UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Mark One

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                     

CLARIENT, INC.

(Exact name of registrant as specified in its charter)

Delaware		75-2649072
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)
31 Columbia
Aliso Viejo, California		92656-1460
(Address of principal executive offices)		(Zip code)

(949) 425-5700
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

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

The number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

Class		Outstanding at April 29, 2010
Common Stock, $0.01 par value per share		85,526,032 shares

 

 

CLARIENT, INC. AND SUBSIDIARIES

Table of Contents

		Page
		No.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)			3
Condensed Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009			3
Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009			4
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3. Quantitative and Qualitative Disclosures About Market Risk			39
Item 4. Controls and Procedures			40
PART II — OTHER INFORMATION
Item 1A. Risk Factors			40
Item 6. Exhibits			41
SIGNATURES			42
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

CLARIENT, INC. AND SUBSIDIARIES

(in thousands, except par values)

		March 31,				December 31,
		2010				2009
ASSETS
Current assets:
Cash and cash equivalents		$	10,928			$	10,903
Restricted cash			767				765
Accounts receivable, net of allowance for doubtful accounts of $10,579 and $8,747 at March 31, 2010 and December 31, 2009, respectively			24,324				21,568
Supplies inventory			1,021				1,291
Prepaid expenses and other current assets			1,037				935
Total current assets			38,077				35,462
Restricted cash			1,314				1,314
Property and equipment, net			13,564				14,346
Intangible assets, net			11,218				11,639
Goodwill			3,959				3,959
Other assets			203				227
Total assets		$	68,335			$	66,947
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Revolving line of credit		$	4,187			$	2,678
Accounts payable			4,073				2,883
Accrued payroll			3,556				3,985
Accrued expenses and other current liabilities			3,230				3,984
Current maturities of capital lease obligations			620				645
Total current liabilities			15,666				14,175
Long-term capital lease obligations			469				604
Deferred rent and other non-current liabilities			2,887				3,055
Contingently issuable common stock			—				2,650
Commitments and contingencies
Preferred stock subject to redemption requirements outside the control of the issuer:
Series A convertible preferred stock $0.01 par value, authorized 8,000 shares, issued and outstanding 5,263 shares at March 31, 2010 and December 31, 2009, respectively. Aggregate liquidation preference and redemption value: March 31, 2010 and December 31, 2009—$55,156 and $55,800, respectively			38,586				38,586
Stockholders’ equity:
Common stock $0.01 par value, authorized 150,000 shares, issued and outstanding 84,827 and 84,092 at March 31, 2010 and December 31, 2009, respectively			841				841
Additional paid-in capital			175,420				172,200
Accumulated deficit			(165,534	)			(165,164	)
Total stockholders’ equity			10,727				7,877
Total liabilities and stockholders’ equity		$	68,335			$	66,947

See accompanying notes to Condensed Consolidated Financial Statements.

CLARIENT, INC. AND SUBSIDIARIES

(in thousands, except per share amounts)

(Unaudited)

		Three Months Ended
		March 31,
		2010				2009
Net revenue		$	26,620			$	23,192
Cost of services			11,167				8,957
Gross profit			15,453				14,235
Operating expenses:
Sales and marketing			4,567				4,288
General and administrative			6,225				5,518
Bad debt			3,572				2,715
Research and development			1,326				200
Total operating expenses			15,690				12,721
Income (loss) from operations			(237	)			1,514
Interest expense, net of interest income of $7 and $1 in the three months ended March 31, 2010 and 2009, respectively			102				190
Interest expense to related party			—				2,980
Other expense (Note 14)			31				—
Loss from continuing operations before income taxes			(370	)			(1,656	)
Income tax benefit			—				599
Loss from continuing operations, net of income taxes			(370	)			(1,057	)
Income from discontinued operations, net of income taxes			—				901
Net loss		$	(370	)		$	(156	)
Net income (loss) per share applicable to common stockholders — basic and diluted (Note 9):
Loss from continuing operations		$	(0.00	)		$	(0.01	)
Income from discontinued operations			—				0.01
Net loss applicable to common stockholders		$	(0.00	)		$	(0.00	)
Weighted-average shares used to compute net income (loss) per common share:
Basic and diluted			83,648				77,003

See accompanying Notes to Condensed Consolidated Financial Statements.

CLARIENT, INC. AND SUBSIDIARIES

(in thousands)

(Unaudited)

		Three Months Ended
		March 31,
		2010				2009
Cash flows from operating activities:
Net loss		$	(370	)		$	(156	)
Income from discontinued operations, net of income taxes			—				(901	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			1,056				811
Bad debt expense			3,572				2,715
Amortization of warrants to related party interest expense			—				2,103
Amortization of deferred financing and offering costs			4				319
Amortization of intangible assets			421				—
Interest on related party debt			—				868
Stock-based compensation			443				570
Issuance of common stock in consideration for research and development services			75				—
Income tax benefit			—				(599	)
Mark to market adjustment for contingently issuable shares (Note 14)			31				—
Changes in operating assets and liabilities:
Interest on restricted cash			(1	)			—
Accounts receivable, net			(6,328	)			(8,468	)
Inventories			236				(136	)
Prepaid expenses and other assets			(82	)			(1,883	)
Accounts payable			1,467				865
Accrued payroll			(429	)			(1,028	)
Accrued expenses and other current liabilities			(628	)			1,075
Deferred rent and other non-current liabilities			(168	)			(557	)
Net cash used in operating activities			(701	)			(4,402	)
Cash flows from investing activities:
Purchases of property and equipment			(677	)			(1,519	)
Increase in restricted cash			(1	)			(2,814	)
Proceeds from sale of discontinued operations, net of selling costs			—				1,500
Net cash used in investing activities			(678	)			(2,833	)
Cash flows from financing activities:
Proceeds from sale of preferred stock			—				29,132
Offering costs from sale of preferred stock			—				(1,052	)
Proceeds from exercise of stock options and warrants			21				—
Repayments on capital lease obligations			(126	)			(64	)
Borrowings on revolving lines of credit			21,870				15,945
Repayments on revolving lines of credit			(20,361	)			(24,162	)
Borrowings on related party debt			—				5,800
Repayments on related party debt			—				(15,500	)
Net cash provided by financing activities			1,404				10,099
Effect of exchange rate changes on cash and cash equivalents			—				1
Net increase in cash and cash equivalents			25				2,865
Cash and cash equivalents at beginning of period			10,903				1,838
Cash and cash equivalents at end of period		$	10,928			$	4,703
Supplemental disclosure of cash flow information:
Cash paid for interest		$	112			$	2,238
Cash paid for income taxes			—				—
Non cash investing and financing activities:
Property and equipment financed by capital leases		$	—			$	1,215
Property and equipment additions included in accounts payable			121				590
Issuance of warrants in connection with borrowings from related party			—				600

See accompanying Notes to Condensed Consolidated Financial Statements

CLARIENT, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(1) Description of Business, Basis of Presentation, and Operating Segment

(a) Description of Business

Clarient, Inc. and its wholly-owned subsidiaries (the “Company”) comprise an advanced oncology diagnostic services company, headquartered in Aliso Viejo, California. The Company’s mission is to help improve the lives of those affected by cancer through translating cancer discoveries into better patient care. The Company combines innovative technologies, clinically meaningful diagnostic tests, and world-class pathology expertise to provide advanced diagnostic services that assess and characterize cancer for physicians treating their patients, as well as for biopharmaceutical companies in the process of clinically testing various therapies. The Company’s customers are connected to its Internet-based portal, PATHSiTE^®, that delivers high resolution images and interpretative reports resulting from the Company’s diagnostic testing services.

California prohibits general corporations from engaging in the practice of medicine pursuant to both statutory and common law principles commonly known as the Corporate Practice of Medicine Doctrine (“CPMD”). In general, the CPMD prohibits non-professional corporations from employing physicians and certain other healthcare professionals who provide professional medical services. All of the Company’s pathology services are provided by, or are under the supervision of, Clarient Pathology Services, Inc. (“CPS”) under a long-term, exclusive professional services agreement by and between the Company and CPS, as amended on September 1, 2009 (the “Professional Services Agreement”). Kenneth J. Bloom, M.D. is the sole stockholder and president of CPS. Dr. Bloom also serves as the Company’s Chief Medical Officer (“CMO”), a senior management function primarily involving the technical oversight of the Company’s diagnostics services laboratory.

The Company is responsible for performing a variety of non-medical administrative services for CPS, as required under the Professional Services Agreement. The Company bills and collects for the pathology services provided by CPS. The Company, in turn, pays CPS a monthly professional services fee equal to the aggregate of all estimated CPS physician salaries and benefits, and all other operating costs of CPS.

(b) Basis of Presentation

The accompanying interim Condensed Consolidated Financial Statements of the Company were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the interim financial statements rules and regulations of the United States Securities and Exchange Commission (“SEC”). These financial statements include the financial position, results of operations, and cash flows of the Company, and the accounts of CPS, which are consolidated as required by applicable GAAP. All inter-company accounts and transactions have been eliminated in consolidation.

The preparation of the accompanying Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions. Such estimates and assumptions affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes thereto. The Company’s most significant estimates relate to revenue recognition, allowance for doubtful accounts, and stock-based compensation expense. Actual results could differ from those estimates. As part of the interim financial statement preparation process, the Company also has evaluated whether any significant events have occurred after the balance sheet date of March 31, 2010 through May 3, 2010, representing the date this Quarterly Report on Form 10-Q was filed with the SEC, and concluded that no additional disclosures or adjustments were required.

The interim operating results are not necessarily indicative of the results for a full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations relating to interim financial statements. The Condensed Consolidated Financial Statements included in this Form 10-Q should be read in conjunction with the Company’s audited Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

(c) Operating Segment

The Company has one reportable operating segment that delivers advanced oncology diagnostic services to community pathologists, oncologists, and biopharmaceutical companies. As of March 31, 2010, all of the Company’s services were provided within the United States, and all of the Company’s assets were located within the United States.

(2) Summary of Significant Accounting Policies

(a) Revenue Recognition

Net revenue for the Company’s diagnostic services is recognized on an accrual basis at the time discreet diagnostic tests are completed. Each test performed relates to a specimen encounter derived from a patient, and received by the Company on a specific date (such encounter is commonly referred to as an “accession”). The Company’s services are billed to various payors, including Medicare, private health insurance companies, healthcare institutions, biopharmaceutical companies, and patients. The Company reports net revenue from contracted payors, including certain private health insurance companies, healthcare institutions, and biopharmaceutical companies, based on the contracted rate, or in certain instances, the Company’s estimate of the amount expected to be collected for the services provided. For billing to Medicare, the Company uses the published fee schedules, net of standard discounts (commonly referred to as “contractual allowances”). The Company reports net revenue from non-contracted payors, including certain private health insurance companies, based on the amount expected to be collected for the services provided. Revenue from patient payors is based on a multiple of the Centers for Medicare & Medicaid Services (CMS) reimbursement schedule, or as applicable, patients’ co-pay or deductible obligations.

(b) Allowance for Doubtful Accounts and Bad Debt Expense

An allowance for doubtful accounts is recorded for estimated uncollectible amounts due from the Company’s various payor groups. The process for estimating the allowance for doubtful accounts involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically, and is principally based upon an evaluation of historical collection experience of accounts receivable by age for the Company’s various payor classes. After appropriate collection efforts, accounts receivable are written off and deducted from the allowance for doubtful accounts. Additions to the allowance for doubtful accounts are charged to bad debt expense. The payment realization cycle for certain governmental and managed care payors can be lengthy, involving denial, appeal, and adjudication processes, and is subject to periodic adjustments that may be significant.

(c) Stock-Based Compensation

The Company records compensation expense related to stock-based awards, including stock options and restricted stock, based on the fair value of the award, which is determined using the Black-Scholes option-pricing model. Stock-based compensation expense recognized during the period is based on the fair value of the portion of the stock-based awards that are ultimately expected to vest, and thus, the gross expense is reduced for estimated forfeitures. The Company recognizes stock-based compensation expense over the vesting period using the straight-line method for employees and ratably as tranches vest for non-employees. The Company classifies compensation expense related to these awards based on the department to which the recipient reports.

(d) Long-Lived Assets

The Company evaluates the possible impairment of its long-lived assets when events or changes in circumstances occur that indicate that the carrying value of its assets may not be recoverable. Recoverability of assets to be held and used is measured by the comparison of the carrying value of such assets to the Company’s pretax cash flows (undiscounted and without interest charges) expected to be generated from their use in Company operations. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds fair value. Assets held for sale, when applicable, are reported at the lower of the carrying amount or fair value, less costs to sell.

One potential impairment indicator is current-period operating and/or cash flow loss, combined with a history of operating and/or cash flow losses. Because this condition applies to the Company, management evaluates the Company’s asset group for impairment at the end of each reporting period. The asset group tested for impairment comprises the Company’s entire laboratory operation, representing the lowest level of its separately identifiable cash flows. The impairment evaluation uses the Company’s operating plan and associated cash flow projection in determining the undiscounted cash flows expected to be generated by its asset group through continuing operations. Such undiscounted cash flows are next compared to the carrying amount of the asset group to determine if an impairment of the asset group is indicated.

The undiscounted net cash flows expected to be generated by the Company’s asset group exceeded the carrying amount of the asset group as of March 31, 2010 and December 31, 2009, therefore, the Company’s asset group is not considered to be impaired. Such conclusion is based upon significant management judgments and estimates inherent in the operating plan and associated cash flow projections, including assumptions pertaining to net revenue growth, expense trends, and working capital management. Accordingly, changes in circumstances or assumptions could adversely impact the results of the Company’s long-lived asset impairment test.

(e) Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Under such method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred taxes are reduced by a valuation allowance to an amount which is more likely than not to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment.

(f) Cash and Cash Equivalents and Restricted Cash

Cash and cash equivalents consist of amounts held as bank deposits and any certificates or notes with an original maturity of three months or less.

Restricted cash is held as bank deposits, and serves as security deposits for the Company’s Aliso Viejo, California facility lease and a certain significant capital lease of computer hardware. Interest accrues to the Company for such accounts. The classification of restricted cash as current or non-current is dependent upon whether the contractual terms for such deposits provide for the complete release of restrictions within one year of the balance sheet date.

The Company has not experienced any significant losses on cash and cash equivalents and does not believe it is exposed to any significant loss risk due to the high-ratings of the institutions in which its balances are deposited. The Company’s unrestricted and restricted cash balances on deposit that exceed the Federal Deposit Insurance Corporation (F.D.I.C.) limits were approximately $11.3 million at March 31, 2010.

(g) Supplies Inventory

Supplies inventory consists of laboratory and research and development supplies and are stated at the lower of cost or market. Supplies inventory is accounted for under the first-in, first-out method (FIFO).

(h) Property and Equipment and Depreciation

Property and equipment are depreciated using the straight-line method over the following estimated useful lives:

Office furniture, computer, software, and laboratory equipment		Three to five years
Leasehold improvements		Shorter of useful life or remaining term of lease

Expenditures for maintenance, repairs, and minor improvements are charged to expense as incurred. Depreciation expense is recognized on the first day of the month subsequent to being placed into service. Leasehold improvements are capitalized and amortized over the shorter of their estimated useful lives or the remaining lease term. All reimbursed leasehold improvements received from the Company’s landlord are recorded to deferred rent and recovered ratably through a reduction of rent expense over the term of the lease.

(i) Capitalized Internal-Use Software Costs

The Company capitalizes eligible internal-use computer software costs. Amortization begins when the internal-use computer software is ready for its intended use, and is amortized over a three to five-year period using the straight-line method.

(j) Research and Development

Research and development costs are expensed as incurred. Research and development expenses consist of compensation and benefits for research and development personnel, license fees, related supplies inventory, payment to access clinical cohorts for ongoing studies, certain information technology personnel, arrangements with consultants and other third parties, and allocated facility-related costs.

(k) Intangible Assets, net

Intangible assets, net, primarily consist of intellectual property represented by proprietary biomarkers in development and substantially ready for use within the Company’s diagnostic testing activities. These intangible assets have associated patents or patents in process, and are amortized on a straight-line basis over estimated useful lives of seven years.

(l) Goodwill

Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The Company performs a two-step process on an annual basis, or more frequently if necessary, to determine (i) whether the fair value of the relevant reporting unit exceeds carrying value, and (ii) to measure the amount of an impairment loss, if any. The “reporting unit” tested for goodwill impairment comprises the Company’s entire laboratory operation, representing its single operating segment. The fair value of the Company’s “reporting unit” is represented by its total market capitalization on the NASDAQ Capital Market as of the close of the business day on December 1, which represents the Company’s annual impairment testing date. The Company’s management was not aware of any indicators of goodwill impairment as of March 31, 2010 and through the date this Quarterly Report on Form 10-Q was filed with the SEC.

(m) Fair Value Measurements

The Company applies relevant GAAP in measuring the fair value of its Variable Shares (see Note 14). Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. GAAP establishes a fair value hierarchy that distinguishes between (i) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (ii) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g. interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 — Inputs that are both significant to the fair value measurement and unobservable.

(3) Balance Sheet Detail

(a) Allowance for Doubtful Accounts

The following is the full year 2009 and three months ended March 31, 2010 summary of activity for the allowance for doubtful accounts:

Ending balance, December 31, 2008		$	8,045
Bad debt expense			12,927
Write-offs			(12,225	)
Ending balance, December 31, 2009			8,747
Bad debt expense			3,572
Write-offs			(1,740	)
Ending balance, March 31, 2010		$	10,579

(b) Property and Equipment

The following is a summary of property and equipment:

		March 31,				December 31,
		2010				2009
Office furniture, computer software, and laboratory equipment		$	21,487			$	21,480
Leasehold improvements			9,917				9,650
Total			31,404				31,130
Accumulated depreciation and amortization			(17,840	)			(16,784	)
Property and equipment, net		$	13,564			$	14,346

As of March 31, 2010 and December 31, 2009, the Company’s associated capital lease obligations were $1.1 million and $1.2 million, respectively.

(c) Intangible assets

The following is a summary of intangible assets:

		March 31,
		2010
Biomarkers		$	11,349
In-process research and development			76
Issued patents			26
Patent applications			123
Non-compete agreements			110
Accumulated amortization			(466	)
Intangible assets, net		$	11,218

The following is a summary of the estimated useful life, estimated annual amortization expense, and expense classification of the Company’s intangible assets:

		Estimated
		Useful Life				Estimated Annual				Condensed Consolidated Statement of
		(years)				Amortization				Operations Classification
Biomarkers			7			$	1,621			Cost of services or research and development*
In-process research and development			7				11			Research and development
Issued patents			7				4			Cost of services
Patent applications			7				18			Cost of services
Non-competition agreements			3				37			Research and development
Total						$	1,691

(4) Discontinued Operations

On March 8, 2007, the Company sold its instrument systems business (the “ACIS Business”), consisting of certain tangible assets, inventory, intellectual property (including the Company’s former patent portfolio and the ACIS and ChromaVision trademarks), contracts, and related assets to Carl Zeiss MicroImaging, Inc. and one of its subsidiaries (collectively, “Zeiss”) for an aggregate purchase price of $12.5 million. The $12.5 million consisted of $11.0 million in cash and an additional $1.5 million in contingent purchase price, subject to the satisfaction of certain post-closing conditions through March 8, 2009 relating to transferred intellectual property (the “ACIS Sale”). As part of the ACIS Sale, the Company entered into a license agreement with Zeiss that granted the Company a non-exclusive, perpetual and royalty-free license to certain of the transferred patents, copyrights, and software code for use in connection with imaging applications (excluding sales of imaging instruments) and the Company’s oncology diagnostic services business.

In March 2009, Zeiss’ management acknowledged the satisfaction of the post-closing conditions of the ACIS Sale and the associated $1.5 million payment due, which the Company subsequently received on April 8, 2009. The Company recorded the $0.9 million as income from discontinued operations, net of income taxes, within the accompanying Condensed Consolidated Statements of Operations for the three months ended March 31, 2009.

The Company retains certain indemnification obligations to Zeiss for any third party claims surviving through the applicable statute of limitations. The Company believes the likelihood of a raised claim(s) is remote and, in any case, would be immaterial in value.

(5) Recent Accounting Pronouncements

FASB Codification

The Financial Accounting Standards Board (“FASB”) Accounting Standards Codification^TM (“FASB Codification”) became the single source of authoritative nongovernmental GAAP on July 1, 2009. The FASB Codification became effective for financial statements that cover interim and annual periods ending after September 15, 2009. Other than resolving certain minor inconsistencies in current GAAP, the FASB Codification does not affect GAAP, but rather organizes historical accounting pronouncements by approximately 90 accounting topics. Accordingly, in this quarterly report on Form 10-Q, the Company describes, in general, pertinent GAAP where applicable and/or cites the associated FASB Codification reference, rather than the historical reference for such GAAP guidance.

Fair Value Measurements

In September 2006, a common definition for fair value was established and is required to be applied to GAAP as applicable. The guidance also establishes a framework for measuring fair value and expands disclosure about such fair value measurements, and became effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007. Subsequent GAAP guidance deferred the effective date for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. The adoption of the aforementioned GAAP for financial assets and financial liabilities, effective January 1, 2008, did not have a material impact on the Company’s consolidated financial position and results of operations. The adoption of aforementioned GAAP for nonfinancial assets and nonfinancial liabilities, effective January 1, 2009, had no impact on the Company’s consolidated financial position, results of operations, and cash flows.

Business Combinations

In December 2007, developments in GAAP significantly changed the accounting for business combinations. Under such guidance, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date at fair value with limited exceptions. Further changes in the accounting treatment for certain specific items include:

•

Transaction costs will be generally expensed as incurred. These costs were previously treated as costs of the acquisition;

•

Contingent consideration is recorded at fair value as an element of purchase price with subsequent adjustments recognized in operations. Contingent consideration was previously accounted for as a subsequent adjustment of purchase price;

•

In-process research and development (IPR&D) will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date;

•

Restructuring costs associated with a business combination will be generally expensed subsequent to the acquisition date; and

•

Subsequent decreases in valuation allowances on acquired deferred tax assets are recognized in operations after the measurement period. Such changes were previously considered to be subsequent changes in consideration and were recorded as decreases in goodwill.

A substantial number of new disclosure requirements became applicable to business combinations for which the acquisition date is on or after January 1, 2009.

In April 2009, additional GAAP guidance was released that affects the accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies, which amends the accounting for assets and liabilities arising from contingencies in a business combination. Such guidance was effective January 1, 2009, and requires pre-acquisition contingencies to be recognized at fair value, if fair value can be reasonably determined during the measurement period. If fair value cannot be reasonably determined, measurement is required to be based on the recognition and measurement criteria of GAAP applicable for accounting for contingencies. See Note 14 for disclosure related to the Company’s business combination accounting in 2010.

Earnings Per Share

In June 2008, GAAP guidance was released for determining whether instruments granted in share-based payment transactions are participating securities. Under such guidance, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, whether they are paid or unpaid, are considered participating securities and should be included in the computation of earnings per share pursuant to the two-class method. As required, the Company adopted such guidance retrospectively effective January 1, 2009, though it did not affect the Company’s consolidated financial position, results of operations, cash flows, or loss per common share in prior periods, as disclosed in Note 9.

Variable Interest Entities

In December 2009, the FASB issued guidance on how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. Such guidance requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity is required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. The Company adopted the guidance as of January 1, 2010, and its application had no impact on the Company’s Condensed Consolidated Financial Statements. The Company currently consolidates the accounts of CPS, which it does not control through voting or similar rights, as disclosed in Note 1(a) and (b).

(6) Significant Risks and Uncertainties

Credit risk with respect to the Company’s accounts receivable is generally diversified due to the large number of payors that comprise its customer base. The Company has significant receivable balances with government payors, health insurance carriers, health care institutions, biopharmaceutical companies, and patients. The Company’s receivable balances are not supported by collateral.

The laboratory services industry faces challenging billing and collection procedures. The cash realization cycle for certain governmental and managed care payors can be lengthy and may involve denial, appeal, and adjudication processes. Collection of governmental, private health insurer, and client receivables are generally a function of providing complete and accurate billing information to such parties within the various filing deadlines. Receivables due from clients and patients, in particular, are generally subject to increased credit risk as compared to the Company’s other payors, due to the clients’ and patients’ credit worthiness or inability to pay.

The percentage of the Company’s gross accounts receivable of $34.9 million and $30.3 million as of March 31, 2010 and December 31, 2009, respectively, by primary payor class, is as follows:

		March 31, 2010				December 31, 2009
Governmental (Medicare and Medicaid)			26	%			20	%
Private health insurers			38	%			43	%
Clients (pathologists, hospitals, clinics)			16	%			18	%
Patients (indirect bill)			10	%			10	%
Patients (direct bill)			10	%			9	%
Total			100	%			100	%

The Company’s aged gross accounts receivable in total, and by payor class, as of March 31, 2010 and December 31, 2009 is as follows:

		March 31, 2010				%				December 31, 2009				%
All payor classes
Total		$	34,903				100	%		$	30,315				100	%
Unbilled			5,412				15	%			4,819				16	%
Current			6,716				19	%			5,817				19	%
31-60 days past due			5,194				15	%			4,341				14	%
61-90 days past due			3,780				11	%			2,799				9	%
91-120 days past due			1,962				6	%			1,963				6	%
121-150 days past due			1,727				5	%			1,299				4	%
Greater than 150 days past due			10,112				29	%			9,277				32	%

		March 31, 2010				%				December 31, 2009				%
Governmental payors (Medicare and Medicaid)
Total		$	8,993				100	%		$	5,989				100	%
Unbilled			1,532				17	%			1,508				25	%
Current			1,844				20	%			1,332				22	%
31-60 days past due			1,774				20	%			517				9	%
61-90 days past due			1,365				15	%			335				6	%
91-120 days past due			223				2	%			228				4	%
121-150 days past due			261				3	%			204				3	%
Greater than 150 days past due			1,994				23	%			1,865				31	%

		March 31, 2010				%				December 31, 2009				%
Private health insurer payors
Total		$	13,328				100	%		$	13,009				100	%
Unbilled			2,658				20	%			2,391				18	%
Current			1,731				13	%			1,989				15	%
31-60 days past due			1,382				10	%			1,395				11	%
61-90 days past due			1,048				8	%			1,069				8	%
91-120 days past due			835				6	%			728				6	%
121-150 days past due			623				5	%			580				5	%
Greater than 150 days past due			5,051				38	%			4,857				37	%

		March 31, 2010				%				December 31, 2009				%
Client (pathologists, hospitals, clinics, and biopharmaceutical) payors
Total		$	5,701				100	%		$	5,433				100	%
Unbilled			825				14	%			585				11	%
Current			2,296				40	%			1,791				33	%
31-60 days past due			887				16	%			1,570				29	%
61-90 days past due			562				10	%			530				10	%
91-120 days past due			138				2	%			299				5	%
121-150 days past due			268				5	%			164				3	%
Greater than 150 days past due			725				13	%			494				9	%

		March 31, 2010				%				December 31, 2009				%
Patient payors (indirect bill)
Total		$	3,375				100	%		$	2,992				100	%
Unbilled			—				—				—				—
Current			155				5	%			137				5	%
31-60 days past due			470				14	%			343				11	%
61-90 days past due			354				10	%			337				11	%
91-120 days past due			298				9	%			302				10	%
121-150 days past due			278				8	%			275				9	%
Greater than 150 days past due			1,820				54	%			1,598				54	%

		March 31, 2010				%				December 31, 2009				%
Patient payors (direct bill)
Total		$	3,501				100	%		$	2,892				100	%
Unbilled			397				11	%			335				12	%
Current			690				20	%			569				19	%
31-60 days past due			682				20	%			516				18	%
61-90 days past due			451				13	%			528				18	%
91-120 days past due			468				13	%			405				14	%
121-150 days past due			297				8	%			76				3	%
Greater than 150 days past due			516				15	%			463				16	%

As of March 31, 2010, the Company maintained a $10.6 million allowance for doubtful accounts in order to carry accounts receivable at the estimated net realizable value of $24.3 million, as presented within the accompanying Condensed Consolidated Balance Sheets. The allowance for doubtful accounts is an estimate that involves considerable professional judgment. As such, the Company’s actual collection of its March 31, 2010 accounts receivable may materially differ from management’s estimate for reasons including, but not limited to: customer mix, concentration of customers within the healthcare sector, and the general downturn in the United States economy.

(7) Lines of Credit

The following table summarizes the Company’s outstanding debt at its carrying value at March 31, 2010 and December 31, 2009. The Company believes the carrying amount of its outstanding debt approximates fair value based upon its short-term nature and associated interest rate.

		March 31,				December 31,
		2010				2009
Gemino Facility		$	4,187			$	2,678
Capital lease obligations			1,089				1,249
Subtotal			5,276				3,927
Less: Short-term debt, including current maturities of capital lease obligations			(4,807	)			(3,323	)
Long-term capital lease obligations		$	469			$	604

Gemino Facility

On July 31, 2008, the Company entered into a secured credit agreement (the “Gemino Facility”) with Gemino Healthcare Finance, LLC (“Gemino”), which was amended on February 27, 2009 (the “February 2009 Gemino Amendment”), November 13, 2009 (the “November 2009 Gemino Amendment”), and December 21, 2009 (the “December 2009 Gemino Amendment”). The Gemino Facility is a revolving facility under which the Company may borrow up to $8.0 million, secured by the Company’s accounts receivable and related assets. The November 2009 Gemino Amendment extended the Gemino Facility’s maturity date to January 31, 2011. The December 2009 Gemino Amendment joined AGI as a borrower under the Gemino Facility.

Outstanding borrowings under the Gemino Facility were $4.2 million at March 31, 2010. The amount which the Company is entitled to borrow under the Gemino Facility at a particular time ($1.1 million availability as of March 31, 2010) is based on the amount of the Company’s qualified accounts receivable and certain liquidity factors.

Borrowings under the Gemino Facility bear interest at an annual rate equal to 30-day LIBOR (subject to a minimum annual rate of 2.50% at all times), plus an applicable margin of 6.0% (prior to the February 2009 Gemino Amendment, the applicable margin was 5.25%). The Company is required to pay a commitment fee of 0.50% per year on the daily average of unused credit availability (prior to the November 2009 Gemino Amendment, the commitment fee was 0.75%), and is required to pay a collateral monitoring fee of 0.40% per year on the daily average of outstanding borrowings. Interest expense on the Gemino Facility for the three months ended March 31, 2010 and 2009, was $0.1 million in each period. Such amounts are included in interest expense within the accompanying Condensed Consolidated Statements of Operations.

The February 2009 Gemino Amendment increased the Company’s capital expenditure limit to $7.5 million in each fiscal year. For the three months ending March 31, 2010, the Company’s aggregate capital expenditures were $0.1 million. The February 2009 Gemino Amendment also modified the minimum level of “excess liquidity” covenant, increasing its threshold from $2.0 million to $3.0 million, though such covenant was subsequently eliminated with the November 2009 Gemino Amendment.

The November 2009 Gemino Amendment (i) extended the maturity date of the Gemino Facility from January 31, 2010 to January 31, 2011; (ii) removed the “excess liquidity” covenant; (iii) increased the facility’s “advance rate” from 75% to 85%; (iv) eliminated the minimum “fixed charge coverage ratio” covenant through December 31, 2009; (v) includes a “maximum loan turnover ratio” covenant (defined as the average monthly loan balance divided by average monthly cash collections multiplied by 30 days) of 35 days only for the three months ended December 31, 2009 (for the three months ended December 31, 2009 the Company’s calculated “maximum loan turnover ratio” was 18 days); (vi) requires a minimum annualized “fixed charge coverage ratio” (defined below) covenant of 1.00 for the three months ending March 31, 2010, 1.10 for six months ending June 30, 2010, 1.20 for the nine months ending September 30, 2010, and 1.20 for the twelve months ending December 31, 2010 and thereafter; and (vii) reduced the commitment fee from 0.75% to 0.50% per year on the daily average of unused credit availability.

The “fixed charge coverage ratio” is defined as the ratio of EBITDA (net income plus interest expense, tax expense, depreciation/amortization expense, and stock-based compensation expense), to the sum of (i) interest expense paid in cash on the Gemino Facility, (ii) payments made under capital leases, (iii) unfinanced capital expenditures, and (iv) taxes paid. For the three months ended March 31, 2010, the Company’s calculated “fixed charge coverage ratio” was 3.11, which exceeded the requirement of 1.00.

The Gemino Facility also contains a “material adverse change” clause (“MAC”) clause. If the Company encountered difficulties that would qualify as a MAC in its (i) operations, (ii) condition (financial or otherwise), or (iii) ability to repay amounts outstanding under the Gemino Facility, it could be cancelled at Gemino’s sole discretion. Gemino could then elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing such indebtedness.

Comerica Facility

On March 26, 2009, the Company fully repaid the $9.8 million outstanding balance under its $12.0 million revolving credit agreement with Comerica Bank (the “Comerica Facility”), using a portion of the proceeds from the initial closing of the Oak Private Placement. The Comerica Facility was terminated at such time, as was Safeguard’s guarantee of the Comerica Facility (as described below). The Company maintains a $1.5 million standby letter of credit with Comerica Bank which is fully supported by a restricted cash account for the same amount. The letter of credit is for the benefit of the Company’s landlord of its leased facility in Aliso Viejo, California.

Borrowings under the Comerica Facility bore interest through February 27, 2009 at Comerica’s prime rate minus 0.5%, or at the Company’s option, at a rate equal to 30-day LIBOR plus 2.45%. The Comerica Facility was amended on February 27, 2009, and as a result, until its retirement on March 26, 2009, borrowings under the Comerica Facility bore interest at the Company’s option of: (i) 0.5% plus the greater of Comerica’s prime rate or 1.75%, or (ii) 30-day LIBOR plus 2.40%. The interest expense on the outstanding balance under the Comerica Facility for the three months ended March 31, 2009 (excluding the usage and guarantee fees charged by Safeguard as described below), was $0.1 million, and is included in interest expense within the accompanying Condensed Consolidated Statements of Operations.

Safeguard Delaware, Inc., a wholly-owned subsidiary of Safeguard Scientifics, Inc. (“Safeguard”), the Company’s largest single stockholder, guaranteed the Company’s borrowings under the Comerica Facility in exchange for 0.5% per year of the total amount guaranteed plus 4.5% per year of the daily-weighted average principal balance outstanding. Additionally, the Company was required to pay Safeguard a quarterly usage fee of 0.875% of the amount by which the daily average outstanding principal balance under the Comerica Facility exceeded $5.5 million. The usage and guarantee fees charged by Safeguard for the Comerica Facility for the three months ended March 31, 2009, was $0.1 million, and is included in interest expense to related parties within the accompanying Condensed Consolidated Statements of Operations.

Safeguard Mezzanine Financing

On March 7, 2007, the Company entered into a senior subordinated revolving credit facility with Safeguard (the “Initial Mezzanine Facility”). The Initial Mezzanine Facility provided the Company with up to $12.0 million in working capital funding, but was reduced by $6.0 million as a result of the ACIS Sale discussed in Note 4. The Initial Mezzanine Facility’s annual interest rate was 12.0%. In connection with the Initial Mezzanine Facility, the Company issued Safeguard 0.3 million common stock warrants to satisfy Safeguard’s commitment fees and maintenance and usage fees. The fair value of these common stock warrants was determined using the Black-Scholes option pricing model, and was initially expensed over the term of the Initial Mezzanine Facility, though the term was subsequently extended to coincide with the term of the New Mezzanine Facility (defined below).

On March 14, 2008, the Company entered into an amended and restated senior subordinated revolving credit facility with Safeguard (the “New Mezzanine Facility”) to refinance, renew, and expand the Initial Mezzanine Facility. The New Mezzanine Facility, which had a stated maturity date of April 15, 2009, provided the Company with up to $21.0 million in working capital funding. Borrowings under the New Mezzanine Facility bore interest at an annual rate of 12.0% through September 30, 2008 and 13.0% thereafter. Proceeds from the New Mezzanine Facility were used to refinance indebtedness under the Initial Mezzanine Facility, for working capital purposes, and to repay in full and terminate the Company’s former GE Capital Facility, which included certain equipment lease obligations.

In connection with the New Mezzanine Facility, the Company issued Safeguard 1.6 million common stock warrants upon its signing. The Company was also required to issue Safeguard an additional 2.2 million common stock warrants, in four equal tranches of 0.55 million if the balance of the New Mezzanine Facility had not been reduced to $6.0 million or less on or prior to May 1, 2008, July 1, 2008, September 1, 2008, and November 1, 2008, respectively. Such reduction was not accomplished and as a result, 0.55 million common stock warrants were issued on each of June 10, 2008, July 2, 2008, September 2, 2008, and November 6, 2008, respectively.

The fair value of the 1.6 million common stock warrants issued on March 14, 2008 and the 2.2 million common stock warrants issued from June 2008 through December 2008 was measured on March 14, 2008, the date of the New Mezzanine Facility commitment. The fair value of any unissued common stock warrants associated with the New Mezzanine Facility was measured and adjusted at each subsequent quarter end. The fair value of all such common stock warrants has been treated for accounting purposes as a debt discount of the New Mezzanine Facility and additional paid-in-capital. As such, the Company began accreting the debt discount in the first quarter of 2008 (as adjusted for the change in fair value of any contingent warrants at each quarter-end) over the term of the New Mezzanine Facility through recording interest expense to related party on a straight-line basis.

The fair value of the common stock warrants issued to Safeguard in connection with the Initial Mezzanine Facility and New Mezzanine Facility was determined using the Black-Scholes option pricing model with the following inputs: zero dividends, a risk-free interest rate ranging from 3.4% to 4.5% (equal to the U.S. Treasury yield curve for the warrants’ term on the date of issuance), and expected stock volatility of 66% to 85% (measured using weekly price observations for a period equal to the warrants’ term).

On February 27, 2009, the Company entered into an amended and restated senior subordinated revolving credit facility with Safeguard (the “Third Mezzanine Facility”) to refinance, renew, and expand the New Mezzanine Facility. The Third Mezzanine Facility had a stated maturity date of April 1, 2010 and provided the Company with up to $30.0 million in working capital funding through March 25, 2009. Borrowings under the Third Mezzanine Facility bore interest at an annual rate of 14.0%, capitalized monthly to the principal balance. Upon the signing of the Third Mezzanine Facility, the Company issued Safeguard 0.5 million fully vested common stock warrants with a five year term and an exercise price equal to $1.376.

In connection with the Initial Oak Closing on March 26, 2009, the Company repaid $14.0 million of the outstanding balance under the Third Mezzanine Facility. Also on March 26, 2009, the Company and Safeguard amended the Third Mezzanine Facility, which resulted in the reduction of its total availability from $30.0 million to $10.0 million. The Second Oak Closing occurred on May 14, 2009, and at such time, the Company repaid the remaining outstanding balance (including accrued interest) of the Third Mezzanine Facility of $5.7 million, which was cancelled upon such repayment.

In connection with the $20.0 million reduction in availability of the Third Mezzanine Facility on March 26, 2009, the Company assessed the associated unamortized debt issuance costs of $1.7 million as of such date (which included unamortized warrant expense). The 67% reduction in borrowing capacity ($20.0 million divided by $30.0 million) resulted in the expensing of debt issuance costs in such proportion, totaling $1.1 million. Such amount was recorded to interest expense to related party for the three months ended March 31, 2009 within the accompanying Condensed Consolidated Statements of Operations. As of March 31, 2009, remaining unamortized debt issuance costs totaled $0.5 million, and were fully amortized through May 14, 2009, the date the Company fully repaid and cancelled the Third Mezzanine Facility.

The interest expense on the outstanding balance under the Mezzanine Facilities, including the amortization of the fair value of issued warrants (see tables below), for the three months ended March 31, 2009, was $3.0 million. Such amount is included in interest expense to related parties within the accompanying Condensed Consolidated Statements of Operations.

The below table summarizes the common stock warrant activity associated with the Initial Mezzanine Facility:

																						Interest Expense
										Warrant				Warrant								Recognized for Three
Number of		Exercise				Warrant				Issuance				Expiration								Months Ended March 31,
warrants		Price				Term				Date				Date				Fair Value				2009
125,000*		$	0.01			4 years				March 7, 2007				March 7, 2011				$	204			$	20
62,500			1.39			4 years				March 7, 2007				March 7, 2011					69				7
31,250*			0.01			4 years				November 14, 2007				November 14, 2011					62				10
31,250*			0.01			4 years				December 17, 2007				December 17, 2011					61				11
31,250*			0.01			4 years				March 5, 2008				March 5, 2012					62				14
Total																		$	458			$	62

The below table summarizes the common stock warrant activity associated with the New Mezzanine Facility:

Interest Expense

Warrant

Recognized for Three

Number of

Exercise

Warrant

Warrant

Expiration

Months Ended March 31,

warrants

Price

Term

Issuance Date

Date

Fair Value

2009

1,643,750*

$

0.01

5 years

March 14, 2008

March 14, 2013

$

2,666

$

615

550,000*

0.01

5 years

June 10, 2008

June 11, 2013

1,140

263

550,000*

0.01

5 years

July 2, 2008

July 2, 2013

1,095

253

550,000*

0.01

5 years

September 2, 2008

September 2, 2013

1,167

269

550,000*

0.01

5 years

November 6, 2008

November 6, 2013

890

206

Total

$

6,958

$

1,606

The below table summarizes the common stock warrant activity associated with the Third Mezzanine Facility:

Interest Expense

Warrant

Recognized for Three

Number of

Exercise

Warrant

Warrant

Expiration

Months Ended March 31,

Warrants Issued

Price

Term

Issuance Date

Date

Fair Value

2009

500,000

$

1.376

5 years

February 27, 2009

February 27, 2014

$

600

$

435

(8) Equipment Financing

On March 31, 2009, the Company entered into a three-year capital lease with Hitachi Data Systems Credit Corporation for computer equipment and related software with a fair value on such date of $1.2 million, associated with the Company’s initiative to upgrade its information technology infrastructure. The Company also has a number of active laboratory equipment and office equipment leases (capital and operating) with various providers as of March 31, 2010.

The Company’s capital lease obligations as of March 31, 2010 are as follows:

Remainder of 2010		$	544
2011			498
2012			142
Subtotal			1,184
Less: interest			(95	)
Total			1,089
Less: current portion			(620	)
Capital lease obligations, long-term portion		$	469

(9) Net Income (Loss) Per Share Information

Effective January 1, 2009, the Company adopted applicable GAAP guidance affecting its earnings per share (“EPS”) calculation and presentation. Such GAAP requires that unvested stock-based compensation awards containing non-forfeitable rights to dividends are “participating securities” (defined below) and should be included in the basic EPS calculation using the “two-class method”. Under the two-class method, all earnings (distributed and undistributed) are allocated to common stock and participating securities, based on their respective rights to receive dividends.

The Company grants restricted stock awards from time to time under its stock-based compensation plan, which generally entitles recipients to non-forfeitable rights to dividends, if and when declared. The Company’s Series A convertible preferred stockholders (see Note 13) also have non-forfeitable rights to dividends, if and when declared. Accordingly, such unvested restricted stock awards and Series A convertible preferred stock are both considered participating securities.

Participating securities are included in the computation of EPS under the two-class method in periods of net income, but are not included in the computation of EPS in periods of net loss, since the contractual terms of the participating securities do not require the holders’ funding of the Company’s losses. Additionally, participating securities are included in the computation of EPS when distributions, or their accounting equivalents- such as an amortized beneficial conversion feature, are in excess of net income.

Income (loss) per share amounts are computed independently for income (loss) from continuing operations, income (loss) from discontinued operations and net income (loss). As a result, the sum of per share amounts from continuing operations and discontinued operations may not equal the total per share amounts for net income (loss). Additionally, income (loss) per share amounts are computed independently for each quarter. As a result, the sum of the per share amounts for each quarter may not equal the year-to-date amounts.

Basic and diluted EPS applicable to common stockholders for the three months ended March 31, 2010 and 2009 is summarized in the table below:

		Three Months Ended March 31,
		2010				2009
Net income (loss) per share applicable to common stockholders—basic and diluted:
Income (loss) from continuing operations, net of income taxes		$	(0.00	)		$	(0.01	)
Income (loss) from discontinued operations, net of income taxes			—				0.01
Net income (loss) applicable to common stockholders		$	(0.00	)		$	(0.00	)

Basic and diluted EPS was computed by dividing net loss applicable to common stockholders by the applicable weighted-average outstanding common shares during each period, as summarized in the tables below:

		Three Months Ended March 31,
		2010				2009
Basic and diluted EPS numerator:
Income (loss) from continuing operations, net of income taxes		$	(370	)		$	(1,057	)
Income from discontinued operations, net of income taxes			—				901
Net income (loss)		$	(370	)		$	(156	)

The following share amounts were used to compute basic and diluted EPS applicable to common stockholders (in periods of net loss, or when distributions or equivalents were in excess of net income, the anti dilutive effects of participating securities, stock options, and warrants, were properly excluded):

		Three Months Ended March 31,
		2010				2009
Basic and Diluted EPS denominator:
Weighted-average outstanding common shares			83,648				77,003

The following outstanding Company securities were excluded from the above calculations of net income (loss) per share applicable to common stockholders because their impact would have been anti-dilutive in periods of net loss:

		Total Outstanding
		March 31, 2010				March 31, 2009
Series A convertible preferred stock (as converted — see Note 13)			21,053				15,333
Common stock options			8,113				7,386
Common stock warrants			1,412				2,824
Unvested restricted stock			557				142
Total			31,135				25,685

(10) Comprehensive Loss

Comprehensive loss consists of net loss and all changes in stockholders’ deficit from non-stockholder sources. The following summarizes the components of the Company’s comprehensive loss:

		Three Months Ended
		March 31,
		2010				2009
Net loss		$	(370	)		$	(156	)
Foreign currency translation adjustment			—				1
Comprehensive loss		$	(370	)		$	(155	)

(11) Stock-Based Compensation

2007 Incentive Award Plan

The Company has one active stockholder-approved stock plan, the 2007 Incentive Award Plan (the “2007 Plan”), which replaced the Company’s former stockholder-approved stock plan (the “1996 Plan”). The 2007 Plan provides for the grant of incentive stock options and nonqualified stock options, restricted stock awards and restricted stock units, stock appreciation rights, performance shares, performance stock units, dividend equivalents, stock payments, deferred stock, performance bonus awards, and performance-based awards.

The maximum number of shares of the Company’s common stock available for issuance under the 2007 Plan is 5.0 million shares (which increased from 4.0 million shares due to an stockholder-approved amendment of the 2007 Plan in June 2009), plus additional availability from forfeited shares under the 1996 Plan. As of March 31, 2010, 0.3 million shares were available for grant under the 2007 Plan. The Company does not hold treasury shares, and therefore all shares issued through exercised stock options are through unissued shares that are authorized and reserved under the 2007 Plan. It is the Company’s policy that before stock is issued through the exercise of stock options, the Company must first receive all required cash payment for such shares.

Stock-based awards are governed by agreements between the Company and the recipients. Incentive stock options and nonqualified stock options may be granted under the 2007 Plan at an exercise price of not less than 100% of the closing fair market value of the Company’s common stock on the respective date of grant. The grant date is generally the date the award is approved by the Company’s Board of Directors, though for aggregate awards of 50,000 or less in each quarter, the grant date is the date the award is approved by the Company’s chief executive officer.

The Company’s standard stock-based award vests 25% on the first anniversary of the date of grant, or for new hires, the first anniversary of their initial date of employment with the Company. Awards vest monthly thereafter on a straight-line basis over 36 months. Stock options must be exercised, if at all, no later than 10 years from the date of grant. Upon termination of employment with the Company, vested stock options may be exercised within 90 days from the last date of employment. In the event of an optionee’s death, disability, or retirement, the exercise period is 365 days from the last date of employment.

Stock-based Compensation Expense

Stock-based compensation, which includes stock options and restricted stock awards, recognized in the Condensed Consolidated Statements of Operations, is as follows:

		Three Months Ended
		March 31,
		2010				2009
Cost of services		$	87			$	33
Operating expenses			431				537
Total stock-based compensation expense		$	518			$	570

Employee stock-based compensation expense for the three months ended March 31, 2010 and 2009 was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. Applicable GAAP requires forfeitures to be estimated at the time of grant and prospectively revised if actual forfeitures differ from those estimates. The Company estimates forfeitures of stock options using the historical exercise behavior of its employees. For purposes of this estimate, the Company has identified two groups of employees. The estimated forfeiture rate of each group is as follows:

		Three Months Ended
		March 31, 2010 and 2009
Executive and senior management group			5	%
Staff group			8	%

Valuation Assumptions

The fair value of stock options granted was estimated at the date of grant using the Black-Scholes option-pricing model. The following assumptions were used to determine fair value for the stock awards granted in the applicable year:

		Three Months				Three Months
		Ended March 31,				Ended March 31,
		2010				2009
Dividend yield			0	%			0	%
Volatility (a)			60.8	%			70.0	%
Average expected option life (b)		5.0 years				5.0 years
Risk-free interest rate (c)			2.6	%			2.1	%

The fair value of restricted stock awards are determined using the Company’s closing stock price on the date of grant multiplied by the respective number of awards granted.

(12) Stock Transactions

Acquisition of Applied Genomics, Inc.

On December 21, 2009, the Company completed its acquisition of Applied Genomics, Inc. (“AGI”) in accordance with the terms and conditions of the Agreement and Plan of Merger and Reorganization, dated as of December 21, 2009, as amended March 17, 2010, by and between the Company and AGI. The purchase price for AGI consisted of 4.4 million of the Company’s common shares issued to the former AGI stockholders at the closing of the acquisition (inclusive of exchanged stock option awards), and a maximum of an additional 3.2 million of the Company’s common shares to the former AGI stockholders (inclusive of exchanged stock option awards), upon the achievement of certain milestones by December 31, 2012. See Note 14 for further discussion of the AGI acquisition.

Stock Purchase Agreement with Oak Investment Partners XII, Limited Partnership

On March 25, 2009, the Company entered into a stock purchase agreement (“Oak Purchase Agreement”) with Oak Investment Partners XII, Limited Partnership (“Oak”). In reliance on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), the Company agreed to sell Oak up to an aggregate of 6.6 million shares of its Series A convertible preferred stock, $0.01 par value (the “Preferred Shares”), in two or more tranches (the “Oak Private Placement”) for aggregate consideration of up to $50.0 million. The initial closing of the Oak Private Placement occurred on March 26, 2009, at which time the Company issued and sold an aggregate of 3.8 million Preferred Shares (the “Initial Oak Closing Shares”) for aggregate consideration of $29.1 million.

The second closing of the Oak Private Placement occurred on May 14, 2009, at which time the Company issued and sold an aggregate of 1.4 million Preferred Shares (the “Second Oak Closing Shares”) for aggregate consideration of $10.9 million. Oak’s ownership interest in the Company’s issued and outstanding voting securities was 19.9% as of March 31, 2010.

Sale by Safeguard Scientifics, Inc.

In August and September 2009, Safeguard, through its wholly owned subsidiaries, completed the sale of an aggregate of 18.4 million shares of the Company’s common stock held by Safeguard in an underwritten public offering which was pursuant to an effective registration statement filed with the SEC. The Company did not, and will not, receive any proceeds from the sale of such shares. The Company was nonetheless obligated to pay certain costs, expenses, and fees of $0.2 million which were incident to Safeguard’s sale, pursuant to an Amended and Restated Registration Rights Agreement dated as of February 27, 2009, by and among the Company, Safeguard, and certain of Safeguard’s wholly-owned subsidiaries. As a result of Safeguard’s sale of such shares and the earlier consummation of the Initial and Second Oak Closings, and other stock activity, Safeguard’s ownership interest in the Company’s issued and outstanding voting securities decreased to 27.8% as of March 31, 2010.

Share Registration Obligations of the Company

As required by the terms of the Oak Purchase Agreement, the Company entered into a Registration Rights Agreement with Oak on March 26, 2009, obligating the Company to register for resale the shares of common stock issuable upon the conversion of the Preferred Shares on a registration statement on Form S-3 to be filed with the SEC at least 90 days prior to March 26, 2010, which was filed with the SEC on December 22, 2009. The Company has from time to time completed several other private placements of its equity securities. In connection therewith, the Company has entered into certain agreements which require the Company to register, for resale, such investors’ securities under the Securities Act. The Company has concluded that it does not meet the conditions to accrue the estimated costs of preparing and filing such future registration statements after considering the terms of the registration rights agreements.

Stock Warrant Activity

The Company has issued stock warrants to various parties in connection with entering and maintaining certain credit facilities, as consideration for various licensing arrangements with other companies, and in conducting other general business. Stock warrant activity is summarized as follows:

						Weighted Average
		Shares				Exercise Price
Warrants outstanding, December 31, 2009			1,413			$	1.26
Granted			—
Exercised			—
Canceled			1
Warrants outstanding, March 31, 2010			1,412			$	1.26

The 1.4 million outstanding stock warrants as of March 31, 2010 are exercisable and have various expiration dates beginning June 2010 through February 2014.

(13) Redeemable Preferred Stock

In March and May 2009, the Company issued and sold an aggregate of 5.3 million Preferred Shares to Oak for aggregate gross consideration of $40.0 million. In connection with the issuance of the Initial and Second Oak Closing Shares, the Company incurred expenses of $1.4 million. These expenses were related to legal fees and investment banker commissions which were recorded in the accompanying Consolidated Balance Sheets for the year ended December 31, 2009, as a reduction of additional paid in capital, rather than expense. Accordingly, the Preferred Shares are presented at $38.6 million in the accompanying Condensed Consolidated Balance Sheets at March 31, 2010 and December 31, 2009, respectively ($40.0 million of aggregate Oak proceeds less $1.4 million of closing expenses in connection therewith).

Each Preferred Share will be voted with common shares on an as-converted basis and is initially convertible, at any time, into four shares of the Company’s common stock, though is subject to broad-based weighted-average anti-dilution protection in the event that the Company issues additional shares at or below the then-applicable conversion price for such share (initially $1.90 per share). This provision will not be triggered, however, unless and until the Company issues shares that, when aggregated with all shares issued after the initial closing, have an aggregate offer or issue price exceeding $5.0 million. The Preferred Shares will automatically convert if, at any time beginning 12 months after March 26, 2009, the Company’s common stock price is above $4.75 per share (as adjusted for stock splits, combinations, recapitalizations and the like) for 20 consecutive trading days over a 30-day trading period (all of which trading days must fall after March 27, 2010).

The Preferred Shares are senior to the Company’s common stock with respect to liquidation preference and dividends, in the event declared, in proportion to the relative number of common shares on an as-converted basis. The Preferred Shares do not accrue dividends. Upon any liquidation of the Company, before any distribution or payment is made to any other stockholders, each Preferred Share holder is entitled to receive a liquidation payment. The liquidation payment is the greater of (1) the initial purchase price of $7.60 per Preferred Share (equal to $1.90 per common share on an if-converted basis, and subject to adjustment for any stock splits, stock dividends or other recapitalizations) plus declared and unpaid dividends thereon or (2) such amount per Preferred Share as would have been payable had each Preferred Share been converted into common stock immediately prior to such liquidation. At any time after March 26, 2013, the Company may, at its option, redeem all Preferred Shares for an amount equal to its full liquidation preference.

The Company’s stock price on the NASDAQ Capital Market closed at $2.62 and $2.65 per common share on March 31, 2010 and December 31, 2009, respectively, which exceeded the Preferred Shares’ $1.90 liquidation value per common share on an if-converted basis. The Company therefore calculated the Preferred Shares’ liquidation preference of $55.2 million and $55.8 million as of March 31, 2010 and December 31, 2009, respectively, disclosed in the accompanying Consolidated Balance Sheets, by multiplying 21.1 million common shares (on an if-converted basis from Preferred Shares) by the $2.62 and $2.65 per common share value. The Company has determined that the events included within the Oak Purchase Agreement, that would give rise to a liquidation payment to the holders of the Preferred Shares, were of minimal probability of occurrence. There are no planned or developing transactions known to the Company’s management that would result in the liquidation of the Company, or result in any change of control of the Company, to require such liquidation payment by the Company to the holders of the Preferred Shares. The carrying amount of the Preferred Shares will be adjusted to its redemption amount only in the event that redemption becomes probable.

The redemption rights of the Preferred Shares are immediately triggered by the occurrence of certain business events enumerated in the Stock Purchase Agreement with Oak. All such business events are deemed to be within the Company’s control, except beginning in the third quarter of 2009, an event of a change in control of the Company, whether by acquisition or merger. As of August 21, 2009, an event of a change of control of the Company became possible with the effective registration of Safeguard’s holdings in the Company through a registration statement on Form S-3 filed with the SEC (the “Safeguard S-3”). The Safeguard S-3 resulted in the ability of a third-party to acquire over 50% of registered shares of the Company on the open market. Accordingly, the Preferred Shares have been classified as temporary equity (rather than permanent equity) within the accompanying Condensed Consolidated Balance Sheets, as required under applicable GAAP, since all redemption events are not solely within Company’s control as of March 31, 2010 and December 31, 2009.

(14) Contingently Issuable Common Stock

AGI Acquisition Summary

On December 21, 2009 (the “Closing Date”), the Company completed the acquisition of AGI (the “AGI Acquisition”) in accordance with the terms and conditions of the Agreement and Plan of Merger and Reorganization, dated as of December 21, 2009, as amended March 17, 2010, among the Company, AGI, and the other parties named therein (the “AGI Agreement”). As of the Closing Date, AGI developed 10 prognostic and predictive multivariate immunohistochemistry-based (IHC) biomarkers for use in assessing the recurrence rates of various cancers, particularly lung cancer, and the likelihood of a favorable response to various treatment options.

The AGI purchase price consisted of 4.4 million of the Company’s common shares, issuable to the former AGI stockholders as of the Closing date, inclusive of exchanged stock option awards. In addition, as of the Closing Date, a maximum of an additional 3.2 million of the Company’s common shares, inclusive of exchanged stock option awards (the “Contingent Shares”), were issuable to the former AGI stockholders upon the achievement of certain revenue and scientific milestones (the “AGI Milestones”) by December 31, 2012. Thus, the maximum consideration for the AGI Acquisition comprised 7.6 million of the Company’s common shares, inclusive of exchanged stock option awards, to the former AGI stockholders.

The AGI acquisition was accounted for as a business combination under applicable GAAP, requiring the use of the acquisition method of accounting. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed, based on their estimated fair values on the Closing Date.

Liability Accounting for Variable Shares

As of December 31, 2009, an aggregate 1.4 million of the Contingent Shares met the requirements for liability accounting under applicable GAAP (the “Variable Shares”). The Variable Shares were variable with respect to the number of common shares that, depending on the sequence of AGI Milestone achievements, are issuable through December 31, 2012, though limited to an aggregate issuance of the 3.2 million shares, inclusive of exchanged stock option awards. The Company, therefore, recorded a $2.7 million long term liability reported as “contingently issuable common shares” on its Consolidated Balance Sheets as of December 31, 2009. The $2.7 million long term liability was derived from a calculation performed by the Company that involves the estimated probability and timing of Variable Share achievement, into a single, present-valued amount, utilizing (i) certain liquidity restrictions on the Variable Shares; (ii) the contingency associated with the Variable Shares; and (iii) the volatility associated with the Company’s stock.

During the three months ended March 31, 2010, 1.5 million of the Contingent Shares became immediately issuable to the former AGI shareholders, based upon the achievement, in February and March 2010, of two milestones under the AGI Agreement. As a result of these two milestones being achieved, the Variable Shares no longer met the requirement for liability accounting as of March 17, 2010.

The Company marked-to-market the Variable Shares through March 17, 2010, comparing their value as of December 31, 2009 to their value as of March 17, 2010. The Company recorded $31,000 of expense within “other expense” on its Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 for this mark to market adjustment. The fair value of the Variable Shares as of March 17, 2010 was derived from a calculation performed by the Company that involved the (i) the Company’s closing stock price on the NASDAQ Capital Market on each of the two milestone achievement dates in February and March 2010 multiplied by the related number of Variable Shares on each of such dates, less (ii) an estimated discount for certain liquidity restrictions on the Variable Shares, incorporating Level 3 inputs (see Note 2(m)) for such fair value measurement.

The Company reclassified the $2.7 million contingently issuable common shares liability reported on its December 31, 2009 Consolidated Balance Sheet to additional paid in capital during the three months ended March 31, 2010. Accordingly, the contingently issuable common shares liability was $-0- at March 31, 2010, as summarized in the table below.

		Contingently Issuable
		Common Stock
December 31, 2009		$	2,650
Mark to market adjustment of Variable Shares (non-cash)			31
Reclassification of Variable Shares to additional paid in capital			(2,681	)
March 31, 2010		$	—

(15) Corrections of Immaterial Classification and Presentation Errors in Prior Period

During the second quarter of 2009, the Company identified a net $0.6 million accounting error which related to revenue transactions and associated bad debt expense originating in the first quarter of 2009. The errors related to the pricing for certain of the Company’s services in the first quarter of 2009. The pricing error correspondingly affected bad debt expense in the first quarter of 2009, since bad debt expense was then recorded as a percentage of each period’s net revenue. Accordingly, the Company recorded a $0.7 million increase to net revenue and a $0.1 million increase to bad debt expense in the first quarter of 2009, which were included in the Condensed Consolidated Statement of Operations for the six months ended June 30, 2009.

During the third quarter of 2009, the Company determined that it did not properly present the income tax effect of the 2007 ACIS Sale (see Note 4) on its Condensed Consolidated Statements of Operations for the three months ended March 31, 2009. Applicable GAAP provides guidance on the process by which an entity should allocate its total tax provision or benefit to the various components of the income statement, including continuing and discontinued operations.

Zeiss, the acquirer in the ACIS Sale, acknowledged the satisfaction of certain post-closing conditions and the associated $1.5 million payment due to the Company in March 2009, which the Company subsequently received on April 8, 2009. The Company previously recorded the $1.5 million as income from discontinued operations to its Condensed Consolidated Statements of Operations for the three months ended March 31, 2009. The proper presentation under applicable GAAP requires the associated income tax benefit within continuing operations, and income from discontinued operations to be presented net of income taxes.

In accordance with applicable GAAP, management evaluated the materiality of the errors identified in the second and third quarters of 2009, both qualitatively and quantitatively, and concluded that the errors in presentation were immaterial to all previously filed consolidated financial statements. See the below table for a summary of the adjustments.

		Three Months Ended
		March 31, 2009
		Previously				As
		Reported				Adjusted
Condensed Consolidated Statements of Operations:
Net revenue		$	22,447			$	23,192
Bad debt expense			2,635				2,715
Total operating expenses			12,641				12,721
Income from operations			849				1,514
Income tax benefit			—				599
Loss from continuing operations			(2,321	)			(1,057	)
Income from discontinued operations, net of income taxes			1,500				901
Net loss			(821	)			(156	)
Net income (loss) per share applicable to common stockholders — basic and diluted:
Loss from continuing operations		$	(0.03	)		$	(0.01	)
Income from discontinued operations			0.02				0.01
Net loss applicable to common stockholders		$	(0.01	)		$	(0.00	)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about us, the industries in which we operate and other matters, as well as management’s beliefs and assumptions and other statements regarding matters that are not historical facts. These statements include, in particular, statements about our plans, strategies and prospects. For example, when we use words such as “projects,” “expects,” “forecasts,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “should,” “would,” “could,” “will,” “opportunity,” “potential” or “may,” variations of such words or other words that convey uncertainty of future events or outcomes, we are making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Our forward-looking statements are subject to risks and uncertainties. Factors that might cause actual results to differ materially, include, but are not limited to: our ability to continue to develop and expand our diagnostic services business, uncertainties inherent in our product development programs, our ability to attract and retain highly qualified managerial, technical, and sales and marketing personnel, our ability to maintain compliance with financial and other covenants under our credit facility, our ability to successfully manage our in-house billing and collection processes, the continuation of favorable third party payor reimbursement for laboratory tests, changes in federal payor regulations or policies, including adjustments to Medicare reimbursement rates, that may affect coverage and reimbursement for our laboratory diagnostics services, our ability to obtain additional financing on acceptable terms or at all, unanticipated expenses or liabilities or other adverse events affecting cash flow, uncertainty of success in identifying and developing new diagnostic tests or novel markers, our ability to fund development of new diagnostic tests and novel markers, and to obtain adequate patent protection covering our use of these tests and markers, and the amount of resources we determine to apply to novel marker development and commercialization, the risk to us of infringement claims and the possibility of the need to license intellectual property from third parties to avoid or settle such claims, failure to obtain regulatory approvals and clearances required to conduct clinical trials if/when required and/or to commercialize our services and underlying diagnostic applications, our ability to compete with other technologies and with emerging competitors in novel cancer diagnostics and our dependence on third parties for collaboration in developing new tests, and those factors set forth under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this Quarterly Report on Form 10-Q and disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors” and “Financial Statements and Supplementary Data” included in our Annual Report on Form 10-K for the year ended December 31, 2009. Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied upon as an indication of future performance. All forward-looking statements attributable to us, or to persons acting on our behalf, are expressly qualified in their entirety by this cautionary statement.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q might not occur.

Overview and Outlook

We are an advanced oncology diagnostics services company, headquartered in Aliso Viejo, California, and incorporated in 1993. Our mission is to help improve the lives of those affected by cancer through translating cancer discoveries into better patient care. We combine innovative technologies, clinically meaningful diagnostic tests, and world-class pathology expertise to provide advanced diagnostic services that assess and characterize cancer for physicians treating their patients, as well as for biopharmaceutical companies in the process of clinically testing various therapies. Our customers are connected to our Internet-based portal, PATHSiTE^®, that delivers high resolution images and critical interpretative reports resulting from our diagnostic testing services.

Our strategic focus is centered on identifying high-value opportunities that enable the expansion and differentiation of our cancer diagnostic services within the highly competitive medical laboratories sector in which we operate. We commercialize our services through our highly developed commercial channels with community pathologists, oncologists, universities, hospitals, and pharmaceutical researchers. An important aspect of our strategy is to develop and expand our diagnostic offerings by applying our technical and medical expertise in combination with available intellectual property. Our diagnostic tests utilize “biomarkers” which are present in human tissues, cells, or fluids to aid in understanding a cancer patient’s diagnosis, prognosis, and expected outcome from the use of specific therapeutics. We believe that diagnostic tests which utilize biomarkers may help bring clarity to critical decision making points related to cancer treatment for healthcare providers and the biopharmaceutical industry.

In 2010, we are focused on four primary areas:

•

Maintain net revenue growth by reaching new customers and increasing “same store sales” to our existing customers with our new services;

•

Maintain financial discipline to achieve profitability;

•

Leverage our industry-leading commercial channel and successfully launch new proprietary diagnostic tests into this channel; and

•

Maximize the effectiveness of our billing and collection function.

Our Services

Overview

We provide a wide range of oncology diagnostic testing and consultative services that include technical laboratory services and professional interpretation by licensed physicians that specialize in pathology; such reports and analyses are provided to our customers through our internet-based portal, PATHSiTE^®.

Our anatomic pathology services are focused on the most common types of solid tumors: breast, prostate, lung, and colon, representing over 80% of annual diagnosed cases in the United States. We also offer an extensive menu of hematopathology testing for leukemia and lymphoma. Our laboratory continues to expand its service offerings as new assays emerge. We also provide a complete complement of commercial services to biopharmaceutical companies and other research organizations, ranging from diagnostic testing services to the development of directed diagnostics through clinical trials.

New Tests Launched in 2010

Clarient Insight^®Dx Pulmotype^®

In February 2010, we launched Clarient Insight^®Dx Pulmotype^® (“Pulmotype”), a five antibody immunohistochemistry (IHC) test that can be used to aid in the histological distinction between adenocarcinoma and squamous cell carcinoma in non-small cell lung cancer tumor specimens. The histologic classification of non-small cell lung tumors has gained clinical relevance because newly developed targeted therapies show different clinical effectiveness or toxicity dependent upon the histology of the tumor. Non-small cell lung cancer accounts for approximately 85 percent of the more than 200,000 lung cancer cases diagnosed each year. There is currently no other widely accepted molecular-based tool to help distinguish these different histological types. Pulmotype can, therefore, assist pathologists through complementing their morphological assessment of lung types, resulting in better diagnostic precision for more targeted therapeutic decisions for patients.

Methodologies Employed in Our Laboratory Services

Our extensive menu of over 350 diagnostic tests used to assess and characterize cancer includes various methodologies which incorporate the latest laboratory technologies: IHC, flow cytometry, polymerase chain reaction (“PCR”), fluorescent in situ hybridization (“FISH”), cytogenetics, and histology, which are briefly described below:

•

IHC refers to the process of localizing proteins in cells of a tissue section and relies on the principle of antibodies binding specifically to antigens in biological tissues. IHC is widely used in the diagnosis of abnormal cells such as those found in cancerous tumors. Specific molecular markers are characteristic of particular cellular events such as proliferation or cell death (apoptosis). IHC is also used to understand the distribution and localization of biomarkers and differentially expressed proteins in various parts of biological tissue.

•

Flow cytometry is a technology that measures and analyzes multiple physical characteristics of single particles, usually cells, as they flow in a fluid stream through a beam of light. The properties measured include a particle’s relative size, relative granularity or internal complexity, and relative fluorescence intensity. The use of flow cytometry assists a pathologist in diagnosing a wide variety of leukemia and lymphoma neoplasms. Flow cytometry is also used to monitor patients through therapy to determine whether the disease burden is increasing or decreasing, otherwise known as minimal residual disease monitoring.

•

PCR is a molecular biology technique that uses small DNA probes to target and amplify specific gene sequences for further analysis. The amplification occurs through the use of the polymerase chain reaction which consists of repeated cycles of heating and cooling the specimen in the presence of specific reagents. The technique is extremely sensitive and rapid, and offers direct detection and visualization of gene sequences.

•

FISH is a molecular technique that can be used to detect and localize the presence or absence of specific DNA sequences on chromosomes. The technique uses fluorescent probes that bind to only those parts of the chromosome with which they show a high degree of sequence similarity. Fluorescence microscopy is used to visualize the fluorescent probes bound to the chromosomes. FISH is often used for finding specific features of the genome for use in genetic counseling, medicine, and species identification. FISH can be used to help identify a number of gene alternations, such as amplification, deletions, and translocations.

•

Histology is the study of the microscopic structure of tissues. Through histology services, a pathologist attempts to determine the diagnosis of disease. Through structural and other changes in cells, tissues, and organs, pathologists can use a number of tools to establish a diagnosis of the type of disease suffered by the patient, a prognosis on the likely progression of the disease, and a determination as to which therapies are most likely to be effective in treating the patient. In addition to histology service, a number of molecular studies can now be run on these samples to gain further insight on prognostic and predictive indicators.

•

Cytogenetics involves genetic testing in cancer to assess a variety of genetic disorders and hematologic malignancies. It involves looking at the chromosome structure to identify changes from patterns seen in normal chromosomes.

Employees

As of March 31, 2010, we, inclusive of CPS (defined in Note 1(a) to the Condensed Consolidated Financial Statements), had 367 employees: 209 in laboratory diagnostics, research and development, and related support positions; 100 in executive, finance, information technology, billing, and administrative positions; and 58 in sales and marketing positions. We are not subject to any collective bargaining agreements, and we believe that our relationship with our employees is good. In addition to full-time employees, we use the services of various independent contractors, primarily for certain service, development, marketing, and administrative activities.

Billing

Overview

Our net revenue is predominately derived from performing oncology diagnostic testing services which are billed to third parties (Medicare and private health insurers), clients (pathologists, hospitals, clinics, and biopharmaceutical companies), and patients. Our laboratory diagnostic services are eligible for third-party reimbursement under well-established medical billing codes. These billing codes are known as Healthcare Common Procedure Coding Systems and incorporate Medicare’s Common Procedural Terminology (“CPT”) codes, providing the means by which Medicare/Medicaid and private health insurers identify certain medical services that are eligible for reimbursement. The Medicare/Medicaid reimbursement amounts are based on the relative value of medical services with associated CPT codes, as established by the Centers for Medicare & Medicaid Services (“CMS”) with recommendations from the American Medical Association’s Relative Value Update Committee.

Medicare reimbursement rates, which provide the basis for substantially all of our billings, are dictated by CPT codes under two distinct reimbursement schedules: a Physician Fee Schedule and a Clinical Fee Schedule. We have the requisite Medicare provider numbers for both schedules, though the vast majority of our billings fall under the Physician Fee Schedule. The relevant CPT billing codes under the Physician Fee Schedule further distinguishes between “Technical” diagnostic services (the performance of a diagnostic test), “Professional” services (the professional interpretation of a diagnostic test, typically performed by a licensed physician), and “Global” services (the combination of Technical and Professional services).

The amount that we are able to be reimbursed from private health insurers is based on several factors, including the type of health insurance coverage (for example, health maintenance organization or preferred provider organization), whether the services are considered to be in network or out of network by the health insurance provider, and the amount of any co-pays or deductibles for which the patient is responsible.

Payor Classes

Third-party billing. The majority of our net revenue is generated from patients who use health insurance coverage through Medicare or private health insurers.

Client billing. We generally establish arrangements with our clients that allow us to bill them an agreed-upon amount for each type of service provided, though our client pricing is generally based upon the effective CPT code rate. It is generally our clients’ responsibility to seek reimbursement from their patients’ health insurance companies and/or the patients themselves.

Patient billing. We bill patients with health insurance co-payment obligations and deductibles (indirect billings), as well as patients without health insurance coverage (direct billings).

We do not rely on any single customer, or subset of customers, for a significant portion of our net revenue and we therefore have minimal risk of customer concentration. We, however, are dependent upon reimbursement from Medicare and its designated administrator for a substantial portion of our services, and any significant delay in payment or reductions in the published Medicare fee schedules could impact our operating results, cash flows, and/or financial condition.

CPT Code Summary — 2010 and 2009

The following table summarizes the Medicare reimbursement rates under the Physician Fee Schedule and Clinical Laboratory Fee Schedule for the most common CPT codes used in our laboratory services. The “TC” modifier denotes Technical services, “26” modifier denotes Professional services, and no modifier denotes Global services (except CPT codes 83891, 83896, 83898, 83907, and 83914 which are Technical). The below CPT codes, which provide the basis for our reimbursement rates per test, are associated with a substantial portion of our net revenue:

				2010*				2009				2010 Change
CPT Code		General Description of Service		(1/1/10 – 5/31/10)				(1/1/09 – 12/31/09)				From 2009
88185		Flow cytometry (cell surface, cytoplasmic, or nuclear marker)		$	58			$	59				(1.7	)%
88342 — TC		IHC (including tissue immunoperoxidase)		$	72			$	72				—
88342 — 26		IHC (including tissue immunoperoxidase)		$	45			$	44				2.3	%
88342		IHC (including tissue immunoperoxidase)		$	117			$	116				0.9	%
88361 — TC		IHC (computer assisted)		$	112			$	116				(3.4	)%
88361 — 26		IHC (computer assisted)		$	60			$	62				(3.2	)%
88361		IHC (computer assisted)		$	173			$	178				(2.8	)%
88368 — TC		FISH (manual)		$	181			$	182				(0.5	)%
88368 — 26		FISH (manual)		$	68			$	70				(2.9	)%
88368		FISH (manual)		$	249			$	251				(0.8	)%
88367 — TC		FISH (computer assisted)		$	221			$	222				(0.5	)%
88367 — 26		FISH (computer assisted)		$	66			$	66				—
88367		FISH (computer assisted)		$	286			$	288				(0.7	)%
83891		PCR - Isolation or extraction of highly purified NA		$	6			$	6				—
83896		PCR- NA probe		$	6			$	6				—
83898		PCR - Amp of patient NA, each NA sequence		$	24			$	24				—
83907		PCR - Lysis of cells prior to NA extraction (FFPE Only)		$	19			$	20				(5.0	)%
83914		PCR - Mutation identification		$	24			$	24				—
83912 — 26		PCR - Interpretation and report		$	20			$	19				5.3	%
88381		PCR - Microdissection, manual		$	234			$	257				(8.9	)%

Characteristics of Our Net Revenue and Expenses

Net revenue

Net revenue is derived from billing governmental and private health insurers, clients, and patients for the services that we provide. We report revenue net of “contractual allowances” which is defined and discussed within the “Critical Accounting Policies and Estimates” section below. Bad debt expense is recorded as an operating expense, and is a key component of our overall operating performance.

Cost of services

Cost of services includes compensation (including stock-based compensation) and benefits of laboratory personnel, laboratory support personnel, and pathology personnel. Cost of services also includes depreciation expense of laboratory equipment, laboratory supplies expense, allocated facilities-related expenses, and certain direct costs such as shipping.

Sales and marketing

Sales and marketing expenses primarily consist of the compensation and benefits of our sales force and sales support, and marketing personnel. It also includes costs attributable to marketing our services to community pathology practices, hospitals, and clinics.

General and administrative

General and administrative expenses primarily include compensation (including stock-based compensation) and benefits for personnel that support our general operations such as: information technology, executive management, billing and collection, client services, financial accounting, purchasing, and human resources. General and administrative expenses also include allocated facilities-related expenses, insurance, recruiting, legal, audit, and other professional services.

Bad debt

Bad debt consists of estimated uncollectible accounts, or portions thereof, recorded during the period. The process of evaluating the required allowance for doubtful account, and resulting bad debt expense, at each period end involves an evaluation of historical collection experience to aged receivable balances by payor class, and also involves our significant assumptions and judgment for those receivables we consider unlikely to be collected.

Research and development

Research and development expenses consist of compensation and benefits for research and development personnel, certain laboratory supplies, certain information technology personnel, research and development consultants, payment to access clinical cohorts for ongoing studies, and allocated facility-related costs. Our research and development activities primarily relate to the development and validation of diagnostic tests in connection with our specialized oncology diagnostic services, as well as the development of technology to electronically deliver such services to our customers.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities as of the dates of the balance sheets and revenue and expenses for the periods presented.

Management believes that the following estimates are the most critical to understand and evaluate our reported financial results, which require management’s most difficult, subjective, or complex judgments, resulting from the need to make estimates that are inherently uncertain.

Revenue recognition

Net revenue for our diagnostic services is recognized at the time of completion of discreet diagnostic tests which comprise a patient encounter at a specific date of service (commonly referred to as an “accession”). Our services are billed to various payors, including Medicare, private health insurance companies, healthcare institutions, and patients. We utilize published fee schedules from CMS for recognized revenue for amounts billed to Medicare for our services. We report revenue for our services from contracted payors, including certain private health insurance companies and healthcare institutions, based on the contracted rate (which is generally based on the CMS published fee schedule) or in certain instances, our estimate of such rate.

The difference between the amount billed and the amount recognized as revenue is the result of standard discounts (commonly referred to as “contractual allowances”). We report net revenue from non-contracted payors, including certain private health insurance companies, based on the amount expected to be approved for payment for our services. Subsequent revenue adjustments for non-contracted payors are recognized in the period realized. Patient revenue is divided into two classes: direct bill and indirect bill. The amount recognized as net revenue for direct bill patients is based on a standard multiple of the CMS published fee schedule. The amount recognized as net revenue for indirect bill patients is based on their co-pay or deductible obligation with their primary insurance payor.

Allowance for doubtful accounts and bad debt expense

An allowance for doubtful accounts is recorded for estimated uncollectible amounts due from our various payor groups. The process for estimating the allowance for doubtful accounts involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically, and is principally based upon an evaluation of historical collection experience of accounts receivable by age for our various payor classes. After appropriate collection efforts, accounts receivable are written off and deducted from the allowance for doubtful accounts. Additions to the allowance for doubtful accounts are charged to bad debt expense. The payment realization cycle for certain governmental and managed care payors can be lengthy, involving denial, appeal, and adjudication processes, and is subject to periodic adjustments that may be significant.

Stock-based compensation

We record compensation expense related to stock-based awards, including stock options and restricted stock, based on the fair value of the award using the Black-Scholes option-pricing model. Stock-based compensation expense recognized during the period is based on the value of the portion of the stock-based awards that are ultimately expected to vest and thus the gross expense is reduced for estimated forfeitures. We recognize stock-based compensation expense over the vesting period using the straight-line method for employees and ratably for non-employees. We classify compensation expense related to these awards in the Condensed Consolidated Statements of Operations based on the department to which the recipient reports.

Results of Operations

Continuing Operations Overview — Three Months Ended March 31, 2010 and 2009

The following table presents our results of continuing operations and the percentage of the quarters’ net revenue (in thousands):

		2010								2009
Net revenue		$	26,620				100.0	%		$	23,192				100.0	%
Cost of services			11,167				41.9	%			8,957				38.6	%
Gross profit			15,453				58.1	%			14,235				61.4	%
Operating expenses:
Sales and marketing			4,567				17.2	%			4,288				18.5	%
General and administrative			6,225				23.4	%			5,518				23.8	%
Bad debt			3,572				13.4	%			2,715				11.7	%
Research and development			1,326				5.0	%			200				0.9	%
Total operating expenses			15,690				58.9	%			12,721				54.9	%
Income (loss) from operations			(237	)			(0.9	)%			1,514				6.5	%
Interest expense, net			102				0.4	%			3,170				13.7	%
Income tax benefit			—				—				599				2.6	%
Other expense			31				0.1	%			—				—
Loss from continuing operations, net of income taxes		$	(370	)			(1.4	)%		$	(1,057	)			(4.6	)%