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, 2009





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


SECURITIES
EXCHANGE ACT OF 1934


For the
transition period from __________ to __________





Commission File
Number0-21537





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:          None





Securities
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 ̈Nox





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





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the 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  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).    Yes  x  No  ̈.





Indicate
by check mark 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.     ̈





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 filer   ̈
              
              Accelerated
      filer   ̈Non-accelerated
      filer   ̈
              
              Smaller
      reporting company  x(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 ̈  Nox





The
aggregate market value of the registrant’s common stock held by non-affiliates
on December 31, 2008 (the last business day of the registrant’s most recently
completed second fiscal quarter) was $6,312,572 based on the average of the bid
and ask prices of such stock on that date of $0.37, as reported on the OTC
Bulletin Board.





On
September 25, 2009, there were 16,707,633 shares of the registrant’s common
stock issued and outstanding.





Documents Incorporated By
Reference:  The registrant’s definitive proxy statement for the
2009 annual meeting of stockholders, which will be filed with the Securities and
Exchange Commission within 120 days after the close of the 2009 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
                    
                    
                    17Item
      2
                    Properties
                    
                    
                    17Item
      3
                    Legal
      Proceedings
                    
                    
                    17Item
      4
                    Submission
      of Matters to a Vote of Security Holders
                    
                    
                    17PART
      IIItem
      5
                    Market
      for Registrant’s Common Equity, Related Stockholder Matters
      and  Issuer Purchases of Equity Securities
                    
                    
                    17Item
      6
                    Selected
      Financial Data
                    
                    
                    18Item
      7
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    
                    
                    18Item
      7A
                    Quantitative
      and Qualitative Disclosures About Market Risk
                    
                    
                    26Item
      8
                    Financial
      Statements and Supplementary Data
                    
                    
                    26Item
      9
                    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                    
                    
                    26Item
      9A(T)
                    Controls
      and Procedures
                    
                    
                    26Item
      9B
                    Other
      Information
                    
                    
                    27PART
      IIIItem
      10**
                    Directors,
      Executive Officers and Corporate Governance
                    
                    
                    27Item
      11**
                    Executive
      Compensation
                    
                    
                    27Item
      12**
                    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                    
                    
                    27Item
      13**
                    Certain
      Relationships and Related Transactions, and Director
      Independence
                    
                    
                    28Item
      14**
                    Principal
      Accountant Fees and Services
                    
                    
                    28PART
      IVItem
      15
                    Exhibits
      and Financial Statement Schedules
                    
                    
                    28SIGNATURES
                    
                    
                    31





**
            Information
      contained in Items 10, 11, 12, 13 and 14 of Part III is incorporated by
      reference from the definitive proxy statement for our 2009 annual meeting
      of stockholders, which will be filed with the Securities and Exchange
      Commission within 120 days after the close of the 2009 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, including
      our expectations for our clinical biomarker
  services,


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


·
            our
      financing goals and plans





The
forward-looking statements in this Annual Report reflect management’s current
views and expectations with respect to our business, strategies, services and
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 9. 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).





Beginning
in fiscal 2008, we expanded our service offering to include clinical biomarker
services for novel biomarkers, as well as custom assay services, to our
pharmaceutical and biotechnology clients. Through our biomarker services, 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. In June 2009 our board of directors approved
changing our corporate name to Pacific Biomarkers, subject to approval by our
stockholders and review by the OTC. Management believes that the name change
represents the direction and positioning in the marketplace desired by the
company and its customers. We intend to seek stockholder approval of the name
change at our upcoming 2009 annual meeting of stockholders.





Business
Strategy





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. In addition, in 2008, we
expanded our provision of services and business development efforts to include
clinical biomarker services, a rapidly growing sector of laboratory services for
clinical drug development.





A key
component of our strategy is to meet the outsourcing needs of pharmaceutical,
biotechnology, diagnostic companies and other central laboratories. 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.





Another
component of our strategy is 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. 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.





Described
below are other strategies we are pursuing, or may pursue in the future, to
further our business.


2


Increase
Specialty Areas





Our goal
is to expand our specialty laboratory expertise, beyond our core specialties of
cardiovascular disease and bone and joint diseases, 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.





As part
of this strategy, in fiscal 2008, we expanded our service offerings into new
areas, both in terms of therapeutic areas and assay methodologies. Through our
biomarker services, 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 future
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. For the fiscal years ended June 30, 2009 and 2008, our
top two clients represented 40% and 28% of our revenue. As a result of ongoing
business development and client diversification efforts, we added 9 new clients
to our client base during the fiscal year ended June 30, 2009, and 7 new clients
in fiscal 2008, and we continue to diversify the total number and types of study
contracts. At June 30, 2009, we held a total of 137 active contracts, compared
to 106 active contracts at June 30, 2008, a 29% 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.





Revenue
from our five largest clients represented a substantial portion of our revenues,
approximately 70% and 56% of our total revenue in fiscal 2009 and 2008. Our
largest client in fiscal 2009 individually accounted for approximately 27% of
our total revenue in fiscal 2009, while our largest client in fiscal 2008
accounted for approximately 14% of our total revenue in fiscal 2008. It is
important to note that our largest client in fiscal 2009 was not our largest
client in fiscal 2008, which illustrates the risk of significant revenue
variability that we face in our marketplace.





We
anticipate that our clinical biomarker services 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. As a result,
we hope to develop client relationships with new divisions within existing
clients, as well as with other companies in the pharmaceutical and biotechnology
industries with whom we previously have not contracted. We believe 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 2010 we hope to build additional
relationships, further expanding joint business development efforts and
implementing operational integration in certain areas that will lead to
streamlined services.  We believe that joint marketing relationships
will provide a unique advantage of combining both scope and depth in quality
specialty testing service.





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.


3


Services





We
provide 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 continue to be a
significant source of revenues in the 2010 fiscal year.





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 continue to be a
significant source of revenue for the 2010 fiscal year.





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,


4





·
            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





In fiscal
2008, we began offering new testing services 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 our
biomarkers division 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.





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, we own certain other proprietary technologies and intellectual
property rights (patented and patent-pending). 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.


5


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 2009 and 2008, our
clients included companies ranging from the world’s largest pharmaceutical
companies and biotechnology companies to small and start-up organizations. In
both fiscal 2009 and 2008, two of our clients individually accounted for more
than 10% of our revenue. During the fiscal year ended June 30, 2009, these
clients represented 40% of our revenue as compared to 28% during the fiscal year
ended June 30, 2008.  Our largest client in fiscal 2009 individually
accounted for approximately 27% of our total revenue in fiscal 2009 and our
second largest client accounted for 13% of our total revenue. 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 14% of our total
revenue. Revenue from our five largest clients represented approximately 70% and
56% of total revenue in fiscal 2009 and 2008. The loss of any of our largest
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.





As of
June 30, 2009, we had master contract service agreements with 16 of our largest
clients as compared to 13 master service agreements as of June 30, 2008. 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, 2009, fixed price contracts amounted to 100% of our
revenue or $10,881,107. We had no contracts priced as fee-for-service with a
cap.  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 2009 or
2008.


6


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 and
biomarker laboratory services include Covance, PPD, Millipore, Quintiles, ICON,
Synarc, Medpace, Esoterix (Labcorp), Linco (Millipore), IBT Laboratories, ALTA
Immunochemistry and Charles River Laboratories.





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,


·
            expertise
      and experience in specific areas,


·
            scope
      of service offerings,


·
            price,


·
            ability
      to acquire, process, analyze and report accurate data in a timely
      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
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 and with a clinical laboratory permit in
the State of New York, 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
continual basis.





The
industry standards for conducting preclinical laboratory testing are embodied in
the Good Laboratory Practices (“GLP”) regulations as defined by the FDA. For the
majority of our testing, which is not 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. Additionally, PBI is now offering
fully GLP compliant services as requested by our clients.





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.


7


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.





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.





Employees





At
September 25, 2009, we had 63 full-time employees and 1 temporary or contract
employees, for a total of 64 employees, 46 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 master’s 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.


8


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.”





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 clinical results;


·
            insufficient
      patient enrollment by the client;


·
            insufficient
      investigator recruitment by the
client;


·
            client
      budgetary constraints;


·
            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.





Our
revenue has been concentrated in a small number of clients, and as a result 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. See “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS” and see “DESCRIPTION OF BUSINESS – Clients/Marketing”
above.





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, 2010 may be less than our
revenue for the fiscal year ended June 30, 2009. 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.


9


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.
Although we have master service agreements with a number of clients, we perform
services under these agreements based on work orders that are separately
negotiated with the client and are usually limited to a specific project with
limited duration, and there is no guaranteed minimum number of work orders or
revenue to us. The client may terminate projects that we undertake at any time.
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 and other scientists are often heavily involved in the
marketing and business development process, and time that they spend in this
area detracts from their 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 the
client and us. 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 hopeful that with the expansion
of our existing service offerings and new biomarker services, we will be able to
attract new clients. 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 under price our contracts or overrun cost
estimates.





Since our
contracts are primarily structured as fixed price (or to a lesser extent as
fee-for-service with a cap), we bear the financial risk if we initially under
price 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
contract 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 be from a few months to over several years. For internal
management purposes, we maintain a contract backlog to track anticipated
revenues that may be earned in the future for work that has not yet been
performed under signed contracts.  Management uses backlog as a
financial metric to internally track our business development efforts and
anticipated revenues. 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, because of the inherent nature of our contracts being subject to
termination, revision, or delay. Our backlog is also affected by the size and
duration of our contracts, and as we see more clients moving towards adaptive
clinical trials, resulting in smaller contracts with shorter duration, this will
impact our backlog. 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 the first quarter of fiscal 2009, our revenue was 13% lower than for
the comparable period of fiscal 2008. The impact of quarterly fluctuations is
clearly observed in the second, third and fourth fiscal quarters of 2009 where
revenue increased 96%, 24% and 34% compared to the comparable quarters in fiscal
2008. The following table shows the significant swings in our quarterly revenue
for each quarter in the past three fiscal years:


10





(Dollars in
      thousands,
                  
                  Fiscal
      yearrounded
      to nearest thousand)
                  
                  2007
                  
                  
                  2008
                  
                  
                  2009Q1,
      ended September 30
                  
                  $
                  2,605
                  
                  
                  $
                  2,082
                  
                  
                  $
                  1,805Q2,
      ended December 31
                  
                  
                  2,219
                  
                  
                  
                  1,648
                  
                  
                  
                  3,231Q3,
      ended March 31
                  
                  
                  1,755
                  
                  
                  
                  2,296
                  
                  
                  
                  2,853Q4,
      ended June 30
                  
                  
                  1,901
                  
                  
                  
                  2,239
                  
                  
                  
                  2,992Total
                  
                  $
                  8,480
                  
                  
                  $
                  8,265
                  
                  
                  $
                  10,881





Our
revenue depends in large part on receiving new clinical or diagnostic studies
and biomarker development projects from our clients. 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 to plan
for cash flow and capital expenditures. During fiscal 2010, 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.





If
we cannot maintain our revenues, we may have operating losses and our cash and
working capital position may decline.





At June
30, 2009, we had approximately $1,365,000 in cash and a
positive working capital position of approximately$2,459,000, both representing
an increase from the previous fiscal year.We use our cash, cash
equivalents, and accounts receivable to fund our investments in capital
equipment. If we cannot maintain our revenue levels or growth, we may experience
operating losses and our cash and working capital positions may be adversely
impacted through fiscal 2010. To maintain and improve our cash position, we
actively seek 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 reducing our expenses;
      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
depend on cash flows from operations to fund our debt obligations, and any
shortfall in working capital could have a material adverse effect on our
business and operations.





We
recently entered into a $4 million term loan (see “ITEM 7 - MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”). The
loan is due and payable over 48 months, with the first 8 months being interest
only ($40,000 per month), and thereafter 40 monthly payments of principal and
interest ($121,822 each). We will need to generate sufficient cash flows from
operations to pay our debt. Any inability to make our loan payments as they
become due could result in an event of default under the loan documents, which
could have a material adverse effect on our business. Upon an event of default,
the holder of the secured debt could seek to foreclose on our assets or exercise
any other remedies available to it, subject to the terms of the loan
documents.


11





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.





Business
disruptions, including an outbreak of H1N1 (swine) flu or a pandemic, could
impact our personnel; clients and suppliers; and could adversely affect our
business.





Our
well-trained staff and scientific professionals are instrumental to our business
productivity and success.  The loss of the services of any such
personnel, due to short-term illness or pandemic could cause significant
disruptions to our employee base and could adversely impact our ability to
provide our services.  Also, because of the scientific and technical
nature of our business, our success is also dependent upon our clients and
supplier’s ability to deliver study samples, chemical reagents and other
supplies necessary to produce test results and data.





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 Intellectual Property and Technologies” above. We protect our intellectual
property through a combination of 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; and generally seeking to control access to
and distribution of our intellectual property.





We
are dependent on single-source suppliers.





We
purchase certain chemical reagents used in our laboratory testing
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.





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.





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.


12


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 2010, 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.





Risks
Relating to Our Industry





A
decrease in research and development expenditures or outsourcing by
pharmaceutical and biotechnology companies would adversely affect
us.





Our
revenue depends greatly on the expenditures made by the pharmaceutical and
biotechnology industries in research and development, and particularly on the
ability and willingness of these companies to outsource the services we provide.
We are therefore subject to risks, uncertainties and trends that affect
companies in these industries, including economic factors, availability of
funding, and changes in research and development budgets. Research and
development budgets fluctuate due to many factors, including changes in
available resources, spending priorities, mergers of pharmaceutical and
biotechnology companies, and institutional policies. A decrease in R&D
expenditures or a decrease in outsourcing by pharmaceutical and biotechnology
companies could materially adversely affect our business and results of
operations.





The
pharmaceutical and biotechnology industries movement to “adaptive clinical
trials” may adversely affect our results of operations.





Recently,
we have observed that our pharmaceutical and biotechnology clients have been
shifting to “adaptive clinical trials”. These adaptive clinical trial protocols
are designed to replace large, multi-year, multi-million dollar contracts. After
each adaptive clinical trial phase, the pharmaceutical or biotechnology company
reviews the results and decides whether to continue or discontinue the work,
after which we may be awarded another small contract for another discrete
clinical phase.  Compared to our traditional contract business, these
adaptive clinical trials are shorter in duration and with fewer test samples
sent to us, resulting in a smaller dollar value contract. The major industry
risk for us is cancellation of contracts for drug research and development
studies outsourced to our company, and with adaptive clinical trial contracts,
there are many more potential stopping points for the testing work. In addition,
the complexity and additional work created by several start and stop and restart
phases within the adaptive clinical trial model challenges profit margins
through its requirement to use greater internal resources to complete the work.
We anticipate that these adaptive clinical trials will require more project
management time and efforts on our behalf, and will require us to increase our
business development in order to bring in more, albeit smaller, contracts. If we
are not able to effectively manage these shorter trials, or increase our
business development, our business may be harmed. In addition, other risks and
issues with these smaller trials is that patient recruiting is multiplied as
well as sample collection, handling, and testing.  While companies in
these industries may actually increase the number of research and development
projects they outsource via the use of adaptive clinical trials, our business
could be materially adversely affected by nature of these many smaller
increments of contract work outsourced to us.





We may be affected by changes in and
trends affecting the pharmaceutical and biotechnology
industries.





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.





In
addition, management continues to review developments in the dyslipidemia drug
development market that provides a substantial portion of our revenues. 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. We
will continue to be impacted by changes affecting the pharmaceutical and
biotechnology industries.


13


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.





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





We seek
to develop and market new services that complement or expand our existing
business, including to allow us to leverage our expertise, broaden our service
menu, diversify our client base, and increase the scope and number of our
contracts. 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. 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.





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 therapeutic
areas,


·
            strengths
      in various geographic markets and global
reach,


·
            scope
      of service offerings,


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


14


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 or
outsourcing.





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) or GLP (Good Laboratory 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.





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 audited 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.





Health care reform or other changes
in government regulation impacting the pharmaceutical or biotechnology
industries could decrease the need for the services we provide and our
revenues.





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, or
may have the effect of putting downward pressure on the prices that
pharmaceutical and biotechnology companies can charge for prescription 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 laboratory services create a risk of liability.





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


15


·
            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.





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.


16


If
we issue additional equity securities in the future, the ownership of our
existing stockholders will be diluted.





If 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.





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 $21,000. The monthly rental
rate increases approximately three percent on each November 1 for the remainder
of the term.





During
fiscal 2009, we leased approximately 500 square feet of office and laboratory
space in a separate Seattle, Washington location for our biomarker services
laboratory. On August 1, 2009, we entered into a new lease that increased the
size of the leased space to approximately 850 square feet.  The
current monthly rent under the lease is $4,845. The lease term is 24 months and
expires August 31, 2011.





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, 2009.





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.”


17


The
following table shows, for each quarter of fiscal 2009 and 2008, 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.





OTC
      Bulletin BoardHigh
                  
                  
                  LowFiscal
      2009:Fourth
      quarter, ended June 30, 2009
                  
                  $
                  0.80
                  
                  
                  $
                  0.51Third
      quarter, ended March 31, 2009
                  
                  
                  0.66
                  
                  
                  
                  0.35Second
      quarter, ended December 31, 2008
                  
                  
                  0.50
                  
                  
                  
                  0.31First
      quarter, ended September 30, 2008
                  
                  
                  0.64
                  
                  
                  
                  0.35Fiscal
      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
                  
                  
                  0.83
                  
                  
                  
                  0.60First
      quarter, ended September 30, 2007
                  
                  
                  0.79
                  
                  
                  
                  0.56





Holders





As of
September 25, 2009, there were 16,707,633 shares of common stock issued and
outstanding, held by approximately 185 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, 2009, 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 reference 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). 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.


18


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 Generally Accepted Accounting Principals, 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.





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 179,392 restricted shares and 192,000 stock
options for the fiscal year ended June 30, 2009, compared to 200,000 restricted
shares for the fiscal year ended June 30, 2008.





Allowance for Doubtful
Accounts





Trade
Receivables – 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 incurred bad debt expense of
$16,137 in the 2009 fiscal year. The balance of the bad debt allowance was
$34,095 and $29,294 for the fiscal years ended June 30, 2009 and June 30,
2008.


19


Other
Receivables – We did not incur any non-trade bad debt in fiscal 2009. 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. During fiscal year 2009, the entire
$100,000 was received by us.





Useful
Lives of Tangible 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 balance of our depreciable assets at
June 30, 2009 was $813,258, net of depreciation and amortization.





Operating
Expenses





Historically,
we have segregated our recurring operating expenses between two categories:
laboratory and cost of goods sold and selling, general and administrative
expenses, which includes 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, laboratory administration expenses and research and
development activities through our science and technology department. 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.


20


Results
of Operations for the Fiscal Years Ended June 30, 2009 and 2008





Revenue:





Years EndedJune 30,
                          
                          
                          $
                          
                          
                          %Dollars in thousands, rounded to nearest
                            thousand
                          
                          2009
                          
                          
                          2008
                          
                          
                          Change
                          
                          
                          ChangeRevenue
                          
                          $
                          10,881
                          
                          
                          $
                          8,265
                          
                          
                          $
                          2,616
                          
                          
                          
                          32





Our
revenue is primarily generated from clinical pharmaceutical trials testing,
clinical biomarker services and diagnostic services. Our revenue increased
approximately 32% to $10,881,000 from $8,265,000 for the comparable fiscal years
ended June 30, 2009 and 2008. In fiscal 2009 we benefited from strong
levels of testing revenue in the diabetes, rheumatoid arthritis and clinical
biomarker therapeutic areas.





We
believe that the overall significant increase in revenue in fiscal 2009 reflects
our investments in business development initiatives over the last two fiscal
years. Although the primary component of our business development efforts has
been directed towards pharmaceutical and biotech companies, which includes our
biomarkers business (“Direct Clinical Services”), in fiscal 2009 we also saw an
increase in revenues from our work with other large clinical laboratories that
refer specialty laboratory testing to us (“Referral Laboratory Partners”).
Another component of the increase in revenues is from the growth of our
biomarker services, which we introduced in February 2008 and has developed over
the two fiscal years. Although the growth of our biomarker services has been
slower than we originally expected, this area is a primary focus of our business
and we believe it addresses a rapidly growing sector of laboratory services for
clinical drug development. As a result, we expect to see our biomarker services
to continue to grow and to represent a larger portion of our
revenues.





The
following table provides a breakdown of the percentage of our total revenue
generated from each of our service areas for the past two fiscal
years:





Direct Clinical Services
                    
                    
                    Referral
                    
                    
                    DiagnosticDirect Trials Testing
                    
                    
                    Biomarkers
                    
                    
                    Laboratories
                    
                    
                    ServicesFiscal
      2009
                    
                    
                    46
                    %
                    
                    
                    8
                    %
                    
                    
                    45
                    %
                    
                    
                    1
                    %Fiscal
      2008
                    
                    
                    65
                    %
                    
                    
                    5
                    %
                    
                    
                    24
                    %
                    
                    
                    6
                    %





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





Recently,
we have observed that our pharmaceutical and biotechnology clients have been
shifting to “adaptive clinical trials”. These adaptive clinical trial protocols
are designed to replace large, multi-year, multi-million dollar contracts. After
each adaptive clinical trial phase, the pharmaceutical or biotechnology company
reviews the results and decides whether to continue or discontinue the work,
after which we may be awarded another small contract for another discrete
clinical phase.  Compared to our traditional contract business, these
adaptive clinical trials are shorter in duration and with fewer test samples
sent to us, resulting in a smaller dollar value contract. The major industry
risk for us is cancellation of contracts for drug research and development
studies outsourced to our company, and with adaptive clinical trial contracts,
there are many more potential stopping points for the testing work. In addition,
the complexity and additional work created by several start and stop and restart
phases within the adaptive clinical trial model challenges profit margins
through its requirement to use greater internal resources to complete the work.
We anticipate that these adaptive clinical trials will require more project
management time and efforts on our behalf, and will require us to increase our
business development in order to bring in more, albeit smaller, contracts. If we
are not able to effectively manage these shorter trials, or increase our
business development, our business may be harmed.  In addition, other
risks and issues with these smaller trials is that patient recruiting is
multiplied as well as sample collection, handling, and testing. While companies
in these industries may actually increase the number of research and development
projects they outsource via the use of adaptive clinical trials, our business
could be materially adversely affected by nature of these many smaller
increments of contract work outsourced to us.


21


In
addition, management continues its review of the cholesterol drug development
market, which provides a substantial proportion of our revenues. Recently other
drugs in the cholesterol drug class 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
      EndedJune
      30,
                          
                          
                          $
                          
                          
                          %Dollars
      in thousands, rounded to nearest
                            thousand
                          
                          2009
                          
                          
                          2008
                          
                          
                          Change
                          
                          
                          ChangeLaboratory
      Expenses and Cost of Goods Sold
                          
                          $
                          5,920
                          
                          
                          $
                          4,841
                          
                          
                          
                          1,079
                          
                          
                          
                          22Percentage
      of Revenue
                          
                          
                          55
                          %
                          
                          
                          59
                          %





Laboratory
expense and cost of goods sold consist primarily of salaries and related
benefits to employees performing analysis of clinical trial samples and the cost
of chemical reagents and supplies for analysis ofclinical trialsamples, and
secondarily, of payments to subcontractors for laboratory services, rent,
insurance, business and occupation taxes. For the comparable fiscal years ended
June 30, 2009 and 2008, laboratory expense and cost of goods sold increased
approximately 22% to $5,920,000 from $4,841,000. The primary expense increases
for the fiscal year ended June 30, 2009 were from reagents, employee salaries
and benefits and outside services.





As a
percentage of revenue, laboratory expense and cost of goods was approximately
55% and 59% in fiscal years 2009 and 2008. The relative decrease in our
laboratory expense and cost of goods sold, as a percentage of revenue, was the
result of variable and fixed costs increasing at a slower rate than revenue. The
following table illustrates changes in Laboratory Expenses and Cost of Goods
Sold in fixed and variable expense categories:





Years EndedJune 30,
                        
                        
                        $
                        
                        
                        %Dollars in thousands, rounded to
                          nearestthousand
                        
                        2009
                        
                        
                        % of
                          revenue
                        
                        
                        2008
                        
                        
                        % of
                          revenue
                        
                        
                        Change
                        
                        
                        ChangeFixed
      Cost DetailRent,
      Utilities, Certain Taxes
                        
                        $
                        511
                        
                        
                        
                        5
                        %
                        
                        $
                        475
                        
                        
                        
                        6
                        %
                        
                        $
                        36
                        
                        
                        
                        8
                        %Variable
      Cost DetailWages,
      Taxes, Benefits
                        
                        
                        2,391
                        
                        
                        
                        22
                        %
                        
                        
                        1,903
                        
                        
                        
                        23
                        %
                        
                        
                        488
                        
                        
                        
                        26
                        %Reagent
      Chemicals
                        
                        
                        2,402
                        
                        
                        
                        22
                        %
                        
                        
                        1,777
                        
                        
                        
                        22
                        %
                        
                        
                        625
                        
                        
                        
                        35
                        %Other
      Variable Costs
                        
                        
                        616
                        
                        
                        
                        6
                        %
                        
                        
                        686
                        
                        
                        
                        8
                        %
                        
                        
                        (70
                        )
                        
                        
                        (10
                        %)Total
                        
                        
                        5,409
                        
                        
                        
                        50
                        %
                        
                        
                        4,366
                        
                        
                        
                        53
                        %
                        
                        
                        1,043
                        
                        
                        
                        24
                        %Total Cost of Goods Sold
                        
                        $
                        5,920
                        
                        
                        
                        55
                        %
                        
                        $
                        4,841
                        
                        
                        
                        59
                        %
                        
                        $
                        1,079
                        
                        
                        
                        22
                        %





The
largest component of laboratory expense during fiscal 2009 was the cost of
laboratory reagents and supplies for analysis of clinical trial samples. During
the fiscal years ended June 30, 2009 and 2008, laboratory reagents and supplies
increased by 35% to approximately $2,402,000 from $1,777,000 as a result of an
increase in the number of tests performed. Over the last three fiscal years,
reagent chemicals used in our laboratory testing have averaged approximately 20%
in cost as a percentage of revenue, but may vary considerably depending on the
type of lab testing we are asked to perform, and constitute a significant
expense item for our business. During the fiscal years ended June 30, 2009 and
2008 lab supplies were approximately 22% of our revenue and accounted for
approximately 41% and 37% of total laboratory expense and cost of goods
sold.


22


Chemical
reagents and supply costs are highly variable depending on the type of tests
performed. During fiscal 2009, we have been involved in more complex assays and
testing methods and lower volume phase I studies, both of which result in an
increased cost of reagents and higher per test labor cost. We experienced cost
increases from several reagent suppliers commencing on January 1, 2009. We
expect these cost increases to continue into fiscal 2010.  As we enter
into new contracts, we will make price adjustments for these supply costs;
however, the majority of our work is based on fixed-price contracts which are
not subject to price adjustments on the basis of our cost experience in
performing the contract.





The other
major component of laboratory expense during fiscal 2009 was salaries and
related benefits. During the fiscal years ended June 30, 2009 and 2008, salaries
and related benefits increased by 26% to approximately $2,391,000 from
$1,903,000 as a result of an increase in staff to accommodate the increase in
the number of tests performed. The expense increase was due primarily to an
increase in laboratory staff by 6 FTE to perform many new and more complex
assays than were performed in the comparable fiscal period last
year.  We have also setup a separate facility for a new class of
assays in our biomarker services area. These new assays have yet to produce
revenue.  During the fiscal years ended June 30, 2009 and 2008
salaries and related benefits were 22% and 23% of our revenue and accounted for
approximately 40% and 39% of total laboratory expense and cost of goods sold. In
addition, we accrued approximately $141,000 of bonuses in the fiscal year ended
June 30, 2009 based on our quarterly results for that period. We accrued only
$5,000 bonuses in the comparable period in the prior fiscal year.





Another
component of laboratory expense during fiscal 2009 was other variable costs.
Other variable costs decreased 10% to approximately $616,000 from $686,000
during the fiscal years ended June 30, 2009 and 2008. The major reason for this
decrease was a decrease in our laboratory contract labor. Several of these
laboratory technicians were hired in fiscal 2009 and they account for a portion
of the increase in FTE, salaries and related benefits.





Selling,
General and Administrative Expense:





Years
      EndedJune
      30,
                              
                              
                              $
                              
                              
                              %Dollars
      in thousands, rounded to nearest
                                thousand
                              
                              2009
                              
                              
                              2008
                              
                              
                              Change
                              
                              
                              ChangeSelling,
      General and Administrative Expense
                              
                              $
                              4,347
                              
                              
                              $
                              3,990
                              
                              
                              
                              357
                              
                              
                              
                              9Percentage
      of Revenue
                              
                              
                              40
                              %
                              
                              
                              48
                              %





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





For the
comparable years ended June 30, 2009 and 2008 selling, general and
administrative expense increased approximately 9% to approximately $4,347,000
from $3,990,000. As a percentage of revenue, selling, general and administrative
expenses were approximately 40% and 48%, respectively, for the comparable fiscal
years ended June 30, 2009 and 2008. The decrease in selling, general and
administrative expense as a percentage of revenue was the result of the
significant increase in our revenues between the comparable
periods.





The
dollar increase in our selling, general and administrative expenses for the
comparable periods is due in large part to an increase in bonuses, public
company expenses and rent for our new biomarker services facility. These
increases were offset somewhat by decreases in legal and accounting expense, bad
debt expense and share-based compensation.


23


Other
Income (Expense):





Years EndedJune 30,
                      
                      
                      $
                      
                      
                      %Dollars in thousands, rounded to nearest
                        thousand
                      
                      2009
                      
                      
                      2008
                      
                      
                      Change
                      
                      
                      ChangeOther Income/(Expense)
                      
                      $
                      623
                      
                      
                      $
                      (5
                      )
                      
                      
                      628
                      
                      
                      
                      11622Percentage of Revenue
                      
                      
                      6
                      %
                      
                      
                      (0
                      )%





We had
other income of approximately $623,000 for the fiscal year ended June 30, 2009,
compared to other expense of approximately $5,000 for the fiscal year ended June
30, 2008. This improvement is primarily attributable to our payment in full on
the convertible notes payable to Laurus in December 2008, reflecting a decrease
in interest expense paid, a decrease in amortization of deferred financial
costs, and a gain due to adjustments to the value of the embedded derivative.
The reduction in principal balance of the Laurus notes is the primary reason for
our interest expense decrease of 82% to approximately $158,000 for the year
ended June 30, 2009, down from approximately $894,000 for the year ended June
30, 2008. The gain from adjustment of embedded and freestanding derivatives to
fair value was approximately $676,000 for the year ended June 30, 2009 compared
to $805,000 for the year ended June 30, 2008. We had approximately $124,000 of
other income for the year ended June 30, 2009 compared to $190,000 for the year
ended June 30, 2008. Higher other income in fiscal 2008 reflected interest
income received from a state tax refund. The decrease in other income in fiscal
2009 was partially offset by the collection of bad debt of $104,000 that we
previously classified as bad debt. Another component of other expense for the
year ended June 30, 2009 was approximately $18,000 of amortization of
deferred financing costs on the Laurus convertible debt, compared to
approximately $107,000 of such expense recorded for year ended June 30,
2008.





Net
Income (Loss):





Years
      EndedJune
      30,
                      
                      
                      $
                      
                      
                      %Dollars
      in thousands, rounded to nearest
                        thousand
                      
                      2009
                      
                      
                      2008
                      
                      
                      Change
                      
                      
                      ChangeNet
      Income (Loss)
                      
                      $
                      1,236
                      
                      
                      $
                      (571
                      )
                      
                      $
                      1,807
                      
                      
                      
                      316Percentage
      of Revenue
                      
                      
                      11
                      %
                      
                      
                      (7
                      )%





We had
net income of approximately $1,236,000 in fiscal 2009 compared to a net loss of
approximately $(571,000) in fiscal 2008. The increase to net income, from net
loss, is principally due to a significant increase in revenue, operating profit
and other income during fiscal 2009 as described above.





Our net
income was favorably impacted by a reduction in interest expense by
approximately $736,000 due to final payment of the outstanding Laurus Notes and
the reduced amounts outstanding on our equipment credit line with Franklin
Funding.





Liquidity
and Capital Resources





At June
30, 2009 our cash and cash equivalents were approximately $1,365,000, compared
to approximately $1,196,000 at June 30, 2008. At June 30, 2009, we had
approximately $2,239,000 in accounts receivable, compared to approximately
$2,146,000 as of June 30, 2008, reflecting timing of revenues billed and
collected. Our accounts receivable generally reflect our billings, and may
include one or several individually large customer receivables from time to
time. We generally have a high collectibility rate on our accounts receivable,
and our allowance for doubtful trade accounts is approximately $34,000, which we
believe is reasonable based on our past experience.


24


Total
liabilities recorded on our balance sheet as of June 30, 2009 were approximately
$1,986,000 compared to approximately $3,871,000 as of June 30, 2008. This
significant decrease in liabilities was the result of retiring both the Laurus
debt and the outstanding note balance from Franklin Funding, both of which were
paid off in December 2008. We paid off the Laurus debt early, one month prior to
maturity. As a result of our payoff of the Laurus notes, the remaining balance
for embedded derivative liability on our balance sheet was reduced to zero by
recording gain of approximately $300,000 for the remaining balance of the
derivative liability. We reclassified freestanding derivative liability by
crediting additional paid-in capital for approximately $378,000 for the
remaining balance of the warrants associated with both Laurus notes, which
remain in effect. This reclassification resulted in no changes to our
accumulated deficit or net loss presented.





At June
30, 2009, we had working capital of approximately $2,459,000, compared to
approximately $331,000 at June 30, 2008. The increase of approximately
$2,128,000 in our working capital is mainly attributable to a significant
decrease in our current liabilities due to Laurus debt payoff and decrease in
other notes payable. Changes providing a positive impact included increases in
prepaid expenses, decreases in secured convertible debt and associated
derivative liability to the Laurus notes, accounts payable, advances from
customers and other notes payable. Changes providing a negative impact included
decreases in other receivable and inventory and increases in capital leases
obligations. Our strong earnings have also improved our working capital
position.





Net cash
provided by operating activities was approximately $1,135,000 for
the fiscal year ended June 30, 2009 andincluded the effect of
approximately $264,000 in depreciation and amortization, approximately $88,000
of amortization related to the Laurus notes, approximately $102,000 in expense
from share-based compensation and approximately $676,000 in income from
adjustment of the compound embedded derivative liability relating to the Laurus
notes. Our investing activities used cash of approximately $45,000 for the fiscal year ended June
30, 2009for the purchase of capital equipment. Cash flows used in
financing activities included approximately $921,000 in payments on notes
payable and payments on capital lease obligations.





We
experienced an increase in our cash and working capital position from operations
during the fiscal year
ended June 30, 2009 and we believe that our cash, current assets and cash
flows from operations will be sufficient to fund operations through fiscal
2010.





Subsequent
to the end of the 2009 fiscal year, on September 1, 2009, we closed a $4 million
term loan with Terry M. Giles, a former member of our Board of Directors. See
Note 14 to Consolidated Financial Statements. We issued a promissory note to Mr.
Giles for the loan and each of our subsidiaries entered into a Subsidiary
Guarantee with Mr. Giles to guarantee the loan. The loan is due and payable over
48 months, with the first 8 months being interest only ($40,000 per month), and
thereafter 40 monthly payments of principal and interest ($121,822 each). During
the first 12 months of the term of the loan, we have the right, in our sole
discretion, to obtain an additional $500,000 loan from Mr. Giles on the same
terms. In connection with and as required by the loan, on September 1, 2009, we
repurchased 2,391,906 shares of common stock from certain stockholders at a
price of $0.70 per share, pursuant to a Stock Redemption Agreement. We received
net loan proceeds of $2,325,666, after payment of the stock repurchase but
excluding our legal and other expenses for the transaction. We intend to use the
net proceeds of the loan to fund our working capital and growth needs, and in
particular our development efforts for our biomarker business.





Other
than this term loan with Mr. Giles, we do not have available to us a bank line
of credit or other general borrowing facility.





In fiscal
2009, we will continue to actively pursue business development and marketing
activities to broaden our client and revenue base. In particular, we anticipate
making additional capital and human resource investments for our clinical
biomarker services. We may also invest from time to time in our technology
infrastructure, operations and other areas of our business. These efforts will
use significant amounts of time, effort and funding and may not be
successful.





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


25


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, 2009.





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 2009 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.





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, 2009, 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, 2009.


26


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 14, 2009, 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, 2009, we (a) extended his employment
agreement for an additional year, to September 30, 2010, (b) increased his
annual base salary to $300,000 (from $250,000), and (c) agreed to grant to
him 100,000 shares of restricted common stock and stock options for 200,000
shares of common stock on October 1, 2009. 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 2009 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, 2009, our fiscal year
end.





ITEM
      11
            EXECUTIVE
      COMPENSATION





Information
called for by Part III, Item 11, is included in our proxy statement
relating to our 2009 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, 2009, 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 2009 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, 2009, our fiscal year end.


27





Equity
Compensation Plan Information





The
following table gives information as of June 30, 2009, 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 for the fiscal year ended June 30, 2009
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)
                          
                          
                          1,123,889
                          
                          
                          $
                          0.79
                          
                          
                          
                          -Equity
      Compensation Plans Approved by Stockholders (2)
                          
                          
                          1,219,740
                          
                          
                          $
                          0.80
                          
                          
                          
                          1,780,260Equity
      Compensation Plans Not Approved by Stockholders
                          
                          
                          3,898,027
                          
                          
                          $
                          1.22
                          
                          
                          
                          -TOTAL
                          
                          
                          6,241,656
                          
                          
                          $
                          1.06
                          
                          
                          
                          1,780,260





(1)
            Consists
      solely of the Pacific Biometrics, Inc. 1996 Stock Incentive Plan. The 1996
      Plan has been terminated and no additional shares or options may be
      awarded, but outstanding options and awards previously granted under the
      1996 Plan continue in accordance with their
  terms.


(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 2009 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, 2009, 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 2009 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, 2009, our fiscal year
end.





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, 2009:


28





Report
      of Independent Registered Public Accounting Firm
                
                
                F-2Consolidated
      Balance Sheets as of June 30, 2009 and 2008
                
                
                F-3Consolidated
      Statements of Operations for the Years Ended June 30, 2009 and
      2008
                
                
                F-4Consolidated
      Statements of Cash Flows for the years ended June 30, 2009 and
      2008
                
                
                F-5Consolidated
      Statement of Stockholders’ Equity for the years ended June 30, 2009 and
      2008
                
                
                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.
                    
                    Description3.1
                    (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
                    (11)
                    Third
      Amendment to Executive Employment Agreement, between Pacific Biometrics,
      Inc. and Ronald R. Helm, dated September 24, 200810.3E
                    **
                    Fourth
      Amendment to Executive Employment Agreement, between Pacific Biometrics,
      Inc. and Ronald R. Helm, dated September 14, 200910.4
      ++
                    (12)
                    Employment
      Agreement, dated October 1, 2004, by and between the Company and Dr.
      Elizabeth Leary10.5A
                    (13)
                    Office
      Lease, dated April 23, 1997, between Tom Kane and Elsa Kane and the
      Company10.5B
                    (14)
                    First
      Amendment to Office Lease, dated January 20, 199810.5C
                    (14)
                    Second
      Amendment to Office Lease, dated April 20, 200710.6
                    **
                    Lease
      Agreement dated August 14, 2009, between Pacific Northwest Research
      Institute and Pacific Biometrics, Inc.10.7
                    (15)
                    Loan
      and Security Agreement, dated September 1, 2009, between Pacific
      Biometrics, Inc. and Terry M. Giles10.8
                    (15)
                    Term
      Note, dated September 1, 2009 by Pacific Biometrics, Inc. in favor of
      Terry M. Giles10.9
                    (15)
                    Subsidiary
      Guarantee, dated September 1, 2009, by Pacific Biometrics, Inc., Pacific
      Biomarkers, Inc., PBI Technology, Inc., and BioQuant, Inc. for the benefit
      of Terry M. Giles10.10
                    (15)
                    Stock
      Redemption Agreement, dated September 1, 2009, between Pacific Biometrics,
      Inc. and Terry M. Giles10.11
                    (16)
                    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.10.12
                    (17)
                    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.




29





10.13
                  (18)
                  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.10.14
                  (19)
                  Common
      Stock Purchase Warrant issued by the Company in favor of Source Capital
      Group, Inc.10.15
                  (20)
                  Form
      of Common Stock Purchase Warrant for March 2006 private
      placement14.1
                  (4)
                  Code
      of Ethics for Financial Officers21.1
                  (11)
                  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.
 (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 Exhibit of Registrant’s Annual Report on Form 10-K filed
      on September 26, 2008.
 (12)
              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.
 (13)
              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.
 (14)
              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.
 (15)
              Incorporated
      by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
      on September 2, 2009.
 (16)
              Incorporated
      by reference to Exhibits of Registrant’s Current Report on Form 8-K filed
      on June 7, 2004.
 (17)
              Incorporated
      by reference to Exhibits of Registrant’s Current Report on Form 8-K filed
      on February 1, 2006.
 (18)
              Incorporated
      by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
      on May 10, 2005.
 (19)
              Incorporated
      by reference to Exhibits of Registrant’s Registration Statement on Form
      SB-2, Registration No. 333-116968, filed on June 29,
  2004.
 (20)
              Incorporated
      by reference to Exhibit of Registrant’s Current Report on Form 8-K filed
      on March 13, 2006.




30





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 25, 2009.





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
      25, 2009Ronald
      R. Helm
                
                (Principal Executive
      Officer)/s/ John P. Jensen
                
                Vice
      President of Finance and Controller
                
                September
      25, 2009John
      P. Jensen
                
                (Principal Financial Officer
      and
                  Principal Accounting
      Officer)/s/ Mario R. Ehlers
                
                Director
                
                September
      25, 2009Mario
      R. Ehlers/s/ Paul G. Kanan
                
                Director
                
                September
      25, 2009Paul
      G. Kanan/s/ Richard W. Palfreyman
                
                Director
                
                September
      25, 2009Richard
      W. Palfreyman/s/ Curtis J. Scheel
                
                Director
                
                September
      25, 2009Curtis
      J. Scheel/s/ Kenneth R. Waters
                
                Director
                
                September
      25, 2009Kenneth
      R. Waters/s/ Stanley L. Schloz
                
                Director
                
                September
      25, 2009Stanley L.
      Schloz




31


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, 2009 and 2008
                                    
                                    
                                    F-3Consolidated
      Statements of Operations for the years ended June 30, 2009 and
      2008
                                    
                                    
                                    F-4Consolidated
      Statements of Cash Flows for the years ended June 30, 2009 and
      2008
                                    
                                    
                                    F-5Consolidated
      Statement of Stockholders’ Equity for the years ended June 30, 2009 and
      2008
                                    
                                    
                                    F-6Notes
      to Consolidated Financial Statements
                                    
                                    
                                    F-7




F-1


PMB Helin
Donovan, LLP


Consultants
and Certified Public Accountants








REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and


Stockholders
of Pacific Biometrics, Inc.





We have
audited the accompanying balance sheets of Pacific Biometrics, Inc. as of June
30, 2009 and 2008, and the related statements of operations, stockholders’
equity, and cash flows for each of the years in the two-year period ended June
30, 2009. Pacific Biometrics, Inc.’s management is responsible for these
financial statements. Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
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, 2009 and 2008, and the results of its operations and its cash flows for each
of the years in the two-year period ended June 30, 2009, in conformity with
accounting principles generally accepted in the United States of
America.





/s/ PMB
Helin Donovan, LLP





PMB Helin
Donovan, LLP


San
Francisco, California


September
1, 2009





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,





2009
                                            
                                            
                                            2008ASSETSCurrent
      assets:Cash
      and cash equivalents
                                            
                                            $
                                            1,365,406
                                            
                                            
                                            $
                                            1,196,310Accounts
      receivable, net
                                            
                                            
                                            2,238,912
                                            
                                            
                                            
                                            2,146,080Other
      receivable, net
                                            
                                            
                                            9,000
                                            
                                            
                                            
                                            451,291Inventory
                                            
                                            
                                            171,885
                                            
                                            
                                            
                                            197,456Prepaid
      expenses and other assets
                                            
                                            
                                            230,974
                                            
                                            
                                            
                                            100,869Deferred
      financing cost on secured convertible note - current
    portion
                                            
                                            
                                            -
                                            
                                            
                                            
                                            18,447Total
      current assets
                                            
                                            
                                            4,016,177
                                            
                                            
                                            
                                            4,110,453Property
      and equipment, net
                                            
                                            
                                            813,258
                                            
                                            
                                            
                                            884,521Total
      assets
                                            
                                            $
                                            4,829,435
                                            
                                            
                                            $
                                            4,994,974LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                                            
                                            $
                                            678,818
                                            
                                            
                                            $
                                            818,224Accrued
      liabilities
                                            
                                            
                                            660,284
                                            
                                            
                                            
                                            450,788Advances
      from customers
                                            
                                            
                                            155,471
                                            
                                            
                                            
                                            643,291Capital
      lease obligation - current portion
                                            
                                            
                                            62,709
                                            
                                            
                                            
                                            32,530Secured
      convertible note, net of unaccreted fair value assigned to conversion
      feature and
                                            
                                            
                                            -
                                            
                                            
                                            
                                            678,535warrants
      of $0 and $214,771, respectively
                                            
                                            
                                            -
                                            
                                            
                                            
                                            642,470Embedded
      derivative liability
                                            
                                            
                                            -Freestanding
      derivative liability
                                            
                                            
                                            -
                                            
                                            
                                            
                                            411,545Other
      notes payable - current portion
                                            
                                            
                                            -
                                            
                                            
                                            
                                            102,467Total
      current liabilities
                                            
                                            
                                            1,557,282
                                            
                                            
                                            
                                            3,779,850Advances
      from customers - long-term portion
                                            
                                            
                                            272,032
                                            
                                            
                                            
                                            -Capital
      lease obligations - long-term portion
                                            
                                            
                                            156,309
                                            
                                            
                                            
                                            91,109Total
      liabilities
                                            
                                            
                                            1,985,623
                                            
                                            
                                            
                                            3,870,959Commitments
      and contingencies
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Stockholders'
      equity:Preferred
      stock, Series A convertible $0.01 par value, 5,000,000
    sharesauthorized,
      0 shares issued and outstanding for 2009 and 2008
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Common
      stock, $0.01 par value, 30,000,000 shares authorized,19,099,539
      and 18,720,147 shares issued and outstanding, respectively
                                            
                                            
                                            190,995
                                            
                                            
                                            
                                            187,201Additional
      paid-in capital
                                            
                                            
                                            29,121,334
                                            
                                            
                                            
                                            28,641,278Accumulated
      deficit
                                            
                                            
                                            (26,468,517
                                            )
                                            
                                            
                                            (27,704,464
                                            )Total
      stockholders' equity
                                            
                                            
                                            2,843,812
                                            
                                            
                                            
                                            1,124,015Total
      liabilities and stockholders' equity
                                            
                                            $
                                            4,829,435
                                            
                                            
                                            $
                                            4,994,974





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


F-3





PACIFIC BIOMETRICS, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


Years
Ended June 30,





2009
                  
                  
                  2008Revenues
                  
                  $
                  10,881,107
                  
                  
                  $
                  8,265,237Laboratory
      expenses and cost of sales
                  
                  
                  5,920,195
                  
                  
                  
                  4,841,033Gross
      profit
                  
                  
                  4,960,912
                  
                  
                  
                  3,424,204Operating
      expenses:Selling,
      general and administrative
                  
                  
                  4,347,482
                  
                  
                  
                  3,990,230Operating
      income (loss)
                  
                  
                  613,430
                  
                  
                  
                  (566,026
                  )Other
      income (expense):Interest
      expense
                  
                  
                  (158,324
                  )
                  
                  
                  (893,662
                  )Gain
      on adjustment of embedded and freestanding derivatives to fair
      value
                  
                  
                  675,691
                  
                  
                  
                  805,013Amortization
      of deferred financing costs - secured convertible debt
                  
                  
                  (18,447
                  )
                  
                  
                  (107,170
                  )Other
      income
                  
                  
                  123,597
                  
                  
                  
                  190,416Total
      other income (expense)
                  
                  
                  622,517
                  
                  
                  
                  (5,403
                  )Net
      income (loss) before tax expense
                  
                  
                  1,235,947
                  
                  
                  
                  (571,429
                  )Tax
      expense
                  
                  
                  -
                  
                  
                  
                  -Net
      income (loss)
                  
                  $
                  1,235,947
                  
                  
                  $
                  (571,429
                  )Net
      income (loss) per share:Basic
      income (loss) per share
                  
                  $
                  0.07
                  
                  
                  $
                  (0.03
                  )Diluted
      income (loss) per share
                  
                  $
                  0.06
                  
                  
                  $
                  (0.03
                  )Weighted
      average common shares outstanding:Basic
                  
                  
                  19,012,769
                  
                  
                  
                  18,812,306Diluted
                  
                  
                  19,640,041
                  
                  
                  
                  18,812,306





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


F-4


PACIFIC
BIOMETRICS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


Years
Ended June 30,





2009
                    
                    
                    2008Cash
      flows from operating activities:Net
      income (loss)
                    
                    $
                    1,235,947
                    
                    
                    $
                    (571,429
                    )Reconciliation
      of net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
                    
                    
                    263,756
                    
                    
                    
                    236,004Accretion
      of fair value assigned to conversion feature and warrants
                    
                    
                    88,134
                    
                    
                    
                    673,772Amortization
      of deferred financing costs on  secured convertible
      note
                    
                    
                    18,447
                    
                    
                    
                    107,170Bad
      debt expense
                    
                    
                    20,431
                    
                    
                    
                    100,000Gain
      from embedded and freestanding derivative liabilities relating to
      secured  convertible note
                    
                    
                    (675,691
                    )
                    
                    
                    (805,013
                    )Warrant
      expense for equipment lease and financing
                    
                    
                    3,940
                    
                    
                    
                    11,820Compensation
      expense from restricted shares and options
                    
                    
                    101,585
                    
                    
                    
                    170,804Changes in assets and
      liabilities:Accounts
      receivable
                    
                    
                    (113,262
                    )
                    
                    
                    (486,597
                    )Other
      receivable
                    
                    
                    442,291
                    
                    
                    
                    (289,538
                    )Inventory
                    
                    
                    25,571
                    
                    
                    
                    (33,491
                    )Prepaid
      expenses and other assets
                    
                    
                    (130,105
                    )
                    
                    
                    3,956Advances
      from customers
                    
                    
                    (215,788
                    )
                    
                    
                    (450,485
                    )Accounts
      payable
                    
                    
                    (139,406
                    )
                    
                    
                    336,166Accrued
      liabilities
                    
                    
                    209,496
                    
                    
                    
                    (28,006
                    )Net
      cash  provided by (used in) operating activities
                    
                    
                    1,135,346
                    
                    
                    
                    (1,024,867
                    )Cash
      flows from investing activities:Purchases
      of capital equipment
                    
                    
                    (45,387
                    )
                    
                    
                    (218,924
                    )Net
      cash used in investing activities
                    
                    
                    (45,387
                    )
                    
                    
                    (218,924
                    )Cash
      flows from financing activities:Payments
      on notes payable
                    
                    
                    (869,136
                    )
                    
                    
                    (1,713,337
                    )Payments
      on capital lease obligations
                    
                    
                    (51,727
                    )
                    
                    
                    (66,488
                    )Net
      cash used in financing activities
                    
                    
                    (920,863
                    )
                    
                    
                    (1,779,825
                    )Net
      increase (decrease) in cash and cash equivalents
                    
                    
                    169,096
                    
                    
                    
                    (3,023,616
                    )Cash
      and cash equivalents, beginning of period
                    
                    
                    1,196,310
                    
                    
                    
                    4,219,926Cash
      and cash equivalents, end of period
                    
                    $
                    1,365,406
                    
                    
                    $
                    1,196,310Supplemental
      Information:Cash
      paid during the period for interest
                    
                    $
                    72,173
                    
                    
                    $
                    235,209Cash
      paid during the period for income tax
                    
                    $
                    -
                    
                    
                    $
                    -Non-cash
      investing and financing activities:Capital
      expenditures funded by capital lease borrowings
                    
                    $
                    147,106
                    
                    
                    $
                    65,667





The
accompanying condensed 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, 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
                )
                
                $
                1,124,015Warrants
      reclassified from debt to APIC
                
                
                -
                
                
                
                -
                
                
                
                378,324
                
                
                
                -
                
                
                
                378,324Warrants
      issued for equipment financing
                
                
                -
                
                
                
                -
                
                
                
                3,940
                
                
                
                -
                
                
                
                3,940Restricted
      shares issued - compensation
                
                
                179,392
                
                
                
                1,794
                
                
                
                71,757
                
                
                
                -
                
                
                
                73,551Stock
      options issued - compensation
                
                
                -
                
                
                
                -
                
                
                
                28,035
                
                
                
                -
                
                
                
                28,035Common
      stock adjusted to par value
                
                
                -
                
                
                
                (173,602
                )
                
                
                173,602
                
                
                
                -
                
                
                
                -Net
      income for year ended June 30, 2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,235,947
                
                
                
                1,235,947Balance
      June 30, 2009
                
                
                19,099,539
                
                
                $
                190,995
                
                
                $
                29,121,334
                
                
                $
                (26,468,517
                )
                
                $
                2,843,812





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. We
conduct our business primarily through our wholly-owned subsidiary,
Pacific Biometrics, Inc., a Washington corporation. Our 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, 2009, we deemed one
client account receivable to be uncollectible in an amount of approximately
$16,000.





Other
accounts receivable consist of non-trade receivables such as state business and
occupation tax refunds, notes receivable and employee advances. These
receivables are stated at amounts per invoice or agreement and due from other
parties, net of an allowance for doubtful accounts. They are evaluated with the
same methods as utilized for trade accounts receivable.  At June 30,
2009, we had approximately $9,000 in other receivables.





The
balance of the bad debt allowance was approximately $34,000 and $29,000 for the
fiscal year ended June 30, 2009 and June 30, 2008, 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 chemical reagents used in
our laboratory testing.





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.


F-7


In
accordance with the Financial Accounting Standards Board’s Statements of
Financial Accounting Standards Statement No. 144 – “Accounting for the Impairment or
Disposal of Long-Lived Assets” (“SFAS 144”), all of our long-lived assets
are reviewed for impairment whenever events or changes in circumstances indicate
the carrying amount may not be recovered. If the sum of the expected future cash
flows is less than the carrying amount of the asset, a loss is recognized. As of
June 30, 2009 and 2008, no impairment was deemed necessary.





Client
Advances





We
receive advances from certain clients to perform consulting, laboratory
services, and clinical studies. We apply these advances as payments to invoices
as work is completed until the amounts advanced are
exhausted.  Advances are also applied to invoices for setup and
administrative fees, billed upon contract approval. These setup and
administrative fees are deferred as unearned income when billed and amortized
over the life of the project. As of June 30, 2009, approximately $272,000 was
reclassified to long-term client advance for a study that is on
hold.





Income
Taxes





We
account for income taxes under an asset and liability approach. This process
involves calculating the temporary and permanent differences between the
carrying amounts of the assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The temporary differences result
in deferred tax assets and liabilities, which would be recorded on our
Consolidated Balance Sheet in accordance with SFAS No. 109, Accounting for Income Taxes,
which established financial accounting and reporting standards for the effect of
income taxes. We must assess the likelihood that its deferred tax assets will be
recovered from future taxable income and, to the extent we believe that recovery
is not likely, we must establish a valuation allowance. Changes in our valuation
allowance in a period are recorded through the income tax provision on the
Consolidated Statement of Operations.





On
January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”)
Interpretation No. 48, Accounting for Uncertainty in Income
Taxes—An interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
entity’s financial statements in accordance with SFAS No. 109, “Accounting
for Income Taxes” and prescribes a recognition threshold and measurement
attributes for financial statement disclosure of tax positions taken or expected
to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax
position on the income tax return must be recognized at the largest amount that
is more-likely-than-not to be sustained upon audit by the relevant taxing
authority. An uncertain income tax position will not be recognized if it has
less than a 50% likelihood of being sustained. Additionally, FIN 48 provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. As a result of the
implementation of FIN 48, we recognized no material adjustment in the liability
for unrecognized income tax benefits. At the adoption date of January 1, 2007,
we had $176,639 of unrecognized tax benefits, none of which would affect its
effective tax rate if recognized.





Fair
Value of Financial Instruments





We
measure our financial assets and liabilities in accordance with generally
accepted accounting principles.  SFAS No. 157, “Fair Value
Measurements,” requires certain disclosures regarding the fair value of
financial instruments.  For certain of our financial instruments,
including cash and cash equivalents, accounts receivable, accounts payable and
accrued liabilities, the carrying amounts approximate fair value due to their
short maturities.





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS
157), which is effective for fiscal years beginning after November 15, 2008, and
for interim periods within those years.  This statement defines fair
value, establishes a framework for measuring fair value and expands the related
disclosure requirements.  The statement indicates, among other things,
that a fair value measurement assumes that the transaction to sell an asset or
transfer a liability occurs in the principal market for the asset or liability
or, in the absence of a principal market, the most advantageous market for the
asset or liability based upon an exit price model.


F-8


SFAS
No. 157 prescribes a fair value hierarchy in order to increase consistency
and comparability in fair value measurements and related
disclosures.  The hierarchy is broken down into three levels based on
the reliability of inputs as follows:
 
 •
              Level 1—Valuations
      based on quoted prices in active markets for identical
      assets.  Since valuations are based on quoted prices that are
      readily and regularly available in an active market, valuation of these
      products does not entail a significant degree of
  judgment.
 •
              Level 2—Valuations
      based on quoted prices in markets that are not active or for which all
      significant inputs are observable, directly or indirectly. Quoted prices
      for similar instruments in active markets, quoted prices for identical or
      similar instruments in markets that are not active, or other inputs that
      are observable or can be corroborated by observable market data for
      substantially the full term of the assets or
  liabilities.
 •
              Level 3—Valuations
      based on inputs that are unobservable and significant to the overall fair
      value measurement.
 
 Financial
Derivatives – Embedded Features
 
 Embedded
conversion and other features embedded in convertible notes are accounted for in
accordance with Statement of Financial  Accounting Standard No. 133
“Accounting for Derivative
Instruments and Hedging Activities” (“SFAS 133”) and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company’s Own Stock”
(“EITF 00-19”). SFAS 133 generally requires companies to bifurcate conversion
features embedded in convertible notes from their host instruments and to
account for them as freestanding derivative financial instruments in accordance
with EITF 00-19.
 
 Our
convertible notes host conversion features and other features that are deemed to
be embedded derivatives financial instruments or beneficial conversion features
based on the commitment date fair value of the underlying common stock. These
notes meet the definition of derivative financial instruments and have, where
applicable, been bifurcated from host instruments and are carried at fair value.
We record the value allocated to warrants issued with the convertible notes,
measured at fair value and recognized by allocating a portion of the proceeds to
derivative liabilities with an offset to discount on the convertible note. The
recorded discount is accreted as interest expense using the effective interest
method over the life of the debt.
 
 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 freestanding derivative financial instruments in
accordance with the provisions of EITF 00-19. Based on the provisions of EITF
00-19, we classify as equity any contracts that (i) require physical settlement
or net-share settlement or (ii) give us a choice of net-cash settlement or
settlement in its own shares (physical settlement or net-share settlement). We
classify as assets or liabilities any contracts that (i) require net-cash
settlement (including a requirement to net cash settle the contract if an event
occurs and if that event is outside our control) (ii) give the counterparty a
choice of net-cash settlement or settlement in shares (physical settlement or
net-share settlement). As of December 31, 2008, we paid the secured convertible
notes in full.
 
 Deferred
Debt Issue Cost
 
 The costs
relating to obtaining and securing debt financing are capitalized and expensed
over the term of the debt instrument. In the event of settlement in part or
whole of such debt in advance of the maturity date, an expense is recognized for
the remaining unamortized deferred debt issue cost. As of June 30, 2009 and June
30, 2008, there were unamortized balances of zero and $18,447.
 
 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.
  F-9
 
 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 years ended June 30:
 
 2009
                    
                    
                    2008Expected
      volatility
                    
                    
                    108.8
                    %
                    
                    
                    105.0
                    %Expected
      dividend yield
                    
                    
                    0
                    %
                    
                    
                    0
                    %Risk-free
      interest rate
                    
                    
                    3.9
                    %
                    
                    
                    4.0
                    %Expected
      life
                    
                    10
      years
                    
                    
                    10
      years
 
 We
granted 192,000 equity-based payment awards under our incentive compensation
plan for the fiscal year ended June 30, 2009. We did not grant any
incentive-based stock options for the fiscal year ended June 30, 2008. We issued
179,392 incentive-based restricted shares for the fiscal year ended June 30,
2009, compared to 200,000 incentive-based restricted shares for the fiscal year
ended June 30, 2008.
 
 Revenue
Recognition
 
 We
recognize revenue in the period that 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.
 
 Net
Income (Loss) Per Share
 
 Basic
income (loss) per share is based upon the weighted average number of our
outstanding common shares. Diluted income (loss) per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding stock options and warrants using the “treasury stock”
method. All per share calculations exclude treasury shares.
 
 For the
year ended June 30, 2009, we included common stock equivalents related to our
(i) in-the-money, vested options and (ii) in-the-money warrants in our
computation of diluted earnings per share. We included these items because we
had net income in this period. For the year ended June 30, 2008, we did not
include common stock equivalents related to our (i) in-the-money, vested options
and (ii) in-the-money warrants in the computation of diluted (loss) per share
because we had net losses in this period and the effect would be
anti-dilutive.
 
 As of
June 30, 2009, our common stock equivalents included:  (i)
in-the-money, vested options to purchase 233,167 shares of common stock and (ii)
in-the-money warrants to purchase 394,105 shares of common
stock.
 
 Components
of basic and diluted income (loss) per share were as follows for the year ended
June 30, 2009 and 2008:
  F-10
  Years
      endedJune 30,2009
                                
                                
                                2008Net
      income (loss)
                                (A)
                                
                                $
                                1,235,947
                                
                                
                                $
                                (571,429
                                )Net
      income (loss) applicable to common stockholders
                                (B)
                                
                                $
                                1,235,947
                                
                                
                                $
                                (571,429
                                )Weighted
      average number of outstandingshares
      of common stock
                                (C)
                                
                                
                                19,012,769
                                
                                
                                
                                18,812,306Weighted
      average number of outstandingshares
      of common stock and common stock equivalents
                                (D)
                                
                                
                                19,640,041
                                
                                
                                
                                18,812,306Income
      (loss) per share:Basic               
                       
                  (B/C)
                                
                                
                                $
                                0.07
                                
                                
                                $
                                (0.03
                                )Diluted                   
              
                    (A/D)
                                
                                
                                $
                                0.06
                                
                                
                                $
                                (0.03
                                )
  Comprehensive
Income
 
 We have
adopted Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive
Income,” which establishes standards for reporting comprehensive income
and its components in the financial statements.  Comprehensive income
consists of net income and other gains and losses affecting stockholders’ equity
that, under generally accepted accounting principles are excluded from net
income. For the year ended June 30, 2009 and 2008, our comprehensive income
(loss) equaled our net income (loss). Accordingly, a statement of comprehensive
income (loss) is not presented.
 
 Use
of Estimates
 
 In
preparing financial statements in conformity with U.S. GAAP, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
 
 Reclassification
  We have
reclassified $173,602 of  the common stock account into the Additional
paid-in capital account during the year ended June 30, 2009,  to
correct the amount recorded as par value. This reclassification has resulted in
no changes to our accumulated deficit or net losses
presented.
  New
Accounting Pronouncements
  In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”). The
Codification does not change current U.S. GAAP, but is intended to simplify user
access to all authoritative U.S. GAAP by providing all the authoritative
literature related to a particular topic in one place. The Codification will
supersede all existing non-SEC accounting and reporting standards. All other
non-grandfathered, non-SEC accounting literature not included in the
Codification will become nonauthoritative. SFAS 168 is effective for financial
statements issued for interim and annual periods ending after September 15,
2009.We do
not expect the adoption of SFAS 168 will have a material impact on our financial
condition or results of operation.
  In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46
(R)” (“SFAS 167”). SFAS 167 amends Interpretation FIN 46R related to the
consolidation of variable interest entities. It requires reporting entities to
perform an analysis to determine whether the enterprise's variable interest or
interests give it a controlling financial interest in a variable interest
entity. It changes the approach to determining a VIE's primary beneficiary from
a quantitative assessment to a qualitative assessment designed to identify a
controlling financial interest, and increases the frequency of required
reassessments to determine whether a company is the primary beneficiary of a
VIE. SFAS 167 is effective for periods beginning after November 15, 2009. We do
not expect the adoption of SFAS 167 will have a material impact on our financial
condition or results of operation.
  F-11
  In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets, an amendment of FASB Statement No. 140” (“SFAS 166”). SFAS 166 removes
the concept of a qualifying special-purpose entity from Statement 140 and
removes the exception from applying FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, to qualifying
special-purpose entities. In addition, this statement amends the criteria
for a transfer of a financial asset to be accounted for as a sale, requires more
information about transfers of financial assets, including securitization
transactions, and provides for new disclosures. SFAS 166 is effective for fiscal
years beginning after November 15, 2009. We do not expect the adoption of SFAS
166 will have a material impact on our financial condition or results of
operation.
  In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. SFAS 165 is effective for interim and annual periods
ending after June 15, 2009. We have complied with the requirements of SFAS
165.
  In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly.” This FSP provides additional
guidance for estimating fair value in accordance with FASB Statement No. 157,
Fair Value Measurements, when the volume and level of activity for the asset or
liability have significantly decreased. This FSP also includes guidance on
identifying circumstances that indicate a transaction is not orderly. This FSP
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the measurement
date under current market conditions. FSP FAS 157-4 is effective for interim and
annual reporting periods ending after June 15, 2009, and is applied
prospectively. We do not believe that the implementation of this standard will
have a material impact on our financial statements.
  In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about
Fair Value of Financial Instruments”. This FSP amends FASB Statement No. 107,
“Disclosures about Fair Value of Financial Instruments” to require disclosures
about fair value of financial instruments for interim reporting periods of
publicly traded companies as well as in annual financial statements. This FSP
also amends APB Opinion No. 28, Interim Financial Reporting, to require those
disclosures in summarized financial information at interim reporting periods.
FSP FAS 107-1 and APB 28-1 are effective for interim and annual reporting
periods ending after June 15, 2009. We do not believe that the implementation of
this standard will have a material impact on our financial
statements.
  In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation
of Other-Than-Temporary Impairments”. This FSP amends the other-than-temporary
impairment guidance for debt securities to make the guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments in the financial statements. The most significant change the FSP
brings is a revision to the amount of other-than-temporary loss of a debt
security recorded in earnings. FSP FAS 115-2 and FAS 124-2 are effective for
interim and annual reporting periods ending after June 15, 2009. We do not
believe that the implementation of this standard will have a material impact on
our financial statements.
  In
November of 2008, the SEC released a proposed roadmap regarding the potential
use by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards (“IFRS”). IFRS is a comprehensive
series of accounting standards published by the International Accounting
Standards Board (“IASB”). Under the proposed roadmap, we may be required in
fiscal 2015 to prepare financial statements in accordance with IFRS. However,
the SEC will make a determination in 2011 regarding the mandatory adoption of
IFRS. We are currently assessing the impact that this potential change would
have on our consolidated financial statements, and we will continue to monitor
the development of the potential implementation of IFRS.
  F-12
  In
October 2008, the FASB issued FASB Staff Position, or FSP, SFAS 157-3,
“Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active.” FSP SFAS 157-3 clarifies the application of SFAS
No. 157 in a market that is not active and addresses application issues
such as the use of internal assumptions when relevant observable data does not
exist, the use of observable market information when the market is not active
and the use of market quotes when assessing the relevance of observable and
unobservable data. FSP SFAS 157-3 is effective for all periods presented in
accordance with SFAS No. 157. The guidance in FSP SFAS 157-3 is
effective immediately and did not have any significant impact on us upon
adoption.
  Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force ("EITF"), the American Institute of Certified Public
Accountants ("AICPA"), and the SEC did not or are not believed by us to have a
material impact on our present or future financial statements.
  We have
adopted all recently issued accounting pronouncements. The adoption of the
accounting pronouncements, including those not yet effective, is not anticipated
to have a material effect on the financial position or results of our
operations.
  3.
              Concentration
      of Credit Risk
 
 Our
largest client in fiscal 2009 individually accounted for approximately 27% of
our total revenues, while our largest client in fiscal 2008 accounted for
approximately 14% of our total revenues. As of June 30, 2009 and 2008,
respectively, approximately 41% and 14% of our accounts receivable balance were
from the two largest clients at that time. These were different clients in each
fiscal period. Component clients included in the largest client calculation may
vary from period to period.
 
 The
majority of our clients are pharmaceutical companies, many of which are on the
list of Fortune 1000 companies. For our revenue calculations, we aggregate
revenues we receive from several divisions within a pharmaceutical company
client as one single client.  For the year ended June 30, 2009, 60% of
our revenue was derived from Fortune 1000 clients compared to 39% 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 $865,406 at June 30, 2009 and by $896,310 at June 30, 2008.
FDIC limits were increased from $100,000 per insured account to $250,000 per
insured account effective October 10, 2008. The new FDIC limits expire on
December 31, 2009.
 
 4.
              Prepaid
      Expenses and Other Assets
 
 Prepaid
expenses consisted of the following at June 30:
 
 2009
                        
                        
                        2008Insurance
                        
                        $
                        95,837
                        
                        
                        $
                        9,747Service
      Contracts
                        
                        
                        22,308
                        
                        
                        
                        31,198Trade
      Show and Conference Fees
                        
                        
                        14,335
                        
                        
                        
                        10,975Security
      and Lease Deposits
                        
                        
                        9,759
                        
                        
                        
                        3,415Laboratory
      Information System Software
                        
                        
                        —
                        
                        
                        
                        6,995Debt Financing
      Broker Fee
                        
                        
                        —
                        
                        
                        
                        25,000Other
                        
                        
                        88,735
                        
                        
                        
                        13,539$
                        230,974
                        
                        
                        $
                        100,869
  F-13
  5.
              Property
      and Equipment
 
 Property
and equipment consisted of the following at June 30:
 
 2009
                                                
                                                
                                                2008Laboratory
      equipment
                                                
                                                $
                                                1,497,275
                                                
                                                
                                                $
                                                1,361,980Computer
      equipment
                                                
                                                
                                                394,020
                                                
                                                
                                                
                                                388,062Internal
      use software
                                                
                                                
                                                233,477
                                                
                                                
                                                
                                                233,477Office
      furniture and equipment
                                                
                                                
                                                213,097
                                                
                                                
                                                
                                                211,857Leasehold
      improvements
                                                
                                                
                                                238,262
                                                
                                                
                                                
                                                238,262Total
      property and equipment
                                                
                                                
                                                2,576,131
                                                
                                                
                                                
                                                2,433,638Less:
      accumulated depreciation and amortization
                                                
                                                
                                                1,762,873
                                                
                                                
                                                
                                                1,549,117Net
      property and equipment
                                                
                                                $
                                                813,258
                                                
                                                
                                                $
                                                884,521
 
 At June
30, 2009 and 2008, respectively, these amounts included assets under capital
leases of $553,621 and $500,987, and related accumulated amortization of
$380,716 and $387,695.  Depreciation expense for the fiscal years
ended June 30, 2009 and 2008 was $263,756 and $236,004,
respectively.
 
 6. Accrued
Liabilities
 
 Accrued
liabilities consisted of the following at June 30:
  2009
                              
                              
                              2008Accrued
      bonuses
                              
                              $
                              204,738
                              
                              
                              $
                              73,463Accrued
      payroll and related payroll taxes
                              
                              
                              178,684
                              
                              
                              
                              158,120Accrued
      vacation
                              
                              
                              88,348
                              
                              
                              
                              76,965Accrued
      audit fees
                              
                              
                              65,000
                              
                              
                              
                              46,677Accrued
      board of directors fees
                              
                              
                              25,000
                              
                              
                              
                              18,750Accrued
      interest expense
                              
                              
                              2,493
                              
                              
                              
                              5,717Accrued
      Laurus note costs due to third party
                              
                              
                              -
                              
                              
                              
                              33,756Accrued
    401(k)
                              
                              
                              -
                              
                              
                              
                              1,652Accrued
      fees due to PBRF
                              
                              
                              -
                              
                              
                              
                              7,835Other
                              
                              
                              95,985
                              
                              
                              
                              27,853$
                              660,284
                              
                              
                              $
                              450,788
  F-14
 
 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 19.35% and mature at various dates through 2014. Annual future minimum
lease payments for years subsequent to June 30, 2009 are as
follows:
 
 2010
                            
                            $
                            88,5132011
                            
                            
                            88,5132012
                            
                            
                            61,8972013
                            
                            
                            26,0282014
                            
                            
                            6,284Total
      minimum payments
                            
                            
                            271,235Less:
      amount representing interest
                            
                            
                            (52,217
                            )Obligations
      under capital leases
                            
                            $
                            219,018Total
      minimum payments
                            
                            $
                            219,018Less:
      current portion
                            
                            
                            62,709Long-term
      portion
                            
                            $
                            156,309
 
 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. Both notes were
paid in full during fiscal 2009.
  In
connection with both Notes, the terms were:
 
 ·
              Interest:  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 were met. The interest rate for both Notes was equal
      to 6.6% and 7% for the fiscal years ended June 30, 2009 and 2008,
      respectively.
 
 ·
              Monthly
      payments: Required accrued interest payments beginning July 1, 2004 (May
      2004 Note) and March 1, 2005 (January 2005 Note).  Commencing
      December 1, 2004, 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).
 
 ·
              Prepayment:  We
      could 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.  Laurus waived this prepayment fee on the final
      payment made December 30, 2008 which was due by January 31,
      2009.
 
 ·
              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.
 
 ·
              Conversion
      and Embedded Derivative Liability:  For each monthly payment
      under either Note, Laurus would be obligated to convert a portion of the
      monthly payment into common stock at the applicable conversion price, if
      certain specified conditions were met. Through December 30, 2008, Laurus
      had converted $710,200 in principal into 670,000 shares of our common
      stock. 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.  Prices for the Notes ($1.06 and $1.17 per share) were
      subject to certain anti-dilution adjustments, including full ratchet
      anti-dilution, if we issued convertible or equity securities at a price
      per share less than the conversion price. As of May 2004, we recorded
      embedded derivative liability in the amount of $683,962, representing the
      value of the conversion feature.  As of January 2005, we
      recorded embedded derivative liability in the amount of $589,743,
      representing the value of the conversion
  feature.
  F-15
 
 ·
              Warrants
      and Free Standing Derivative Liability:  We issued Laurus
      warrants to purchase up to 681,818 shares of common stock at an exercise
      price of $1.25, recorded to the freestanding derivative liability, in the
      amount of $573,266 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, recorded to the freestanding derivative liability, in the amount of
      $229,898 exercisable at any time prior to January 31, 2012.  In
      accounting for the issuance of the new warrants, we recorded amounts to
      the freestanding derivative liability associated with the convertible
      note; 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 a total of 1,000,000 shares issued on May 6, 2005, $383,013
      allocated to the May 2004 Note and $244,356 allocated to the January 2005
      Note.
 
 ·
              Deferred
      financing costs:  We incurred and recorded fees of $293,500 as
      deferred financing costs, which were being amortized to other expense over
      the life of the note. This amount included 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, 2009, the unamortized balance of the
      deferred financing costs was zero.
 
 ·
              Laurus Waiver — May 2004 $2.5
      million Secured Convertible
Note
 
 o
              On
      January 31, 2005, Laurus formally agreed to extend the principal payment
      portion of any monthly amount due for the six-month period from December
      2004 through May 2005.  The 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.
 
 ·
              Laurus Deferral and Extension
      — May 2004 $2.5 million and January 2005 $1.5 million Secured Convertible
      Notes
 
 o
              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 Notes.
 
 o
              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 31, 2009, respectively. There was no change
      in the interest rate charged by Laurus on the unpaid
      principal.
 
 o
              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.
 
 At June
30, 2009, the principal balance of both Laurus Notes is zero. The remaining
principal and interest due under the May 2004 Note was paid July 28,
2008.  The remaining principal and interest due under the January 2005
Note that held a maturity date of January 31, 2009, was paid early totaling
$50,317, on December 30, 2008.
 
 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 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.  We
recognized expenses related to the grant of the warrants in the fiscal years
ended June 30, 2009 and June 30, 2008 of approximately $3,940 and $11,820,
respectively.  The final payment of principal and interest was paid in
the amount of $46,462 on December 29, 2008.
  F-16
  Summary
of Laurus and Franklin Funding Notes Payable
 
 We had
the following other notes payable as of June 30:
  2009
                                      
                                      
                                      2008May 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
                                      
                                      
                                      (1,756,851
                                      )
                                      
                                      
                                      (1,373,132
                                      )Less:
      Fair value of conversion feature and warrants
                                      
                                      
                                      (32,949
                                      )
                                      
                                      
                                      (32,949
                                      )-
                                      
                                      
                                      
                                      383,719Less:
      Current Portion
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (383,719
                                      )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
                                      
                                      
                                      (1,444,815
                                      )
                                      
                                      
                                      (1,150,000
                                      )Less:
      Fair value of conversion feature and warrants
                                      
                                      
                                      (55,185
                                      )
                                      
                                      
                                      (55,185
                                      )-
                                      
                                      
                                      
                                      294,815Less:
      Current Portion
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (294,815
                                      )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 paid in full
      November 2008, principal balance only
                                      
                                      
                                      -
                                      
                                      
                                      
                                      96,492Principal
      balance plus interest
                                      
                                      
                                      -
                                      
                                      
                                      
                                      102,467Less:
      Current Portion
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (102,467
                                      )Long-Term
      Portion
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
  F-17
  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:
 
 2009
                            
                            
                            2008Tax
      benefit computed at federal statutory rate
                            
                            $
                            421,000
                            
                            
                            $
                            (194,000
                            )Permanent
      differences
                            
                            
                            (186,000
                            )
                            
                            
                            63,000Valuation
      allowance (tax benefit of recognizing prior year net operating loss
      carryforward)
                            
                            $
                            (235,000
                            )
                            
                            $
                            131,000$
                            -
                            
                            
                            $
                            -
 
 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
our net deferred tax assets are approximately as follows at June
30:
 
 2009
                        
                        
                        2008Net
      deferred tax asset:Net
      operating loss carryforward
                        
                        $
                        5,019,000
                        
                        
                        $
                        5,239,000Research
      and experimentation credit
                        
                        
                        326,000
                        
                        
                        
                        326,000Effect
      of stock option variable pricing
                        
                        
                        331,000
                        
                        
                        
                        297,000Accrued
      liabilities
                        
                        
                        19,000
                        
                        
                        
                        17,000Allowance
      for bad debts
                        
                        
                        12,000
                        
                        
                        
                        44,000Depreciation
      and amortization
                        
                        
                        (7,000
                        )
                        
                        
                        12,0005,700,000
                        
                        
                        
                        5,935,000Less
      valuation allowance
                        
                        
                        (5,700,000
                        )
                        
                        
                        (5,935,000
                        )$
                        -
                        
                        
                        $
                        -
 
 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 our
effective tax rate is as follows:
 
 June
      30, 2009
                          
                          
                          June
      30, 2008Statutory
      regular federal income benefit rate
                          
                          
                          34.0
                          %
                          
                          
                          34.0
                          %Other
                          
                          
                          (11.0
                          )%
                          
                          
                          (11.0
                          )%Change
      in valuation allowance
                          
                          
                          (23.0)
                          %
                          
                          
                          (23.0)
                          %Total
                          
                          
                          0.0
                          %
                          
                          
                          0.0
                          %
 
 At June
30, 2009, 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 $5,697,000
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, 2009, the
valuation allowance was decreased by approximately $235,000. For the fiscal year
ended June 30, 2008, the valuation allowance was increased by approximately
$193,000, respectively.
 
 Internal
Revenue Code Section 382 places a limitation on the amount of taxable income
that can be offset by carryforwards after a change in control (generally greater
than 50% change in ownership).  As a result of these provisions,
utilization of the NOL and credit carryforwards may be limited.
  F-18
 
 10. Stock
Option Plan
 
 1996
Stock Incentive Plan
 
 Our 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 have been either incentive stock options within the meaning of Section
422(b) of the Internal Revenue Code, or nonqualified options. Our 1996 Stock
Incentive Plan expired during fiscal 2007, but outstanding options and awards
previously granted under the 1996 Plan continue in accordance with their
terms.
 
 2005
Stock Incentive Plan
 
 We have 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 restricted stock or performance shares. 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, 2009, 1,956,211 shares of common stock remained
available for future grant under the 2005 Plan.
 
 The
following is a summary of the activity in the1996 and 2005 Plans for the years
ended June 30, 2009 and 2008:
 Shares
      Under OptionNumber
                
                
                Weighted
      Average
                
                
                Weighted
      AverageOf
                
                
                Exercise
      Price per
                
                
                Fair
      Value ofShares
                
                
                share
                
                
                Options
      Granted1996
      Plan Options at June 30, 2007
                
                
                1,353,9072005
      Plan Options at June 30, 2007
                
                
                130,245Total Options
      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
                
                
                $
                0.861996 and 2005 Plan
      OptionsGranted
                
                
                -
                
                
                
                -Exercised
                
                
                -
                
                
                
                -Terminated
      (1996 Plan)
                
                
                (2,000
                )
                
                
                0.81Terminated
      (2005 Plan)
                
                
                (9,082
                )
                
                
                0.99Total Options
      outstanding at June 30, 2008
                
                
                1,473,070
                
                
                $
                0.812005 Plan Restricted
      SharesGranted
                
                
                200,000
                
                
                
                0.73
                
                
                
                0.73Options
      and Restricted Shares outstanding at June 30, 2008
                
                
                2,216,304
                
                
                $
                0.761996 and 2005 Plan
      OptionsGranted
      (2005 Plan)
                
                
                192,000
                
                
                
                0.41Exercised
                
                
                -
                
                
                
                -Terminated
      (1996 Plan)
                
                
                (228,018
                )
                
                
                0.81Terminated
      (2005 Plan)
                
                
                (6,667
                )
                
                
                0.99Total Options
      outstanding at June 30, 2009
                
                
                1,430,385
                
                
                $
                0.762005 Plan Restricted
      SharesGranted
                
                
                179,392
                
                
                
                0.41
                
                
                
                0.41Options
      and Restricted Shares outstanding at June 30, 2009
                
                
                2,353,011
                
                
                $
                0.59
 The
weighted average contractual life remaining of options outstanding at June 30,
2009 is approximately 5.5 years.
  F-19
 
 As of
June 30, 2009, outstanding options had exercise periods which expired over the
following time periods:
 
 Weighted
      AverageRemaining
      LifeExercise Price
                                              
                                              Number Outstanding
                                              
                                              
                                              (in years)
                                              
                                              
                                              Number Exercisable$
                                              0.41
                                              
                                              
                                              192,000
                                              
                                              
                                              
                                              9.3
                                              
                                              
                                              
                                              48,000$
                                              0.51
                                              
                                              
                                              175,167
                                              
                                              
                                              
                                              3.2
                                              
                                              
                                              
                                              175,167$
                                              0.70
                                              
                                              
                                              1,000
                                              
                                              
                                              
                                              5.2
                                              
                                              
                                              
                                              1,000$
                                              0.81
                                              
                                              
                                              702,722
                                              
                                              
                                              
                                              4.5
                                              
                                              
                                              
                                              702,722$
                                              0.86
                                              
                                              
                                              125,000
                                              
                                              
                                              
                                              6.2
                                              
                                              
                                              
                                              125,000$
                                              0.90
                                              
                                              
                                              2,000
                                              
                                              
                                              
                                              4.6
                                              
                                              
                                              
                                              2,000$
                                              0.96
                                              
                                              
                                              90,000
                                              
                                              
                                              
                                              5.5
                                              
                                              
                                              
                                              90,000$
                                              0.99
                                              
                                              
                                              114,496
                                              
                                              
                                              
                                              7.2
                                              
                                              
                                              
                                              108,135$
                                              1.01
                                              
                                              
                                              1,000
                                              
                                              
                                              
                                              5.0
                                              
                                              
                                              
                                              1,000$
                                              1.15
                                              
                                              
                                              25,000
                                              
                                              
                                              
                                              6.5
                                              
                                              
                                              
                                              25,000$
                                              1.75
                                              
                                              
                                              2,000
                                              
                                              
                                              
                                              4.4
                                              
                                              
                                              
                                              2,0001,430,385
                                              
                                              
                                              
                                              5.4
                                              
                                              
                                              
                                              1,280,024
 
 As of
June 30, 2009, the fair value of options to be vested is $302,561.
 
 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, 2009 and
2008:
 
 Exercise
      Price
                            per Share
                          
                          
                          Weighted
                            Average
                            Exercise
      Price
                            per Share
                          
                          
                          NumberWarrants
      outstanding at June 30, 2008
                          
                          $
                          0.1875 - $1.60
                          
                          
                          $
                          1.25
                          
                          
                          
                          4,149,677Warrants
      outstanding at June 30, 2009
                          
                          $
                          0.51 - $1.60
                          
                          
                          $
                          1.22
                          
                          
                          
                          3,898,027
 
 12.  Commitments
and Contingencies
 
 Operating
Leases
 
 On
January 20, 1998, we entered into a non-cancelable operating lease for office
facilities and laboratory space. Under the current lease we are responsible
for our proportionate share of real estate taxes, insurance and common area
maintenance costs. 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 30,2010
                            
                            
                            313,6692011
                            
                            
                            322,9202012
                            
                            
                            282,1382013
                            
                            
                            91,668$
                            1,010,395
  F-20
 
 Security
Interest
 
 In
connection with its secured convertible note agreements, we granted to Laurus
Master Fund, Ltd. a security interest in all of our assets. Franklin Funding
also had a security interest in the equipment it has financed. Both of these
security interests terminated in fiscal 2009 with the payment in full
of these debts. See Note 14 below.
 
 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, 2009, our matching expense was $74,324 and 401(k) payable balance as of
June 30, 2009 was $0.
 
 14.
Subsequent Events
 
 On
September 1, 2009, subsequent to the end of the 2009 fiscal year, we closed a
new debt facility with Terry M. Giles, a former member of our Board of
Directors, for $4 million term loan. In connection with the loan, we granted to
Mr. Giles a security interest in all of our assets. We issued a promissory note
to Mr. Giles for the loan and each of our subsidiaries entered into a Subsidiary
Guarantee with Mr. Giles to guarantee the Loan. In addition, during the first 12
months of the term of the loan, we have the right, in our sole discretion, to
obtain an additional $500,000 loan from Mr. Giles on the same terms. In
connection with and as required by the Loan, on September 1, 2009, we also
repurchased 2,391,906 shares of common stock from certain stockholders at a
price of $0.70 per share, pursuant to a Stock Redemption Agreement. We received
net loan proceeds of $2,325,665.80, after payment of the stock repurchase but
excluding our legal and other expenses for the transaction. We intend to use the
net proceeds of the loan to fund our working capital and growth needs, and in
particular our development efforts for our biomarker business.
  F-21