**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





**x** **ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


For
      the
      fiscal year ended June 30, 2008





**o** **TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


For
      the
      transition period from __________ to __________





Commission
                File Number**0-21537**





**Pacific
      Biometrics, Inc.**


(Exact
      name of registrant as
      specified in its charter )





**Delaware**
            
            **93-1211114**(State
                or other jurisdiction of incorporation or organization)
            
            (IRS
                Employer Identification Number)





**220
      West Harrison Street**


**Seattle,
      Washington 98119**


(Address
      of principal executive offices)





**(206)
      298-0068**


(Registrant’s
      telephone number, including area code)





Securities
                registered under Section 12(b) of the Exchange Act:
            NoneSecurities
                registered under Section 12(g) of the Exchange Act:
            **Common
                Stock, $0.01 par value per
                share**





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 c heck
      mark
      if the registrant is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act.     Yes o No x





Indicate
      by check mark whether the registrant (1) filed all reports required to be filed
      by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or
      for such shorter period that the registrant was required to file such reports),
      and (2) has been subject to such filing requirements for the past 90
      days.    Yes x No o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K 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 amendment 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
      definitions of “large accelerated filer,” “accelerated filer” and “smaller
      reporting company” in Rule 12b-2 of the Exchange Act.





Large
                accelerated filero
            Accelerated
                fileroNon-accelerated
                filero
            Smaller
                reporting companyx(Do
                not check if a smaller reporting company)





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





The
      aggregate market value of the registrant’s common stock held by non-affiliates
      on December 31, 2007 (the last business day of the registrant’s most recently
      completed second fiscal quarter) was $11,058,631 based on the average of the
      bid
      and ask prices of such stock on that date of $0.63, as reported on the OTC
      Bulletin Board.





On
      September 25, 2008, there were 19,188,421 shares of the registrant’s common
      stock issued and outstanding.





**Documents
      Incorporated By Reference** :
      The
      registrant’s definitive proxy statement for the annual meeting of stockholders
      for the fiscal year ended June 30, 2008, which will be filed with the Securities
      and Exchange Commission within 120 days after the close of the 2008 fiscal
      year,
      is incorporated by reference in Part III hereof.








PACIFIC
      BIOMETRICS, INC.





Form
      10-K
      Annual Report





Table
      of
      Contents





PagePART
                IItem
                1
            Description
                of Business
            
            2Item
                1A
            Risk
                Factors
            
            9Item
                1B
            Unresolved
                Staff Comments
            
            18Item
                2
            Properties
            
            18Item
                3
            Legal
                Proceedings
            
            18Item
                4
            Submission
                of Matters to a Vote of Security Holders
            
            18PART
                IIItem
                5
            Market
                for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                Purchases of Equity Securities
            
            18Item
                6
            Selected
                Financial Data
            
            19Item
                7
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            19Item
                7A
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            27Item
                8
            Financial
                Statements and Supplementary Data
            
            27Item
                9
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            
            27Item
                9A(T)
            Controls
                and Procedures
            
            27Item
                9B
            Other
                Information
            
            28PART
                IIIItem
                10**
            Directors,
                Executive Officers and Corporate Governance
            
            28Item
                11**
            Executive
                Compensation
            
            29Item
                12**
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            
            29Item
                13**
            Certain
                Relationships and Related Transactions, and Director
                Independence
            
            29Item
                14**
            Principal
                Accountant Fees and Services
            
            29PART
                IVItem
                15
            Exhibits
                and Financial Statement Schedules
            
            30SIGNATURES
            
            
            33





**
            Information
                contained in Items 10, 11, 12, 13 and 14 of Part III is incorporated
                by
                reference from the definitive proxy statement for our 2008 annual
                meeting
                of stockholders, which will be filed with the Securities and Exchange
                Commission within 120 days after the close of the 2008 fiscal
                year.


-i-


**EXPLANATORY
      NOTE**





Unless
      otherwise indicated or the context otherwise requires, all references in this
      Annual Report on Form 10-K to “we,” “us,” “our,” and the “Company” are to
      Pacific Biometrics, Inc. and our wholly-owned subsidiaries, Pacific Biometrics,
      Inc., a Washington corporation, Pacific Biomarkers, Inc., PBI Technology, Inc.
      and BioQuant, Inc.





**CAUTIONARY
      NOTICE REGARDING FORWARD LOOKING STATEMENTS**





This
      Annual Report on Form 10-K contains certain forward-looking statements,
      including statements about





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


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


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


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


·
            our
                financing goals and plans, including raising of additional capital
                through
                future equity and debt financings.





The
      forward-looking statements in this Annual Report reflect management’s current
      views and expectations with respect to our business, strategies, products,
      future results and events and financial performance. All statements other than
      statements of historical fact, including future results of operations or
      financial position, made in this Annual Report on Form 10-K are forward
      looking. In particular, the words “believe,” “expect,” “intend,” “anticipate,”
“estimate,” “desire,” “goal,” “may,” “will,” variations of such words, and
      similar expressions identify forward-looking statements, but are not the
      exclusive means of identifying such statements and their absence does not mean
      that the statement is not forward-looking. These forward-looking statements
      are
      subject to certain risks and uncertainties, including those discussed below.
      Our
      actual results, performance or achievements could differ materially from
      historical results as well as those expressed in, anticipated or implied by
      these forward-looking statements. We do not undertake any obligation to revise
      these forward-looking statements to reflect any future events or
      circumstances.





For
      a
      discussion of some of the factors that may affect our business, results and
      prospects, see “ITEM 1A – RISK FACTORS” beginning on page 10. Readers are urged
      to carefully review and consider the various disclosures made by us in this
      Report and in our other reports previously filed with the Securities and
      Exchange Commission, including our periodic reports on Forms 10-K, 10-Q and
      8-K,
      and those described from time to time in our press releases and other
      communications, which attempt to advise interested parties of the risks and
      factors that may affect our business, prospects and results of
      operations.


-
          1
          -


**PART
      I**





**ITEM
              1**
            **BUSINESS**





**General**





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





During
      the course of fiscal 2008 we established a new, wholly owned subsidiary, Pacific
      Biomarkers, Inc., to focus on the delivery of clinical biomarker services to
      our
      pharmaceutical and biotechnology clients. Through Pacific Biomarkers, we provide
      assay development services for novel biomarkers, as well as custom assay
      services for immunogenicity testing and multiplex testing. We anticipate that
      our clinical biomarker services will help diversify our client base because
      these services apply to therapeutic areas beyond our traditional specialty
      areas, and there is also an emphasis on biologic drugs. We expect that these
      biomarker services will also complement and extend our strong reputation in
      specialty testing services.





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





**Business
      Strategy**





Specialty
      reference and central laboratory service companies like ours typically derive
      substantially all of their revenue from the research and development
      expenditures of the pharmaceutical, biotechnology, and diagnostic industries.
      Participants in these industries typically outsource a significant quantity
      of
      these services both to central laboratories and to specialty reference
      laboratories. In addition, central laboratories outsource to specialty reference
      laboratories some of the specialty testing where the central laboratory lacks
      expertise. We believe that such outsourcing will continue and may increase
      in
      the future because of many factors, including continuing pressures on the
      pharmaceutical and biotechnology industries to contain costs, limitations on
      pharmaceutical companies’ internal capacity, difficulty in developing expertise
      in specialty testing areas internally within pharmaceutical companies or central
      labs, a need for faster development time for new drugs, research in multiple
      countries simultaneously and stringent government regulation. The development
      of
      new drugs and diagnostic products require a significant investment of time
      and
      money by pharmaceutical, biotechnology, and diagnostic companies. We believe
      that these factors create opportunities for companies like ours to provide
      our
      expertise and services to help reduce the time in the drug development and
      laboratory diagnostic product development processes and make the processes
      more
      efficient.





Our
      strategy is to meet the needs for outsourcing by pharmaceutical, biotechnology,
      diagnostic companies and other central laboratories, and to assist in enhancing
      the drug and diagnostic development processes by developing and delivering
      innovative services that apply science and technology in the provision of high
      quality service within our areas of specialty.





Our
      primary business strategy is to continue our focus on providing high quality
      specialty reference laboratory services in our core areas, including
      cardiovascular disease and bone and joint diseases because of active drug
      development activities. In addition, beginning in fiscal 2008, we expanded
      our
      provision of services and business development efforts to a rapidly growing
      sector of laboratory services for clinical drug development, namely clinical
      biomarker services. To that end, we formed a wholly-owned subsidiary, Pacific
      Biomarkers, Inc. in February 2008, to further differentiate and expand our
      clinical biomarker services. Moreover, we also intend to pursue other strategies
      identified below to further our business. However, because of the significant
      expense associated with some of these strategies, we may not pursue some of
      these strategies unless our revenue increases significantly or we are able
      to
      raise equity or debt financing to adequately fund these strategies. There can
      be
      no assurance that we will pursue any or all of the strategies below or, if
      pursued, that any of such strategies will be successful.


-
          2
          -





*Increase
      Specialty Areas*





In
      addition to our core specialties of cardiovascular disease and bone and joint
      diseases, our goal is to further expand our specialty laboratory expertise
      within related areas where we have a competitive advantage of existing in-depth
      expertise. This includes diabetes, obesity, metabolic syndrome, rheumatoid
      and
      osteo arthritis, and related inflammatory diseases. ****





In
      fiscal
      2008, we expanded our service offerings into new areas, both in terms of
      therapeutic areas and assay methodologies. Through Pacific Biomarkers, we offer
      custom biomarker assay development, immunogenicity assay development, and
      multiplex testing. We expect these activities to lead to significant growth
      in
      our customer base and increases in our backlog and, eventually, revenues.





*Diversify
      Client Base*





We
      have a
      goal to continue to diversify our client base, both in terms of the number
      of
      clients and the number of contracts within any particular client. Historically,
      our largest two clients in any individual fiscal year have represented in excess
      of 50% of our revenue. However, for the past two fiscal years we have been
      able
      to reverse this trend. For the fiscal years ended June 30, 2008 and 2007, our
      top two clients represented 27% and 33%, respectively, of our revenue. As a
      result of ongoing business development and client diversification efforts,
      we
      added 7 new clients to our client base during the fiscal year ended June 30,
      2008, and 12 new clients in fiscal 2007, and we continue to diversify the total
      number and types of study contracts. At June 30, 2008, we held a total of 106
      active contracts, compared to 100 active contracts at June 30, 2007, a 6%
      increase. Management believes that as a result of these continuing business
      development activities, we will incrementally diversify our client base and
      spread our revenues across a larger number of clients and a larger number of
      individual study contracts.





Despite
      our efforts to expand our client base, a substantial portion of our revenues
      are
      generated through five large clients. Revenue from our five largest clients
      represented approximately 56% and 65% of our total revenue in fiscal 2008 and
      2007, respectively. Our largest client in fiscal 2008 individually accounted
      for
      approximately 14% of our total revenue in fiscal 2008, while our largest client
      in fiscal 2007 accounted for approximately 17% of our total revenue in fiscal
      2007. While on the one hand this reflects an improvement in terms of decreasing
      our revenue reliance on a single client, on the other hand it is important
      to
      note that our largest client in fiscal 2008 was not our largest client in fiscal
      2007, which illustrates the risk of significant revenue variability that we
      face
      in our marketplace. Because our revenue has historically been concentrated
      in
      several large clients, we can be materially adversely impacted by changes with
      these clients. Such changes could include delays in undertaking clinical studies
      or submitting samples for testing services, early termination or reductions
      in
      work orders or clinical studies, or decreases in the volume or timing of new
      work orders. In fiscal 2009 we will continue to actively pursue business
      development and marketing activities to broaden our client and revenue
      base.





We
      anticipate that the provision of our clinical biomarker services through Pacific
      Biomarkers, beginning in fiscal 2008, will help diversify our client base.
      These
      biomarker services apply to therapeutic areas beyond our traditional specialty
      areas, and there is also an emphasis on biologic drugs. We also expect that
      these biomarker services will complement and extend our strong reputation in
      specialty testing services.





*Global
      Central Laboratory Capability*





We
      believe that in the central laboratory services business it is important to
      provide a broad geographic base as most clinical drug development programs
      are
      global. Through partnering with Quintiles Transnational Corp., a major central
      laboratory with a large established client base and existing infrastructure
      for
      managing clinical studies globally, we believe that we can compete with other
      central laboratories that have offices, monitoring sites and laboratories in
      many countries around the globe. In fiscal 2008 we realized significant
      financial benefit from our relationship with Quintiles, a trend we expect to
      continue during fiscal 2009; although there is no guarantee that the
      relationship will generate revenues consistently going forward. In fiscal 2009
      we expect to build on this relationship by further expanding joint business
      development efforts and implementing operational integration in certain areas
      that will lead to streamlined services. An example of the latter is the creation
      of a Joint Technical Committee in fiscal 2008, which meets every two weeks
      and
      overseas important joint projects. We believe that this joint marketing
      relationship continues to provide a unique advantage of combining both scope
      and
      depth in quality specialty testing service.


-
          3
          -





*Acquisitions
      and Strategic Relationships*





Our
      clients and our competitors have experienced significant consolidation over
      the
      last several years and we expect that trend to continue. The uncertainty caused
      by the consolidation trend may result in other companies in the industry seeking
      to form strategic relationships or joint ventures or to be acquired in order
      to
      stay competitive. This may make it possible for us to make strategic
      acquisitions that are complementary to our existing services and that expand
      our
      ability to serve our clients. We are also exploring other strategic alternatives
      for our business and operations, which may include joint ventures, co-marketing
      relationships, or other strategic relationships especially with diagnostic
      companies with emerging or proprietary technologies. Additionally, we will
      evaluate, as appropriate, any potential business combinations involving our
      company as a whole, or involving a portion of our assets.





*Upgrading
      Information Technology and Back-up Systems.*





We
      are
      currently focusing a significant portion of our capital expenditures and
      investments in carefully selected hardware and software products, information
      technology systems and networks. During fiscal 2008, we continued to invest
      in
      our information systems. In fiscal 2009, we will continue to test and invest
      in
      the improvement of our information systems. We believe capital improvements
      in
      these areas are important to meet the changing demands of drug development
      by
      improving and facilitating our data reporting, testing data capacity and
      efficiency and the overall service to and communications with our
      clients.





**Services**





We
      provide both specialty reference laboratory services and central laboratory
      services, as well as clinical biomarker services.





*Specialty
      Reference Laboratory Services*





Our
      specialty reference laboratory in Seattle, Washington has established itself
      as
      a technical leader due to our strong expertise in certain core areas. Our three
      general areas of expertise include:





·
            cardiovascular
                disease (dyslipidemia, atherosclerosis, and coronary heart disease),


·
            diabetes,
                metabolic syndrome, and obesity, and


·
            bone
                and joint diseases (osteoporosis as well as osteo and rheumatoid
                arthritis).





Management
      believes that among prospective new drugs, these areas of expertise represent
      three of the top ten areas of focus by the pharmaceutical industry.





With
      respect to cardiovascular disease, we are one of the leaders in lipid services
      for clinical drug development and diagnostic product development in the U.S.
      and
      internationally. Our expertise is concentrated on the measurement of
      cardiovascular disease markers, especially cholesterol and lipoproteins,
      including HDL, LDL, HDL and LDL subfractions, remnant cholesterol,
      apolipoproteins, Lp(a), and lipoprotein fraction compositions.





We
      are
      enhancing our activities in the area of diabetes and related disorders, notably
      obesity and metabolic syndrome. Metabolic syndrome is a collection of
      abnormalities that include central obesity, dyslipidemia (low HDL cholesterol
      and high triglycerides), insulin resistance, pre-diabetes and pre-hypertension.
      In the U.S. the prevalence of metabolic syndrome is estimated at 47 million
      individuals (Heart Disease and Stroke Statistics – 2006 Update, American Heart
      Association). People with metabolic syndrome are at increased risk for
      cardiovascular disease and associated morbidity and mortality and as a result,
      this population is coming under increased scrutiny for pharmacological
      intervention. Because of our established strengths in testing for lipids,
      cardiovascular risk and diabetes, we believe we are well-positioned to take
      advantage of this emerging area of pharmaceutical drug development. Moreover,
      we
      are expanding our test menu in areas related to diabetes and metabolic syndrome,
      notably in testing for markers of inflammation and gut hormones. For example,
      during the 2008 fiscal year, we noticed a significant increase in interest
      in
      assays for hormones such as GLP-1, GIP, PYY, and ghrelin, which are produced
      in
      the gut and are dysregulated in conditions such as diabetes and obesity. We
      believe our strength in performing these difficult assays will be a significant
      source of revenues in the 2009 fiscal year and beyond.


-
          4
          -





We
      are
      active in promoting the standardization of bone metabolism biomarkers, and
      are
      involved in technologies for monitoring treatment response in diseases such
      as
      osteoporosis. We have used our expertise in osteoporosis-indicating
      bone-biomarker assays to manage the first proficiency-testing programs for
      bone-resorption markers. In the areas of bone metabolism and women’s health, we
      also specialize in the measurement of hormones, and our menu of biochemical
      markers includes pyridinolines, various C- and N- terminal telopeptides,
      procollagens, osteocalcin and bone-specific alkaline phosphatase. Moreover,
      in
      recent years we have actively expanded our test menu to include biochemical
      markers of cartilage turnover as relating to drug development for arthritis,
      and
      we have performed specialty testing to support clinical drug development of
      drugs for rheumatoid arthritis and osteoarthritis. Further, in recent years
      there has been significant demand for our testing services in drug development
      for rheumatoid arthritis, and we expect this to be a significant source of
      revenue for the 2009 fiscal year and beyond.





In
      connection with these stated areas of expertise, we offer a variety of services
      through our specialty reference laboratory, including





·
            clinical
                study testing services,


·
            development
                of laboratory reference methods,


·
            development
                of clinical trial protocols, and


·
            contract
                research and development.





Our
      involvement with clients frequently begins at the protocol design stage.
      Clinical trial support includes coordinating the collection and receipt of
      specimens from investigative sites, processing the samples, generating test
      databases and reporting the consolidated data to study sites and sponsors.
      The
      extensive knowledge we have in test development and our close collaboration
      with
      diagnostic manufacturers, frequently allow us to offer novel tests to our
      clinical research clients before such tests are commercially
      available.





*Clinical
      Biomarker Services*





Through
      our new, wholly owned subsidiary, Pacific Biomarkers, Inc., we began offering
      new testing services in fiscal 2008 that relate to the use of biomarkers in
      clinical drug development. “Biomarkers” are any biological parameters that can
      be measured in patient samples (e.g., blood or urine) and that provide specific
      information about the effects (both safety and efficacy) of a particular drug.
      There is a rapidly growing trend in the pharmaceutical and biotechnology
      industries to use biomarkers to help guide drug development.





Leveraging
      our extensive experience and expertise in performing demanding assays as well
      as
      our long history of supporting diagnostic product development, we created
      Pacific Biomarkers to focus on this new market segment and to aggressively
      expand and market our services for:





·
            biomarker
                assay development


·
            immunogenicity
                testing


·
            multiplex
                testing





We
      anticipate that our clinical biomarker services will help diversify our client
      base because these services apply to therapeutic areas beyond our traditional
      specialty areas, and there is also an emphasis on biologic drugs. We also expect
      that these biomarker services will complement and extend our strong reputation
      in specialty testing services.





*Central
      Laboratory Services*





Coupled
      with our expertise in specialty testing we also provide central laboratory
      services. Our full-service central laboratory support for multi-center clinical
      trials provides project management and routine safety lab tests (general
      chemistry, hematology and urinalysis); and full-service operations support
      which includes study-specific specimen collection supplies, coordinating
      collection and the receipt of specimens from clinical sites, processing the
      samples, generating test databases, and reporting data to sites and
      sponsors.


-
          5
          -





We
      generally provide full-service central laboratory services in support of Phase
      I
      and Phase II FDA clinical trials. These trials are typically smaller and more
      geographically focused than Phase III trials.





*Other
      Intellectual Property and Technologies*





We
      have
      developed certain computer software and internal procedures and products
      intended to enhance the quality and effectiveness of our services. Although
      our
      intellectual property rights are important to our results of operations, we
      believe that such factors as the technical expertise, knowledge, ability and
      experience of our laboratory professionals are more important, and that,
      overall, these technological capabilities provide significant benefits to our
      clients.





In
      addition, through our wholly owned subsidiary, PBI Technology, Inc., we own
      certain other proprietary technologies and intellectual property rights
      (patented and patent-pending). These technologies include our isothermal DNA
      amplification method (LIDA) and a genetic method for distinguishing live from
      dead cells (Cell Viability). These technologies require additional development
      before they can be commercialized, and currently we are not engaged in any
      research and development expenditures on these assets. We cannot predict whether
      or when we will recommence development efforts on these assets.





**Clients
      / Marketing**





We
      provide specialty reference and central laboratory services to, among others,
      the pharmaceutical, biotechnology, and laboratory diagnostic industries. We
      also
      act as a subcontractor for large central laboratories for our specialty
      reference laboratory services. In fiscal years 2008 and 2007, our clients
      included companies ranging from the world’s largest pharmaceutical companies and
      biotechnology companies to small and start-up organizations. In fiscal 2008,
      two
      of our clients individually accounted for more than 10% of our revenue as
      compared to four clients which individually accounted for more than 10% of
      our
      revenue in 2007. During the fiscal year ended June 30, 2008, these clients
      represented 27% of our revenue as compared to 58% during the fiscal year ended
      June 30, 2007. Our largest client in fiscal 2008 individually accounted for
      approximately 14% of our total revenue in fiscal 2008 and our second largest
      client accounted for 13% of our total revenue. Our largest clients in fiscal
      2007 accounted for 17%, 16%, 15% and 10% of our revenue, respectively. Revenue
      from our five largest clients represented approximately 56% and 65% of total
      revenue in fiscal 2008 and 2007, respectively. The loss of any of our 10%
      clients could have a material adverse impact on our revenues and results of
      operations.





Our
      scientific expertise is an integral and interrelated part of our marketing
      and
      sales process. Our Chief Scientific Officer and science and technology team
      are
      directly involved in sales and marketing through company capability and
      scientific presentations as well as consultation with pharmaceutical clinical
      teams beginning at the protocol design stage. Our extensive knowledge in test
      development and our close collaboration with diagnostic manufacturers frequently
      allow us to offer novel tests to our clinical research clients before such
      tests
      are commercially available.





**Contractual
      Arrangements**





Our
      contracts with clients are primarily fixed price, although occasionally we
      enter
      into contracts with fee-for-service, either with or without a cap. In cases
      where the contracts are fixed price, we generally bear the cost of overruns,
      but
      we benefit if the costs are lower than we anticipated. In cases where our
      contracts are fee-for-service with a cap, the contracts contain an overall
      budget for the trial based on time and cost estimates. If our costs are lower
      than anticipated, the client generally benefits from the savings. If our costs
      are higher than estimated, we bear the responsibility for the overrun unless
      the
      increased cost is a result of a change requested by the client, such as an
      increase in the number of patients to be enrolled or the type or amount of
      data
      to be collected. Contracts may range from a few months to several years
      depending on the nature of the work performed. For most contracts, a portion
      of
      the contract fee is paid at the time the study or trial is started with the
      balance of the contract fee payable in installments upon the progress of the
      work completed or achievement of milestones over the study or trial duration.
      We
      recognize revenue in the period that we perform the related
      services.


-
          6
          -





As
      of
      June 30, 2008, we had master contract service agreements with 13 of our largest
      clients as compared to 10 agreements we had as of June 30, 2007. Under these
      master service agreements, we perform laboratory research services based on
      work
      orders submitted to us by the client. There is no guaranteed minimum number
      of
      work orders or revenue to us. Each work order is separately negotiated with
      the
      client and is usually limited to a specific project with limited
      duration.





Most
      of
      our contracts or work orders may be terminated or modified at any time by the
      client either immediately or upon notice. Typical reasons for termination or
      modification include that the client may change the scope of the study or the
      study may be terminated, reduced in scope or delayed by the client or regulatory
      authorities. Our contracts typically entitle us to receive payment for services
      performed by us up to the time of termination and reimbursement for
      out-of-pocket costs incurred prior to termination. In certain limited instances,
      our contracts also entitle us to a termination fee or payment for the costs
      of
      winding down the terminated projects.





Most
      of
      our contracts also provide for the client to indemnify us for any third party
      damages and claims arising from our providing services under the contract.
      The
      typical exception to this is that no indemnification will be provided if the
      damage or claim results from our negligence or intentional
      misconduct.





For
      the
      fiscal year ended June 30, 2008, fixed price contracts amounted to 99% of our
      revenue or $8,208,400, and contracts priced as fee-for-service with a cap
      amounted to 1% of revenue or $56,837. We had no contracts priced as
      fee-for-service without a cap in fiscal 2008. For the fiscal year ended June
      30,
      2007, fixed price contracts amounted to 94% of our revenue or $7,973,428,
      contracts priced as fee-for-service with a cap amounted to 3% of revenue or
      $225,976, and contracts priced as fee-for-service without a cap amounted to
      3%
      of revenue or $280,926.





**Competition**





The
      clinical laboratory services industries, including specialty reference and
      central laboratory services and biomarker services, have many participants
      ranging from small, limited-service providers to a limited number of
      full-service laboratories with global capabilities.





For
      specialty reference laboratory services in our areas of expertise, we primarily
      compete against other full-service and limited-service specialty and central
      laboratory services organizations and, to a lesser extent, laboratories in
      academic centers. Many of these organizations have significantly greater
      resources than we do, with somewhat different focus and business targets. Our
      significant competitors in specialty reference laboratory services include
      Covance, PPD, ARUP, Mayo Clinic, Millipore, Synarc, Medpace, Esoterix
      (Labcorp.), LipoScience, Atherotech, and NW Lipid Laboratory. For our biomarker
      business, competitors include Covance, Linco (Millipore), IBT Laboratories,
      ALTA
      Immunochemistry, Charles River Laboratories and MSD.





In
      fiscal
      2005 we entered into a joint marketing arrangement with Quintiles Transnational
      Corp., a major central laboratory with a large established client base and
      existing infrastructure for managing clinical studies globally, and through
      this
      relationship we believe that we can compete with other central laboratories
      that
      have international capabilities. In fiscal 2008 we realized significant
      financial benefit from our relationship with Quintiles, a trend we expect to
      continue during fiscal 2009; although there is no guarantee that the
      relationship will generate revenues consistently going forward.





There
      is
      significant competition for clients on the basis of many factors for both
      specialty reference and full-service central laboratory services and biomarker
      services, including





·
            technological
                expertise and efficient drug development
                processes,


·
            financial
                stability,


·
            reputation
                for on-time quality performance,


·
            strengths
                in various geographic markets and global
                reach,


·
            ability
                to manage large-scale clinical trials both domestically and
                internationally,


-
          7
          -


·
            expertise
                and experience in specific areas,


·
            scope
                of service offerings,


·
            price,


·
            ability
                to acquire, process, analyze and report data in a timely and accurate
                manner,


·
            size,
                and


·
            expertise
                and experience in health economics and outcomes
                services.





While
      size and global reach are more important competitive factors in the central
      laboratory services business, we believe that technological expertise is more
      important for specialty reference laboratory services. Except as to size and
      international capacity, where we know certain other competitors have an
      advantage, we believe we compete very favorably in a majority of these areas,
      particularly with respect to our technical expertise in our three specialty
      areas.





**Government
      Regulation**





Our
      laboratory services are subject to various regulatory requirements designed
      to
      ensure the quality and integrity of our laboratory testing in support of
      clinical trials. The industry standards for conducting clinical laboratory
      testing are embodied in the Clinical Laboratory Improvement Amendments of 1988
      (“CLIA”). As a medical test site in the State of Washington, we have established
      quality assurance programs at our laboratory facilities that monitor ongoing
      compliance with CLIA. In addition, we are a College of American Pathologists
      (“CAP”) -certified test site. This certification provides monitoring for CAP and
      CLIA compliance by CAP on a yearly basis.





The
      industry standards for conducting preclinical laboratory testing are embodied
      in
      the Good Laboratory Practices (“GLP”) regulations as defined by the FDA.
      Although we do not perform testing related to preclinical research, we do comply
      with specific sections of the GLP regulations, at our discretion, when it is
      either important to our clients or is determined by management as advantageous
      to our quality assurance program.





Our
      clinical laboratory services are subject to industry standards for the conduct
      of clinical research and development of studies that are embodied in the
      regulations for Good Clinical Practice (“GCP”). The FDA requires that test
      results submitted to such authorities be based on studies conducted in
      accordance with GCP. Noncompliance with GCP can result in the disqualification
      of some or all of the data collected during the clinical trial, as well as
      precipitate a full investigation of all previous and current regulatory
      submissions.





We
      are
      subject to licensing and regulation under federal, state and local laws relating
      to workplace hazard communications and employee right-to-know regulations,
      the
      handling and disposal of medical specimens and hazardous waste and radioactive
      materials, as well as the safety and health of laboratory employees. Our
      laboratory is subject to applicable federal, state and local laws and
      regulations relating to the storage and disposal of all laboratory specimens
      including regulations of the Environmental Protection Agency, the Nuclear
      Regulatory Commission, the Department of Transportation, the National Fire
      Protection Agency and the Resource Conservation and Recovery Act. Although
      we
      believe that we are currently in compliance in all material respects with such
      federal, state and local laws, failure to comply could subject us to denial
      of
      the right to conduct business, fines, criminal penalties and other enforcement
      actions.





In
      addition to its comprehensive regulation of safety in the workplace, the
      Occupational Safety and Health Administration has established extensive
      requirements relating to workplace safety for health care employers whose
      workers may be exposed to blood borne pathogens such as HIV and the hepatitis
      B
      virus, as well as radiation. Our employees receive initial and periodic training
      focusing on compliance with applicable hazardous materials regulations and
      health and safety guidelines.





In
      the
      past few years, the United States and foreign governments have become more
      concerned about the disclosure of confidential personal data. In the U.S.,
      the
      Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) governs
      the disclosure of confidential medical information. We do not process IIHI
      (Individually Identifiable Health Information) during any phase of our business
      practices related to clinical testing. We therefore are currently exempt from
      HIPAA regulations.


-
          8
          -





The
      regulations of the U.S. Department of Transportation, the U.S. Public Health
      Service and the U.S. Postal Service apply to the surface and air transportation
      of laboratory specimens. We also comply with the International Air Transport
      Association (IATA) regulations, which govern international shipments of
      laboratory specimens. Furthermore, when materials are sent to a foreign country,
      the transportation of such materials becomes subject to the laws, rules and
      regulations of such foreign country.





**Laurus
      Debt Investments**





In
      fiscal
      2004 and 2005, we entered into two financing arrangements with Laurus Master
      Fund, Ltd. (“Laurus”), a New York City based investment fund, for a total of $4
      million of secured convertible debt financing, consisting of a $2.5 million
      secured convertible note (the “2004 Note”) and a $1.5 million secured
      convertible note (the “2005 Note”). The Notes are secured by a blanket security
      interest in our assets. We also issued certain stock purchase warrants to Laurus
      and to our broker in connection with the debt financings.





As
      of
      June 30, 2008, the remaining principal balance on the 2004 Note was $416,669.
      Subsequent to the end of the 2008 fiscal year, we paid in full the remaining
      principal balance of the 2004 Note on July 28, 2008, the maturity date, and
      the
      2004 Note has been cancelled.





As
      of
      June 30, 2008, the remaining principal balance on the 2005 Note was $350,000.
      We
      are required to make monthly payments of principal on the 2005 Note in the
      amount of $50,000 (less any amounts due that are converted into common stock),
      at a rate of 102% of the principal amount due. We can prepay the 2005 Note
      at
      any time upon payment of an amount equal to 107.5% of the then-outstanding
      principal balance, plus accrued and unpaid interest. In addition, Laurus has
      the
      option at any time to convert any or all of the outstanding principal and
      accrued and unpaid interest on the 2005 Note into shares of our common stock
      at
      a conversion price of $1.17 per share (subject to certain antidilution
      adjustments). The maturity date for the 2005 Note is January 31, 2009, unless
      earlier prepaid or converted into common stock. As of September 18, 2008, the
      remaining principal balance on the 2005 Note was $200,000.





Under
      U.S. GAAP, the accounting treatment for these convertible Notes and warrants,
      as
“financial derivatives,” is very complex. Please see “Note 8 to Notes to
      Consolidated Financial Statements” for a discussion of the terms of these
      financing arrangements, the Notes and warrants and the associated accounting
      treatment.





**Employees**





At
      September 18, 2008, we had 56 full-time employees and 2 temporary or contract
      employees, for a total of 58 employees, 40 of whom were employed in laboratory
      operations, laboratory administration and client services, 5 were employed
      in
      sales, marketing and business development, and 13 were employed in
      administrative capacities. Six of our employees hold doctorate level degrees
      and
      two others hold masters degrees or other postgraduate degrees. None of our
      employees are represented by labor unions. We believe that our relationships
      with our employees are good.





**Available
      Information**





We
      make
      available free of charge through links on our website at www.pacbio.com ,
      our
      Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
      on
      Form 8-K and amendments to those reports filed or furnished pursuant to Section
      13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably
      practicable after such reports are electronically filed with, or furnished
      to,
      the SEC.





**ITEM
              1A**
            **RISK
                FACTORS**





*The
      following discussion in this Annual Report on Form 10-K contains forward-looking
      statements regarding our company, our business, prospects and results of
      operations that involve risks and uncertainties. Our actual results could differ
      materially from the results that may be anticipated by such forward-looking
      statements and discussed elsewhere in this Report. Factors that could cause
      or
      contribute to such differences include, but are not limited to, those discussed
      below, as well as those discussed under the captions “Business” and
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” as well as those discussed elsewhere in this Report. In evaluating
      our business, prospects and results of operations, readers should carefully
      consider the following factors in addition to other information presented in
      this Report and in our other reports filed with the Securities and Exchange
      Commission that attempt to advise interested parties of the risks and factors
      that may affect our business, prospects and results of operations. See
“Cautionary Notice Regarding Forward Looking Statements.”*


-
          9
          -





**Risks
      Relating to Our Company and Our Business**





**We
      may bear financial losses because most of our contracts are of a fixed price
      nature and may be delayed, terminated or reduced in scope for reasons beyond
      our
      control.**





Our
      contracts principally provide for services on a fixed price basis and they
      may
      be terminated, delayed or reduced in scope by our clients at any time, either
      immediately or upon notice. See “DESCRIPTION OF BUSINESS – Contractual
      Arrangements” above. Contract termination, delay or reduction in scope may occur
      for a variety of reasons, most of which are beyond our control, including:





·
            unexpected
                or undesired results of the client’s
                products,


·
            insufficient
                patient enrollment by the client;


·
            insufficient
                investigator recruitment by the client;


·
            the
                client’s decision to terminate the development of a product or to end a
                particular study.





Because
      we primarily receive revenue on the basis of the number of clinical samples
      we
      test and process, the loss, reduction in scope or delay of a large contract
      or
      the loss or delay of multiple contracts could materially adversely affect our
      business, results of operations, financial condition and cash flows. Our
      contracts typically entitle us to receive payment for fees earned by us up
      to
      the time of termination and reimbursement for out-of-pocket costs incurred
      prior
      to termination. In certain limited instances, our contracts also entitle us
      to a
      termination fee or payment for the costs of winding down the terminated
      projects.





**We
      depend on small number of clients for a significant portion of our revenue.
      Any
      decrease in revenue from these clients could materially adversely affect
      us.**





Historically,
      our largest two clients in any individual fiscal year have represented in excess
      of 50% of our revenue. However, during the fiscal year ended June 30, 2008,
      our
      top two clients represented 27% of our revenue and 33% during the fiscal year
      ended June 30, 2007. Our largest client in fiscal 2008 individually accounted
      for approximately 14% of our total revenue in fiscal 2008, while our largest
      client in fiscal 2007 accounted for approximately 17% of our total revenue
      in
      fiscal 2007. While on the one hand this reflects an improvement in terms of
      improving our diversification and decreasing our revenue reliance on a single
      client, on the other hand it is important to note that our largest client in
      fiscal 2008 was not our largest client in fiscal 2007, which illustrates the
      risk of significant revenue variability that we face in our marketplace. Revenue
      from our five largest clients represented approximately 56% and 65% of total
      revenue in fiscal 2008 and 2007, respectively. See “MANAGEMENT’S DISCUSSION AND
      ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” and see “DESCRIPTION
      OF BUSINESS – Clients/Marketing” above. Because our revenue has been
      concentrated in a small number of clients, we can be materially adversely
      impacted by decreases in work generated from these clients, including any delays
      in undertaking clinical studies or submitting samples for testing services,
      any
      early termination or reductions in work orders or clinical studies, or any
      decreases in the volume or timing of new work orders.





We
      have
      expanded our business development efforts and have continued to submit bids
      and
      proposals to these and other companies for our services, to increase our revenue
      and to diversify our client base. Although we believe that we have good
      relations with all of our large clients and other companies in the industry,
      and
      we expect to receive additional work orders in the future, we cannot predict
      the
      timing or amount of any such additional work or whether we will be successful
      in
      further diversifying our client base. If we are unsuccessful in our sales and
      business development efforts with our existing clients and potential clients,
      our revenue for the fiscal year ending June 30, 2009 may be less than our
      revenue for the fiscal year ended June 30, 2008. In addition, unless we are
      able
      to attract additional clients for medium to large studies, we will continue
      to
      be dependent on a small number of clients for a substantial majority of our
      revenue.


-
          10
          -





**If
      we do not gain new clients and new projects from our business development
      efforts, our growth may be limited, sales of our services may decrease and
      our
      operating results may suffer.**





We
      generally do not have long-term contracts with clients for our services. In
      addition, any project we undertake may generally be terminated at any time
      by
      the client on short notice. As a result, it is difficult for us to forecast
      future sales, and our future revenue depends on our ability to generate new
      clients and new projects. Our business development efforts are substantially
      dependent on our ability to effectively manage our time, personnel and
      resources. In particular, our Chief Scientific Officer is often heavily involved
      in the marketing and business development process, and time that she spends
      in
      this area detracts from her available time for laboratory and development work.
      Our success in business development depends in part on our reputation in the
      industry and client perceptions (including as to our laboratory capacity and
      financial health), and also to a degree on personal relationships between us
      and
      the client. With the significant consolidation in the pharmaceutical industry,
      it is often a long and complex process in finding and meeting with the right
      person within the client company. We also understand that some companies in
      the
      pharmaceutical industry have “preferred vendor” lists, such that a vendor cannot
      participate in requests for proposal or contract with the company unless the
      vendor is pre-approved on the list. We are attempting to expand our efforts
      in
      this area. In addition, we are hopeful that with the expansion of our service
      offerings, such as our biomarker services through Pacific Biomarkers, we will
      be
      able to attract new clients. If a client or prospective client has negative
      perceptions about our capabilities, our laboratory capacity or our financial
      health, this may affect our ability to develop new clients or projects. If
      our
      business development efforts are not successful, our revenue and cash flow
      may
      decrease and our operating results may suffer.





**We
      may bear financial risk if we underprice our contracts or overrun cost
      estimates.**





Since
      our
      contracts are primarily often structured as fixed price (or to a lesser extent
      as fee-for-service with a cap), we bear the financial risk if we initially
      underprice our contracts or otherwise overrun our cost estimates. Such under
      pricing or significant cost overruns could have a material adverse effect on
      our
      business, results of operations, financial condition and cash
      flows.





**Our
      backlog is subject to customer cancellation or modification and may not result
      in future revenue.**





We
      enter
      into contracts for studies and projects to be performed over an extended period
      of time, which may exceed several years. For internal management purposes,
      we
      maintain an order backlog to track anticipated net revenues that may be earned
      in the future for work that has not yet been performed. Backlog generally
      includes work to be performed under signed agreements (i.e., contracts and
      letters of intent), and once we commence work under a signed agreement, we
      recognize net revenues over the life of the project. Although backlog can
      provide helpful information to our management with respect to a particular
      study, we believe that our aggregate backlog as of any date is not necessarily
      a
      meaningful indicator of our future results for a variety of reasons. These
      reasons include that the scope of studies may change and studies may be
      terminated, reduced in scope or delayed at any time by the client or regulatory
      authorities. As a result, we cannot predict to what extent our backlog will
      ultimately result in future revenues or estimate the portion expected to be
      filled in any particular fiscal period. A reduction in backlog during any
      particular period or the failure of our backlog to result in future revenues
      could adversely affect our results of operations.





**Our
      revenue is unpredictable and varies significantly from quarter to quarter and
      year to year.**





We
      typically experience significant quarterly fluctuations in revenue in any fiscal
      year. For fiscal 2008 compared to fiscal 2007, even though our yearly revenue
      decreased only 3% to approximately $8,265,000 from approximately $8,480,000,
      we
      had significant revenue changes from quarter to quarter. The impact of quarterly
      fluctuations is clearly observed in the first and second fiscal quarters of
      2008
      where revenue decreased 23% compared to the comparable quarters in fiscal 2007.
      While, for the last six months of fiscal 2008, our revenue was 24% higher than
      for the comparable period of fiscal 2007. The following table shows the
      significant swings in our quarterly revenue for each quarter in the past three
      fiscal years:


-
          11
          -





(D*ollars
                in thousands,*
            
            **Fiscal year***rounded
                to nearest thousand)*
            
            **2006**
            
            **2007**
            
            **2008**Q1,
                ended September 30
            
            $
            1,834
            
            $
            2,605
            
            $
            2,082Q2,
                ended December 31
            
            
            3,113
            
            
            2,219
            
            
            1,648Q3,
                ended March 31
            
            
            3,110
            
            
            1,755
            
            
            2,296Q4,
                ended June 30
            
            
            2,693
            
            
            1,901
            
            
            2,239Total
            
            $
            10,750
            
            $
            8,840
            
            $
            8,265





Our
      revenue depends in large part on receiving new clinical or diagnostic studies
      from our clients, and we cannot predict the timing or amount of revenue we
      may
      recognize from quarter to quarter. With these dramatic quarterly fluctuations,
      it makes it difficult for management for its cash flow and capital expenditure
      planning purposes. During fiscal 2009, we are planning to make additional
      investments in our business development, technology infrastructure, operations
      and other areas of our business in an effort to become more competitive and
      to
      increase our revenue. These efforts will use significant amounts of time, effort
      and funding. These efforts may not be successful in generating additional
      revenue.





**We
      have historically had working capital deficits. If our revenue does not
      increase, our losses may increase; cash and working capital position may
      decline.**





We
      have
      had cash flow shortages and deficiencies in working capital in previous fiscal
      years. At June 30, 2008, we had approximately $1,196,000 in cash and a
      positive working capital position of approximately $331,000,
      both representing a significant decrease from the previous fiscal year; we
      also had significant amounts of debt, including secured convertible notes,
      the
      derivative liabilities associated with the notes and notes payable of
      approximately $1,835,000 and other liabilities of approximately $2,036,000
      and
      stockholders’ equity of approximately $1,124,000. For
      the
      last fiscal year ended June 30, 2008 we had an operating loss of approximately
      $566,000. For the previous fiscal year ended June 30, 2007 we had an operating
      loss of approximately $565,000. At June 30, 2008, we had an accumulated deficit
      of approximately $27,704,000.





We
      use
      our cash, cash equivalents, and accounts receivable to fund our operating losses
      and investments in capital expenditures. Unless revenue increases, we will
      likely experience losses and our cash and working capital positions may be
      adversely impacted through fiscal 2009. To improve our cash position, we are
      actively seeking to increase revenue, improve operating income and secure new
      debt and/or equity funding. However, our continuing efforts to improve our
      cash
      position, reduce expenses and generate revenue may not be
      successful.





Our
      future capital requirements depend upon many factors, including, but not limited
      to:





·
            the
                timing and number of clinical trials by clients, the number of samples
                submitted to us for testing, and the amount of revenue generated
                from
                these tests;


·
            our
                ability to enter into and build relationships with new clients, and
                obtain
                additional projects from existing
                clients;


·
            capital
                expenditure requirements, including for research and development
                efforts,
                upgrading or replacing laboratory equipment and making investments
                in
                information technology;


·
            delays
                or early terminations of clinical testing agreements with
                clients;


·
            our
                plans to pursue additional business
                strategies;


·
            our
                ability to manage our cash flow, including by managing or reducing
                our
                expenses associated with being a public company;
                and


·
            other
                business and economic factors that may occur from time to
                time.





None
      of
      these factors can be predicted with certainty. Additionally, if we desire to
      invest in our laboratory technology or research and development, we may require
      additional financing.





**We
      may need to raise additional capital to fund operations in the future. If our
      financing efforts are not successful, we will need to explore alternatives
      to
      continue operations, which may include a merger, asset sale, joint venture,
      loans or expense reductions.**





We
      may
      need to raise additional capital through equity or debt financing or through
      the
      establishment of other funding facilities in order to keep funding operations,
      particularly if we continue to experience significant quarterly fluctuations
      in
      our revenue or if our revenue does not continue to increase. In the current
      market condition, raising capital has been, and may continue to be difficult,
      and we may not receive sufficient funding. Any future financing that we seek
      may
      not be available in amounts or at times when needed, or, even if it is
      available, may not be on terms acceptable to us. Also, if we raise additional
      funds by selling equity or equity-based securities, the ownership of our
      existing stockholders will be diluted.


-
          12
          -





We
      continually evaluate various other alternatives to enable us to fund continuing
      operations, which may or may not occur, including, but are not limited to,
      any
      one or more of the following:





·
            engaging
                a financial advisor to explore strategic alternatives, which may
                include a
                merger, asset sale, joint venture or other similar
                transaction;


·
            forming
                a joint venture with one or more strategic partners to provide additional
                capital resources to fund
                operations.





These
      potential alternatives may not be open to us, or may only be available on
      unfavorable terms. If we are unable to obtain sufficient cash either to continue
      to fund operations or to locate a strategic alternative, we may be forced to
      seek protection from creditors under the bankruptcy laws or cease operations.
      Any inability to obtain additional cash as needed could have a material adverse
      effect on our financial position, results of operations and ability to continue
      in existence. During fiscal 2009, we are planning to make additional investments
      in our business development, technology infrastructure, operations and other
      areas of our business in an effort to become more competitive and to increase
      our revenue. These efforts will use significant amounts of time, effort and
      funding.





**The
      loss of our key personnel could adversely affect our
      business.**





Our
      success depends to a significant extent upon the efforts of our senior
      management team and other key personnel. The loss of the services of any such
      personnel could adversely affect our business. Also, because of the scientific
      and technical nature of our business, our success is dependent upon our ability
      to attract and retain technologically qualified personnel. There is substantial
      competition for qualified personnel, and an inability to recruit or retain
      qualified personnel may impact our ability to grow our business and compete
      effectively in our industry.





As
      previously disclosed, effective August 22, 2008, Dr. Mario Ehlers resigned
      from
      our employment as our Chief Medical Officer, a position he has held since
      September 2002.  We cannot predict the impact to our business from Dr.
      Ehlers’ resignation.  We have retained Dr. Ehlers’ services through a
      consulting contract up to a maximum of six months including his continuing
      to
      serve as President of our subsidiary, Pacific Biomarkers, Inc. In addition,
      although we intend to commence a search for a new Chief Medical Officer, we
      cannot predict whether or when we will be able to find a suitable qualified
      replacement.  Our business, particularly our business development efforts,
      may be materially adversely impacted.





**Our
      ability to protect our intellectual property is essential to the growth and
      development of our products and services.**





We
      rely,
      in part, on trade secrets and know-how to develop and maintain our competitive
      position and technological advantage on our existing intellectual property
      and
      any future intellectual property we develop. See “DESCRIPTION OF BUSINESS –
Other Technologies and Products” above. We protect our intellectual property
      through a combination of license agreements, trademark, service mark, copyright,
      trade secret laws and other methods of restricting disclosure and transferring
      title. We have and intend to continue entering into confidentiality agreements
      with our employees, consultants and vendors; entering into license agreements
      with third parties; and generally seeking to control access to and distribution
      of our intellectual property.





**Risks
      Relating to Our Industry**





**We
      depend on the pharmaceutical and biotechnology industries** .





Our
      revenue depends greatly on the outsourcing expenditures made by the
      pharmaceutical and biotechnology industries in research and
      development. The major industry risk for us is cancellation of contracts
      for drug research and development studies outsourced to our company.
      Accordingly, economic factors and industry trends that affect our clients in
      these industries also affect our business. Secondarily, failure of drugs
      during clinical trials also results in a premature end of our work on active
      contracts. If companies in these industries were to reduce the number of
      research and development projects they outsource, our business could be
      materially adversely affected.


-
          13
          -





Our
      clients in the pharmaceutical and biotechnology industries have experienced
      significant consolidation over the last several years and we expect that trend
      to continue. The uncertainty caused by consolidation, before, during and after
      a
      business combination can result in product delays, changes in strategy, and
      consolidation and/or elimination of research and development efforts. Any of
      these effects can have a materially adverse affect on us if it results in
      testing delays, sample volume reductions or termination of tests.





In
      addition, management continues to review developments in the dyslipidemia drug
      development market that provides a substantial portion of our revenues. The
      late-stage withdrawal of the HDL-raising drug torcetrapib by Pfizer in December
      2006 had the potential to significantly impact our future revenues. Several
      major drug programs at a number of pharmaceutical companies were postponed,
      suspended or terminated, and we believe this likely impacted our ability to
      win
      new business in this therapeutic area during fiscal 2008 and fiscal 2007.
      Despite these events, however, towards the latter half of fiscal 2008 we
      observed a modest resurgence in the dyslipidemia pipeline, and we are cautiously
      optimistic that this trend will continue. Moreover, we have also observed a
      shift in emphasis in pharma from pure “cholesterol drugs” towards drugs that
      treat type 2 diabetes and obesity, both of which are therapeutic areas in which
      we have considerable expertise. Consequently, a significant proportion of new
      backlog signed during fiscal 2008 has been for drugs in these areas. We will
      continue to be impacted by changes affecting the pharmaceutical and
      biotechnology industries.





**Failure
      to keep pace with changes in the marketplace may cause us to lose market share
      and our revenue may decrease.**





The
      market for our services is subject to rapid technological change and innovation.
      In particular, laboratories are regularly developing new assays to incorporate
      into clinical testing and have to maintain up-to-date laboratory equipment
      to
      stay competitive. In developing and enhancing our services, we have made, and
      will continue to make, assumptions about which features, standards and
      performance criteria will be attractive to, or demanded by, our clients. If
      we
      implement criteria that are different from those required by our clients or
      if
      our competitors introduce products and systems that better address these needs,
      market acceptance of our offerings may suffer or may become obsolete. In that
      event, our market share and revenue would likely decrease. In addition, clients
      are requiring that laboratories maintain secure and sophisticated information
      technology systems, as a means for storing data and facilitating communication
      between the laboratory and the client. Although we continue to expend efforts
      and resources in these areas, we may not be successful in keeping up with client
      needs or expectations. In addition, if a client or prospective client has
      negative perceptions about our abilities based on our financial strength, this
      may affect our ability to attract new clients or projects. Many of our
      competitors have greater resources than we do. We are also exploring additional
      financing to be used to continue to update our laboratory service capability.
      If
      we are unsuccessful in raising funds as and when needed, we may, or it may
      be
      perceived, that we are less efficient and less economical than our competitors
      and we may lose business to our competitors. If this occurs, it would have
      a
      material adverse effect on our revenue and financial performance.





In
      an
      effort to mitigate these risks, we are continually evaluating new business
      opportunities that allow us to leverage our expertise, broaden our service
      menu,
      diversify our client base, and increase the scope and number of our contracts.
      A
      major initiative in this regard has been the creation of Pacific Biomarkers
      to
      focus on a rapidly expanding market segment, clinical biomarker services.
      However, if the market for these services does not develop as we anticipate,
      we
      may not be successful in attracting new clients and generating
      revenue.





**We
      may not be able to successfully develop and market new
      services.**





We
      may
      seek to develop and market new services that complement or expand our existing
      business. If we are unable to develop new services and or create demand for
      those newly developed services, our future business, results of operations,
      financial condition and cash flows could be adversely affected.


-
          14
          -





Despite
      these risks, we believe we have been successful in evaluating new business
      opportunities that allow us to leverage our expertise, broaden our service
      menu,
      diversify our client base, and increase the scope and number of our contracts.
      Specifically, we launched a major initiative in this regard in fiscal 2008
      by
      creating Pacific Biomarkers to focus on a rapidly expanding market segment,
      clinical biomarker services. We are hopeful that these new services will help
      us
      to attract new clients, and increase the number and total value of our
      contracts. However, if the market for these services does not develop as we
      anticipate, we may not be successful in attracting new clients and generating
      revenue. In addition, these new services require management time and efforts,
      which may detract from our core business.





**We
      operate in a highly competitive industry, and we may lose or fail to attract
      clients for our services to our competitors.**





Our
      competitors range from small, limited-service providers to full service global
      contract research organizations. Our main competition consists of in-house
      departments of pharmaceutical companies, full-service contract research
      organizations **,** and, to
      a lesser degree, universities. See “DESCRIPTION OF BUSINESS – Competition”
above. We compete on a variety of factors, including





·
            technological
                expertise and efficient drug development
                processes,


·
            reputation
                for on-time quality performance,


·
            price,


·
            expertise
                and experience in specific areas,


·
            strengths
                in various geographic markets and global
                reach,


·
            ability
                to manage large-scale clinical trials both domestically and
                internationally,


·
            scope
                of service offerings,


·
            ability
                to acquire, process, analyze and report data in a time-saving and
                accurate
                manner, and


·
            expertise
                and experience in health economics and outcomes
                services.





Many
      of
      our competitors have greater resources than we do, have global operations and
      greater name recognition. If we experience significant competition which is
      based on factors which we do not have in our business, such as global management
      of projects or size, our business could be materially adversely affected.
      Through our joint marketing arrangement with Quintiles, we believe we are able
      to improve our competitive position. We continue to realize significant
      financial benefit from this relationship, even though this arrangement may
      not
      be successful in generating revenue for us or improving our competitive position
      in the future.





**Changes
      in government regulations could decrease the need for our
      services.**





Governmental
      agencies throughout the world, but particularly in the United States, highly
      regulate the drug development and approval process. See “DESCRIPTION OF BUSINESS
– Government Regulation” above. Our business involves performing safety and
      efficacy laboratory testing during clinical trials of new pharmaceutical drugs.
      Clinical trial laboratory data is used by pharmaceutical and biotechnology
      companies in the submission process to the FDA for the marketing approval of
      a
      new drug. Changes in regulations, such as a relaxation in regulatory
      requirements or the introduction of simplified drug approval procedures or
      an
      increase in regulatory requirements that we have difficulty satisfying, could
      eliminate or substantially reduce the need for our services. Also, government
      efforts to contain drug costs and pharmaceutical and biotechnology company
      profits from new drugs may have an impact on the drug development and approval
      process, and our clients may spend less, or reduce their growth in spending,
      on
      research and development.





**Failure
      to comply with existing government regulations could result in a loss of revenue
      or earnings from a project.**





Any
      failure on our part to comply with applicable government regulations could
      result in the termination of on-going research or sales and marketing projects
      or the disqualification of data for submission to regulatory authorities. For
      example, if we failed to validate analytical test methods performed on samples
      collected during and in support of a trial or if we fail to comply with GCP
      (Good Clinical Practice) regulations, the generated test data could be
      disqualified. If this were to happen, we could be contractually required to
      repeat the trial at no further cost to our client, but at substantial cost
      to
      us.


-
          15
          -





**We
      must maintain certifications from our clients in order to be eligible to bid
      on
      projects.**





Many
      of
      our clients require our laboratories to be tested from time to time for
      certification that we comply with their internal requirements. If we fail to
      comply, we will probably be terminated from existing contracts and we will
      not
      be eligible to bid on that client’s future projects. While generally we have
      been very successful in maintaining certifications and in gaining new
      certifications, if we fail certification tests, especially for our major
      clients, our business would be materially adversely affected.





**We
      may expand our business through acquisitions.**





We
      may
      review acquisition opportunities. Factors which could affect our ability to
      grow
      successfully through acquisitions include





·
            difficulties
                and expenses in connection with integrating the acquired companies
                and
                achieving the expected benefits,


·
            diversion
                of management’s attention from current
                operations,


·
            the
                possibility that we may be adversely affected by risk factors facing
                the
                acquired companies, and


·
            acquisitions
                could be dilutive to earnings, or in the event of acquisitions made
                through the issuance of our common stock to the stockholders of the
                acquired company, dilutive to the percentage of ownership of our
                existing
                stockholders.





**We
      may be affected by potential health care reform.**





In
      recent
      years, governments of the United States, Europe and Asia have considered various
      types of health care reform in order to control growing health care costs.
      We
      are unable to predict what legislative proposals will be adopted in the future,
      if any. Implementation of health care reform legislation that contains costs
      could limit the profits that can be made from the development of new drugs.
      This
      could adversely affect research and development expenditures by pharmaceutical
      and biotechnology companies which could in turn decrease the business
      opportunities available to us. In addition, new laws or regulations may create
      a
      risk of liability, increase our costs or limit our service
      offerings.





**Specialty
      reference and central laboratory services create a risk of liability.**





In
      contracting to work on drug development trials, we face a range of potential
      liabilities, including





·
            errors
                or omissions in laboratory data being generated relating to the safety
                and
                efficacy of the drug, that could affect the regulatory approval of
                the
                drug, and


·
            errors
                and omissions during a trial that may undermine the usefulness of
                a trial
                or data from the trial.





While
      we
      maintain what we believe is adequate insurance coverage and obtain contractual
      indemnifications protecting us against liability arising from our own actions
      (other than negligence or intentional misconduct), we could be materially and
      adversely affected if we were required to pay damages or bear the costs of
      defending any claim which is not covered by a contractual indemnification
      provision or which is beyond the level of our insurance coverage. Due to the
      rising costs of insurance, we may not be able to maintain such insurance
      coverage at levels or on terms acceptable to us.





**We
      are dependent on single-source suppliers.**





We
      purchase certain reagents from many  single
      source suppliers. The disruption of such supply relationships could impair
      our
      ability to perform laboratory testing, result in contract delays or cause us
      to
      incur costs associated with the finding of alternative sources of supplies.
      This
      could have a material adverse effect on our financial condition and results
      of
      operations.


-
          16
          -





**Risks
      Related to Our Common Stock**





**Our
      common stock is traded on the OTC Bulletin Board and is considered a “penny
      stock”. Our stockholders’ ability to sell shares in the secondary trading market
      may be limited.**





Our
      common stock is currently quoted for trading on the OTC Bulletin Board. As
      a
      result, the liquidity of our common stock is limited, not only in the number
      of
      shares that are bought and sold, but also through delays in the timing of
      transactions, and the lack of coverage by security analysts and the news media
      of our company.





In
      addition, because our stock is quoted on the OTC Bulletin Board, our common
      stock is subject to certain rules and regulations relating to “penny stock.” A
“penny stock” is generally defined as any equity security that has a price less
      than $5.00 per share and that is not quoted on the NASDAQ Stock Market or a
      national securities exchange. Being a penny stock generally means that any
      broker who wants to trade in our shares (other than with established clients
      and
      certain institutional investors) must comply with certain “sales practice
      requirements,” including delivery to the prospective purchaser of the penny
      stock a risk disclosure document describing the penny stock market and the
      risks
      associated therewith. In addition, broker-dealers must take certain steps prior
      to selling a “penny stock,” which steps include:





·
            obtaining
                financial and investment information from the
                investor;


·
            obtaining
                a written suitability questionnaire and purchase agreement signed
                by the
                investor; and


·
            providing
                the investor a written identification of the shares being offered
                and the
                quantity of the shares.





If
      these
      penny stock rules are not followed by the broker-dealer, the investor has no
      obligation to purchase the shares. The application of these comprehensive rules
      will make it more difficult for broker-dealers to sell our common stock, and
      as
      a practical matter, these requirements may mean that brokers are less likely
      to
      make recommendations on our shares to its general clients.





As
      a
      result, for as long as our common stock is quoted on the OTC Bulletin Board
      and
      subject to these penny stock rules, our stockholders may have difficulty in
      selling their shares in the secondary trading market. In addition, prices for
      shares of our common stock may be lower than might otherwise prevail if our
      common stock were quoted on the NASDAQ Stock Market or traded on a national
      securities exchange, like The New York Stock Exchange or American Stock
      Exchange. This lack of liquidity may also make it more difficult for us to
      raise
      capital in the future through the sale of equity securities.





**Risks
      related to our common stock include, but are not limited to the
      following:**





· Our
      quarterly operating results may vary, and these fluctuations could affect the
      market price of our stock.


· Our
      stock price is volatile and a stockholder’s investment in our common stock could
      suffer a decline in value.


· The
      market for our stock has not been liquid.





**As
      we issue additional equity securities in the future, including upon conversion
      of any of our secured convertible debt, the ownership of our existing
      stockholders will be diluted. In particular, the secured convertible debt has
      a
      full ratchet anti-dilution provision that could significantly dilute the
      ownership of our stockholders.**





Our
      2005
      Note with Laurus is convertible into shares of our common stock at an initial
      conversion price of $1.17 per share. See “DESCRIPTION OF BUSINESS – Laurus Debt
      Investment” above. In addition, the 2005 Note carries a full ratchet
      anti-dilution provision, such that if we issue convertible or equity securities
      (subject to certain exceptions, including stock option grants and issuances
      in
      connection with certain acquisition transactions) at a price less than the
      initial conversion price, the note conversion price will be automatically
      adjusted down to that lesser price. In addition to the conversion rights of
      the
      convertible debt, as we issue stock or convertible securities in the future,
      including for any future equity financing or upon exercise of any of the
      outstanding stock purchase warrants and stock options, those issuances would
      also dilute our stockholders. If any of these additional shares are issued
      and
      are sold into the market, it could decrease the market price of our common
      stock
      and could also encourage short sales. Short sales and other hedging transactions
      could place further downward pressure on the price of our common
      stock.


-
          17
          -




**We
      do not intend to pay cash dividends, so any return on investment must come
      from
      appreciation.**





We
      have
      not declared dividends on our common stock in the past, and do not intend to
      declare dividends on our common stock in the foreseeable future. As a result,
      any investment return in our common stock must come from increases in the fair
      market value and trading price of our common stock.





**ITEM
                1B**
              **UNRESOLVED
                  STAFF COMMENTS**





Not
      Applicable.





**ITEM
              2**
            **PROPERTIES**





We
      lease
      approximately 15,000 square feet of office and laboratory space in Seattle,
      Washington for our executive offices and laboratory. In April 2007 we entered
      into an amendment to the lease to extend its term through October 31, 2012.
      The
      current monthly rent under the lease is $20,361. The monthly rental rate
      increases approximately three percent on each November 1 for the remainder
      of
      the term.





We
      believe the leased premises are suitable and adequate for their current intended
      use. In the opinion of management, the leased premises are adequately covered
      by
      insurance.





We
      do not
      own any real property. We do not have a policy pertaining to investments in
      real
      estate. Our current practice is to invest solely in short-term market securities
      per our investment policy.





**ITEM
              3**
            **LEGAL
                PROCEEDINGS**





We
      are
      not a party to any pending material legal proceedings.





**ITEM
              4**
            **SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY HOLDERS**





No
      matters were submitted to a vote of security holders during the fourth quarter
      of the fiscal year ended June 30, 2008.




**PART
      II**





**ITEM
              5**
            **MARKET
                FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
                PURCHASES OF EQUITY
                SECURITIES**





**Common
      Stock**





Our
      common stock is currently quoted for trading on the OTC Bulletin Board under
      the
      symbol “PBME.”





The
      following table shows, for each quarter of fiscal 2008 and 2007, the high and
      low closing sales prices as reported by the OTC Bulletin Board. The quotations
      from the OTC Bulletin Board reflect inter-dealer prices without retail mark-up,
      mark-down, or commissions and may not represent actual
      transactions.


-
          18 -





**OTC
                Bulletin Board**High
            
            Low**Fiscal
                2008:**Fourth
                quarter, ended June 30, 2008
            
            $
            0.50
            
            $
            0.35Third
                quarter, ended March 31, 2008
            
            
            0.66
            
            
            0.45Second
                quarter, ended December 31, 2007
            
            
            0.82
            
            
            0.60First
                quarter, ended September 30, 2007
            
            
            0.79
            
            
            0.56**Fiscal
                2007:**Fourth
                quarter, ended June 30, 2007
            
            $
            0.90
            
            $
            0.42Third
                quarter, ended March 31, 2007
            
            
            1.07
            
            
            0.75Second
                quarter, ended December 31, 2006
            
            
            1.16
            
            
            0.90First
                quarter, ended September 30, 2006
            
            
            1.23
            
            
            0.85





**Holders**





As
      of
      September 25, 2008, there were 19,188,421 shares of common stock issued and
      outstanding, held by approximately 207 holders of record.





**Dividends**





We
      have
      never declared or paid any cash dividends with respect to our common stock,
      and
      do not plan to do so in the foreseeable future.





We
      anticipate that we will retain future earnings for use in the operation and
      expansion of our business and do not anticipate paying cash dividends on our
      equity in the foreseeable future. Any future determination with regard to the
      payment of dividends will be at the discretion of our board of directors and
      will be dependent upon our future earnings, financial condition, applicable
      dividend restrictions and capital requirements and other factors deemed relevant
      by the board of directors.





**ITEM
              6**
            **SELECTED
                FINANCIAL DATA**





Not
      Applicable.





**ITEM
              7**
            **MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS**





*You
      should read the following discussion and analysis in conjunction with our
      consolidated audited financial statements and related notes for the fiscal
      year
      ended June 30, 2008, included elsewhere in this Report. Except for historical
      information, the following discussion contains forward-looking statements.
      See
“Cautionary Notice Regarding Forward Looking Statements” and “Risk
      Factors.”*





**Overview**





We
      provide specialty central laboratory services to support pharmaceutical and
      laboratory diagnostic manufacturers in the conduct of human clinical research,
      for use in their drug and diagnostic product development efforts. Our clients
      include a number of the world’s largest multi-national pharmaceutical,
      biotechnology and diagnostic companies. Our well-recognized specialty areas
      include cardiovascular disease (dyslipidemia, atherosclerosis, and coronary
      heart disease), diabetes (and obesity), and bone and joint diseases
      (osteoporosis as well as osteo and rheumatoid arthritis). Coupled with our
      specialty testing, we also have central laboratory capability and provide
      full-service central laboratory support for multi-center clinical trials,
      including routine safety lab tests (general chemistry, hematology, and
      urinalysis). Beginning in fiscal 2008, we also provide clinical biomarker
      services for novel biomarkers, as well as custom assay services, to our
      pharmaceutical and biotech clients. Our company is a Delaware corporation,
      incorporated in May 1996, and we conduct our operations primarily through our
      wholly-owned subsidiary, Pacific Biometrics, Inc., a Washington
      corporation.


-
          19 -





**Critical
      Accounting Estimates and Policies**





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





We
      have
      identified below some of our accounting policies that we consider critical
      to
      our business operations and the understanding of our results of operations.
      This
      is not a complete list of all of our accounting policies, and there may be
      other
      accounting policies that are significant to our company. For a detailed
      discussion on the application of these and our other accounting policies, see
      Note 2 to the Consolidated Financial Statements included in this
      Report.





***Revenue
      Recognition*** **





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





***Financial
      Derivatives – Embedded Features***





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





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


-
          20 -





***Common
      Stock Purchase Warrants and Other Derivative Financial
      Instruments***





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





***Stock-Based
      Compensation***





Effective
      January 1, 2006, we adopted the provisions of SFAS No. 123(R), “ *Share-Based
      Payment”,* using
      the
      modified prospective transition method. This requires companies to estimate
      the
      fair value of equity-based payment awards on the date of grant using an
      option-priced model. The value of the portion of the award that is ultimately
      expected to vest is recognized as an expense over the requisite service periods
      in our consolidated income statements. Determining the fair value of
      equity-based awards at the grant date requires judgment. In addition, judgment
      is also required in estimating the amount of equity-based awards that are
      expected to be forfeited. If actual results differ significantly from these
      estimates, equity-based compensation expense and our results of operations
      could
      be materially impacted. We granted 200,000 restricted shares for the fiscal
      year
      ended June 30, 2008, compared to 543,234 restricted shares and 130,245 stock
      options for the fiscal year ended June 30, 2007.





***Allowance*** ** ***for
      Doubtful Accounts***





Trade
      Receivable s  – While
      we
      historically have experienced very low levels of bad debt, we continually
      monitor our current accounts receivable for past due accounts and adjust the
      allowance as circumstances warrant.  As the recorded bad debt provision is
      based upon management’s judgment, actual bad debt write-offs may be greater than
      or less than the amount recorded.  If we have specific knowledge of a
      current account that may be uncollectible, we will add that amount to our
      allowance for doubtful accounts.  We are susceptible to changes in the
      pharmaceutical market as well as to changes in the overall economy.  A
      market downturn or cost reductions from one of our largest clients may influence
      how we estimate our allowance for bad debt. We did
      not incur any bad debt expense in the current fiscal year. The balance of the
      bad debt allowance was $29,294 and $29,294 for the fiscal year ended June 30,
      2008 and June 30, 2007, respectively.





Other
      Receivables – In fiscal 2008, we experienced significant non-trade bad debt
      where we wrote off $100,000 related to our loan and
      security agreement with Saigene
      Corporation .
      Saigene
      Corporation filed for Chapter 11 bankruptcy and we deemed that 100% of the
      note
      receivable from Saigene was uncollectible.





***Useful
      Lives of Tangible and Intangible Assets***





The
      assets we acquire are subject to our best estimates of useful lives of the
      asset
      for depreciation purposes. Due to the uncertainty of current studies which
      are
      subject to cancellation, which may occur at any time, as well as changes in
      scientific methods for our testing, we may no longer have use for certain
      tangible and intangible assets and may take a charge against current earnings
      should changes in our estimated asset lives occur.





We
      depreciate equipment and computers over three to five years, while leasehold
      improvements are depreciated over the remaining life of the lease or ten years.
      This estimate of a three to five-year useful life on equipment and computers
      and
      a useful life based on the remaining years left on the building lease for
      leasehold improvements reflects management’s judgment that these useful life
      periods reflect a reasonable estimate of the life over which the equipment,
      computers and leasehold improvements will be used by us. Software costs incurred
      in connection with obtaining and developing internal use software (“software
      costs”), are capitalized in accordance with Statement of Position (SOP) No. 98-1 *Accounting
      for the Costs of Computer Software Developed or Obtained for Internal Use.* Software
      costs are amortized over a period not to exceed three years and are included
      in
      Property and Equipment (see Note 5). The amount of depreciation and amortization
      expense we record in any given period will change if our estimates of the useful
      life of our equipment, computers, and software or leasehold interests were
      to
      increase or decrease. We use the discounted cash flow method according to SFAS
      144 to test our assets for impairment. The current balance of our depreciable
      assets at June 30, 2008 is $884,521, net of depreciation and amortization.
      We
      currently do not carry material amounts of intangible assets on our balance
      sheet.


-
          21 -





***Operating
      Expenses***





Historically,
      we have segregated our recurring operating expenses among three categories:
      laboratory and cost of goods sold; selling, general and administrative expenses;
      and research and development. Laboratory expenses and cost of goods sold consist
      of amounts necessary to complete the revenue and earnings process, and includes
      direct labor and related benefits, other direct costs, and an allocation of
      facility charges and information technology costs, and depreciation and
      amortization. Also, laboratory expenses and cost of goods sold include shipping
      and handling fees and reimbursable out-of-pocket costs. Laboratory expenses
      and
      cost of goods sold, as a percentage of net revenue, tends, and is expected,
      to
      fluctuate from one period to another, as a result of changes in labor
      utilization and the mix of service offerings involving studies conducted during
      any period of time. Selling, general and administrative expenses include
      business development activities, sales and marketing expenses and related
      commissions, and laboratory administration expenses. Selling, general and
      administrative expenses consist primarily of administrative payroll and related
      benefit charges, legal and accounting fees, advertising and promotional
      expenses, administrative travel and an allocation of facility charges,
      information technology costs, and depreciation and amortization.





**Results
      of Operations for the Fiscal Years Ended June 30, 2008 and 2007**





**Revenue:**





**Years
                Ended**
              **June
                30,***Dollars in thousands, rounded to nearest*
              *thousand*
            
            2008
            
            2007
            
            $ change
            
            % change**Revenue**
            
            $
            8,265
            
            $
            8,480
            
            $
            (215
            )
            
            (3
            )%





Our
      revenue is primarily generated from clinical pharmaceutical trials testing
      services and from diagnostic services. In addition, in fiscal 2008 we also
      recognized initial revenue from our clinical biomarker services. The
      approximately 3% decrease in fiscal 2008 revenue from fiscal 2007 was primarily
      attributable to a decrease in the size of clinical pharmaceutical trials testing
      and diagnostic testing services we performed.





We
      work
      directly with pharmaceutical and biotech companies as well as other large
      clinical laboratories that refer (“Referral Laboratory Partners”) specialty
      laboratory testing to us. We experience significant uncertainty regarding
      existing revenues and estimates of future revenues, during any period. Studies
      that we bid on are uncertain until we have a signed contract. Once work on
      a
      study commences, it may be cancelled by the sponsor at some time during the
      testing phase. Accordingly, our revenues significantly hinge on the success
      or
      failure of the testing phase, and factors that are not within our control.
      Moreover, drug development activities by pharmaceutical companies in the lipid
      /
      cholesterol market in general, representing a major portion of our revenues,
      remain unclear. In addition, several factors may adversely affect our future
      revenues, including a large number of pharmaceutical companies’ cost reduction
      announcements and continuing consolidation in the pharmaceutical
      market.





Combined
      revenue for the first and second quarters for the fiscal year ended June 30,
      2008 showed a decrease of approximately $1,094,000 over the comparable quarters
      in the prior fiscal year. Combined revenue for the third and fourth quarters
      for
      fiscal 2008 showed an increase in revenue of approximately $879,000 over the
      comparable quarters in the prior fiscal year. We have previously experienced
      quarterly fluctuations in revenue that were above or below previous fiscal
      years’ revenues. Typically our revenue fluctuations are primarily explained by
      the timing between our work on testing and open work orders, and prior work
      orders having been completed or terminated.


-
          22 -





Management
      continues its review of the cholesterol drug development market, which provides
      a substantial proportion of our revenues. The late-stage failure of the Pfizer
      drug torcetrapib (designed to raise "good" cholesterol, HDL) in December 2006
      resulted in a limited number of studies being suspended, postponed or
      terminated. As a result, we observed softness in the cholesterol testing market
      in calendar 2007. However, recently other drugs in the same class as torcetrapib
      have been reactivated and we are cautiously optimistic that the cholesterol
      testing market will improve in fiscal 2009 and beyond. Moreover, we have also
      noted recent strong demand in related markets, such as diabetes and
      obesity.





**Laboratory
      Expense and Cost of Goods Sold:**





**Years
                Ended**
              **June
                30,***Dollars in thousands, rounded to nearest*
              *thousand*
            
            2008
            
            2007
            
            $ change
            
            % change**Laboratory Expenses and Cost of Goods Sold**
            
            $
            4,841
            
            $
            5,153
            
            $
            (312
            )
            
            (6
            )%**Percentage
                of Revenue**
            
            
            59
            %
            
            61
            %





Laboratory
      expense and cost of goods sold consist primarily of salaries and related
      benefits to employees performing analysis of clinical trial samples and the
      cost
      of reagents and supplies for analysis of **** clinical
      trial **** samples,
      and secondarily, of payments to subcontractors for laboratory services and
      other
      expenses such as rent, insurance, business and occupation taxes. For the
      comparable fiscal years ended June 30, 2008 and 2007, laboratory expense and
      cost of goods sold decreased approximately 6% to $4,841,000 from $5,153,000.
      Increases in cost of reagents, maintenance and repair expenses were offset
      by a
      decrease in salaries and benefits, depreciation expense, and expenses for
      outside services. As a percentage of revenue, laboratory expense and cost of
      goods was approximately 59% and 61% in fiscal years 2008 and 2007. The following
      table illustrates changes in Laboratory Expenses and Cost of Goods Sold in
      fixed
      and variable expense categories:





**Years
                Ended**
              **June
                30,***Dollars in thousands, rounded to*
              *nearest thousand*
            
            2008
            
            %
                of revenue
            
            2007
            
            %
                of revenue
            
            $
                change
            
            %
                change**Fixed
                Cost Detail**Rent,
                Utilities, Certain Taxes
            
            **$**
            **475**
            
            
            **6**
            **%**
            **$**
            **503**
            
            
            **6**
            **%**
            **$**
            **(28**
            **)**
            
            **(6**
            **)%****Variable
                Cost Detail**Wages,
                Taxes, Benefits
            
            
            1,903
            
            
            23
            
            
            2,052
            
            
            24
            
            
            (149
            )
            
            (7
            )Reagent
                Chemicals
            
            
            1,777
            
            
            22
            
            
            1,647
            
            
            19
            
            
            130
            
            
            8Other
                Variable Costs
            
            
            686
            
            
            8
            
            
            951
            
            
            12
            
            
            (265
            )
            
            (28
            )Total
            
            
            **4,366**
            
            
            **53**
            
            
            **4,650**
            
            
            **55**
            
            
            **(284**
            **)**
            
            **(6**
            **)****Total
                Cost of Goods Sold**
            
            **$**
            **4,841**
            
            
            **59**
            **%**
            **$**
            **5,153**
            
            
            **61**
            **%**
            **$**
            **(312**
            **)**
            
            **(6**
            **)%**





The
      largest component of laboratory expense during fiscal 2008 was salaries and
      related benefits. During the fiscal years ended June 30, 2008 and 2007,
      respectively, salaries and related benefits were 23% and 24% of revenue and
      accounted for approximately 39% and 40% of total laboratory expense and cost
      of
      goods sold. During fiscal 2008, as the number of our clinical studies declined
      slightly from 2007, we did not reduce our laboratory staff. Our highly skilled
      laboratory technical people are difficult to find, and once hired, we train
      our
      staff extensively on our proprietary methods. However, laboratory salaries
      and
      related benefits decreased approximately 7% to $1,903,000 from $2,052,000,
      for
      the fiscal years ended June 30, 2008 and 2007, respectively, due primarily
      to
      staff transfer in our laboratory. We promoted two technical positions to our
      Science and Technology team, and this expense is included in the Sales, General
      and Administrative expense (described below) and no longer as laboratory
      expense.


-
          23 -





The
      other
      primary component of laboratory expense is the cost of supplies for analysis
      of
      clinical trial samples. During the fiscal years ended June 30, 2008 and 2007,
      respectively, lab supplies were approximately 37% and 32%, and outside services
      were approximately 3% and 9%, of total laboratory expense and cost of goods
      sold. The 8% increase in laboratory supplies reflects a change in the mix of
      testing performed in the laboratory. In particular, the mix of testing during
      the year ended June 30, 2008 used significantly less outside testing services
      than for the comparable period June 30, 2007, but required comparable amounts
      of
      reagent. These reagent and supply costs are highly variable depending on the
      type of tests performed and level of revenues.





**Selling,
      General and Administrative Expense:**





**Years
                Ended**
              **June
                30,***Dollars in thousands, rounded to nearest*
              *thousand*
            
            2008
            
            2007
            
            $
                change
            
            %
                change**Selling,
                General and Administrative Expense**
            
            $
            3,990
            
            $
            3,892
            
            $
            98
            
            
            3
            %**Percentage
                of Revenue**
            
            
            48
            %
            
            46
            %





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





For
      the
      comparable years ended June 30, 2008 and 2007, respectively, selling, general
      and administrative expense increased approximately 3% to approximately
      $3,990,000 from $3,892,000. As a percentage of revenue, selling, general and
      administrative expenses were approximately 48% and 46%, respectively, for the
      comparable fiscal years ended June 30, 2008 and 2007. The dollar increase in
      our
      selling, general and administrative expenses for the comparable periods is
      due
      in large part to salaries and benefits for management, sales and administrative
      personnel, which increased approximately $384,000 as a result of hiring a new
      scientist and re-categorizing two of our laboratory technologists to our Science
      and Technology team. This change increased headcount to 17 FTE in fiscal 2008
      from 14 FTE in fiscal 2007.





For
      the
      year ended June 30, 2008, we also had increases in management consulting expense
      associated with Sarbanes-Oxley Act compliance, legal expenses, bad debt expense
      related to our loan and
      security agreement with Saigene
      Corporation ,
      trade
      show and advertising expenses. These increases were partially offset by
      decreases in share-based compensation expense, bonuses, public company expense
      and expenses for computer consultants. We
      incurred approximately $171,000 of share-based compensation expense during
      fiscal year 2008 compared to $560,000 for fiscal year 2007. Overall decrease
      of
      public company expense was due to a reduction of investor relations
      expense and adjustment of fair value of broker warrants related to our debt
      financing arrangement with Laurus.





**Other
      Expense:**





**Years
                Ended**
              **June
                30,***Dollars in thousands, rounded to nearest*
              *thousand*
            
            2008
            
            2007
            
            $
                change
            
            %
                change**Other
                Expense**
            
            $
            5
            
            $
            648
            
            $
            (643
            )
            
            (99
            )%**Percentage
                of Revenue**
            
            
            0
            %
            
            8
            %





Total
      other expense decreased 99% to approximately $5,000 from expense of
      approximately $648,000 during the fiscal years ended June 30, 2008 and 2007,
      respectively. These improvements in our other expense are primarily attributable
      to a decrease in interest expense paid on the 2004 and 2005 Notes, an increase
      in the gain on adjustment of embedded and freestanding derivatives to fair
      value, and an increase in interest income and other income for the year ended
      June 30, 2008.


-
          24 -





During
      fiscal 2008 and 2007, we continued to make monthly payments of principal and
      accrued interest on our notes payable to Laurus. The reduction in the principal
      balances of the Laurus notes decreased accrued interest, and our interest
      expense decreased 42% to $220,000 in fiscal 2008, down from $377,000 for the
      year ended June 30, 2007. In addition, with the reduction in the principal
      balances, the number of common shares into which the notes were convertible
      also
      decreased. This resulted in an increase in the “gain on adjustment of embedded
      and freestanding derivatives to fair value” in fiscal 2008 of approximately
      $111,000 to $805,000 or 16%, up from $694,000 for the year ended June 30, 2007.
      Another component of other expense in the year ended June 30, 2008 was
      approximately $674,000 of non-cash interest expense that represented the
      accretion of the intrinsic value of the conversion feature and warrants,
      compared to $886,000 of such non-cash interest expense recorded for the 2007
      fiscal year.





We
      had
      approximately $202,000 of other income; with approximately $96,000 of interest
      income from our investments; $47,000 of interest income and $57,000 from a
      state
      tax refund and $2,000 from disposal of fixed assets.





We
      also
      recognized approximately $107,000 of expense associated with amortization of
      approximately $293,500 in fees and expenses related to the 2004 Note, and
      approximately $168,000 in fees and expenses related to the 2005 Note. We are
      amortizing these fees to deferred financing costs over the amended 48-month
      life
      of each note. As of June 30, 2008, unamortized balance was approximately
      $18,000.





During
      the fiscal year ended June 30, 2007, other expense included settlement charges
      we paid totaling $50,000. This sum represents a promissory note in principal
      amount of $50,000 issued jointly by us and Saigene Corporation in connection
      with our prior asset purchase agreement dated August 28, 2002. We did not have
      a
      comparable expense in fiscal year ended June 30, 2008.





**Net
      Loss:**





**Years Ended**
              **June 30,***Dollars in thousands, rounded to nearest*
              *thousand*
            
            2008
            
            2007
            
            $ change
            
            % change**Net
                Loss**
            
            $
            (571
            )
            $
            (1,213
            )
            $
            642
            
            
            53
            %**Percentage
                of Revenue**
            
            
            (7
            )%
            
            (14
            )%





We
      had a
      net loss of approximately $(571,000) in fiscal 2008 compared to a net loss
      of
      approximately $(1,213,000) in fiscal 2007. Considering our slight decrease
      in
      revenue between the fiscal years, this improvement in net loss was primarily
      attributable to our significant decrease in other expenses, as described above.
      In addition, net loss was improved by decreases in laboratory expenses, which
      more than offset the increase in our selling, general and administrated
      expenses.





**Liquidity
      and Capital Resources:**





We
      had a
      decrease in revenues and a net operating loss for the fiscal year ended June
      30,
      2008. However, our net loss has significantly improved compared to the fiscal
      year ended June 30, 2007, primarily due to a decrease in other expenses related
      to Laurus convertible debt.





While
      revenues have decreased slightly from fiscal 2007, we experienced the third
      highest revenue in our history for fiscal 2008. We have continued to experience
      significant volatility in our revenues over the past several years. We may
      experience significant losses and our cash and working capital position will
      be
      adversely impacted if our revenues continue to decrease significantly in future
      periods. Our operations historically have been funded through revenues generated
      from operations and from debt and equity financings.





At
      June
      30, 2008 our cash and cash equivalents were approximately $1,196,000, compared
      to approximately $4,220,000 at June 30, 2007. The decrease in our cash primarily
      reflects our on-going monthly payments of principal and accrued interest on
      our
      secured Laurus convertible debt. Cash flow from operations was down
      approximately $1,188,000 from fiscal 2007. We expect improved results and a
      cash
      balance that we believe will fund our current operating needs through fiscal
      2009. The net decrease in our cash and cash equivalents from the prior fiscal
      year is the result of: (a) increases in accounts receivable and other
      receivable, (b) decreases in advances from customers,
      (c) payments on our accrued liabilities, (d) increases in inventory. For
      the fiscal year 2009, we expect improved results and adequate cash
      balance to fund our current operating needs.





-
          25 -




At
      June
      30, 2008, we had approximately $2,146,000 in accounts receivable, compared
      to
      approximately $1,659,000 as of June 30, 2007, reflecting timing of revenues
      billed and collected. Our accounts receivable generally reflect our billings,
      and may include one or several individually large customer receivables from
      time
      to time. We generally have a high collectibility rate on our accounts
      receivable, and our allowance for doubtful trade accounts is approximately
      $29,000, which we believe is reasonable based on our past experience. In fact,
      we did not incur any bad trade debt in the 2008 fiscal year. However, during
      2008 we experienced significant non-trade bad debt where we wrote off $100,000
      related to our loan and
      security agreement with Saigene
      Corporation .
      Saigene
      Corporation filed for Chapter 11 bankruptcy and we deemed that 100% of the
      note
      receivable from Saigene is uncollectible.





Total
      liabilities recorded on our balance sheet as of June 30, 2008 were approximately
      $3,871,000 compared to approximately $5,859,000 as of June 30, 2007. The
      significant decrease in liabilities was the result of a large decrease in our
      overall balance of secured Laurus convertible debt, as well as decreases in
      our
      other notes payable and capital lease obligations. Significant components of
      our
      liabilities include the 2004 and 2005 Notes with Laurus, and, to a lesser
      degree, our prior $350,000 in borrowings in fiscal 2006 under our credit
      facility with Franklin Funding. As required by U.S. generally accepted
      accounting principles, the liability we recorded for the 2004 and 2005 Notes
      reflected a discount from the face value of the secured Laurus convertible
      notes
      by approximately $674,000, related to the valuation of the conversion features
      and the warrants. Those conversion features and warrants are bifurcated from
      the
      convertible notes and reported as derivative liabilities. During the fiscal
      year
      ended June 30, 2008, Laurus did not convert any portion of the principal amount
      due on the 2004 Note. As of June 30, 2008 the remaining principal balance on
      the
      2004 Note was approximately $417,000. This balance was subsequently paid in
      full
      on July 28, 2008. No amounts of the 2005 Note have been converted, and as of
      June 30, 2008 the remaining principal balance on the 2005 Note was $350,000.
      Accordingly, if the discount to face value is disregarded, our total liabilities
      as of June 30, 2008 and June 30, 2007, respectively, would be approximately
      $3,959,000 and $6,620,000.





At
      June
      30, 2008, we had working capital of approximately $331,000, compared to
      approximately $827,000 at June 30, 2007. The approximately $496,000 decrease
      in
      working capital is attributable to several changes in the components of working
      capital. Changes providing negative impact include decreases in cash and
      increases in accounts payable. Changes providing positive impact include
      increases in accounts receivable, inventory and decreases in customer advances,
      capital lease obligations, derivative liability related to the 2004 and 2005
      Notes, and other notes payable. In addition, the 2004 and 2005 Notes are
      classified as short-term liabilities on this basis, which reduces working
      capital.





Net
      cash
      used in operating activities was approximately
      $1,025,000 for the fiscal year ended June 30, 2008. For
      the
      fiscal year ended June 30, 2008, net cash used in operations included the effect
      of approximately $674,000 of accretion of fair value related to the 2004 and
      2005 Notes and approximately $236,000 in depreciation and amortization. Our
      investing activities used approximately $219,000 for the fiscal year ended
      June
      30, 2008 for the acquisition of capital equipment related to our laboratory.
      Cash flows used in financing activities included approximately $1,780,000
      consisting primarily of approximately $1,600,000 in payments on our 2004 and
      2005 Notes with Laurus, $113,000 in payments on note payable with Franklin
      Funding, and payments of approximately $67,000 on capital lease obligations.





As
      described above, we experienced a small decrease in revenue for the year ended
      June 30, 2008, and we incurred a net loss. We have realized a substantial
      decline in our cash and working capital position from operations. However,
      we
      expect these trends will not continue during fiscal 2009, as we will no longer
      have monthly principal payments associated with our Laurus debt due to final
      payment on the 2004 Note in July 2008 and scheduled final payment on the 2005
      Note in January 2009. We are considering new debt financing for fiscal 2009.
      However, the terms of that debt are unknown at this time. In fiscal 2009 we
      will
      continue to actively pursue business development and marketing activities to
      broaden our client and revenue base, and we anticipating make additional
      investments from time to time in our technology infrastructure, operations
      and
      other areas of our business. These efforts will use significant amounts of
      time,
      effort and funding. Our efforts to improve our operations and increase revenue
      may not be successful.





-
          26 -




We
      expect
      that our current cash, current assets and any cash flows from operations will
      be
      sufficient to fund operations through fiscal 2009. (See **** “Note
      8
      to Consolidated Financial Statements” included in this Report). However, any
      decreases in future revenue would adversely affect our financial condition,
      and
      we may need to seek additional capital before fiscal 2010. We may not be able
      to
      raise sufficient financing, whether debt or equity. We have no additional
      amounts available to us under our Franklin Funding credit facility, and we
      do
      not have any other credit facility in place. In addition, until the Laurus
      notes
      are paid in full, based on the terms of the Laurus debt financings, raising
      additional capital may be difficult or highly dilutive to existing stockholders.





**ITEM
              7A**
            **QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK**





Not
      Applicable.





**ITEM
              8**
            **FINANCIAL
                STATEMENTS AND SUPPLEMENTARY
                DATA**





The
      information required by this Item is set forth in our Consolidated Financial
      Statements and Notes thereto beginning at page F-1 of this Annual Report on
      Form
      10-K.





**ITEM
                9**
              **CHANGES
                  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                  DISCLOSURE**





None.





**ITEM 9A(T)**
              **CONTROLS
                  AND PROCEDURES**





**Disclosure
      Control and Procedures**





We
      maintain disclosure controls and procedures designed to ensure that information
      required to be disclosed in our reports filed or submitted under the Securities
      Exchange Act of 1934 is (a) recorded, processed, summarized and reported within
      the time periods specified in the Securities and Exchange Commission’s rules and
      forms and (b) accumulated and communicated to management, including our
      Chief Executive Officer and Vice President of Finance, as appropriate, to allow
      timely decisions regarding required disclosure.





As
      required by Rule 13a-15 under the Exchange Act, As of the end of the period
      covered by this Annual Report on Form 10-K, we carried out an evaluation of
      the effectiveness of the design and operation of our disclosure controls and
      procedures. This evaluation was carried out under the supervision and with
      the
      participation of our management, including our Chief Executive Officer and
      Vice
      President of Finance. Based upon that evaluation, management and our Chief
      Executive Officer and Vice President of Finance concluded that our disclosure
      controls and procedures are effective at June 30, 2008.





A
      control
      system, no matter how well conceived and operated, can provide only reasonable,
      not absolute, assurance that the objectives of the control system are met.
      Because of the inherent limitations in all control systems, no evaluation of
      controls can provide absolute assurance that all control issues, if any, within
      a company have been detected.





There
      has
      been no change in our internal control over financial reporting (as defined
      in
      Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during
      the
      fourth quarter of fiscal 2008 that has materially affected, or is reasonably
      likely to materially affect, our internal control over financial
      reporting.





In
      response to the Sarbanes-Oxley Act of 2002, we are continuing a comprehensive
      review of our disclosure procedures and internal controls and expect to make
      minor modifications and enhancements to these controls and procedures.
      Management continually reviews, modifies and improves its systems of accounting
      and controls in response to changes in business conditions and operations and
      in
      response to recommendations in reports prepared by the independent registered
      public accounting firm and outside consultants.





-
          27 -




**Management’s
      Annual Report on Internal Control Over Financial Reporting**





Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting (as defined in Exchange Act Rule 13a-15(f)).
      Under the supervision and with the participation of our management, including
      our Chief Executive Officer and Vice President of Finance, we conducted an
      evaluation of our internal control over financial reporting as of June 30,
      2008,
      based on the framework in Internal Control Integrated Framework issued by the
      Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based
      on our evaluation under the framework in Internal Control – Integrated
      Framework, management concluded that our internal control over financial
      reporting was effective as of June 30, 2008.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Therefore, even those systems determined to
      be
      effective can provide only reasonable assurance with respect to financial
      statement preparation and presentation.





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
      Securities and Exchange Commission that permit us to provide only management’s
      report in this Annual Report on Form 10-K.





/S/    Ronald
                R. Helm
            
            /S/    John
                P. JensenRonald
                R. Helm
              Chief
                Executive Officer
            
            John
                P. Jensen
              Vice
                President of Finance





THE
      FOREGOING MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING SHALL
      NOT BE DEEMED TO BE “FILED” WITH THE SEC, NOR SHALL SUCH INFORMATION BE
      INCORPORATED BY REFERENCE INTO ANY PAST OR FUTURE FILING UNDER THE SECURITIES
      ACT OR THE EXCHANGE ACT, EXCEPT TO THE EXTENT WE SPECIFICALLY INCORPORATE IT
      BY
      REFERENCE INTO SUCH FILING.





**ITEM
              9B**
            **OTHER
                INFORMATION**





On
      September 24, 2008, we entered into an amendment of our employment agreement
      with Ronald R. Helm, our Chief Executive Officer. Under this amendment, to
      be
      effective October 1, 2008, we (a) extended his employment agreement for an
      additional year, to September 30, 2010, (b) increased his annual base
      salary to $250,000 (from $240,000), and (c) agreed to grant to him 50,000
      shares of restricted common stock and stock options for 150,000 shares of common
      stock on October 1, 2008. The restricted shares vest on the third anniversary
      of
      the grant date and are subject to forfeiture under certain conditions if his
      employment is terminated prior to the vesting date. The stock options vest
      monthly over a period of three years from the grant date, and will have an
      exercise price equal to the closing market price on the grant date.





**PART
      III**





**ITEM
              10**
            **DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE
                GOVERNANCE**





The
      information called for by Part III, Item 10, is included in our proxy
      statement relating to our 2008 annual meeting of stockholders, and is
      incorporated herein by reference to the sections captioned “Directors and
      Executive Officers,” “Section 16(a) Beneficial Ownership Reporting
      Compliance,” “Board Meetings and Committees,” “Audit Committee,” “Policy on
      Stockholder Nomination of Directors” and “Code of Ethics”. The proxy statement
      will be filed within 120 days of June 30, 2008, our fiscal year end.





-
          28 -





**ITEM
              11**
            **EXECUTIVE
                COMPENSATION**





Information
      called for by Part III, Item 11, is included in our proxy statement
      relating to our 2008 annual meeting of stockholders, and is incorporated herein
      by reference to the section captioned “Executive Compensation.” The proxy
      statement will be filed within 120 days of June 30, 2008, our fiscal year
      end.





**ITEM
              12**
            **SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS**





Certain
      information called for by Part III, Item 12, is included in our proxy
      statement relating to our 2008 annual meeting of stockholders, and is
      incorporated herein by reference to the section captioned “Principal
      Stockholders.” The proxy statement will be filed within 120 days of June 30,
      2008, our fiscal year end.





**Equity
      Compensation Plan Information**





The
      following table gives information as of June 30, 2008, regarding our common
      stock that may be issued upon the exercise of options, warrants and other rights
      under our equity compensation plans. See also “Notes 10 and 11 to Consolidated
      Financial Statements” to our Consolidated Financial Statements for the fiscal
      year ended June 30, 2008 included in this report.





**(a)**
            
            **(b)**
            
            **(c)**Plan Category
            
            No. of Shares
              to be Issued
              Upon Exercise of
              Outstanding Options,
              Warrants and Rights
            
            Weighted Average
              Exercise Price of
              Outstanding Options,
              Warrants and Rights
            
            No. of Shares Available
              for Future Issuance,
              excluding securities
              reflected in Column (a)Equity
                Compensation Plans Approved by Stockholders (1)
            
            
            1,351,907
            
            $
            0.79
            
            
            448,093Equity
                Compensation Plans Approved by Stockholders (2)
            
            
            864,397
            
            $
            0.99
            
            
            2,135,603Equity
                Compensation Plans Not Approved by Stockholders
            
            
            4,149,677
            
            $
            1.25
            
            
            -TOTAL
            
            
            6,365,981
            
            $
            1.11
            
            
            2,583,696







(1)
            Consists
                solely of the Pacific Biometrics, Inc. 1996 Stock Incentive
                Plan.


(2)
            Consists
                solely of the Pacific Biometrics, Inc. 2005 Stock Incentive
                Plan.





**ITEM
              13**
            **CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                INDEPENDENCE**





Information
      called for by Part III, Item 13, is included in our proxy statement
      relating to our 2008 annual meeting of stockholders, and is incorporated herein
      by reference to the section captioned “Related-Party Transactions.” The proxy
      statement will be filed within 120 days of June 30, 2008, our fiscal year
      end.





**ITEM
              14**
            **PRINCIPAL
                ACCOUNTANT FEES AND
                SERVICES**





Information
      called for by Part III, Item 14, is included in our proxy statement
      relating to our 2008 annual meeting of stockholders, and is incorporated herein
      by reference to the sections captioned “Policy for Approval of Audit and
      Permitted Non-Audit Services” and “Audit and Related Fees.” The proxy statement
      will be filed within 120 days of June 30, 2008, our fiscal year
      end.





-
          29 -





**PART
      IV**





**ITEM
              15**
            **EXHIBITS
                AND FINANCIAL STATEMENT
                SCHEDULES**





Documents
      filed as part of this Report are as follows:





1.  Financial
      Statements :
      The
      following consolidated financial statements, related notes and report of
      independent registered public accounting firm are incorporated by reference
      into
      Item 8 of Part II of this Annual Report on Form 10-K for the fiscal year
      ended June 30, 2008:





Report
                of Independent Registered Public Accounting Firm
            F-2Consolidated
                Balance Sheets as of June 30, 2008 and 2007
            F-3Consolidated
                Statements of Operations for the Years Ended June 30, 2008 and
                2007
            F-4Consolidated
                Statements of Cash Flows for the years ended June 30, 2008 and
                2007
            F-5Consolidated
                Statement of Stockholders’ Equity for the years ended June 30, 2008 and
                2007
            F-6Notes
                to the Consolidated Financial Statements
            F-7





2.  Financial
      Statement Schedules :
      All
      schedules have been omitted because they are not applicable or not required,
      or
      the required information is included in the financial statements or notes
      thereto. ****





3.  Exhibits.





**Exhibit**
              **No.**
            
            **Description**3.1
            (1)
            Amended
                and Restated Certificate of Incorporation of the Company, as
                amended – includes (a) Amended and Restated Certificate of
                Incorporation dated July 9, 1996, (b) Certificate of Amendment to
                Certificate of Designation for Series A Convertible Preferred Stock,
                dated
                as of August 28, 2002, (c) Certificate of Amendment to Restated
                Certificate of Incorporation, dated February 14, 2003, and
                (d) Certificate of Designation for Series B Convertible Preferred
                Stock, dated as of March 6, 20033.2
            (2)
            Amended
                and Restated By-Laws of the Company4.1
            (2)
            Specimen
                Stock Certificate10.1A
            (3)
            1996
                Stock Incentive Plan, as amended10.1B
            (4)
            Form
                of stock option agreement (for employees and officers) under 1996
                Stock
                Incentive Plan10.1C
            (4)
            Form
                of stock option agreement (for directors) under 1996 Stock Incentive
                Plan10.2A
            (5)
            2005
                Stock Incentive Plan10.2B
            (6)
            Form
                of stock option agreement under 2005 Stock Incentive
                Plan10.2C
            (7)
            Form
                of restricted stock award agreement under 2005 Stock Incentive
                Plan10.3A
            (8)
            Executive
                Employment Agreement, dated June 1, 2006, between Pacific Biometrics,
                Inc.
                and Ronald R. Helm10.3B
            (9)
            First
                Amendment to Executive Employment Agreement, between Pacific Biometrics,
                Inc. and Ronald R. Helm, dated August 30, 200610.3C
            (10)
            Second
                Amendment to Executive Employment Agreement, between Pacific Biometrics,
                Inc. and Ronald R. Helm, dated October 19, 200710.3D
            **
            Third
                Amendment to Executive Employment Agreement, between Pacific Biometrics,
                Inc. and Ronald R. Helm, dated September 24, 200810.4
                ++
            (11)
            Employment
                Agreement, dated October 1, 2004, by and between the Company and
                Dr.
                Elizabeth Leary10.5A
            (12)
            Office
                Lease, dated April 23, 1997, between Tom Kane and Elsa Kane and the
                Company10.5B
            (13)
            First
                Amendment to Office Lease, dated January 20,
                1998




-
          30 -




10.5C
            (13)
            Second
                Amendment to Office Lease, dated April 20, 200710.6
            (14)
            Securities
                Purchase Agreement, dated January 31, 2005 between the Company and
                Laurus
                Master Fund, Ltd.10.7
            (14)
            $1.5
                Million Secured Convertible Term Note, dated January 31, 2005, made
                by the
                Company in favor of Laurus Master Fund, Ltd.10.8
            (15)
            Master
                Security Agreement dated May 28, 2004, among the Company, BioQuant,
                Inc.,
                Pacific Biometrics, Inc., a Washington corporation, PBI Technology,
                Inc.,
                and Laurus Master Fund, Ltd.10.9
            (15)
            Subsidiary
                Guaranty dated May 28, 2004, among Pacific Biometrics, Inc., a Washington
                corporation, BioQuant, Inc., and PBI Technology, Inc.10.10
            (15)
            Stock
                Pledge Agreement dated May 28, 2004, between the Company and Laurus
                Master
                Fund, Ltd.10.11
            (14)
            Amendment
                No. 2, dated January 31, 2005, among the Company, Pacific Biometrics,
                Inc., a Washington corporation, BioQuant, Inc., PBI Technology, Inc.
                and
                Laurus Master Fund, Ltd.10.12
            (16)
            Amendment
                No. 1, dated May 6, 2005, between Pacific Biometrics, Inc. and Laurus
                Master Fund, Ltd.10.13
            (17)
            Omnibus
                Amendment to Laurus Convertible Term Notes, dated May 30,
                200810.14
            (15)
            Common
                Stock Purchase Warrant, dated May 28, 2004, issued by the Company
                in favor
                of Laurus Master Fund, Ltd. for 681,818 shares of common
                stock.10.15
            (14)
            Common
                Stock Purchase Warrant, dated January 31, 2005, issued by the Company
                in
                favor of Laurus Master Fund, Ltd. for 326,087 shares of common
                stock.10.16
            (16)
            Common
                Stock Purchase Warrant, dated May 6, 2005, issued by Pacific Biometrics,
                Inc. in favor of Laurus Master Fund, Ltd. for 1,000,000 shares of
                common
                stock.10.17
            (18)
            Common
                Stock Purchase Warrant issued by the Company in favor of Source Capital
                Group, Inc.10.18
            (19)
            Loan
                and Security Agreement, dated November 3, 2005, between Pacific
                Biometrics, Inc. and Franklin Funding, Inc.10.19
            (20)
            Form
                of Common Stock Purchase Warrant for March 2006 private
                placement14.1
            (4)
            Code
                of Ethics for Financial Officers21.1
            **
            Subsidiaries
                of Pacific Biometrics, Inc.23.1
            **
            Consent
                of PMB Helin Donovan, LLP31.1
            **
            Certification
                by Ronald R. Helm, Chief Executive Officer31.2
            **
            Certification
                by John P. Jensen, Vice President of Finance and
                Controller32.1
            **
            Certification
                by Ronald R. Helm, Chief Executive Officer and John P. Jensen, Vice
                President of Finance and Controller, of Pacific Biometrics, Inc.,
                pursuant
                to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.





**
            Filed
                herewith


++
            Portions
                of the marked exhibit have been omitted pursuant to a request for
                confidential treatment filed with the
                SEC.


(1)
            Incorporated
                by reference to Exhibits of Registrant’s Quarterly Report on Form 10-QSB
                for the quarter ended March 31, 2003, filed on May 15,
                2003.


(2)
            Incorporated
                by reference to Exhibits of Registrant’s Pre-Effective Amendment No. 1 to
                Registration Statement on Form SB-2, Registration No. 333-11551,
                filed on
                October 11, 1996.


(3)
            Incorporated
                by reference to Exhibits of Registrant’s Annual Report on Form 10-KSB for
                the fiscal year ended June 30, 2003, filed on September 29,
                2003.


(4)
            Incorporated
                by reference to Exhibits of Registrant’s Annual Report on Form 10-KSB for
                the fiscal year ended June 30, 2004, filed on September 23,
                2004.


(5)
            Incorporated
                by reference to Appendix A of Registrant’s Definitive Proxy Statement on
                Schedule 14A filed on October 25,
                2005.


(6)
            Incorporated
                by reference to Exhibits of Registrant’s Annual Report on Form 10-KSB for
                the fiscal year ended June 30, 2006, filed on October 3,
                2006.


(7)
            Incorporated
                by reference to Exhibits of Registrant’s Quarterly Report on Form 10-QSB
                for the quarter ended December 31, 2007, filed on February 13,
                2008.


(8)
            Incorporated
                by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
                on June 7, 2005.






-
          31 -




(9)
            Incorporated
                by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
                on September 5, 2006.


(10)
            Incorporated
                by reference to Exhibits of Registrant’s Quarterly Report on Form 10-QSB
                for the quarter ended September 30, 2007, filed on November 14,
                2007.


(11)
            Incorporated
                by reference to Exhibits of Registrant’s Quarterly Report on Form 10-QSB
                for the quarter ended September 30, 2004, filed on November 15,
                2004.


(12)
            Incorporated
                by reference to Exhibits of Registrant’s Annual Report on Form 10-KSB for
                the fiscal year ended June 30, 1997, filed on September 29,
                1997.


(13)
            Incorporated
                by reference to Exhibits of Registrant’s Annual Report on Form 10-KSB for
                the fiscal year ended June 30, 2007, filed on October 5,
                2007.


(14)
            Incorporated
                by reference to Exhibits of Registrant’s Current Report on Form 8-K filed
                on February 1, 2006.


(15)
            Incorporated
                by reference to Exhibits of Registrant’s Current Report on Form 8-K filed
                on June 7, 2004.


(16)
            Incorporated
                by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
                on May 10, 2005.


(17)
            Incorporated
                by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
                on June 5, 2008. (18)Incorporated
                by reference to Exhibits of Registrant’s Registration Statement on Form
                SB-2, Registration No. 333-116968, filed on June 29,
                2004.


(19)
            Incorporated
                by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
                on November 7, 2005.


(20)
            Incorporated
                by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
                on March 13, 2006.


-
          32 -





**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized, on September 26, 2008.





PACIFIC
                BIOMETRICS, INC.By:
            /s/
                Ronald R. HelmRonald
                R. HelmPresident
                and Chief Executive Officer





In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.





***Signature***
            ***Capacities***
            ***Date***/s/
                Ronald R. Helm
            Chief
                Executive Officer, President, and Director
            September
                26,2008Ronald
                R. Helm
            (*Principal
                Executive Officer*)/s/
                John P. Jensen
            Vice
                President of Finance and Controller
            September
                26,2008John
                P. Jensen
            (*Principal
                Financial Officer and*
              *Principal
                Accounting Officer*)/s/
                Terry M. Giles
            Director
            September
                26,2008Terry
                M. Giles/s/
                Paul G. Kanan
            Director
            September
                26,2008Paul
                G. Kanan/s/
                Richard W. Palfreyman
            Director
            September
                26,2008Richard
                W. Palfreyman/s/
                Curtis J. Scheel
            Director
            September
                26,2008Curtis
                J. Scheel/s/
                Kenneth R. Waters
            Director
            September
                26,2008Kenneth
                R. Waters/s/
                Stanley L. Schloz
            Director
            September
                26,2008Stanley L.
                Schloz





-
          33 -


PACIFIC
      BIOMETRICS, INC.





Form
      10-KSB Annual Report





Index
      to
      Consolidated Financial Statements




PageReport
                of Independent Registered Public Accounting Firm
            F-2Consolidated
                Financial Statements:Consolidated
                Balance Sheets as of June 30, 2008 and 2007
            F-3Consolidated
                Statements of Operations for the years ended June 30, 2008 and
                2007
            F-4Consolidated
                Statements of Cash Flows for the years ended June 30, 2008 and
                2007
            F-5Consolidated
                Statement of Stockholders’ Equity for the years ended June 30, 2008 and
                2007
            F-6Notes
                to Consolidated Financial Statements
            F-7




F-1





PMB
      Helin
      Donovan, LLP


Certified
      Public Accountants & Business Consultants





Pacific
      Biometrics, Inc.


Seattle,
      WA





REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





We
      have
      audited the accompanying balance sheets of Pacific Biometrics, Inc. as of June
      30, 2008 and 2007, and the related statements of operations, stockholders'
      equity and cash flows for the years then ended. 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. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of Pacific Biometrics, Inc. as of
      June
      30, 2008 and 2007 and the results of its operations, stockholders' equity and
      its cash flows for the years then ended in conformity with accounting principles
      generally accepted in the United States of America.





/s/
      PMB
      Helin Donovan LLP





PMB
      Helin
      Donovan LLP


Certified
      Public Accountants


San
      Francisco, California


September
      18, 2008


50
      Francisco Street,


Suite
      120
      San Francisco, CA 94133


Phone
      (415) 399-1330- Fax (415) 399-9212- www.pmbhd.com


F-2


**PACIFIC
        BIOMETRICS, INC.**
 **CONSOLIDATED
        BALANCE SHEETS**
 **As
        of June 30,**


**2008**
            
            **2007****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            1,196,310
            
            $
            4,219,926Accounts
                receivable, net
            
            
            2,146,080
            
            
            1,659,483Other
                receivables, net
            
            
            451,291
            
            
            261,753Inventory
            
            
            197,456
            
            
            163,965Prepaid
                expenses and other assets
            
            
            100,869
            
            
            104,825Deferred
                financing cost on secured convertible note - current
                portion
            
            
            18,447
            
            
            107,170Total
                current assets
            
            
            4,110,453
            
            
            6,517,122Property
                and equipment, net
            
            
            884,521
            
            
            835,934Other
                assets:Deferred
                financing cost on secured convertible note - long-term
                portion
            
            
            -
            
            
            18,447Total
                assets
            
            $
            4,994,974
            
            $
            7,371,503**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            818,224
            
            $
            482,058Accrued
                liabilities
            
            
            450,788
            
            
            478,794Advances
                from customers
            
            
            643,291
            
            
            1,093,776Capital
                lease obligation - current portion
            
            
            32,530
            
            
            58,841Secured
                convertible note, net of unaccreted fair value assigned to conversion
                feature and warrants of $214,771 and $761,907,
                respectively
            
            
            678,535
            
            
            1,604,761Embedded
                derivative liability
            
            
            642,470
            
            
            1,047,492Freestanding
                derivative liability
            
            
            411,545
            
            
            811,536Other
                notes payable - current portion
            
            
            102,467
            
            
            113,339Total
                current liabilities
            
            
            3,779,850
            
            
            5,690,597Capital
                lease obligations - long - term portion
            
            
            91,109
            
            
            65,619Other
                notes payable - long - term portion
            
            
            -
            
            
            102,467Total
                liabilities
            
            
            3,870,959
            
            
            5,858,683Commitments
                and contingencies
            
            
            -
            
            
            -Stockholders'
                equity:Preferred
                  stock, Series A convertible $0.01 par value, 5,000,000 shares authorized,
                  0 shares issued and outstanding for 2008 and
                  2007
            
            
            -
            
            
            -Common
                  stock, $0.01 par value, 30,000,000 shares authorized, 19,920,147
                  and
                  18,720,147 shares issued and outstanding,
                  respectively
            
            
            362,803
            
            
            360,803Additional
                paid-in capital
            
            
            28,465,676
            
            
            28,285,052Accumulated
                deficit
            
            
            (27,704,464
            )
            
            (27,133,035
            )Total
                stockholders' equity
            
            
            1,124,015
            
            
            1,512,820Total
                liabilities and stockholders' equity
            
            $
            4,994,974
            
            $
            7,371,503


The
        accompanying notes are an integral part of these consolidated financial
        statements.
  F-3




**PACIFIC
        BIOMETRICS, INC.**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
 **Years
        Ended June 30,**




**2008**
            
            **2007**Revenues
            
            $
            8,265,237
            
            $
            8,480,330Laboratory
                expenses and cost of sales
            
            
            4,841,033
            
            
            5,153,039Gross
                profit
            
            
            3,424,204
            
            
            3,327,291Operating
                expenses:Selling,
                general and administrative
            
            
            3,990,230
            
            
            3,892,054Operating
                loss
            
            
            (566,026
            )
            
            (564,763
            )Other
                income (expense):Interest
                expense
            
            
            (219,890
            )
            
            (376,927
            )Interest
                  expense from accretion of conversion feature and warrants – secured
                  convertible debt
            
            
            (673,772
            )
            
            (886,304
            )Gain
                on adjustment of embedded and freestanding derivatives to fair
                value
            
            
            805,013
            
            
            694,205Amortization
                of deferred financing costs - secured convertible debt
            
            
            (107,170
            )
            
            (107,170
            )Other
                income
            
            
            190,416
            
            
            27,869Total
                other expense
            
            
            (5,403
            )
            
            (648,327
            )Net
                loss before tax expense
            
            
            (571,429
            )
            
            (1,213,090
            )Tax
                expense
            
            
            -
            
            
            -Net
                loss
            
            $
            (571,429
            )
            $
            (1,213,090
            )Net
                loss per share:
            
            $
            (0.03
            )
            $
            (0.06
            )Weighted
                average common shares outstanding, basic and diluted:
            
            
            18,812,306
            
            
            18,720,147




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


F-4




**PACIFIC
        BIOMETRICS, INC.**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **Years
        Ended June 30,**


2008
              
              2007Cash
                  flows from operating activities:Net
                  loss
              
              $
              (571,429
              )
              $
              (1,213,090
              )Reconciliation
                  of net loss to net cash provided by (used in) operating
                  activities:Depreciation
                  and amortization
              
              
              236,004
              
              
              290,222Accretion
                  of fair value assigned to conversion feature and warrants
              
              
              673,772
              
              
              886,303Amortization
                  of deferred financing costs on secured convertible note
              
              
              107,170
              
              
              107,170Bad
                  debt expense
              
              
              100,000
              
              
              23,909Gain
                  from embedded and freestanding derivative liabilities relating
                  to secured
                  convertible note
              
              
              (805,013
              )
              
              (694,205
              )Warrant
                  expense for equipment lease and financing
              
              
              11,820
              
              
              11,820Compensation
                  expense from restricted shares and options
              
              
              170,804
              
              
              560,415Changes
                  in assets and liabilities:Accounts
                  receivable
              
              
              (486,597
              )
              
              294,197Other
                  receivable
              
              
              (289,538
              )
              
              (3,490
              )Inventory
              
              
              (33,491
              )
              
              (163,965
              )Prepaid
                  expenses and other assets
              
              
              3,956
              
              
              25,664Advances
                  from customers
              
              
              (450,485
              )
              
              127,203Accounts
                  payable
              
              
              336,166
              
              
              (67,459
              )Accrued
                  liabilities
              
              
              (28,006
              )
              
              (21,064
              )Net
                  cash provided by (used in) operating activities
              
              
              (1,024,867
              )
              
              163,629Cash
                  flows from investing activities:Purchases
                  of capital equipment
              
              
              (218,924
              )
              
              (127,458
              )Acquisition
                  of Company common stock
              
              
              -
              
              
              (201,544
              )Net
                  cash used in investing activities
              
              
              (218,924
              )
              
              (329,002
              )Cash
                  flows from financing activities:Payments
                  on notes payable
              
              
              (1,713,337
              )
              
              (1,056,414
              )Payments
                  on capital lease obligations
              
              
              (66,488
              )
              
              (56,024
              )Net
                  cash used in financing activities
              
              
              (1,779,825
              )
              
              (1,112,438
              )Net
                  decrease in cash and cash equivalents
              
              
              (3,023,616
              )
              
              (1,277,811
              )Cash
                  and cash equivalents, beginning of period
              
              
              4,219,926
              
              
              5,497,737Cash
                  and cash equivalents, end of period
              
              $
              1,196,310
              
              $
              4,219,926Supplemental
                  Information:Cash
                  paid during the period for interest
              
              $
              235,209
              
              $
              362,797Cash
                  paid during the period for income taxes
              
              $
              -
              
              $
              -Non-cash
                  investing and financing activities:Cashless
                  exercise of stock options and warrants
              
              $
              -
              
              $
              272




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


F-5


**PACIFIC
        BIOMETRICS, INC.**
 **CONSOLIDATED
        STATEMENT OF STOCKHOLDERS’ EQUITY**


Additional
                
                
                
                TotalCommon
                    Stock
                
                Paid-in
                
                Accumulated
                
                Stockholders’Shares
                
                Amount
                
                Capital
                
                Deficit
                
                EquityBalance
                    June 30, 2006
                
                
                18,336,884
                
                $
                355,098
                
                $
                27,920,065
                
                $
                (25,919,941
                )
                $
                2,355,221Cashless
                    exercise of stock options and warrants
                
                
                27,229
                
                
                272
                
                
                (272
                )
                
                -
                
                
                -Warrants
                    issued for equipment financing
                
                
                -
                
                
                -
                
                
                11,820
                
                
                -
                
                
                11,820Restricted
                    shares issued
                
                
                543,234
                
                
                5,433
                
                
                532,369
                
                
                -
                
                
                537,802Stock
                    options issued - compensation
                
                
                -
                
                
                -
                
                
                22,615
                
                
                -
                
                
                22,615Common
                    stock purchased
                
                
                (187,200
                )
                
                -
                
                
                (201,544
                )
                
                -
                
                
                (201,544
                )Net
                    loss for year ended June 30, 2007
                
                
                -
                
                
                -
                
                
                -
                
                
                (1,213,090
                )
                
                (1,213,090
                )Balance
                    June 30, 2007
                
                
                18,720,147
                
                
                360,803
                
                
                28,285,052
                
                
                (27,133,035
                )
                
                1,512,820Warrants
                    issued for equipment financing
                
                
                -
                
                
                -
                
                
                11,820
                
                
                -
                
                
                11,820Restricted
                    shares issued - compensation
                
                
                200,000
                
                
                2,000
                
                
                144,000
                
                
                -
                
                
                146,000Stock
                    options issued - compensation
                
                
                -
                
                
                -
                
                
                24,804
                
                
                -
                
                
                24,804Net
                    loss for year ended June 30, 2008
                
                
                -
                
                
                -
                
                
                -
                
                
                (571,429
                )
                
                (571,429
                )Balance
                    June 30, 2008
                
                
                18,920,147
                
                
                362,803
                
                $
                28,465,676
                
                $
                (27,704,464
                )
                $
                1,124,015




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


F-6




**PACIFIC
      BIOMETRICS, INC.**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**1.
      Organization and Basis of Presentation**





Pacific
      Biometrics, Inc., a Delaware corporation (“PBI” or the “Company”), provides
      specialty reference laboratory services to the pharmaceutical and diagnostics
      industries. The Company was incorporated in Delaware in May 1996. The Company
      conducts its business primarily through its wholly-owned subsidiary, Pacific
      Biometrics, Inc., a Washington corporation. The Company’s three other
      wholly-owned subsidiaries are PBI Technology, Inc., a Washington corporation,
      BioQuant, Inc., a Michigan corporation, and Pacific Biomarkers, Inc., a
      Washington corporation. All material intercompany balances and transactions
      have
      been eliminated in the accompanying consolidated unaudited interim financial
      statements. All references in this report to “we,” “our,” “us” or similar
      expressions are to the Company and its wholly-owned subsidiaries.





**2.
      Summary of Significant Accounting Policies**





*Principles
      of Consolidation*





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





*Cash
      and Cash Equivalents*





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





*Accounts
      Receivable*





Trade
      accounts receivable are stated at amounts billed to and due from clients, net
      of
      an allowance for doubtful accounts. Credit is extended based on evaluation
      of a
      client’s financial condition, and collateral is not required. In determining the
      adequacy of the allowance, management identifies specific receivables for which
      collection is not certain and estimates the potentially uncollectible amount
      based on the most recently available information. We write off accounts
      receivable when they are determined to be uncollectible, and payments
      subsequently received on such receivables are credited to the allowance for
      doubtful accounts. At June 30, 2008, we deemed no additional accounts receivable
      uncollectible.





Other
      accounts receivable consist of non-trade receivables such as state business
      and
      occupation tax refunds, notes receivable and employee accounts receivable.
      These
      receivables are stated at amounts per invoice or agreement and due from other
      parties net of an allowance for doubtful accounts. Credit is extended based
      on
      evaluation of the parties financial condition, and collateral may be required.
      In determining the adequacy of the allowance, management identifies specific
      receivables for which collection is not certain and estimates the potentially
      uncollectible amount based on the most recently available information. We write
      off accounts receivable when they are determined to be uncollectible, and
      payments subsequently received on such receivables are credited to the allowance
      for doubtful accounts. ** At June
      30, 2008, management deemed no additional other receivable accounts
      uncollectible, but nevertheless continued an allowance for the entire receivable
      from Saigene Corporation that was deemed uncollectible at December 31, 2007
      due
      to their bankruptcy filing late in 2007.





The
      balance of the bad debt allowance was approximately $129,000 and $29,000 for
      the
      fiscal years ended June 30, 2008 and June 30, 2007, respectively.





*Inventory*





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





F-7




*Long
      –Lived Assets*





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





In
      accordance with the Financial Accounting Standards Board’s Statements of
      Financial Accounting Standards Statement No. 144 – “ *Accounting
      for the Impairment or Disposal of Long-Lived Assets” (“SFAS
      144”),* all of
      our long-lived assets are reviewed for impairment whenever events or changes
      in
      circumstances indicate the carrying amount may not be recovered. If the sum
      of
      the expected future cash flows is less than the carrying amount of the asset,
      a
      loss is recognized.





*Client
      Advances*





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




*Income
      Taxes*





We
      recognize deferred tax assets and liabilities based on differences between
      the
      financial reporting and tax bases of assets and liabilities using the enacted
      tax laws and rates that are expected to be in effect when the differences are
      expected to be recovered. We provide a valuation allowance for deferred tax
      assets due to the uncertainty of realization. We follow SFAS 109, as amended,
      to
      prepare our income tax reporting.




*Financial
      Instruments*





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





*Financial
      Derivatives – Embedded Features*





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





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





F-8




*Common
      Stock Purchase Warrants and Other Derivative Financial
      Instruments*





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


(physical
      settlement or net-share settlement).





*Deferred
      Debt Issue Cost*





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





For
      the
      year ended June 30, 2008 and the year ended June 30, 2007, the estimated fair
      value of the Company's deferred debt issue cost was $18,447 and $107,170,
      respectively.





*Stock-Based
      Compensation*





Effective
      January 1, 2006, we adopted the provisions of SFAS No. 123(R), “ *Share-Based
      Payment”,* using
      the
      modified prospective transition method. SFAS No. 123(R) requires companies
      to
      estimate the fair value of equity-based payment awards on the date of grant
      using an option-priced model. The value of the portion of the award that is
      ultimately expected to vest is recognized as an expense over the requisite
      service periods in our consolidated income statements.





We
      use
      the Black-Scholes option-pricing model to estimate the calculated value of
      our
      share-based payments. Stock options are valued as of the date of grant. The
      volatility assumption used in the Black-Scholes formula is based on the
      volatility of our common stock. The following assumptions were used to compute
      the fair value of option grants for the fiscal year ended June 30:




2008
            
            2007Expected
                volatility
            
            
            105
            %
            
            105
            %Expected
                dividend yield
            
            
            0
            %
            
            0
            %Risk-free
                interest rate
            
            
            4
            %
            
            5
            %Expected
                life
            
            
            10
                year
            s
            
            10
                year
            s





We
      did
      not grant any incentive-based stock options for the year ended June 30, 2008
      compared to 130,245 incentive-based stock options granted for the fiscal year
      ended June 30, 2007. We issued 200,000 incentive-based restricted shares for
      the
      fiscal year ended June 30, 2008, compared to 543,234 incentive-based restricted
      shares issued in the fiscal year ended June 30, 2007.





*Revenue
      Recognition*





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





F-9




*Net
      Loss Per Share*





Basic
      earnings (loss) per share is based upon the weighted average number of
      outstanding common shares. Diluted earnings per share is computed on the basis
      of the weighted average number of common shares outstanding plus the effect
      of
      outstanding stock options and warrants using the “treasury stock” method and the
      effect of preferred stock on an as-converted basis. All per share calculations
      exclude treasury shares.





The
      net
      income / (loss) per common share for the year ended June 30, 2008 and 2007
      is
      based on the weighted average number of shares of common stock outstanding
      during the periods. Potentially dilutive securities include options and
      warrants; however, such securities have not been included in the calculation
      of
      the net loss per common share as their effect is anti-dilutive.





The
      following table is a reconciliation of the numerator (net loss) and the
      denominator (number of shares) used in the basic and diluted EPS calculations
      and sets forth potential shares of common stock that are not included in
      the


diluted
      net loss per share calculation as the effect is antidilutive:





YEAR ENDED
              June 30,
              2007
            
            YEAR ENDED
              June 30,
              2006Numerator
                - basic and dilutedNet
                loss
            
            $
            (571,429
            )
            $
            (1,213,090
            )Denominator
                - basic or dilutedWeighted
                  average common shares outstanding
            
            
            18,812,306
            
            
            18,720,147Net
                loss per share - basic and diluted
            
            $
            (0.03
            )
            $
            (0.06
            )




*Preferred
      and Common Stock*





Our
      common stock currently is quoted on the OTC Bulletin Board under the symbol
      “PBME”.





*Comprehensive
      Income*





We
      have
      adopted Statement of Financial Accounting Standards No. 130, "Reporting
      Comprehensive Income," which establishes standards for reporting comprehensive
      income and its components in the financial statements. Comprehensive income
      consists of net income and other gains and losses affecting shareholders' equity
      that, under generally accepted accounting principles are excluded from net
      income. For the year ended June 30, 2008 and 2007, the Company's comprehensive
      income (loss) had equaled its net loss. Accordingly, a statement of
      comprehensive loss is not presented.





*Use
      of Estimates*





In
      preparing financial statements in conformity with accounting principles
      generally accepted in the United States of America (“U.S. GAAP”), management is
      required to make estimates and assumptions that affect the reported amounts
      of
      assets and liabilities, the disclosure of contingent assets and liabilities
      at
      the date of the financial statements, and the reported amounts of revenues
      and
      expenses during the reporting period. Actual results could differ from those
      estimates.


F-10





*New
      Accounting Pronouncements*




In
      May
      2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee
      Insurance Contracts - an interpretation of FASB Statement No. 60" ("SFAS 163").
      SFAS 163 requires that an insurance enterprise recognize a claim liability
      prior
      to an event of default (insured event) when there is evidence that credit
      deterioration has occurred in an insured financial obligation. This Statement
      also clarifies how Statement 60 applies to financial guarantee insurance
      contracts, including the recognition and measurement to be used to account
      for
      premium revenue and claim liabilities. Those clarifications will increase
      comparability in financial reporting of financial guarantee insurance contracts
      by insurance enterprises. This Statement requires expanded disclosures about
      financial guarantee insurance contracts. The accounting and disclosure
      requirements of the Statement will improve the quality of information provided
      to users of financial statements. SFAS 163 will be effective for financial
      statements issued for fiscal years beginning after December 15, 2008. We do
      not
      expect the adoption of SFAS 163 will have a material impact on our financial
      condition or results of operation.




In
      May
      2008, the FASB also issued SFAS No. 162, "The Hierarchy of Generally Accepted
      Accounting Principles" ("SFAS 162"). This Statement identifies the sources
      of
      accounting principles and the framework for selecting the principles to be
      used
      in the preparation of financial statements of nongovernmental entities that
      are
      presented in conformity with generally accepted accounting principles (GAAP)
      in
      the United States (the GAAP hierarchy). SFAS 162 is effective 60 days following
      the SEC's approval of the Public Company Accounting Oversight Board amendments
      to remove the GAAP hierarchy from the auditing standards. We do not expect
      the
      adoption of SFAS 162 will have a material impact on our financial condition
      or
      results of operation.




In
      March
      2008, the FASB released Statement of Financial Accounting Standards No. 161,
      "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS 161").
      SFAS 161 requires qualitative disclosures about objectives and strategies for
      using derivatives, quantitative disclosures about fair value amounts of gains
      and losses on derivative instruments and disclosures about credit-risk-related
      contingent features in derivative agreements. The application of SFAS 161 is
      required for fiscal years beginning after November 15, 2008 and interim periods
      within those fiscal years. We are currently reviewing the implications of SFAS
      161and its impact on the financial statements and the accompanying notes has
      not
      yet been determined.




In
      December 2007, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 160, "Noncontrolling Interests in
      Consolidated Financial Statements" ("SFAS 160"), an amendment of ARB No. 51.
      SFAS 160 was issued to establish accounting and reporting standards for the
      noncontrolling interest in a subsidiary (formerly called minority interests)
      and
      for the deconsolidation of a subsidiary. It clarifies that a noncontrolling
      interest in a subsidiary is an ownership interest in the consolidated entity
      that should be reported as equity in the consolidated financial
      statements.  This
      Statement changes the way the consolidated income statement is presented by
      requiring net income to be reported at amounts that include the amounts
      attributable to both the parent and the noncontrolling interest and to disclose
      those amounts on the face of the income statement. SFAS 160 applies
      prospectively for
      fiscal years and interim periods beginning on
      or
      after December 15, 2008 ,
      except
      for the presentation and disclosure requirements . The
      presentation and discloser requirements shall be applied retrospectively for
      all
      periods presented. We do not expect the adoption of SFAS No. 160 will have
      a
      material impact on our financial condition or results of
      operation.




In
      December 2007, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141(R)").
      SFAS 141(R) establishes
      principles and requirements for the reporting entity in a business combination,
      including recognition and measurement in the financial statements of the
      identifiable assets acquired, the liabilities assumed, and any noncontrolling
      interest in the acquiree. This Statement also establishes disclosure
      requirements to enable financial statement users to evaluate the nature and
      financial effects of the business combination .
      SFAS
      141(R) applies prospectively to business combinations for which the acquisition
      date is on or after the beginning of the first annual reporting period beginning
      on or after December 15, 2008. We do not expect the adoption of SFAS No. 141(R)
      will have a material impact on our financial condition or results of
      operation.


F-11




**3.**  **Concentration
      of Credit Risk**





Our
      largest client in fiscal 2008 individually accounted for approximately 14%
      of
      our total revenues, while our largest client in fiscal 2007 accounted for
      approximately 17% of our total revenues. As of June 30, 2008 and 2007,
      respectively, approximately 33% and 37% of our accounts receivable balance
      were
      from the two largest clients at that time. Component clients included in the
      largest client calculation may vary from period to period.





Our
      clients are primarily pharmaceutical companies, many of which are on the list
      of
      Fortune 1000 companies. The revenues from several pharmaceutical company
      divisions are aggregated as a single client for our revenue calculations. Thirty
      nine percent of our revenue was derived from Fortune 1000 clients for the year
      ended June 30, 2008. We believe that our exposure to concentration of credit
      risk is very low considering the financial strength of our clients.





We
      maintain cash in three insured commercial accounts and one uninsured investment
      account at major financial institutions. Although the financial institutions
      are
      considered creditworthy and have not experienced any losses on client deposits,
      our cash balance exceeded Federal Deposit Insurance Corporation (FDIC) limits
      by
      $896,310 at June 30, 2008 and by $3,919,926 at June 30, 2007.





**4.**  **Prepaid
      Expenses and Other Assets**





Prepaid
      expenses consisted of the following at June 30:





2008
            
            2007Laboratory
                Information System Software
            
            $
            6,995
            
            $
            -Debt
                Financing Broker Fee
            
            
            25,000
            
            
            -Insurance
            
            
            9,747
            
            
            30,120Property
                Taxes
            
            
            -
            
            
            13,795Service
                Contracts
            
            
            31,198
            
            
            37,543Trade
                Show and Conference Fees
            
            
            10,975
            
            
            12,813Security
                and Lease Deposits
            
            
            3,415
            
            
            -Other
            
            
            13,539
            
            
            10,554$
            100,869
            
            $
            104.825





**5.**  **Property
      and Equipment**





Property
      and equipment consisted of the following at June 30:





2008
            
            2007Laboratory
                equipment
            
            $
            1,361,980
            
            $
            1,099,878Computer
                equipment
            
            
            388,062
            
            
            368,258Internal
                use software
            
            
            233,477
            
            
            233,417Office
                furniture and equipment
            
            
            211,857
            
            
            209,232Leasehold
                improvements
            
            
            238,262
            
            
            238,262Total
                property and equipment
            
            
            2,433,638
            
            
            2,149,047Less:
                accumulated depreciation and amortization
            
            
            1,549,117
            
            
            1,313,113Net
                property and equipment
            
            $
            884,521
            
            $
            835,934





At
      June
      30, 2008 and 2007, respectively, these amounts included assets under capital
      leases of $500,987 and $434,056, and related accumulated amortization of
      $387,695 and $337,265. Depreciation expense for the fiscal years ended June
      30,
      2008 and 2007 was $236,004 and $290,222, respectively.


F-12





**6.
      Accrued Liabilities**





Accrued
      liabilities consisted of the following at June 30:




2008
            
            2007Accrued
                Laurus note costs due to third party
            
            $
            33,756
            
            $
            131,592Accrued
                payroll and related payroll taxes
            
            
            158,120
            
            
            135,304Accrued
                vacation
            
            
            76,965
            
            
            64,649Accrued
                audit fees
            
            
            46,677
            
            
            46,677Accrued
                interest expense
            
            
            5,717
            
            
            18,500Accrued
                401(k)
            
            
            1,652
            
            
            2,550Accrued
                board of directors fees
            
            
            18,750
            
            
            18,750Accrued
                fees due to PBRF
            
            
            7,835
            
            
            7,835Other
            
            
            27,853
            
            
            52,937$
            377,325
            
            $
            478,794





**7.
      Capital Lease Obligations**





We
      lease
      laboratory and other equipment under capital lease arrangements. The obligations
      under capital leases have interest rates ranging from approximately 6.5% to
      17.64% and mature at various dates through 2009. Annual future minimum lease
      payments for years subsequent to June 30, 2008 are as follows:





2009
            
            $
            42,5742010
            
            
            35,4842011
            
            
            35,4842012
            
            
            31,0712013
            
            
            4,458Total
                minimum payments
            
            
            149,071Less:
                amount representing interest
            
            
            (25,432
            )Obligations
                under capital leases
            
            $
            123,639Total
                minimum payments
            
            $
            123,639Less:
                current portion
            
            
            32,530Long-term
                portion
            
            $
            91,109





**8.
      Notes Payable**





*Laurus
      Debt*





Effective
      May 28, 2004 and January 31, 2005, we entered into financing arrangements with
      Laurus Master Fund, Ltd., a New York City based investment fund (“Laurus”).
      These financing arrangements consisted of secured convertible notes (“Notes”) of
      $2.5 million and $1.5 million each with a term of three years. In connection
      with both Notes, we also issued Laurus a warrants to purchase up to 681,818
      shares of common stock at an exercise price of $1.25, exercisable at any time
      prior to May 28, 2011 and to purchase up to 326,087 shares of common stock
      at an
      exercise price of $1.37, exercisable at any time prior to January 31, 2012.
      The
      Notes bear interest at an initial rate equal to the prime rate plus two percent
      (2%), subject to reduction on a month-to-month basis if certain specified
      conditions are met. The interest rate for both Notes was equal to 7% and 10.25%
      for the fiscal years ended June 30, 2008 and 2007, respectively.





Under
      the
      original terms of the note, we were obligated to make monthly payments of
      accrued interest beginning July 1, 2004 (May 2004 Note) and March 1, 2005
      (January 2005 Note), commencing December 1, 2004, begin to make monthly payments
      of $85,000 to reduce the principal amount by $83,333 (May 2004 Note) and,
      commencing August 1, 2005, monthly payments of $51,000 to reduce the principal
      amount by $50,000 (January 2005 Note).





In
      addition, we can prepay either note at any time upon payment of an amount equal
      to 107.5% of the then-outstanding principal balance, plus accrued and unpaid
      interest.


F-13





The
      initial conversion prices for the Notes ($1.06 and $1.17 per share) are subject
      to certain anti-dilution adjustments, including full ratchet anti-dilution,
      if
      we issue convertible or equity securities at a price per share less than the
      conversion price. As security for the obligations to Laurus, we and each of
      our
      subsidiaries granted a blanket security interest in all of their respective
      assets to Laurus, and we entered into a stock pledge with Laurus for the capital
      stock in each of its subsidiaries. We were obligated to register with the SEC
      for resale the shares of common stock that are issuable upon conversion of
      the
      note and upon exercise of the warrant. The registration, deemed effective by
      the
      SEC on September 28, 2004, we maintained the effectiveness of the registration
      statement as required, which expired January 31, 2008.





Laurus,
      for each monthly payment under either Note, will be obligated to convert a
      portion of the monthly payment into common stock at the applicable conversion
      price, if certain specified conditions are met. As of June 30, 2008, Laurus
      had
      converted $710,200 in principal into 670,000 shares of our common stock.





In
      conjunction with the financing, we incurred and recorded fees of $293,500 as
      deferred financing costs, which are being amortized to other expense over the
      life of the note. This amount includes a potential payment to our broker of
      up
      to $100,000 should Laurus convert all or a portion of the 2004 Note. At June
      30,
      2008, the unamortized balance of the deferred financing costs was approximately
      $18,000.





As
      of May
      2004, we also recorded discounts to the secured convertible note in the amount
      of $683,962 and $573,266, respectively, representing the value of the conversion
      feature and value allocated to the warrant to purchase 681,818 shares. As of
      May
      6, 2005, we modified the discount balance of the loan to account for the
      warrants issued as of January 31, 2005 for the postponement of principal
      payments due and for the warrants issued as of May 6, 2005 as consideration
      for
      the deferral and extension of the 2004 Note.




Upon
      conversion of any amounts owing under the note, we are obligated to issue
      warrants for up to a maximum of 181,818 shares of common stock to its broker,
      in
      the amount of 8% of amounts converted, at an exercise price of $1.25 per share,
      exercisable for five years.





*Laurus
      Waiver — May 2004 $2.5 million Secured Convertible Note*





On
      January 31, 2005, Laurus formally agreed that we would not be required to pay
      the principal portion of any monthly amount due for the six-month period from
      December 2004 through May 2005, and instead such deferred principal amounts
      would be due on May 1, 2007, the maturity date of the 2004 Note. In
      consideration for the principal payment deferral and the waiver, we issued
      a
      warrant to Laurus to purchase up to 200,000 shares of our common stock at an
      exercise price of $1.48. The warrant expires on January 31, 2010. The cost
      to us
      associated with the issuance of this warrant was attributed to the discount
      balance on the May 2004 Note.





In
      accounting for the issuance of the new warrants, we recorded discounts to the
      secured convertible note; representing the value of the conversion feature
      of
      $1,084,906, the value allocated to the warrant to purchase 681,818 shares issued
      on May 28, 2004 of $452,076, the value allocated to the warrant to purchase
      200,000 shares issued on January 31, 2005 of $120,445, and the value allocated
      to the warrant to purchase 625,000 shares issued on May 6, 2005 of $383,013.
      The
      warrant to purchase 625,000 shares represents the pro-rata share of the May
      2004
      Note related to the warrant to purchase a total of 1,000,000 shares issued
      on
      May 6, 2005, with the balance allocated to the January 2005 Note.




*Laurus
      Deferral and Extension — May 2004 $2.5 million and January 2005 $1.5 million
      Secured Convertible Notes*





On
      May 6,
      2005, Laurus and the Company amended the terms of the 2004 Note and the 2005
      Note, to provide for a twelve-month deferral and extension of both. With respect
      to 2004 Note, Laurus agreed to (a) extend the term for an additional year,
      to be due in full on May 28, 2008, and (b) defer 12 months of principal
      payments (originally due June 1, 2005 through May 1, 2006) to be paid monthly
      beginning June 1, 2007 through May 1, 2008. With respect to the 2005 Note,
      Laurus agreed to (a) extend the term for an additional year, to be due in
      full on January 31, 2009, and (b) defer 12 months of principal payments
      (originally due August 1, 2005 through July 1, 2006) to be paid monthly
      beginning February 1, 2008 through January 1, 2009.


F-14





As
      a
      result of these amendments, the first repayments of principal owed to Laurus
      on
      the 2004 and 2005 Notes became due on June 1, 2006 and August 1, 2006,
      respectively, and the maturity dates for the 2004 and 2005 Notes are now July
      28, 2008 and January 1, 2009, respectively. There was no change in the interest
      rate charged by Laurus on the unpaid principal. Furthermore, commencing as
      of
      May 31, 2005 we adjusted the amortization schedules for the 2004 Note and 2005
      Note related to the conversion feature, stock purchase warrants and deferred
      finance costs.





In
      consideration for the principal payment deferral and the extension of the 2004
      and 2005 Notes, we issued an additional common stock purchase warrant to Laurus
      to purchase up to 1,000,000 shares of our common stock at an exercise price
      of
      $1.05. The warrant expires on May 6, 2010. The cost to us associated with the
      issuance of this warrant was attributed to the discount balances of the May
      2004
      and January 2005 Notes based on the pro-rata amounts of the respective Notes.





Through June
      30,
      2008, the remaining principal balance on the 2004 Note is $416,669, net of
      conversions and principal payments. There have been no conversions of principal
      on the 2005 Note, leaving a remaining principal balance of $350,000, net of
      principal payments.





*Loan
      and Security Agreement with Franklin Funding*





On
      November 3, 2005, we entered into a loan and security agreement with Franklin
      Funding, Inc., providing for a non-revolving line of credit of up to $500,000
      for equipment financing collateralized by the equipment. In connection with
      the
      loan and security agreement, we agreed to grant to Franklin Funding stock
      purchase warrants to purchase up to 50,000 shares of our common stock, in
      increments of 5,000 shares, for each $50,000 borrowed, each with an exercise
      price determined as of the respective date of borrowing and expiration date
      of
      10 years. Through June 30, 2006, we have borrowed a total of $350,000 under
      this
      equipment line of credit and issued to Franklin Funding warrants to purchase
      35,000 shares, at an exercise price of $1.17 per share. The loan and security
      agreement provided that a maximum of $500,000 was available for borrowing until
      May 3, 2006, consequently no further borrowings may be made under the loan
      and
      security agreement. We recognized expenses related to the grant of the warrants
      in the fiscal years ended June 30, 2008 and June 30, 2007 of approximately
      $11,820 and $11,820, respectively.


F-15





*Summary
      of Laurus and Franklin Funding Notes Payable*





We
      had
      the following other notes payable as of June 30:


2008
            
            2007May
                2004 Secured Convertible Note Payable:Secured
                convertible note to Laurus, secured by all assets, interest at prime
                plus
                2% (subject to reduction upon specified conditions), monthly payments
                of
                $83,333 plus interest beginning May 1, 2006, due May 1,
                2008
            
            $
            2,500,000
            
            $
            2,500,000Less:
                Principal amount converted into common stock
            
            
            (710,200
            )
            
            (710,200
            )Less:
                Principal payments
            
            
            (1,373,132
            )
            
            (373,133
            )Less:
                Fair value of conversion feature and warrants
            
            
            (32,949
            )
            
            (514,641
            )383,719
            
            
            902,026Less:
                Current Portion
            
            
            (383,719
            )
            
            (902,026
            )Long-Term
                Portion
            
            **$**
            **-**
            
            $
            -January
                2005 Secured Convertible Note Payable:Secured
                convertible note to Laurus, secured by all assets, interest at prime
                plus
                2% (subject to reduction upon specified conditions), monthly payments
                of
                $50,000 plus interest beginning August 1, 2006, due February 1,
                2009
            
            $
            1,500,000
            
            $
            1,500,000Less:
                Principal payments
            
            
            (1,150,000
            )
            
            (550,000
            )Less:
                Fair value of conversion feature and warrants
            
            
            (55,185
            )
            
            (247,265
            )294,815
            
            
            702,735Less:
                Current Portion
            
            
            (294,815
            )
            
            (702,735
            )Long-Term
                Portion
            
            **$**
            **-**
            
            $
            -Other
                Notes Payable:Loan
                and security agreement, secured by specific equipment, 17.64% interest,
                monthly payments of $11,878, balloon payment of $46,864 due November
                2008,
                principal balance only
            
            
            96,492
            
            
            210,953Principal
                balance plus interest
            
            
            102,467
            
            
            244,765Less:
                Current Portion
            
            
            (102,467
            )
            
            (141,533
            )Long-Term
                Portion
            
            $
            -
            
            $
            102,232





Aggregate
      maturities of notes payable (at face value, gross of the unaccreted fair value
      assigned to conversion, other features and warrants related to the secured
      convertible note financing with Laurus) were approximately $766,669 as of June
      30, 2008.





F-16


**9.
      Income Taxes**





The
      income tax expense reconciled to the tax expense computed at the statutory
      rate
      was approximately as follows during the years ended June 30:





2008
            
            2007Tax
                benefit computed at federal statutory rate
            
            $
            (194,000
            )
            $
            (372,000
            )Permanent
                differences
            
            
            63,000
            
            
            74,000Valuation
                allowance (tax benefit of recognizing prior year net operating loss
                carryforward)
            
            $
            131,000
            
            $
            298,000$
            -
            
            $
            -





Deferred
      income taxes reflect the net tax effects of temporary differences between the
      carrying amounts of assets and liabilities for financial reporting purposes
      and
      the amounts used for income tax purposes. Significant components of the
      Company’s net deferred tax assets are approximately as follows at June
      30:





2008
            
            2007Net
                deferred tax asset:Net
                operating loss carryforward
            
            $
            5,239,000
            
            $
            5,154,000Research
                and experimentation credit
            
            
            326,000
            
            
            326,000Impairment
                of technology assets
            
            
            -
            
            
            -Effect
                of stock option variable pricing
            
            
            297,000
            
            
            239,000Accrued
                liabilities
            
            
            17,000
            
            
            14,000Allowance
                for bad debts
            
            
            44,000
            
            
            10,000Depreciation
                and amortization
            
            
            12,000
            
            
            61,0005,935,000
            
            
            5,804,000Less
                valuation allowance
            
            
            (5,935,000
            )
            
            (5,804,000
            )$
            -
            
            $
            -





Utilization
      of the net operating losses and credits may be subject to a substantial annual
      limitation due to the “change in ownership” provision of the Internal Revenue
      Code of 1986, as amended, and similar state provisions.  The annual
      limitation may result in the expiration of net operating losses and credits
      before utilization Reconciliation
      of the statutory federal income tax to the Company’s effective tax rate is as
      follows:





June
                30, 2008
            
            June
                30, 2007Statutory
                regular federal income benefit rate
            
            
            34.0
            %
            
            34.0
            %Other
            
            
            (11.0
            )%
            
            (7.0
            )%Change
                in valuation allowance
            
            
            (23.0
            )%
            
            (27.0
            )%Total
            
            
            00.0
            %
            
            00.0
            %





At
      June
      30, 2008, operating loss carryforwards of approximately $15 million expiring
      through 2028 are available to offset future taxable income. For financial
      reporting purposes, a valuation allowance of approximately $5,935,000 has been
      recognized to offset the deferred tax asset due to the uncertainty of future
      utilization of net operating loss carryforwards and realization of other
      deferred tax assets. For the fiscal year ended June 30, 2008, the valuation
      allowance was increased by approximately $131,000, year. For the fiscal year
      ended June 30, 2007, the valuation allowance was increased by approximately
      $298,000, respectively.


F-17





**10.
      Stock Option Plan**





*1996
      Stock Incentive Plan*





The
      Company’s 1996 Stock Incentive Plan (the “1996 Plan”) provided for the issuance
      of up to 1,800,000 shares of common stock under this Plan. Options granted
      under
      the 1996 Plan may be either incentive stock options within the meaning of
      Section 422(b) of the Internal Revenue Code, or nonqualified options. We may
      also award stock appreciation rights, restricted stock, performance shares,
      loans or tax offset payments. The option price of each incentive stock option
      granted shall not be less than the fair value of the underlying common stock,
      and will expire no later than ten years following the date of grant. With
      respect to nonqualified options, the exercise price and term will be determined
      at the discretion of the Board. However, the exercise price will not be less
      than 85% of the fair value of the underlying stock, and the term will not exceed
      a period of ten years. The options generally vest over a range of immediately
      to
      five years. The Company’s 1996 Stock Incentive Plan expired during fiscal
      2007.





*2005
      Stock Incentive Plan*





The
      Company has a Stock Incentive Plan (the “2005 Plan”) with 3,000,000 shares of
      common stock reserved for issuance under this Plan. Options granted under the
      Plan may be either incentive stock options within the meaning of Section 422(b)
      of the Internal Revenue Code, or nonqualified options. We may also award
      stock appreciation rights, restricted stock, performance shares, loans or tax
      offset payments. The option price of each incentive stock option granted
      shall not be less than the fair market value of the underlying common stock
      on
      the grant date, and will expire no later than ten years following the date
      of
      grant. With respect to nonqualified options, the exercise price and term
      shall be determined at the discretion of the Board. However, the exercise price
      shall not be less than the fair market value of the underlying common stock
      on
      the grant date, and the term will not exceed a period of ten years.  The
      options generally vest over a range of immediately to three years. As of June
      30, 2008, 2,135,603 shares of common stock remained available for future grant
      under the 2005 Plan.





The
      following is a summary of the activity in the 1996 and 2005 Plans for the years
      ended June 30, 2008 and 2007:





Shares Under OptionNumber
              Of
              Shares
            
            Weighted
              Average
              Exercise Price
              per share
            
            Weighted
              Average
              Fair Value of
              Options
              GrantedOptions
                outstanding at June 30, 2006
            
            
            1,493,207
            
            $
            0.821996
                and 2005 Plan OptionsGranted            (1996
                Plan)
            
            
            25,000
            
            $
            1.15
            
            $
            1.15Granted
            
            
            130,245
            
            
            0.99
            
            
            0.99Exercised
            
            
            0.00
            
            
            0.00Terminated      (1996
                Plan)
            
            
            (164,300
            )
            
            1.03Options
                outstanding at June 30, 2007
            
            
            1,484,152
            
            $
            0.812005
                Plan Restricted SharesGranted
            
            
            543,234
            
            
            0.99
            
            
            0.99Options
                and Restricted Shares outstanding at June 30, 2007
            
            
            2,027,386
            
            $
            0.862005
                Plan OptionsGranted
            
            
            0.00Exercised
            
            
            0.00Terminated
            
            
            (11,082
            )
            
            0.99Options
                outstanding at June 30, 2008
            
            
            1,473,070
            
            $
            0.812005
                Plan Restricted SharesGranted
            
            
            200,000
            
            
            0.71
            
            
            0.71Options
                and Restricted Shares outstanding at June 30, 2008
            
            
            2,216,304
            
            $
            0.76




F-18





The
      weighted average contractual life remaining of options outstanding at June
      30,
      2008 is approximately 5.8 years.





As
      of
      June 30, 2008, outstanding options had exercise periods which expired over
      the
      following time periods:





Exercise Price
            
            Number Outstanding
            
            Weighted Average
              Remaining Life
              (in years)
            
            Number Exercisable$
            0.51
            
            
            183,917
            
            
            4.2
            
            
            183,917$
            0.70
            
            
            3,000
            
            
            6.2
            
            
            3,000$
            0.81
            
            
            909,990
            
            
            5.6
            
            
            909,990$
            0.86
            
            
            125,000
            
            
            7.2
            
            
            92,569$
            0.90
            
            
            6,000
            
            
            5.7
            
            
            6,000$
            0.96
            
            
            90,000
            
            
            6.5
            
            
            90,000$
            0.99
            
            
            121,163
            
            
            8.2
            
            
            69,971$
            1.01
            
            
            3,000
            
            
            6.0
            
            
            3,000$
            1.15
            
            
            25,000
            
            
            7.5
            
            
            25,000$
            1.75
            
            
            6,000
            
            
            5.4
            
            
            6,0001,473,070
            
            
            7.3
            
            
            1,389,447




As
      of
      June 30, 2008, the fair value of options to be vested is $78,570.





The
      1996
      Plan expired by its terms on July 9, 2006, but outstanding options and awards
      previously granted under the 1996 Plan continue in accordance with their
      terms.





**11.
      Stock Purchase Warrants**





The
      following is a summary of outstanding warrants as of June 30, 2008 and
      2007:





Exercise Price
              per Share
            
            Weighted
              Average
              Exercise Price
              per Share
            
            NumberWarrants
                outstanding at June 30, 2007
            
            
            $0.1875 - $1.60
            
            $
            1.23
            
            
            4,390,372Warrants
                outstanding at June 30, 2008
            
            
            $0.1875 - $1.60
            
            $
            1.25
            
            
            4,149,677





In
      May
      2005, in connection with the extension and deferral of principal payments on
      the
      $2.5 million secured convertible note and the $1.5 million secured convertible
      note and, we granted the lender a warrant to purchase up to 1,000,000 shares
      of
      common stock at an exercise price of $1.05 per share, exercisable at any time
      prior to May 28, 2010.





In
      January 2005, in connection with a $1.5 million secured convertible note, we
      granted the lender a warrant to purchase up to 326,087 shares of common stock
      at
      an exercise price of $1.25 per share, exercisable at any time prior to May
      28,
      2011. In addition, we issued to our broker a five-year warrant, exercisable
      as
      and to the extent that any amounts owing under the convertible note are
      converted into common stock, for up to 181,818 shares of common stock at an
      exercise price of $1.25 per share. Also in January 2005, in connection with
      a
      the deferral of principal on the $2.5 million secured convertible note, we
      granted the lender a warrant to purchase up to 200,000 shares of common stock
      at
      an exercise price of $1.48 per share, exercisable at any time prior to January
      31, 2010.


F-19





In
      June
      2004, in connection with a $2.5 million secured convertible note, we granted
      the
      lender a warrant to purchase up to 681,818 shares of common stock at an exercise
      price of $1.25 per share, exercisable at any time prior to May 28, 2009. In
      addition, we issued to our broker a five-year warrant, exercisable as and to
      the
      extent that any amounts owing under the convertible note are converted into
      common stock, for up to 181,818 shares of common stock at an exercise price
      of
      $1.25 per share.





In
      March
      and April 2006, in connection with a private placement of common stock, we
      granted warrants to investors covering 955,600 shares of unregistered common
      stock at $1.60 per share and the placement agents covering 225,200 shares of
      unregistered common stock at $1.60 per share.





During
      fiscal year 2006, we borrowed a total of $350,000 under an equipment line of
      credit and issued to Franklin Funding warrants to purchase 35,000 shares, at
      an
      exercise price of $1.17 per share.  We recorded $7,142 warrant expense for
      equipment lease during fiscal year 2006. We recorded $11,820 warrant
      expense for equipment lease financing, for each of the fiscal years ended June
      30, 2008 and 2007.





**12.
      Commitments and Contingencies**





*Operating
      Leases*





We
      have
      entered into a non-cancelable operating lease for office facilities. Under
      the
      current lease we are responsible for its proportionate share of real estate
      taxes, insurance and common area maintenance costs. Rent expense was $240,940
      and $231,192 for the years ended June 30, 2008 and 2007, respectively. The
      office lease has been renewed per agreement with the lessor on April 1, 2007,
      effective November 1, 2007.





Future
      minimum lease payments are as follows:





Year
                Ended June 30,2009
            
            
            249,4472010
            
            
            257,1152011
            
            
            264,7832012
            
            
            272,448$
            1,043,793




*Security
      Interest*





In
      connection with its secured convertible note agreements, we have granted to
      Laurus Master Fund, Ltd. a secured interest in all of company’s assets. Franklin
      Funding also has a security interest in the equipment it has
      financed.





*Guarantor
      Obligation*





In
      connection with its purchase of certain assets from Saigene Corporation
      (Saigene), in December 2002, we guaranteed a note payable held by Saigene.
      During fiscal 2007 we extinguished the debt of $50,000. This transaction was
      unrelated to $100,000 secured note with Saigene.





**13.
      Retirement Plan**





We
      have a
      401(k) Plan that was reopened to employees in May 2005. The 401(k) Plan covers
      all employees over the age of 21 with 1,000 hours of service in a 12-month
      eligibility computation. We make a contribution equal to one-half of the
      employee’s contribution up to the maximum of 6%. We can make discretionary
      contributions as determined by its board of directors, not to exceed the amount
      permissible under the Internal Revenue Code. We have not made any discretionary
      contributions since the plan was reopened. For the fiscal year ended June 30,
      2008, our matching expense was $68,825 and 401(k) payable balance was $0.


F-20





**14.
      Subsequent Events**




On
      July
      28, 2008, we paid in full the remaining principal balance of our $2.5 million
      secured convertible note (the “2004 Note”) with Laurus.  As of September
      18, 2008, the remaining principal balance on the 2005 Note was
      $200,000.




The Company has been advised that its 2006 Federal tax
      return
      has been selected for examination by the IRS. No adjustments to the Company's
      tax liabilities have been proposed to date.


F-21