modification to the laboratory facilities, as well as the cost of reagents.
  Intellectual Property
 
 We rely on a combination of patents, trade secret, copyright and trademark laws, license agreements, nondisclosure and other contractual provisions and technical measures to protect our intellectual property rights in our products, technology and processes. We have proprietary rights in four areas.
 
 First, we exclusively license from USC the use of the RGI-1 extraction method, which has been patented in the United States. Currently, this exclusive license includes four United States patents related to this technology. We use this patented method when processing specimens, particularly isolating RNA from FFPE tissue, as part of our contractual obligations with various clients, including Taiho. We also have proprietary rights in additional variations on the RGI-1 extraction technology, for which patent applications are pending in the United States and in select critical countries. We also use or intend to use these proprietary methods when meeting our contractual obligations with various clients and when developing diagnostic tests for cancer. We intend to protect these proprietary technologies, including our RGI-2 extraction method, by continuing to file patent applications in the United States and abroad.
 
 Next, we have identified and are in the process of identifying tumor response markers, which provide an indication of an anti-cancer drug’s effectiveness or ineffectiveness based upon the level of such determinant in a particular tumor. We intend to protect these proprietary developments to the extent allowable under current law. We have patented and have patent applications pending related to certain tumor response markers in the United States and in select critical countries. For example, we have patented methods of quantifying expression of response markers from tumor tissue, which provide guidance in determining appropriate chemotherapeutic regimens for patients that are candidates for treatment with particular chemotherapies. Currently, we have eleven United States patents that relate to certain tumor markers. Such markers include thymidylate synthase (TS), dihydropyrimidine dehydrogenase (DPD), excision repair gene CC1 (ERCC1), glutathione-s transferase pi (GST-π), epidermal growth factor receptor (EGFR) and HER2/neu gene. We use some of these patented methods as part of our contractual obligations with various clients. Additionally, we have licensed the use of our HER2/neu methods to Roche. We have also licensed the use of certain markers and technology know-how to GSK.
 
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 Additionally, we have proprietary rights in our database, in which we have compiled the results of our analysis of archived paraffin-embedded tissue specimens, clinical trials, and recently received patient tissue specimens in establishing response determinants for anti-cancer drugs, and in which we are continuing to compile data. We have protected and will continue to protect this database as a trade secret.
 
 Finally, we have proprietary rights and know-how in the factors which allow us to standardize the quantitative gene expression levels used in our database, and the computation of such values from the readings provided by the laboratory equipment used in the analysis of the mRNA extracted from a patient’s tumor, using our proprietary conversion factors.
 
 We have and will continue to pursue the registration of our trademarks in the United States and internationally. Response Genetics, Danenberg Tumor Profile, Man in Circle Design, DTP, Kras is Only Half the Equation, and The Right Therapy for each Patient the First Time are registered trademarks in the United States. We have pursued additional marks by filing trademark applications in the United States and abroad. We currently hold the domain names www.responsegenetics.com and www.responsedx.com.
 
 We intend to broaden the scope of our intellectual property and consider our technologies and proprietary know-how to be critical to our future success.
 
 Regulations
 
 The Clinical Laboratory Improvement Amendments of 1988, or CLIA, provide for the regulation of clinical laboratories by the United States Department of Health and Human Services (DHHS). This law requires the certification of clinical laboratories that conduct tests on human subjects and imposes specific conditions for certification. CLIA is intended to ensure the accuracy, reliability and timeliness of patient test results performed in clinical laboratories in the United States by mandating specific standards in the areas of personnel qualification, administration participation in proficiency testing, patient test management, quality control, quality assurance and inspections. CLIA regulations also contain guidelines for the qualification, responsibilities, training, working conditions and oversight of clinical laboratory employees. In addition, specific standards are imposed for each type of test that is performed in a laboratory. The categorization of commercially marketed in vitro diagnostic tests under CLIA is the responsibility of the FDA. The FDA will assign commercially marketed test systems into one of three CLIA regulatory categories based on their potential risk to public health. Tests will be designated as waived, of moderate complexity or of high complexity. CLIA and the regulations promulgated thereunder are enforced through quality inspections of test methods, equipment, instrumentation, materials and supplies on a periodic basis.
 
 CLIA regulations are enforced through biennial surveys and inspections. Moreover, CLIA inspectors may make random inspections of our laboratory. Since April 21, 2008, we have been CLIA certified and any loss of CLIA certification, change in CLIA or CLIA regulations or in the interpretation thereof, could have a material adverse effect on our business.
 
 Other Laboratory Regulations
 
 CLIA does not preempt more stringent state clinical laboratory laws. Since March 26, 2007, we have been a licensed clinical laboratory in California. California laws establish standards for day-to-day operation of our clinical laboratory, including the training and skills required of personnel and quality control. Moreover, several states require that we hold licenses to test specimens from patients residing in those states. Accordingly, we are also licensed in Florida, Pennsylvania, Maryland and Rhode Island. We have a license application pending in New York. Other states in which we chose to operate may have similar requirements or may adopt similar requirements in the future. Finally, we may be subject to regulation in foreign jurisdictions if we seek to expand offering our tests or distribution of our tests internationally.
 
 If we lose our California license, we would not be able to sell tests for prospective clinical trials which would limit our revenues and harm our business. If we were unable to obtain or lost necessary licenses in other states, we would not be able to test specimens in those states.
 
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HIPAA Compliance and Privacy Protection





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





Food and Drug Administration





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





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





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





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





Good Laboratory Practice (GLP)





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




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





Regulation of Reimbursement and Coverage





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





In 2009, we derived approximately 19% of our net sales of ResponseDX testing services directly from the Medicare program and 21% in 2010. Therefore, compliance with complex Medicare reimbursement rules is important to our operations. Once Medicare has determined that it will cover a particular test, or that a test will be provided as a benefit, payment is generally made under the Clinical Laboratory Fee Schedule with amounts assigned to specific procedure billing codes. Each Medicare carrier jurisdiction has a fee schedule that establishes the price for each specific laboratory billing code. This fee schedule is updated annually. As a Medicare-participating laboratory based in California, we bill the Medicare program's California contractors and will have to comply with this contractor's coverage and payment policies. In recent years, both government and private sector payers have made efforts to contain or reduce health care costs, including reimbursement for clinical laboratory services.





Manufacturing





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





Information Technology





We have implemented an internally developed database system that is used to perform tracking, evaluation, and reporting of laboratory specimens as they are analyzed. The database system is maintained using application software consisting of a multi-tier MS SQL Server application using Thin Crystal reports for data reporting. Analysis results are imported from TaqMan® PCR instruments. The application platform consists of a Windows 2000 server on the back end, with Windows XP Professional workstations as clients operating within the corporate Local Area Network (“LAN”). We also make use of commercial software applications that allow biostatistical analysis of data generated from chip array studies. These systems will be used in the facilities developed overseas by us to ensure that results from sample processing are consistent from location to location.





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





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




- 17 -


Competition





We provide services in a segment of the healthcare industry that is highly fragmented and extremely competitive. Any failure to respond to technological advances and emerging industry standards could impair our ability to attract and retain clients. This industry is characterized by rapid technological change. Our actual and potential competitors in the United States and abroad may include major pharmaceutical, biotechnology, genomic and diagnostic companies such as Genomic Health, Inc., Clarient, Inc.(recently acquired by GE), and Genzyme Corp (recently acquired by Lab Corp of America)., large clinical and pathology laboratories, universities and other research institutions. Many of our potential competitors have considerably greater financial, technical, marketing, research and other resources than we do, which may allow these competitors to discover important information and technology before we do. It is anticipated that competition will continue to increase due to such factors as the perceived potential for commercial applications of biotechnology and the continued availability of investment capital and government funding for cancer-related research. Our competitors may succeed in developing diagnostic products that circumvent our technologies or product candidates. Also, our competitors may succeed in developing technologies or products that are more effective than those that will be developed by us or that would render our technology or product candidates less competitive or obsolete.





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





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





Employees





As of December 31, 2010, we had 95 full-time and part-time employees. We employ 87 full-time and 8 part-time employees. Our employees are not represented by any collective bargaining organizations and we consider our relations with our employees to be good.





Reports to Security Holders





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





Item 1B. Unresolved Staff Comments.





None.





Item 2.  Properties.





Our corporate headquarters are located at 1640 Marengo St., Los Angeles, California, 90033. We sub-lease a total of 15,103 square feet of space, adjacent to the University of Southern California, where research and development and administrative functions are performed. Our current lease expires on March 31, 2011. Subsequent to December 31, 2010, we extended the lease for an additional one year period with virtually the same terms as the initial lease. We believe that our facility is sufficient for our U.S. operations through this additional term. We also sub-lease 180 square feet of space at 103 South Carroll Street, Suite 2b, Frederick, Maryland 21701, where administrative functions are performed. Our current lease expired on August 31, 2010 and our lease is currently on a month-to-month basis.  Subsequent to December 31, 2010, we increased the square feet of this lease to approximately 500 square feet and extended this lease through December 31, 2011.





Our subsidiary, Response Genetics Ltd., maintained its headquarters at Chancellor’s Building, Royal Infirmary of Edinburgh, 49 Little France Crescent, Edinburgh Scotland EH16 5JB. We leased 490 square meters of space (approximately 5,275 square feet of space), where our administrative functions and laboratory functions were performed. We terminated this lease on April 30, 2009.




- 18 -


Item 3. Legal Proceedings.





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





Part II





Item 4. Reserved





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





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





2010First


Second


Third


FourthQuarter


Quarter


Quarter


QuarterStock price - High

$
1.81


$
2.84


$
3.07


$
2.50Stock price - Low

$
1.15


$
1.86


$
2.27


$
2.08





2009First


Second


Third


FourthQuarter


Quarter


Quarter


QuarterStock price - High

$
1.55


$
1.37


$
2.18


$
1.95Stock price - Low

$
0.85


$
1.02


$
1.20


$
1.10





Stockholders





As of March 28, 2011, there were approximately 36 stockholders of record of the 18,361,720 outstanding shares of Common Stock.





Dividends





The Company has not paid dividends to its stockholders since its inception and does not plan to pay cash dividends in the foreseeable future. The Company currently intends to retain earnings, if any, to finance the growth of the Company.





Recent sales of Unregistered Securities





On February 27, 2009, we entered into a Purchase Agreement with certain affiliates of Special Situations Funds for the private placement of 2,000,000 newly-issued shares of the Company's common stock at a per share price of $1.00. The closing of the sale of the shares occurred on Monday, March 2, 2009 and we received the funds on the same date.  The shares were sold in reliance upon exemptions from registration under Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.





In connection with the Special Situations Funds Private Placement, we also entered into a Registration Rights Agreement, dated February 27, 2009, (the "Registration Rights Agreement") pursuant to which the Company filed a registration statement with the Securities and Exchange Commission ("SEC") to register the 2,000,000 shares for resale, which registration statement became effective on June 30, 2009.





On July 22, 2009, we entered into a Purchase Agreement with certain funds of Lansdowne Partners Limited for the private placement of 3,057,907 newly-issued shares of the Company's common stock at a per share price of $1.30. The closing of the sale of the shares occurred on July 23, 2009. The aggregate offering price of the shares was approximately $4 million.  In connection with the acquisition of the shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of the Company’s capital stock, subject to various exceptions and limitations. We received the funds on July 23, 2009.  The shares were sold in reliance upon exemptions from registration under Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.





In connection with the Lansdowne Private Placement, we also entered into a Registration Rights Agreement, dated July 22, 2009, with the Purchasers (the "Registration Rights Agreement") pursuant to which the Company filed a registration statement with the SEC to register the 3,057,907 shares for resale, which registration statement became effective on November 3, 2009.  The Company also granted certain "piggyback" registration rights to Lansdowne which are triggered if the Company proposes to file a registration statement for its own account or the account of one or more shareholders until the earlier of the sale of all of the shares or the shares become eligible for sale under Rule 144(b)(1) without restriction.




- 19 -


On March 5, 2010, we entered into a Purchase Agreement with certain affiliates of and funds managed by Lansdowne Partners Limited Partnership, Greenway Capital Partners and Paragon Associates for the private placement of 3,005,349 newly-issued shares of our common stock at a per share price of $1.31.  The closing of the sale of the shares occurred on Friday, March 5, 2010.  In connection with the acquisition of the shares, the Purchasers were granted certain preemptive rights permitting them to maintain their percentage ownership interests in connection with future issuances of our capital stock, subject to various exceptions and limitations.  Lansdowne participated in the Private Placement by electing to exercise the preemptive rights granted to it pursuant to the Purchase Agreement by and between the Company and Lansdowne, dated July 22, 2009.  The shares were sold in reliance upon exemptions from registration under Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.





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





Purchases of Equity Securities





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





Item 6. Selected Financial Data.





The following selected consolidated statement of operations data for the years ended December 31, 2009 and 2010 and the balance sheet data at December 31, 2009 and 2010 have been derived from our audited consolidated financial statements, which are included elsewhere in this report.  Historical results are not necessarily indicated of the results of operations for future periods.  The following data is qualified in its entirety and should be read in conjunction with the rest of the information contained in this section and our consolidated financial statements and related notes included elsewhere in this report.





Consolidated Statement of Operations Data:





Year ended


Year endedDecember 31,

2009


December 31,

2010(1)Revenue

$
9,066,683


$
21,277,415Operating expenses:Cost of revenue

$
5,864,787


$
10,460,994Selling and marketing

$
3,542,082


$
5,988,746General and administrative

$
6,020,614


$
8,072,667U.K. expenses

$
752,901


$
24,455Research and development

$
2,293,303


$
1,611,582Operating loss

$
(9,407,004
)

$
(4,881,029
)Net loss

$
(9,341,055
)

$
(4,670,379
)Net Loss as adjusted for the revenue impact of $1,902,667 resulting from the conversion to accrual for Private Payors (refer to Note 2)

$
(9,341,055
)

$
(6,573,046
)Net loss per common share:Basic and diluted

$
(0.70
)

$
(0.26
)Basic and diluted loss per share as adjusted for the revenue impact of $1,902,667 (refer to Note 2)

$
(0.70
)

$
(0.37
)Weighted average common shares outstanding:Basic and diluted


13,276,095



17,791,584,





(1) Effective April 1, 2010, the Company recognizes all product revenue from its ResponseDX tests on an accrual basis. Through March 31, 2010, the Company recognized revenue from private Payors on a cash basis as the Company had not, until then, established a collection history.  As of April 1, 2010, a pattern of collections was established and the Company began to record revenues from Private Payors of ResponseDX on an accrual basis. As a result of the conversion from the cash basis to the accrual basis of recording revenue for ResponseDX tests paid by Private Payors, the Company recognized a total of $1,902,667 more in revenue during the year ended December 31, 2010,  than it would have recognized had the Company continued to recognize such amounts on the cash basis during this same period.




- 20 -


Consolidated Balance Sheet data:





December 31,

2009


December 31,

2010Consolidated Balance Sheet Data:Cash and cash equivalents

$
7,058,365


$
4,120,074Total assets

$
10,792,974


$
10,601,570Common stock classified outside of stockholders’ equity (deficit)

$
3,975,279


$
7,854,682Total stockholders’ equity (deficit)

$
649,220


$
(3,275,396
)





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





Special Note Regarding Forward Looking Statements





Certain statements in this report constitute “forward-looking statements.” These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance, or achievements of Response Genetics, Inc. to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Specifically, the actions of competitors and customers and our ability to execute our business plan, and our ability to increase revenues is dependent upon our ability to continue to expand our current business and to expand into new markets, general economic conditions, and other factors. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues,” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligations to publicly update or review any forward-looking statements, whether as a result of new information, future developments or otherwise.





The following discussion of our financial condition and results of operation should be read in conjunction with our audited consolidated financial statements and related notes to the consolidated financial statements included elsewhere in this annual report on Form 10-K for the year ended December 31, 2010. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward looking statements.





Overview





Response Genetics, Inc. (the “Company”) was incorporated in the state of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin wax. In August 2000, we changed our name to Response Genetics, Inc.   In November 2006, we established Response Genetics Ltd., a wholly owned subsidiary in Edinburgh, Scotland. On February 9, 2009 we implemented a reduction of workforce pursuant to which we closed our subsidiary in Edinburgh. See "liquidity and capital resources" for additional information.





Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. Our pharmacogenomic analysis of clinical trial specimens for the pharmaceutical industry may provide data that will lead to a better understanding of the molecular basis for response to specific drugs and, therefore lead to individualized treatment. We are focusing our efforts in the following areas:





·
Continued commercialization of our ResponseDX TM tests;





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





·
Expanding our pharmacogenomic testing services business into and creating a standardized and integrated testing platform in the major markets of the healthcare industry, including outside of the United States.




- 21 -


Our patented technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, specimens and thereby to analyze genetic information contained in these tissues. This is significant because the majority of patients diagnosed with cancer have a tumor biopsy sample stored in paraffin, while only a small percentage of patients’ tumor specimens are frozen. Our technologies also enable us to use the FFPE patient biopsies for the development of diagnostic tests. To our knowledge, we were the first company to generate clinically relevant information regarding the risks of recurrence of cancer or chemotherapy response using approximately 30,000 genes available from microarray profiling of FFPE specimens.




- 22 -


ResponseDXTM





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





At present most chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients’ tissues that may predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we are developing genetic tests that will measure predictive factors for tumor response in tumor tissue samples. We have begun offering tests for non-small cell lung cancer (NSCLC) (ResponseDX: Lung TM), colorectal cancer (CRC) (ResponseDX: ColonTM) and gastric and gastroesophageal (GE) cancer  (ResponseDX: GastricTM) patients’ tumor tissue through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 (CLIA), and we anticipate offering additional tests for ovarian and pancreatic cancer in the future. These tests are proprietary based tests which serve to help oncologists make optional therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among chemotherapy regimens to treat their cancer patients. As of December 31, 2010, our recently formed sales team had been expanded to 19 sales people located in the West Coast, Midwest, and East Coast areas of the United States.




- 23 -


Diagnostic Tests for Other Cancers





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





Expansion of our pharmacogenomic testing services business





We have started the expansion of our pharmacogenomic testing services business into major markets of the healthcare industry outside of the United States. We have a service laboratory in Japan and in China, through collaboration with some of our current clients in the pharmaceutical industry. The pharmaceutical industry is in need of standardized integrated worldwide analysis of clinical trial specimens. It is important to the pharmaceutical industry and the regulatory agencies that the same analytical methods are used for each clinical trial sample around the world so that the data can be easily compared and used for global drug development. Also, export of clinical trial specimens to the United States is restricted from some areas of the world, such as China. Our goal is to offer an analysis of patient specimens and generate consistent data based on integrated common platforms and technology into the major markets of the healthcare industry including outside of the United States.





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





We anticipate that, over the next 12 months, a substantial portion of our capital resources and efforts will be focused on research and development to expand our series of diagnostic tests for cancer patients, to establish a laboratory overseas in collaboration with certain of our current pharmaceutical clients, sales and marketing activities related to our ResponseDX diagnostic tests, and for other general corporate purposes.





Research and development expenses represented 12.4% and 6.2% of our total operating expenses for the years ended December 31, 2009 and 2010, respectively. Major components of the $2,293,303 and $1,611,582 in research and development expenses for the years ended December 31, 2009 and 2010, respectively, included supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, insurance, business consulting and sample procurement costs.




- 24 -


Critical Accounting Policies and Significant Judgments and Estimates





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





Revenue Recognition





Pharmacogenomic Revenue





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





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





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





ResponseDX Revenue





Effective April 1, 2010, the Company recognizes all product revenue from its ResponseDX tests on an accrual basis. Through March 31, 2010, the Company recognized revenue from Private Payors on a cash basis as the Company had not, until then, established a collection history.  As of April 1, 2010, a pattern of collections had been established and the Company began to record revenues from Private Payors of ResponseDX on an accrual basis.





For accounting purposes, the change from the cash basis to the accrual basis of recording revenue for ResponseDX tests paid by Private Payors, is considered a change in accounting estimate leading to a change in accounting principle.  The change in accounting estimate was derived from the establishment of a reasonable basis to estimate the amount to be collected from certain Private Payors.  This change in estimate resulted in the change in accounting principle from the cash basis to the accrual basis of revenue recognition for ResponseDX tests paid by Private Payors.  Accordingly, the Company has recorded in the second quarter a one-time adjustment to increase revenue by $1,507,187, which represents the amount of ResponseDX tests completed in prior periods for which cash payment under the former revenue recognition method had not been received as of April 1, 2010.  Since all sales of Response DX tests are on the accrual basis from April 1, 2010, the Company does not expect any future one-time adjustments to revenue.  The revenue recorded from ResponseDX sales to Private Payors for the period from April 1, 2010 to December 31, 2010 was $4,388,270.  As a result of the conversion from the cash basis to the accrual basis of recording revenue for ResponseDX tests paid by Private Payors, the Company recognized a total of $1,902,667 more in revenue during the year ended December 31, 2010, respectively, than it would have recognized had the Company continued to recognize such amounts on the cash basis during this same period.





The Company has its Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes.  ResponseDX revenues related to Medicare billings are recorded at established billing rates net of an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors.  Response DX revenue related to Private Payors are recorded at established billing rates less an allowance to reflect the revenue at the amounts expected based on historical collections patterns.





License Fees





We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from USC in exchange for royalty fees on revenue generated by use of this technology. These royalties are calculated as a fixed percentage of revenue that we generate from use of the technology licensed from USC. Total license fees expensed in cost of revenue under the royalty agreement to USC were $227,956 and $439,540 for the years ended December 31, 2009 and 2010, respectively. We also maintain a non-exclusive license to use Roche’s polymerase chain reaction (PCR), homogenous PCR, and reverse transcription PCR processes. We pay Roche a fixed percentage royalty fee for revenue that we generate through use of this technology. Royalties expensed in cost of revenue under this agreement totaled $198,279 and $426,366 for the years ended December 31, 2009 and 2010, respectively.





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




- 25 -


Accounts Receivable





We invoice our pharmaceutical clients as specimens are processed and any other contractual obligations are met. Our contracts with pharmaceutical clients typically require payment within 45 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, our clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal and there is no allowance for doubtful accounts for our pharmaceutical revenue at December 31, 2009 and 2010.





We bill Medicare and Private Payors for ResponseDX upon completion of the required testing services. As such, we take assignment of benefits and the risk of collection with Medicare and Private Payors. We continue to monitor the collection history for Medicare and Private Payors.  Based on the historical experience for our Medicare and Private Payor accounts, we have determined that related accounts receivable associated with billings over one year old are unlikely to be collected.  Therefore, we have recorded an allowance for doubtful accounts of $113,838 as of December 31, 2010.  There was no allowance for doubtful accounts recorded as of December 31, 2009.





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





Income Taxes





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





Results of Operations





Years Ended December 31, 2010 and December 31, 2009





Revenue.  Revenues were $21,277,415 for the year ended December 31, 2010, as compared to $9,066,683 for the year ended December 31, 2009, an increase of $12,210,732, or 134.7%.   Revenues, excluding the net revenue impact of $1,902,667 resulting from the conversion to the accrual basis of revenue recognition for Private Payors, were $19,374,748 for the year ended December 31, 2010, as compared to $9,066,683 for the year ended December 31, 2009, an increase of $10,308,065, or 113.7%.  The increase, excluding the net revenue impact of $1,902,667 for the year ended December 31, 2010, was due to increases in ResponseDX revenue of $6,125,680 and pharmaceutical revenues of $4,182,385 (including the $322,469 out of period adjustment-see Note 15).  Excluding the net revenue impact of $1,902,667 for the year ended December 31, 2010, ResponseDX revenue accounted for 44.2% of total revenue compared to 36.2% for the year ended December 31, 2009.  Excluding the net revenue impact of $1,902,667, ResponseDX revenues for the year ended December 31, 2010, as compared to the year ended December 31, 2009, increased 186.8%.  This increase was primarily due to an increase of our sales force and adding additional genes to our tests. We expect that revenues will continue to increase as we add additional sales managers in 2011. For the year ended December 31, 2010, our two most significant pharmaceutical customers accounted for approximately 43.7% of our revenue, as compared to approximately 59.5% of our revenue for the year ended December 31, 2009.





Cost of Revenue.  Cost of revenues for the year ended December 31, 2010 were $10,460,994 as compared to $5,864,787 for the year ended December 31, 2009, an increase of $4,596,207 or 78.4%.   To support the increase in revenue, the Company hired additional lab personnel and temporary help, incurred additional costs for lab supplies, reagents and shipping costs. Specifically, the increase in Cost of revenue resulted primarily from increases in personnel and temporary help costs of $2,151,034, lab supplies and reagent costs of $957,594, equipment service and repair costs of $126,121, consulting costs of $253,904, royalties of $439,670, third party (Hitachi Chemical and Shanghai Bio) processing costs of $175,102 and shipping costs of $265,856.  Cost of revenues as a percentage of revenues was 49.2% for the year ended December 31, 2010, as compared to 64.7% for the year ended December 31, 2009, a decrease of 15.5%. Excluding the net revenue impact of $1,902,667 resulting from the conversion to accrual for Private Payors, cost of revenues as a percentage of revenue was 54.0% for the year ended December 31, 2010 as compared to 64.7% for the year ended December 31, 2009, a decrease of 10.7%.




- 26 -


Research and Development Expenses.  Research and development expenses were $1,611,582 for the year ended December 31, 2010, as compared to $2,293,303 for the same period in 2009, a decrease of $681,721 or 29.7%. This decrease resulted primarily from decreases in laboratory supplies, reagents and microarray costs of $135,825, personnel related costs of $235,182 and consulting costs of $252,550. We expect research and development expenses to increase as we work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.





General and Administrative Expenses.  General and administrative expenses totaled $8,072,667 for the year ended December 31, 2010, as compared to $6,020,614 for the year ended December 31, 2009, an increase of $2,052,053 or 34.1%. This increase resulted primarily from increases in personnel costs of $653,493, legal costs primarily associated with the proxy activities of $576,128, business consulting costs of $175,221, billing service costs of $274,855, an impairment to property and equipment of $371,872 and bad debt expenses of $224,978, offset by a decrease in accounting service costs of $237,268.





Sales and Marketing Expenses.   For year ended December 31, 2010, our sales and marketing expenses totaled $5,988,746 compared to $3,542,082 for the year ended December 31, 2009, an increase of $2,446,664 or 69.1%.  The increase primarily resulted from increased sales and marketing activities for ResponseDX, which included increases in personnel costs of $1,485,971, marketing and promotional costs of $697,033, and travel and meeting costs of $310,798.  We expect that sales and marketing costs will continue to increase as we expand our sales and marketing activities in order to gain clinical acceptance of our ResponseDX assays.





United Kingdom (U.K) Operating Expenses.In December, 2008, we made the decision to increase the operational efficiency of the Company by consolidating our U.K. operations with our US operations.  On February 9, 2009, management implemented a reduction of workforce pursuant to which the Company closed its UK testing facility to consolidate services at its CLIA-certified laboratory facilities in Los Angeles. This reduction did not affect our genetic testing services or current partnership agreements.  The reduction of workforce was substantially completed on March 31, 2009 and the lease for our UK testing facility expired on April 30, 2009. The operating costs related to our U.K. laboratory were $752,901 for the year ended December 31, 2009, which included redundancy costs of $295,799 incurred in connection with the reduction of workforce.  UK operating expenses were $24,455 for the year ended December 31, 2010.





Other Income.  In 2010, we applied and received a one time federal grant relating to qualified research and development activities.  The gross amount of the proceeds received was $244,479.  This amount, net of $22,677 of related direct costs, is shown as other income on the accompanying 2010 consolidated statement of operations.





Interest Income.  Interest income was $682 for the year ended December 31, 2010, compared with $22,265 for the same period in 2009. This $21,583 decrease was due to lower average cash balances and lower rates of interest during the year ending December 31, 2010.





Income Taxes. As of December 31, 2009 and 2010, a full valuation allowance has been recorded for the net deferred tax assets since we do not believe the recoverability of the net deferred income tax assets in the near future is more likely than not.





Liquidity and Capital Resources





We incurred net losses of $4,670,379 and $9,341,055 during the years ended December 31, 2010 and 2009, respectively. Since our inception in September 1999, we have incurred cumulative losses and as of December 31, 2010, we had an accumulated deficit of $43,817,163. We have not yet achieved profitability and anticipate that we will likely incur additional losses for the next year. We cannot provide assurance as to when we will achieve profitability. We expect that our cash and cash equivalents will be used to fund our selling and marketing activities primarily related to our ResponseDX tests, research and development, and general corporate purposes. As a result, we will need to generate significant revenues to achieve profitability.  Management plans to effectively manage cash flows in 2011 and expects that cash and cash equivalents will be sufficient to meet the Company’s working capital requirements through the next 12 months. Nevertheless, until we can generate and maintain sufficient revenues to finance our cash requirements, which we may never do, we expect to finance additional cash needs primarily through public or private equity offerings, strategic collaborations, and other financing opportunities as they may arise.  We do not know whether additional funding will be available on acceptable terms, if at all.  If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate selling and marketing activities or research and development programs.




- 27 -


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





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





Recent contract amendments





In January 2010, we amended our agreement with Taiho and the agreement was renewed for an additional three years. According to the terms of the renewal, Taiho’s appointment as an exclusive purchaser in Japan of tests and testing services and its minimum purchasing obligations were extended through 2010.





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





For each calendar quarter of 2009 and the first two quarters of 2010, €200,000 of the existing credit shall apply to all services rendered to GSK Bio during such calendar quarter.  Pursuant to the Amended and Restated Agreement, in July of 2010 GSK Bio extended the term of the agreement for an additional one-year period through December 31, 2011.  As the agreement was extended,  the then remaining balance of the existing credit shall be divided into six equal quarterly amounts and apply to all services rendered to GSK Bio in each of the last two quarters of 2010 and the four calendar quarters of 2011.  In all cases, GSK Bio shall remit payment to the Company for all services rendered to GSK Bio in any such calendar quarter that is in excess of the applicable credit amount.  In the event the amount of services rendered to GSK Bio in a calendar quarter does not exceed the applicable credit amount, the existing credit for the following calendar quarter shall be increased by such unused amount. The aggregate credit is included as part of deferred revenue. The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products.




- 28 -


Private placements





Under the Company’s Articles of Incorporation, the Company has one class of common stock and its holders have no preemptive, subscription, redemption or conversion rights.  As more fully described in Note 15, the Company sold shares of its common stock during 2009 and 2010 in three private placements, as described below.  In connection with these private placements, the Company entered into registration rights agreements with the purchasers of the common shares.





On February 27, 2009, we entered into a Purchase Agreement with certain affiliates of Special Situations Funds for the private placement of 2,000,000 newly-issued shares of the Company's common stock at a per share price of $1.00. The closing of the sale of the Shares occurred on Monday, March 2, 2009 and we received net proceeds of $2,000,000 on the same date.





In connection with the Special Situations Funds Private Placement, we also entered into a Registration Rights Agreement, dated February 27, 2009, with the Purchasers (the "Registration Rights Agreement") pursuant to which the Company filed a registration statement with the Securities and Exchange Commission ("SEC") to register the 2,000,000 shares for resale, which registration statement became effective on June 30, 2009.





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





Common stock classified outside of stockholders’ equity (deficit)





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





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





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





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





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





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




- 29 -


Comparison of years ended December 31, 2010 and 2009





As of December 31, 2010, we had $4,120,074 in cash and cash equivalents, working capital of $3,873,539 and an accumulated deficit of $43,817,163.





Cash flows provided by operating activities





During the year ended December 31, 2010, the Company used cash flows in operating activities of $6,491,670 compared to $8,414,406 used in the year ended December 31, 2009.  The reasons for the decrease in cash used in operating activities of $1,922,736 was due mainly to the decrease in net loss and increases in accounts payable, accrued expenses, accrued royalties and accrued payroll and related liabilities, offset by the increase in accounts receivable and prepaid expenses and other current assets, and the decrease in deferred revenue.





The increase in accounts receivable related mainly to the increased revenue and accounts receivable from the conversion to accrual for Private Payors.  The increase in accounts payable and accrued expenses primarily resulted from increased sales and marketing and business development activities related to the growth of ResponseDX.  The increase in accrued royalties primarily related to the increased ResponseDX revenues subject to license fees in 2010.  The increase in accrued payroll and related liabilities is primarily due to the increased number of employees at December 31, 2010 and accrued bonuses at December 31, 2010.  The decrease in deferred revenue related to the revenue recognition of deferred revenue totaling $2,392,227, which includes an out of period adjustment of $322,469 (see Note 15).





Cash flows used in investing activities





Net cash used in investing activities was $391,518 and $175,686 for the years ended December 31, 2010 and 2009, respectively. This increase was attributable to the need for property and equipment for our laboratory and new personnel.





Cash flows used in financing activities





Cash flows from financing activities for the years ended December 31, 2010 and 2009 provided net cash of $3,953,483 and $6,061,901, respectively, primarily relating to the sale of common stock.





Off-Balance Sheet Arrangements





We do not have any off-balance sheet arrangements.




- 30 -





Recent Accounting Pronouncements





In December 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) — Accounting for Transfers of Financial Assets (“ASU 2009-16”). ASU 2009-16 formally codifies SFAS 166, Accounting for Transfers of Financial Assets. ASU 2009-16 eliminates the concept of a qualifying special-purpose entity (“SPE”) and removes the scope exception for a qualifying SPE from ASC 810, Consolidations. As a result, previously unconsolidated qualifying SPEs must be re-evaluated for consolidation by the sponsor or transferor. In addition, this accounting update amends the accounting guidance related to transfers of financial assets in order to address practice issues that have been highlighted by the events of the recent economic decline. ASU 2009-16 is effective as of the beginning of the annual reporting period that begins after November 15, 2009. The recognition and measurement provisions will be applied to transfers that occur on or after the effective date and all qualifying SPEs that exist on and after the effective date must be evaluated for consolidation.  The adoption of this guidance did not have a material effect on our results of operations or financial position.





In December 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”). ASU 2009-17 codifies SFAS 167, Amendments to FASB Interpretation No. 46(R), and amends the consolidation guidance related to a variable interest entity (“VIE”). Primarily, the current quantitative analysis used under ASC 810, Consolidations, will be eliminated and replaced with a qualitative approach that is focused on identifying the variable interest that has the power to direct the activities that most significantly impact the performance of the VIE and absorb losses or receive returns that could potentially be significant to the VIE. In addition, this new accounting standard will require an ongoing reassessment of the primary beneficiary of the VIE, rather than reassessing the primary beneficiary only upon the occurrence of certain pre-defined events. ASU 2009-17 will be effective as of the beginning of the annual reporting period that begins after November 15, 2009, and requires the reconsideration of all VIEs for consolidation in which an entity has a variable interest upon the effective date of these amendments. The adoption of this guidance did not have a material effect on our results of operations or financial position.





In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 requires new disclosures and clarifies existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. ASU 2010-06 amends Codification Subtopic 820-10 to now require that (1) a reporting entity must disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; (2) in the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements and (3) a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. ASU 2010-06 is 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 15, 2010, and for interim periods within those fiscal years. The adoption of this guidance did not have a material effect on our results of operations or financial position.





In February 2010, Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2010-09, Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements, which amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements.  ASU 2010-09 is effective upon issuance. The adoption of ASU 2010-09 did not have a material impact on our consolidated financial statements.





On April 14, 2010, the FASB issued Accounting Standard Codification (ASC) update 2010-12 to ASC 740-10, “Income Taxes.” On March 30, 2010, the President signed the Health Care and Education Reconciliation Act of 2010, which is a reconciliation bill that amends the Patient Protection and Affordable Care Act that was signed by the President on March 23, 2010 (collectively the "Acts"). Recently, questions have arisen about the effect, if any, that the different signing dates might have on the accounting for these two Acts. This timing difference, related solely to the signing dates, should not have an impact on a majority of registrants because the Acts were both signed within a relatively short time period, which for the vast majority of companies falls into the same reporting period.  After consultation with the FASB staff, the Office of the Chief Accountant would not object to a view that the two Acts should be considered together for accounting purposes.  The adoption of this guidance did not have a material effect on our results of operations or financial position.





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





- 31 -





Item 8.  Financial Statements and Supplementary Data.





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





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





None.





Item 9A.  Controls and Procedures.





Evaluation of Disclosure Controls and Procedures





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





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





Management’s Annual Report on Internal Control over Financial Reporting





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





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





Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on its assessment, management believes that, as of December 31, 2010, our internal control over financial reporting was effective based on those criteria.





This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Annual Report on Form 10-K.




- 32 -





Changes in Internal Control over Financial Reporting





There were no changes in our internal control over financial reporting during the year ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.





Item 9B.  Other Information.





None.





Part III





Certain information required by Part III is omitted from this Annual Report on Form 10-K since we intend to file our definitive proxy statement for our 2011 annual meeting of stockholders, pursuant to Regulation 14A of the Securities Exchange Act, not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and certain information to be included in the proxy statement (the “Proxy Statement”) is incorporated herein by reference.





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





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





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





Code of Ethics





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





Item 11.  Executive Compensation.





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





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





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





Equity Compensation Plan Information





The table below sets forth certain information as of December 31, 2010 about the Company’s Common Stock that may be issued upon the exercise of options and rights under all of our existing equity compensation plans (shares in thousands):




- 33 -





Securities Authorized For Issuance Under Equity Compensation Plans





Plan Category

Number of securities to be

issued upon exercise of

outstanding options, warrants

and rights

(a)


Weighted-average exercise

price of outstanding options,

warrants and rights

(b)


Number of securities remaining

available for future issuance

under equity compensation

plans (excluding securities

reflected in column (a))

(c)Equity compensation plans approved by security holders


2,095,280


$
4.35



970,720Equity compensation plans not approved by security holders


—



—



—Total


2,095,280


$
4.35



970,720





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





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





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





Item 14.  Principal Accountant Fees and Services.





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




- 34 -





FINANCIAL STATEMENTS





INDEX





PageReport of Independent Registered Public Accounting Firm
36Consolidated Balance Sheets as of December 31, 2009 and 2010
37Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2009 and 2010
38Consolidated Statements of Cash Flows for the Years Ended December 31, 2009 and 2010
39Consolidated Statements of Stockholders’ Equity (Deficit) and Comprehensive Loss for the Years Ended December 31, 2009 and 2010
40Notes to Consolidated Financial Statements
41 - 63




- 35 -





Report of Independent Registered Public Accounting Firm





To the Board of Directors and Stockholders


Response Genetics, Inc.


Los Angeles, California





We have audited the accompanying consolidated balance sheet of Response Genetics, Inc. and subsidiary as of December 31, 2010 and 2009 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit) and comprehensive loss, and cash flows for each of the two years in the period  ended December 31, 2010. These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.





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





In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Response Genetics, Inc. and subsidiary at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.





/s/ BDO USA, LLP






Los Angeles, California


March 30, 2011





- 36 -





RESPONSE GENETICS, INC.





CONSOLIDATED BALANCE SHEETS





As of December 31,2009


2010ASSETSCurrent assetsCash and cash equivalents

$
7,058,365


$
4,120,074Accounts receivable, net of allowance for doubtful accounts of zero and $113,838 at December 31,2009 and 2010, respectively


1,982,951



4,733,698Prepaid expenses and other current assets


418,289



941,981Total current assets


9,459,605



9,795,753Property and equipment, net


1,253,714



805,817Other assets


79,655



—Total assets

$
10,792,974


$
10,601,570LIABILITIES, COMMON STOCK CLASSIFIED OUTSIDE OF STOCKHOLDERS’ EQUITY (DEFICIT) AND STOCKHOLDERS’ EQUITY (DEFICIT)Current liabilitiesAccounts payable

$
729,100


$
1,247,151Accrued expenses


503,612



1,075,636Accrued royalties


455,995



809,694Accrued payroll and related liabilities


468,774



1,271,037Deferred revenue


2,596,066



1,518,696Total current liabilities


4,753,547



5,922,214Deferred revenue, net of current portion


1,414,928



100,070Total liabilities


6,168,475



6,022,284Commitments and contingencies (Note 5)Common stock classified outside of stockholders’ equity (deficit)  (Note 13)


3,975,279



7,854,682Stockholders’ equity (deficit)Common stock, $0.01 par value; 50,000,000 shares authorized; 15,297,183 and 18,357,406 shares issued and outstanding at December 31, 2009 and 2010, respectively


122,393



122,942Additional paid-in capital


39,858,986



40,612,785Accumulated deficit


(39,146,784
)


(43,817,163
)Accumulated other comprehensive loss


(185,375
)


(193,960
)Total stockholders’ equity (deficit)


649,220



(3,275,396
)Total liabilities, common stock classified outside of stockholders’ equity (deficit) and stockholders’ equity (deficit)

$
10,792,974


$
10,601,570





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




- 37 -





RESPONSE GENETICS, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS





Year Ended December 31,2009


2010Net revenue

$
9,066,683


$
21,277,415Operating expenses:Cost of revenue


5,864,787



10,460,994Selling and marketing


3,542,082



5,988,746General and administrative


6,020,614



8,072,667U.K. expenses


752,901



24,455Research and development


2,293,303



1,611,582Total operating expenses


18,473,687



26,158,444Operating loss


(9,407,004
)


(4,881,029
)Other income (expense):Interest expense


(10,822
)


(10,578
)Interest income


22,265



682Other


49,718



221,802Loss before income tax provision (benefit)


(9,345,843
)


(4,669,123
)Income tax provision (benefit)


(4,788
)


1,256Net loss

$
(9,341,055
)

$
(4,670,379
)Unrealized gain (loss) on foreign currency translation


46,350



(8,585
)Total comprehensive loss

$
(9,294,705
)

$
(4,678,964
)Net loss per share — basic and diluted

$
(0.70
)

$
(0.26
)Weighted-average common shares — basic and diluted


13,276,095



17,791,584





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





- 38 -





RESPONSE GENETICS, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS





Year Ended

December 31,2009


2010Cash flows from operating activities:Net loss

$
(9,341,055
)

$
(4,670,379
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


385,429



465,689Bad debt expense


—



224,978Share-based compensation


986,432



680,268Loss (gain) on sale of property and equipment


(48,615
)


1,854Impairment of property and equipment


—



371,872Changes in operating assets and liabilities:Accounts receivable


136,553



(2,975,725
)Prepaid expenses and other assets


(21,647
)


(444,037
)Accounts payable


182,125



518,051Accrued expenses


(12,048
)


572,024Accrued royalties


(70,717
)


353,699Accrued payroll and related liabilities


314,589



802,263Deferred revenue


(925,452
)


(2,392,228
)Net cash used in operating activities


(8,414,406
)


(6,491,671
)Cash flows from investing activities:Purchase of property and equipment


(224,301
)


(391,518
)Proceeds from sale of property and equipment


48,615



—Net cash used in investing activities


(175,686
)


(391,518
)Cash flows from financing activities:Proceeds from issuance of common stock


5,975,279



3,879,403Exercise of stock options


—



74,080Capital contribution


86,622



—Net cash provided by financing activities


6,061,901



3,953,483Effect of foreign exchange rates on cash and cash equivalents


41,556



(8,585
)Net decrease in cash and cash equivalents


(2,486,635
)


(2,938,291
)Cash and cash equivalents:Beginning of the year


9,545,000



7,058,365End of the year

$
7,058,365


$
4,120,074Cash paid during the period for:Income taxes

$
—


$
1,256Interest

$
10,822


$
10,578





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





- 39 -





RESPONSE GENETICS, INC.





Consolidated Statement of Stockholders’ Equity (Deficit) and Comprehensive Loss





Common StockNumber of

Shares


Amount


Additional

Paid-in

Capital


Accumulated

Deficit


Accumulated

Other

Comprehensive

Loss


Total

Stockholders'

Equity (Deficit)Balances at December 31, 2008


10,239,276


$
102,393


$
36,805,932


$
(29,805,729
)

$
(231,725
)

$
6,870,871Issuance of common stock


5,057,907



20,000



1,980,000



—



—



2,000,000Capital contribution


—



—



86,622



—



—



86,622Share-based compensation expense


—



—



986,432



—



—



986,432Unrealized gain on foreign currency translation


—



—



—



—



46,350



46,350Net loss


—



—



—



(9,341,055
)


—



(9,341,055
)Total comprehensive loss


—



—



—



—



—



(9,294,705
)Balances at  December 31, 2009


15,297,183


$
122,393


$
39,858,986


$
(39,146,784
)

$
(185,375
)

$
649,220Issuance of common stock


3,005,349



—



—



—



—



—Exercise of stock options


54,874



549



73,531



—



—



74,080Share-based compensation expense


—



—



680,268



—



—



680,268Unrealized gain on foreign currency translation


—



—



—



—



(8,585
)


(8,585
)Net loss


—



—



—



(4,670,379
)


—



(4,670,379
)Total comprehensive loss


—



—



—



—



—



(4,678,964
)Balances at  December 31, 2010


18,357,406


$
122,942


$
40,612,785


$
(43,817,163
)

$
(193,960
)

$
(3,275,396
)





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




- 40 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





1. Organization, Operations and Basis of Accounting





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





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





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




Since its inception, the Company has devoted substantial effort in developing its product and has incurred losses and negative cash flows from operations, and at December 31, 2010 has an accumulated deficit of $43,817,163. The Company is forecasting continued losses and negative cash flows as it funds its selling and marketing activities and research and development programs.
 
 Based on the Company’s current operating plan which includes various assumptions concerning the level and timing of cash receipts from product sales and cash outlays for operating expenses and capital expenditures, management believes that existing cash and cash equivalents will be sufficient to meet the Company’s working capital requirements through the next twelve months.  The Company’s ability to successfully carry out its business plan is primarily dependent upon its ability to (1) obtain sufficient additional capital at acceptable costs, (2) attract and retain knowledgeable workers, and (3) generate significant revenues. The Company plans to seek additional financing and/or strategic investments; however, there can be no assurance that any additional financing or strategic investments will be available on acceptable terms, if at all.
 
 However, if events or circumstances occur such that the Company does not meet its operating plan as expected, in addition to seeking the additional capital as described above, the Company will most likely be required to reduce certain discretionary spending, which could have a material adverse effect on the Company’s ability to achieve its intended business objectives.  No adjustments have been made to the accompanying financial statements to reflect any of the matters discussed above.  The consolidated financial statements have been prepared on the basis that the Company will continue as a going concern.


2. Summary of Significant Accounting Policies





Basis of Consolidation





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





Cash and Cash Equivalents





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





Accounts Receivable





Clinical Accounts Receivable





The Company invoices its clients as specimens are processed and any other contractual obligations are met. The Company’s contracts with clients typically require payment within 45 days of the date of invoice. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its clients to make required payments. The Company specifically analyzes accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, the Company’s clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal. Pharmaceutical company accounts receivable as of December 31, 2009 and 2010 were $1,089,012 and $1,694,130, respectively.  There were no allowances for doubtful accounts recorded against these pharmaceutical accounts receivable at December 31, 2009 and 2010.





- 41 -


RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Accounts Receivable – (continued)





ResponseDX Accounts Receivable





Response DX accounts receivable are recorded from three primary payors: Medicare, third party and private payors (Private Payors) and NeoGenomics Laboratories, a clinical reference laboratory authorized to offer our tests, based upon their respective applicable billing rates.  ResponseDX accounts receivable related to Medicare are recorded at established billing rates less an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors. Beginning with the second quarter of 2010, as discussed in our Revenue Recognition accounting policy, ResponseDX accounts receivable related to Private Payors are recorded at established billing rates less an estimated billing adjustment reflecting historical collections patterns.  Prior to the quarter ended June 30, 2010, the Company did not record accounts receivable related to Private Payors as the related revenue was recorded on a cash basis.  NeoGenomics Laboratories’ billings are based on their established contractual billing rates.  Management performs ongoing valuations of accounts receivable balances based on management’s evaluation of historical collection experience and industry trends.  Based on the historical experience for our Medicare and Private Payor accounts, management has determined that related accounts receivable associated with billings over one year are unlikely to be collected.  Applying this policy, the Company has recorded an allowance for doubtful accounts of $113,838 at December 31, 2010.  There was no bad debt expense recorded during the year ended December 31, 2009.  During the year ended December 31, 2010, the Company recorded bad debt expense of $224,978.





ResponseDX accounts receivable as of December 31, 2009 and 2010, consisted of the following:





December 31,

2009


December 31,

2010Net Medicare receivable

$
772,899


$
1,092,386Net Private Payor receivable for ResponseDX revenues from April 1, 2010 to December 31, 2010


—



1,726,154Net Private Payor receivable for ResponseDX revenues through March 31, 2010


—



334,866NeoGenomics Laboratories accounts receivable


109,768



—Other


11,272



—893,939



3,153,406Allowance for doubtful accounts


—



(113,838
)Net ResponseDX accounts receivable

$
893,939


$
3,039,568





The receivable for Medicare is net of contractual allowances.  The receivables for Private Payors are net of an allowance to reflect the estimated collection percentage established from historical collection data.





Property and Equipment





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





Laboratory equipment

5 to 7 yearsFurniture and Equipment

5 to 7 yearsLeasehold Improvements

Shorter of the useful life or the lease term





Maintenance and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the related accounts and the resulting gain or loss is reflected in the statements of operations. The Company has capitalized costs related to the development of database software development (see Note 3), which has not yet been placed into service and accordingly has not been depreciated. During the year ended December 31, 2010, the Company recorded an impairment loss of $371,872 relating to the abandonment of a portion of these software development costs. The Company intends to put the remaining software developed into service and amortize those costs beginning in 2011 in accordance with ASC 350-40, Internal-Use Software, (formerly SOP 98-1).





- 42 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Revenue Recognition





Pharmacogenomic Revenue





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





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





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





ResponseDX Revenue





Effective April 1, 2010, the Company recognizes all product revenue from its ResponseDX tests on an accrual basis. Through March 31, 2010, the Company recognized revenue from Private Payors on a cash basis as the Company had not, until then, established a collection history.  As of April 1, 2010, a pattern of collections had beenestablished and the Company began to record revenues from Private Payors of ResponseDX on an accrual basis.





For accounting purposes, the change from the cash basis to the accrual basis of recording revenue for ResponseDX tests paid by Private Payors, is considered a change in accounting estimate leading to a change in accounting principle.  The change in accounting estimate was derived from the establishment of a reasonable basis to estimate the amount to be collected from certain Private Payors.  This change in estimate resulted in the change in accounting principle from the cash basis to the accrual basis of revenue recognition for ResponseDX tests paid by Private Payors.  Accordingly, the Company has recorded in the second quarter a one-time adjustment to increase revenue by $1,507,187, which represents the amount of ResponseDX tests completed in prior periods for which cash payment under the former revenue recognition method had not been received as of April 1, 2010.  Since all sales of Response DX tests are on the accrual basis from April 1, 2010, the Company does not expect any future one-time adjustments to revenue.  The revenue recorded from ResponseDX sales to Private Payors for the period from April 1, 2010 to December 31, 2010 was $4,388,270.  As a result of the conversion from the cash basis to the accrual basis of recording revenue for ResponseDX tests paid by Private Payors, the Company recognized a total of $1,902,667 more in revenue during the year ended December 31, 2010, respectively, than it would have recognized had the Company continued to recognize such amounts on the cash basis during this same period.





ResponseDX Revenue is recognized in accordance with ASC 605, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.  ResponseDX revenue is recorded on an accrual basis in the month that the test results are completed.





The Company received its Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes.  ResponseDX revenues related to Medicare billings are recorded at established billing rates net of an estimated billing adjustment, based on reporting models utilizing historical cash collection percentages and updated for current effective reimbursement factors.  Response DX revenue related to Private Payors are recorded at established billing rates less an allowance to reflect the revenue at the amounts expected based on historical collections patterns.  ResponseDX revenues related to NeoGenomics Laboratories billings are based on their established billing rates.





- 43 -


RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Revenue Recognition - (continued)





The following details ResponseDX revenue for the years ended December 31, 2009 and 2010:





Year Ended December 31,2009


2010Net Medicare revenue

$
1,760,709


$
4,483,316Private Payor revenue through March 31, 2010


—



1,507,187Private Payor revenue subsequent to March 31, 2010


—



4,388,270Revenue recorded on the cash basis prior to April 1, 2010


1,181,663



717,284NeoGenomics Laboratories revenue


336,456



185,064Other


—



26,054Net ResponseDX revenue

$
3,278,828


$
11,307,175





The following table provides details of ResponseDX revenue for the years ended December 31, 2009 and 2010 based upon the former cash basis revenue recognition policy relating to Private Payors.  This table is presented to provide the amount of revenue recognized if the change to the accrual basis of revenue recognition for Private Payors had not occurred effective April 1, 2010:





Year Ended December 31,2009


2010(Proforma)Net Medicare revenue

$
1,760,709


$
4,483,316Neogenomics Laboratories revenue


336,456



185,064Revenue recognized on the cash basis


1,181,663



4,710,074Other


—



26,054Net ResponseDX revenue

$
3,278,828


$
9,404,508





- 44 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Revenue Recognition - (continued)





Cost-Containment Measures





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





Regulatory Matters





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





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





Cost of Revenue





Cost of revenue represents the cost of materials, direct labor, costs associated with processing tissue specimens including pathological review, staining, microdissection, paraffin extraction, reverse transcription polymerase chain reaction, or (“RT-PCR”) and quality control analyses, license fees and delivery charges necessary to render an individualized test result. Costs associated with performing tests are recorded as the tests are processed.  Costs of revenue associated with the Private Payor revenue recognized as of April 1, 2010, were  expensed in the period incurred.





License Fees





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





Research and Development





The Company expenses costs associated with research and development activities as incurred. Research and development costs are allocated on a pro rata basis using the number of research-only specimens that are processed by the Company versus specimens that are processed and paid for by various third parties via contract. Research and development costs include employee costs (salaries, payroll taxes, benefits, and travel), equipment depreciation and warranties and maintenance, laboratory supplies, primers and probes, reagents, patent costs and occupancy costs.





- 45 -


RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Income Taxes





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





ASC 740, Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. As of December 31, 2009 and 2010, the Company does not have a liability for unrecognized tax benefits. The Company recognizes interest and penalties associated with tax matters as part of the income tax provision and includes accrued interest and penalties with the related tax liability in the balance sheet.





Stock-Based Compensation





The Company accounts for stock-based compensation in accordance with ASC 718, Stock Compensation (formerly SFAS 123(R), Share-Based Payment). Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value estimated in accordance with the provisions of ASC 718.  The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of three to four years





The Company accounts for equity instruments issued to non-employees in accordance with ASC 505, Equity, (formerly EITF 96-18 – Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods or Services). Under ASC 505, stock option awards issued to non-employees are measured at fair value using the Black-Scholes option-pricing model and recognized pursuant to a performance model.





Management Estimates





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





Long-lived Assets





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





- 46 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Foreign Currency Translation





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





Comprehensive Loss





Comprehensive loss encompasses the change in equity from transactions and other events and circumstances from non-owner sources and the Company’s net loss. The components of comprehensive loss and accumulated other comprehensive loss comprise net loss and foreign currency translation adjustments for the years ended December 31, 2009 and 2010.





Fair Value of Financial Instruments





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





Sales and marketing costs





The Company markets its services through its advertising activities in trade publications and on line. Advertising costs are included in selling and marketing expenses on the statements of operations and are expensed as incurred.  Advertising costs for the years ended December 31, 2009 and 2010 were $393,049 and $657,697, respectively.





Reclassifications





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





- 47 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Concentration of Credit Risk Clients and Limited Suppliers





Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were fully insured at December 31, 2010 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may again exceed federally insured limits. Interest-bearing amounts on deposit in excess of federally insured limits at December 31, 2010 approximated $1.2 million.  In addition, the Company has invested its excess cash in money market instruments which are not insured under the Federal Deposit Insurance Corporation but are insured under the Securities Industry Protection Corporation.  At December 31, 2010, the Company had $2,225,833 of cash in money market instruments and has not incurred any losses on these cash balances.  At December 31, 2010, $185,730 of cash was held outside of the United States and is uninsured.





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





YearEnded December 31,2009


2010Revenue


Percent of

Total

Revenue


Revenue


Percent of

Total

RevenueTaiho Pharmaceutical

$
1,782,950



20
%

$
*



*GlaxoSmithKline and GlaxoSmithKline Biologicals

$
3,611,683



40
%

$
7,442,469



35
%Medicare

$
1,760,710



19
%

$
4,483,316



21
%


*Less than 10%





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





As ofDecember 31,2009


2010Receivable

Balance


Percent of

Total

Receivables


Receivable

Balance


Percent of

Total

ReceivablesTaiho Pharmaceutical

$
263,725



13
%

$
*



*GlaxoSmithKline and GlaxoSmithKline Biologicals

$
771,618



39
%

$
1,305,829



28
%Medicare

$
772,899



39
%

$
1,092,386



23
%


*Less than 10%





Many of the supplies and reagents used in the Company’s testing process are procured from a limited number of suppliers. Any supply interruption or an increase in demand beyond the suppliers’ capabilities could have an adverse impact on the Company’s business. Management believes it can identify alternative sources, if necessary, but it is possible such sources may not be identified in sufficient time to avoid an adverse impact on its business. Refer also to Note 6 for further discussion regarding these supply agreements. The Company purchases certain laboratory supplies and reagents primarily from two or three suppliers. Purchases from the top two of those companies accounted for approximately 80% and 61% of the Company’s reagent purchases for years ended December 31, 2009 and 2010.





- 48 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





2. Summary of Significant Accounting Policies - (continued)





Recent Accounting Pronouncements





In December 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) — Accounting for Transfers of Financial Assets (“ASU 2009-16”). ASU 2009-16 formally codifies SFAS 166, Accounting for Transfers of Financial Assets. ASU 2009-16 eliminates the concept of a qualifying special-purpose entity (“SPE”) and removes the scope exception for a qualifying SPE from ASC 810, Consolidations. As a result, previously unconsolidated qualifying SPEs must be re-evaluated for consolidation by the sponsor or transferor. In addition, this accounting update amends the accounting guidance related to transfers of financial assets in order to address practice issues that have been highlighted by the events of the recent economic decline. ASU 2009-16 is effective as of the beginning of the annual reporting period that begins after November 15, 2009. The recognition and measurement provisions will be applied to transfers that occur on or after the effective date and all qualifying SPEs that exist on and after the effective date must be evaluated for consolidation.  The adoption of this guidance did not have a material effect on our results of operations or financial position.





In December 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”). ASU 2009-17 codifies SFAS 167, Amendments to FASB Interpretation No. 46(R), and amends the consolidation guidance related to a variable interest entity (“VIE”). Primarily, the current quantitative analysis used under ASC 810, Consolidations, will be eliminated and replaced with a qualitative approach that is focused on identifying the variable interest that has the power to direct the activities that most significantly impact the performance of the VIE and absorb losses or receive returns that could potentially be significant to the VIE. In addition, this new accounting standard will require an ongoing reassessment of the primary beneficiary of the VIE, rather than reassessing the primary beneficiary only upon the occurrence of certain pre-defined events. ASU 2009-17 will be effective as of the beginning of the annual reporting period that begins after November 15, 2009, and requires the reconsideration of all VIEs for consolidation in which an entity has a variable interest upon the effective date of these amendments. The adoption of this guidance did not have a material effect on our results of operations or financial position.





In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 requires new disclosures and clarifies existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. ASU 2010-06 amends Codification Subtopic 820-10 to now require that (1) a reporting entity must disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; (2) in the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements and (3) a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. ASU 2010-06 is 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 15, 2010, and for interim periods within those fiscal years. The adoption of this guidance did not have a material effect on our results of operations or financial position.





In February 2010, Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2010-09, Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements, which amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements.  ASU 2010-09 is effective upon issuance. The adoption of ASU 2010-09 did not have a material impact on our consolidated financial statements.





On April 14, 2010, the FASB issued Accounting Standard Codification (ASC) update 2010-12 to ASC 740-10, “Income Taxes.” On March 30, 2010, the President signed the Health Care and Education Reconciliation Act of 2010, which is a reconciliation bill that amends the Patient Protection and Affordable Care Act that was signed by the President on March 23, 2010 (collectively the "Acts"). Recently, questions have arisen about the effect, if any, that the different signing dates might have on the accounting for these two Acts. This timing difference, related solely to the signing dates, should not have an impact on a majority of registrants because the Acts were both signed within a relatively short time period, which for the vast majority of companies falls into the same reporting period.  After consultation with the FASB staff, the Office of the Chief Accountant would not object to a view that the two Acts should be considered together for accounting purposes.  The adoption of this guidance did not have a material effect on our results of operations or financial position.





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





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RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





3. Property and Equipment





Property and equipment consists of the following:





December 31,2009


2010Laboratory equipment

$
2,321,628


$
2,389,339Furniture and equipment


549,271



735,731Leasehold improvements


188,509



194,899Software development


371,872



107,062Total


3,431,280



3,427,031Less: Accumulated depreciation and amortization


(2,177,566
)


(2,621,214
)Total property and equipment, net

$
1,253,714


$
805,817





Depreciation expense, included in cost of revenue, general and administrative expenses, and research and development expenses for the years ended December 31, 2009 and 2010 was $385,429 and $465,689, respectively.  During the year ended December 31, 2010, the Company recorded an impairment loss of $371,872 relating to the abandonment of capitalized software development costs.





4. Loss Per Share





The Company calculates net loss per share in accordance with ASC 260, Earnings Per Share, (formerly SFAS No. 128 – Earnings per Share). Under the provisions of ASC 260, basic net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding for the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive common stock equivalents then outstanding. Common stock equivalents consist of shares of common stock issuable upon the exercise of stock options and warrants.





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





Year Ended December 31,2009


2010Numerator:Net loss

$
(9,341,055
)

$
(4,670,379
)Numerator for basic and diluted earnings per share

$
(9,341,055
)

$
(4,670,379
)Net Loss as adjusted for the revenue impact of $1,902,667 resulting from the conversion to accrual for Private Payors (refer to Note 2)

$
(9,341,055
)

$
(6,573,046
)Denominator:Denominator for basic and diluted earnings per share — weighted-average shares


13,276,095



17,791,584Basic and diluted loss per share

$
(0.70
)

$
(0.26
)Basic and diluted loss per share as adjusted for the revenue impact of $1,902,667 (refer to Note 2)

$
(0.70
)

$
(0.37
)





Outstanding stock options and warrants to purchase 2,056,490 shares and 2,095,280 shares for the years ended December 31, 2009, and 2010, respectively, of which 100,000 warrants are included in these amounts for 2009 and 2010, were excluded from the calculation of diluted loss per share as their effect would have been anti-dilutive.




- 50 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





5. Commitments and Contingencies





Operating Leases





The Company leases office and laboratory space under a noncancelable operating lease that expires on March 31, 2011, as amended and extended. The lease was extended for an additional one year period subsequent to year-end with virtually the same terms and conditions as the initial lease. The Company also leases space at 103 South Carroll Street, Suite 2b, Fredrick, Maryland 21701, for administrative purposes. This lease expired on August 31, 2010 and the Company has been leasing the space on a month-to-month basis. Subsequent to year-end, the Company renewed the lease through December 31, 2011.





Rent expense, included in cost of revenue, general and administrative, and research and development expenses was $413,243 and $476,666 for the years ended December 31, 2009 and 2010, respectively.





Future minimum lease payments by year and in the aggregate, under the Company’s noncancelable operating leases, consist of the following at December 31, 2010:





Year Ending December 31,2011

$
456,7422012


156,058Total

$
612,800





Systems and Services Agreement





The Company entered in to a Systems and Service agreement with Xifin, Inc on December 21, 2010.  The term of this agreement is for 36 months, with automatic renewals thereafter for 12 months, unless termination notice is given by either party.  Xifin is in the business of providing internet based solutions with integrated infrastructure services for accounts receivable and billing management.





Guarantees





The Company enters into indemnification provisions under its agreements with other counterparties in its ordinary course of business, typically with business partners, clients and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities. These indemnification provisions generally survive termination of the underlying agreement. The Company reviews its exposure under these agreements no less than annually, or more frequently when events indicate. The Company believes the estimated fair value of these agreements is minimal as historically, no payments have been made by the Company under these indemnification obligations. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2009 and 2010.





Legal Matters





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





Employment Agreements





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




- 51 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





6. License and Collaborative Agreements





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





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





In consideration for this license, the Company agreed to pay to USC royalties based on a percentage of the revenues generated by the use of RGI-1 and related technology.  Royalty expense relating to this agreement amounted to $227,958 and $439,540 for the years ended December 31, 2009 and 2010, respectively.  Such expense is included in cost of revenue in the accompanying statements of operations.





License Agreement with Roche Molecular Systems (“Roche”)





In July 2001, the Company entered into a diagnostic services agreement with Roche to provide the Company with access to Roche’s patented PCR technology. In November 2004, this agreement was replaced by a non-exclusive license to use Roche’s PCR, homogenous PCR, and reverse transcription PCR processes. In consideration for these rights, the Company is obligated to pay royalties to Roche, based on a percentage of net sales of products or services that make use of the PCR technology. Royalty expense included in cost of revenue relating to this agreement amounted to $198,279 and $426,366 for the years ended December 31, 2009 and 2010, respectively.





In November 2004, the Company entered into an agreement with Roche, pursuant to which the Company is collaborating with Roche to produce commercially viable assays used in the validation of genetic markers for pharmaceutical companies. Specifically, the Company has licensed the rights to Roche to use the pre-diagnostic assays the Company develops in the course of using its RNA-extraction technologies to provide testing services to pharmaceutical companies and to produce diagnostic kits that then can be sold commercially to those pharmaceutical companies. Roche is required to pay the Company royalties of a certain percentage of net sales of such diagnostic kits sold to pharmaceutical companies. Through December 31, 2010, Roche has not been required to pay any royalties to the Company pursuant to this agreement.





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





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





In consideration for the testing services provided, Taiho paid an upfront payment at the commencement of the agreement and is obligated to pay regular testing fees, covering the specific services performed on a monthly basis.  In January 2010, the Company amended its agreement with Taiho and the agreement was renewed for an additional three years. According to the terms of the renewal, Taiho’s appointment as an exclusive purchaser in Japan of certain tests and testing services and its minimum purchasing obligations ended December 31, 2010.





Taiho is obligated to purchase a minimum amount of testing services from the Company each calendar quarter. Revenue recognized under this agreement was $1,782,950 and $1,864,175 for the years ended December 31, 2009 and 2010, respectively.




- 52 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





6. License and Collaborative Agreements - (continued)





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





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





In December 2008, the Company amended and restated its master service agreement with GSK. Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000, which was received on January 5, 2009.  The balance of deferred revenue for this agreement at December 31, 2010 is $30,582.





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





The Company recognized revenue of $190,935 and $1,636,518 (including the $322,469 prior period adjustment noted above) relating to all of the GSK agreements for the years ended December 31, 2009 and 2010, respectively.





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





In December 2006, the Company entered into a Master Services agreement with GSK Bio, the vaccine division of GSK (see above), pursuant to which it will provide testing services, principally in relation to profiling the expression of various genes from a range of human cancers. The Company will conduct the testing services on tissue specimens provided by GSK Bio. The agreement required that GSK Bio make an upfront payment of €2,000,000 (approximately $2,620,000), which was received by the Company in December 2006. The agreement further specified that GSK Bio  pay annual minimum payments in 2007, 2008 and 2009 and that the upfront payment made in December 2006 will be credited against the annual minimum payments in 2007 and 2008. The agreement also provided that any differences between the annual minimum payments made in 2007, 2008 or 2009 and the amounts due to the Company for testing services performed on specimens submitted by GSK Bio during the three years ended December 31, 2009 be credited towards services performed during the year ending December 31, 2010, the final year of the agreement. If the Company ceases to provide services under the agreement or any reason, the Company shall remit to GSK Bio payment of the then remaining balance of the existing credit within sixty days of the date on which the Company ceased to provide services to GSK Bio.





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





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




- 53 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





6. License and Collaborative Agreements - (continued)





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





For each calendar quarter of 2009 and the first two quarters of 2010, €200,000 of the existing credit shall apply to all services rendered to GSK Bio during such calendar quarter.  Pursuant to the Amended and Restated Agreement, GSK Bio has extended the term of the agreement for an additional one-year period through December 31, 2011.   As provided in the Amended and Restated Agreement, the remaining balance of the existing credit of approximately €1,357,800 was divided into six equal quarterly amounts and will be applied to all services rendered to GSK Bio in each of the last two quarters of 2010 and the four calendar quarters of 2011.  Beginning in the third quarter of 2010, the amount of the credit to be applied to all services rendered to GSK Bio is €226,300.   In all cases, GSK Bio shall remit payment to the Company for all services rendered to GSK Bio in any such calendar quarter that is in excess of the applicable credit amount.  In the event the amount of services rendered to GSK Bio in a calendar quarter does not exceed the applicable credit amount, the existing credit for the following calendar quarter shall be increased by such unused amount.





The Amended and Restated Agreement further provides that the Company shall provide additional services on a fee-for-service basis, upon GSK Bio’s written request, relating to the bridging of assays/diagnostic tests to third parties that develop, manufacture and sell the commercial diagnostic tests to be used with certain of GSK Bio’s products. The amount of deferred revenue for this agreement at December 31, 2009 and December 31, 2010 is $2,588,896 and $1,333,186, respectively.  The timing of the recognition of these amounts is dependent upon when GSK submits the specimens for testing. The Company recognized revenue of $3,420,748 and $5,805,951 relating to the GSK Bio agreement for the years ended December 31, 2009, and 2010, respectively, which includes for 2010 $1,255,710 of previously recorded  deferred revenue.





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





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





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





This agreement has an initial term of five years, with an automatic renewal for an additional three-year term unless either party gives 90 days notice in advance of the renewal date of its intent not to renew. Pursuant to the agreement, SBC will receive a percentage of the gross margin, as defined in the agreement, collected from the Company’s clients in China as compensation for its testing services performed. For the year ended December 31, 2009, no testing services were performed.  For the year ended December 31, 2010, testing services totaled $169,400.





Commission Agreement with Hitachi Chemical Co., Ltd.





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





This Agreement has an initial term expiring on March 31, 2010, with an automatic renewal for one year at the end of the original period under the same terms and conditions. Pursuant to the agreement, Hitachi will receive a percentage of the revenue, as provided in the agreement, collected from the Company's clients in the Territory, for its testing services performed which totaled $1,369,794 and $1,395,688 for the years ended December 31, 2009 and 2010, respectively.





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




- 54 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





7. Stock Option Plan





In March 2000, the Company adopted a Stock Option Plan (the “2000 Plan”) as approved by its board of directors. Under the 2000 Plan, the Company may grant options to acquire up to 1,600,000 shares of common stock. In connection with the adoption of the 2006 Employee, Director and Consultant Stock Plan, as further discussed below, the Company will grant no additional options under its 2000 Plan under which options to purchase 190,000 shares remained outstanding as of December 31, 2010. Although no more options may be granted under the 2000 Plan, the terms of the 2000 Plan continue to apply to all outstanding options. The Company also granted options to purchase 16,000 shares of common stock to two consultants which were granted under separate agreements outside of the 2000 Plan.





On October 26, 2006, the Board of Directors of the Company approved, and on May 1, 2007, reapproved the adoption of the 2006 Employee, Director and Consultant Stock Plan (the “2006 Stock Plan”). The stockholders approved the 2006 Stock Plan on June 1, 2007. The initial number of shares which may be issued from time to time pursuant to this Plan is 2,160,000 shares of common stock.  In addition, on the first day of each fiscal year of the Company during the period beginning in fiscal year 2008, and ending on the second day of fiscal year 2017, the number of shares that may be issued from time to time pursuant to the Plan shall be increased by 200,000 shares.  The initial number of shares available for issuance of 2,160,000 increased by 200,000 in 2008, 2009 and 2010, resulting in the total number of shares that may be issued as of January 1, 2010 to be 2,760,000.   As of December 31, 2010, there were 970,720 options available to grant under the 2006 Stock Plan.





Employee options vest according to the terms of the specific grant and expire 10 years from the date of grant. Non-employee option grants to date vest typically over a 2 to 3 year period. The Company had 1,995,280 options outstanding at a weighted average exercise price of $4.18 at December 31, 2010. There were 935,278 non-vested stock options with a weighted average grant date fair value of $1.47 outstanding at December 31, 2010.  As of December 31, 2010, there was $1,372,148 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 2.45 years.





The Company estimated share-based compensation expense for the years ended December 31, 2009 and 2010 using the Black-Scholes model with the following weighted average assumptions:





2009


2010Risk free interest rate

3.01%


1.64-3.0%Expected dividend yield

—


—Expected volatility

67.0%


77.6-82.0%Expected term (in years)

6


5.5-6.25Forfeiture rate

2.2%


6.9%





The following table summarizes the stock option activity for the year ended December 31, 2010:





Number of

Shares


Weighted

Average

Exercise

Price


Remaining

Contractual

Life (Years)


Aggregate

Intrinsic

ValueOutstanding, December 31, 2009


1,956,490


$
5.12



7.52


$
—Granted


603,500



2.57Exercised


(54,874
)


1.35Forfeited


(509,836
)


6.17Outstanding, December 31, 2010


1,995,280


$
4.18



7.62


$
446,501Exercisable, December 31, 2010


1,060,002


$
5.45



6.57


$
169,251





- 55 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





7. Stock Option Plan – (continued)





The exercise price for all of the options granted though December 31, 2009 was below the Company’s stock price at December 31, 2009.   As such, there was no aggregate intrinsic value at December 31, 2009.





The weighted-average grant-date fair value of options granted during the years ended December 31, 2009 and 2010 was $0.84 and $1.80, respectively.





Information about stock-based compensation included in the results of operations for the years ended December 31, 2009 and 2010 is as follows:





Year Ended December 31,2009


2010Cost of revenue

$
240,125


$
176,005Selling and marketing


—



85,172General and administrative


675,703



398,973Research and development


70,604



20,118Totals

$
986,432


$
680,268





8. Common Stock Warrants





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





In June 2007, in conjunction with the initial public offering, the Company issued 100,000 warrants to purchase 100,000 shares of its common stock at an exercise price of $7.70 to the underwriters as part of the initial public offering.





There were no warrants granted during the years ended December 31, 2009 and 2010.  As of December 31, 2010, all of the warrants were outstanding and exercisable and had a remaining contractual life of 1.50 years.




- 56 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





9. Income Taxes





The components of the income tax (benefit) provision for the years ended December 31, 2009 and 2010 were as follows:





2009


2010CurrentFederal

$
—


$
—Foreign


—



—State


(4,788
)


1,256(4,788
)


1,256DeferredFederal


—



—Foreign


—



—State


—



——



—Income tax provision (benefit)

$
(4,788
)

$
1,256





For financial statement purposes, loss before income tax provision (benefit) for the years ended December 31, 2009 and 2010 includes the following components:





2009


2010Domestic

$
(8,595,059
)

$
(4,644,914
)Foreign


(750,784
)


(24,209
)$
(9,345,843
)

$
(4,669,123
)





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





2009


2010Income tax benefit based on federal statutory rate

$
(3,178,000
)

$
(1,588,000
)State income tax benefit, net of federal income tax


(532,000
)


(311,000
)Change in deferred tax valuation allowance


3,706,000



1,783,000Foreign income taxed at varying rates


30,000



—Other, net


(30,788
)


117,256Income tax benefit (provision)

$
(4,788
)

$
1,256





- 57 -


RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





9. Income Taxes – (continued)





The tax effects of temporary differences that give rise to significant portions of the Company’s deferred tax assets and deferred tax liabilities at December 31, 2009 and 2010 are presented below:


2009


2010Deferred tax assets:Domestic net operating loss carryforwards

$
7,166,000


$
9,341,000Foreign net operating loss carryforwards


1,677,000



1,572,000Deferred revenue


1,589,000



550,000Federal and state tax credit


245,000



240,000Stock-based compensation


1,853,000



2,104,000Capitalized costs


1,235,000



1,242,000Other, net


194,000



541,000Total gross deferred tax assets


13,959,000



15,590,000Less valuation allowance on deferred tax assets


(13,719,000
)


(15,502,000
)Net deferred tax assets


240,000



88,000Deferred tax liabilities:Plant and equipment, principally accelerated depreciation


(240,000
)


(88,000
)Total deferred tax liabilities


(240,000
)


(88,000
)Net deferred taxes

$
—


$
—





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





We file U.S. federal, U.S. state, and foreign tax returns. Our major tax jurisdictions are U.S. federal and the State of California and are subject to tax examinations for the open years from 2002 through 2010.





As of December 31, 2010, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $24.0 million and $19.6 million, respectively. If not utilized, the federal net operating loss and tax credit carryforwards will expire beginning in 2020. If not utilized, the state net operating loss carryforward will expire beginning in 2012.





As of December 31, 2010, the Company had U.K. net operating loss carryforwards totaling approximately $5.6 million that may be carried forward indefinitely. A full valuation allowance has been provided against this asset.




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RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





10. Related Party Transactions





While employed at USC, Kathleen Danenberg, president, chief executive officer and director, developed and patented (United States Patent 6,248,535; Danenberg , et al., Method For Isolation of RNA From Formalin-Fixed Paraffin-Embedded Tissue Specimens) an extraction method that allowed reliable and consistent isolation of RNA from FFPE suitable for RT-PCR. USC retains ownership of this patent but has exclusively licensed this technology to the Company. In consideration for this license, the Company is obligated to pay royalties to USC, as a percentage of net sales of products or services using the technology, and to meet a certain minimum in royalty payments. Pursuant to USC policy, the inventors of technology owned by the University and then licensed for commercialization are paid a portion of royalties received by the University from the licensed technology. USC therefore pays a portion of royalties received from the Company to Ms. Danenberg in recognition of her invention. Amounts paid to Ms. Danenberg amounted to $5,465 and $32,758 for the years ended December 31, 2009 and 2010, respectively.





11. Segment Information





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





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





Year Ended December 31,Revenue:

2009


2010United States

$
3,862,985


$
13,607,289Europe


3,420,748



5,805,951Japan


1,782,950



1,864,175$
9,066,683


$
21,277,415





December31,Long-lived assets:
2009

2010United States

$
1,253,714


$
805,817$
1,253,714


$
805,817





12.  U.K. Operations





In December, 2008, we made the decision to increase the operational efficiency of the Company by consolidating our U.K. operations with our US operations.  On February 9, 2009, management implemented a reduction of workforce pursuant to which the Company closed its UK testing facility to consolidate services at its CLIA-certified laboratory facilities in Los Angeles. This reduction did not affect our genetic testing services or current partnership agreements.  The reduction of workforce was substantially completed on March 31, 2009 and the lease for our UK testing facility expired on April 30, 2009. The operating costs related to our U.K. laboratory were $752,901 for the year ended December 31, 2009, which included redundancy costs of $295,799 incurred in connection with the reduction of workforce.  UK operating expenses were $24,455 for the year ended December 31, 2010.




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RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





13. Private Placements





On February 27, 2009, the Company entered into a Purchase Agreement with certain affiliates of Special Situations Funds for the private placement of 2,000,000 newly-issued shares of the Company's common stock at a per share price of $1.00. The closing of the sale of the Shares occurred on March 2, 2009.  The aggregate offering price of the shares was $2 million and the Company received the funds on March 2, 2009.





In connection with the Special Situations Funds Private Placement, we also entered into a Registration Rights Agreement, dated February 27, 2009, with the Purchasers (the "Registration Rights Agreement") pursuant to which the Company filed a registration statement with the Securities and Exchange Commission ("SEC") to register the 2,000,000 shares for resale, which registration statement became effective on June 30, 2009.





Common stock classified outside of stockholders’ equity (deficit)





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





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





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




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RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





13. Private Placements – (continued)





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





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





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





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





As of December 31, 2009 and 2010, a total of $3,975,279 and $7,854,682 of common stock was classified outside of stockholders’ equity (deficit), respectively.




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RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





14. Fair Value Measurements





On January 1, 2009, the Company adopted ASC 820 (formerly SFAS No. 157) which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.  ASC 820 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement. The first two inputs are considered observable and the last unobservable, that may be used to measure fair value and include the following:





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





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





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





As of December 31, 2010, the Company held certain assets that are required to be measured at fair value on a recurring basis, including its cash and cash equivalents. The fair value of these assets and liabilities was determined using the following inputs in accordance with ASC 820 at December 31, 2010:





Fair Value Measurement as of December 31, 2010Total


Level 1


Level 2


Level 3Description

$


$


$


$Money market accounts (1)


2,225,833



2,225,833



—



—





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




- 62 -





RESPONSE GENETICS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





15.   Correction of an error





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





Increase(Decrease)Statement of operations:Net revenue

$
322,469Operating loss


(322,469
)Net loss


(322,469
)Net loss per share – basic and diluted


(0.02
)Balance Sheet:Deferred revenue

$
(322,469
)Total liabilities


(322,469
)Accumulated deficit


(322,469
)





16. Subsequent events








- 63 -





Part IV.





Item 15.  Exhibits, Financial Statement Schedules.





3.1*

Amended and Restated Certificate of Incorporation, as amended.3.2*◊

Amended and Restated Bylaws of the Company.4.1*

Form of Common Stock Certificate.10.1†^

Amended and Restated Master Agreement for the supply of Laboratory Test Services by and between SmithKline Beecham Corporation (a.b.a. GlaxoSmithKline) and the Company dated as of December 22, 200810.2†!

Amended and Restated Master Agreement for the Supply of Laboratory Services by and between GlaxoSmithKline Biologicals and the Company, dated as of September 7, 2009.10.4*†

License Agreement by and between Roche Molecular Systems, Inc. and the Company, dated as of November 23, 2004.10.5*†

Patent License Agreement by and between Roche Molecular Systems Inc. and the Company, dated as of November 16, 2004.10.7*†

Option and License Agreement by and between the University of Southern California and the Company, as amended, dated as of April 19, 2000.10.8*#

Employment Agreement by and between Thomas Stankovich and the Company, dated as ofOctober 25, 2006, as amended on May 29, 2007.10.9*#

Employment Agreement by and between Kathleen Danenberg and the Company, dated as of October 26, 2006, as amended on December 14, 2006, and on May 29, 2007.10.10*#

Employment Agreement by and between David O’Toole and the Company, dated as of May 3, 2010.10.11▲ #

Employment Agreement by and between Michael McNulty and the Company, dated as of June 2, 2010.10.12 □#

Amended and Restated Employment Agreement by and between Denise McNairn and the Company, dated as of September 10, 2010.10.13*#

Response Genetics, Inc. 2006 Employee, Director and Consultant Stock Plan.10.14

Office Lease by and between Health Research Association and the Company, dated effective as of January 25, 2005, as amended on March 4, 2011.10.15*†

Collaboration Agreement by and between the Company and Shanghai Biochip Company, Ltd., dated as of March 5, 200710.16*

Lease Agreement by and between the Company and the University Court of the University of Edinburgh, dated as of March 15, 2007.10.17*#

Executive Officer Form of Incentive Stock Option Agreement.10.18*#

Executive Officer Form of Non-Qualified Stock Option Agreement.10.19@†

Commission Agreement by and between Hitachi Chemical Co., LTD. and the Company, dated as of July 26, 2007.14*

Code of Ethics.21*

Subsidiaries of the Small Business Issuer.23

Consent of BDO USA, LLP.31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906





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


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


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


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


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


! Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009.


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


∆ Incorporated by reference to the Company’s Current Report on Form 8-K dated May 5, 2010.


▲Incorporated by reference to the Company’s Current Report on Form 8-K dated June 16, 2010.


□ Incorporated by reference to the Company’s Current Report on Form 8-K dated September 16, 2010.




- 64 -





SIGNATURES





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





RESPONSE GENETICS, INC.





March 30, 2011
/s/ Kathleen DanenbergDate
Kathleen DanenbergChief Executive Officer





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





Signatures

Title

DateBy:

/s/ Kathleen DanenbergKathleen Danenberg

President and Chief Executive Officer (principal executive officer) and Director

March 30, 2011By:

/s/ David O’TooleDavid O’Toole

Vice President and Chief Financial Officer (principal financial and accounting officer)

March 30, 2011By:

/s/ Kirk CalhounKirk Calhoun

Chairman of the Board

March 30, 2011By:

/s/ Gary D. NusbaumGary D. Nusbaum

Director

March 30, 2011By:

/s/ David WurzerDavid Wurzer

Director

March 30, 2011By:

/s/ Michael SerruyaMichael Serruya

Director

March 30, 2011By:

/s/ David M. SmithDavid M. Smith

Director

March 30, 2011By:

/s/ Jan FagerbergJan Fagerberg

Director

March 30, 2011By:

/s/ Michael MetzgerMichael Metzger

Director

March 30, 2011





By:

/s/ Richard van den BroekRichard van den Broek

Director

March 30, 2011




- 65 -