Summary of RESPONSE GENETICS INC

Item 7. Management's Discussion and Analysis of Financial Condition and results of Operations.

Special Note Regarding Forward Looking Statements

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

The following discussion of our financial condition and results of operation should be read in conjunction with our audited financial statements and related notes to the financial statements included elsewhere in this Annual Report on Form 10-K as of December 31, 2008 and 2007 and our audited financial statements for the year ended December 31, 2006 included in our Annual Report on Form 10-KSB previously filed with the SEC. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward looking statements.

Overview

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

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

• Commercialization of our ResponseDX ™ tests;

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

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

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

ResponseDX™

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

At present most chemotherapy regimens are administered without any pre-selection of patients on the basis of their particular genetics. However recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients' tissues that can predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better chemotherapy outcome for cancer patients, we are developing genetic tests that will measure predictive factors for tumor response in tumor tissue samples. We have begun offering tests for non-small cell lung cancer (NSCLC) (ResponseDX: Lung Ô ) and colorectal cancer (CRC) (ResponseDX: Colon Ô ) patients' tumor tissue through our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 (CLIA), and we anticipate offering additional tests for esophageal, ovarian, gastric and pancreatic cancer in the future. These tests are proprietary based tests which serve to help oncologists make optional therapeutic decisions for cancer patients. The results from our tests can help oncologists choose among chemotherapy regimens to treat their cancer patients. On September 29, 2008, we announced an exclusive agreement with NeoGenomics Laboratories (OTCBB: NGNM) whereby NeoGenomics will offer our proprietary ResponseDx: Colon and ResponseDx: Lung tests nationwide. Under the terms of the agreement NeoGenomics will be the national exclusive clinical reference laboratory authorized to offer our proprietary tests through NeoGenomics national sales force and our newly formed sales team. Currently, our newly formed sales team was expanded to 10 sales people located in the West Coast, Midwest, and East Coast areas of the United States.

Diagnostic Tests for Other Cancers

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

Expansion of our pharmacogenomic testing services business

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

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

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

Research and development expenses represented 18.5% and 12.7% of our total operating expenses for the years ended December 31, 2007 and December 31, 2008, respectively. Major components of the $2,155,749 in research and development expenses for the year ended December 31, 2008 included supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, stock-based compensation and sample procurement costs.

Critical Accounting Policies and Significant Judgments and Estimates

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

Revenue Recognition

Revenues are derived from services provided to pharmaceutical companies and from revenues generated from our ResponseDX tests. Revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition, which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

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

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

We recognize a portion of product revenue from our ResponseDX tests invoiced to Medicare on an accrual basis and to third-party payors, including private payors on a cash basis. We have received our Medicare provider number which allows us to invoice and collect from Medicare. Our invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology (CPT) codes. We recognize revenue from third party and private payors currently on a cash basis until a collection history can be determined. Until we are reasonably assured about a pattern of collections we will continue to record revenues from third party payors of ResponseDx on a cash basis. We continue to process samples for ResponseDx testing services. Currently we are processing more samples for ResponseDx testing services than revenue is being recorded. This is primarily due to timing and recognition of revenue from third party payors until a collection history can be established.

We are subject to potentially significant variations in the timing of revenue recognized from period to period due to a variety of factors including: (1) the timing of when specimens are submitted to us for testing; and (2) the specific terms, such as minimum assay requirements in any given period, advance payment requirements, and terms of agreements, as set forth in each contract we have with significant clients.

License Fees

We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from USC in exchange for royalty fees on revenue generated by use of this technology. These royalties are calculated as a fixed percentage of revenue that we generate from use of the technology licensed from USC. Total license fees due under the royalty agreement to USC were $152,502 and $79,052 for the years ended December 31, 2007 and December 31, 2008, respectively. We also maintain a non-exclusive license to use Roche's polymerase chain reaction (PCR), homogenous PCR, and reverse transcription PCR processes. We pay Roche a fixed percentage royalty fee for revenue that we generate through use of certain applications of this technology. Royalties accrued under this agreement totaled $219,721 and $292,481 for the years ended December 31, 2007 and December 31, 2008, respectively. We are subject to potentially significant variations in royalties recorded in any period. While the amount paid is based on a fixed percentage from revenues of specific tests pursuant to terms set forth in the agreements with USC and Roche, the amount due is calculated based on the revenue we recognize using the respective licensed technology. As discussed above, this revenue can vary from period to period as it is dependent on the timing of the specimens submitted by our clients for testing.

Accounts Receivable

We invoice our pharmaceutical clients as specimens are processed and any other contractual obligations are met. Our contracts with pharmaceutical clients typically require payment within 45 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, our clients have primarily been large pharmaceutical companies. As a result, bad debts to date have been minimal.

We generally bill Medicare and third-party payors for ResponseDX upon delivery of a report to the physician. As such, we take assignment of benefits and the risk of collection with Medicare and third-party payors. As we continue to generate revenues from ResponseDX, we will monitor the collection history from third party payors. Until we are reasonably assured about a pattern of collections, we will continue to record revenues from third party payors of ResponseDX on a cash basis.

Income Taxes

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

Results of Operations

Years Ended December 31, 2008 and December 31, 2007

Revenues. Revenues were $7,124,771 for the year ended December 31, 2008, as compared to $7,789,789 for the comparable period in 2007, a decrease of $665,018, or 8.5%. This decrease was generated primarily due to a delay in receipt of samples to be tested from our pharmaceutical clients which we expect to receive in 2009 and 2010 and a reduction in revenue from the fluorescent in situ hybridization, immunohistochemistry (or IHC) and bioinformatics services provided by us to our pharmaceutical company clients and a slowdown in the pharmaceutical services business due to the current economic environment. Combined revenue from fluorescent in situ hybridization, IHC and bioinformatics services provided by us decreased $1,679,707 for the year ended December 31, 2008 compared to the year ended December 31, 2007. This decrease was partially offset by $236,363 in revenue associated with our new Response DX assays which were not available in the year ended December 31, 2007. Additionally, revenues from GSK Bio increased $2,693,015 in 2008 as compared to 2007. This increase was offset by decreases from our clients Taiho and GSK amounting to $1,336,000 and $1,563,257, respectively, in 2008 compared to 2007. For the year ended December 31, 2008, two of our clients, GSK and Taiho, accounted for approximately 94% of our revenue, as compared to approximately 85% of our revenue for the year ended December 31, 2007.

Cost of Revenues. Cost of revenues for the year ended December 31, 2008 were $3,594,355 as compared to $4,045,715 for the year ended December 31, 2007, a decrease of $451,360 or 11.1%. This decrease is primarily related to a decrease in expenses associated with floursecent in situ hybridization processing and bioinformatics expenses of $615,440, and a $117,569 reduction in expenses associated with issuance of stock options to employees and consultants. These decreases were partially offset by increases in reagents and lab supplies of $293,508 to support our pharmaceutical clients and our new ResponseDX assay.

Research and Development Expenses. Research and development expenses were $2,155,749 for the year ended December 31, 2008, as compared to $2,455,044 for the same period in 2007, a decrease of $299,295 or 12.2%. This decrease resulted primarily from a decrease in share-based compensation related to stock options issued to employees and consultants of $134,523, a decrease in laboratory supplies and reagents of $104,508, and a decrease associated with an academic research collaboration of $45,360. We expect research and development expenses to increase as we continue work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

General and Administrative Expenses. General and administrative expenses totaled $7,863,314 for the year ended December 31, 2008, as compared to $5,156,711 for the comparable period in 2007, an increase of $2,706,603 or 52.5%. This increase resulted primarily from an increase of $963,928 in personnel expenses primarily related to our sales and marketing activities for our new ResponseDX assay, an increase in our advertising and business consulting expenses of $640,890 primarily related to our sales and marketing activities for our new ResponseDX assay, an increase of $176,300 in board of director fees compared to $11,500 in 2007, an increase of $151,801 of stock based compensation related to issuance of stock options to some of our key employees, costs related to expenses in Japan of $273,374 which did not exist in 2007, an increase in royalties of $239,802,and an increase of $161,868 in insurance related expenses primarily related to directors and officers insurance. We expect general and administrative expenses to increase as a result of the need to hire additional administrative personnel and due to higher legal, accounting, compliance and related expenses associated with being a public company.

U.K. Operating Costs and U.K. Impairment of Property and Equipment. In December, 2008, we made the decision to increase the operational efficiency of the Company by consolidating our UK operations with our US operations. Based on this decision we began implementation of a reduction of workforce pursuant to which we will close our UK testing facility and consolidate testing services in our laboratory facilities located in Los Angeles. As a result of the implementation of the reduction of workforce management performed a recoverability test of the long-lived assets located at the United Kingdom testing facility. Based on the recoverability analysis performed, the Company recorded a non-cash charge for the impairment of long-lived assets of $0.9 million as of December 31, 2008 to write down the carrying value of the long-lived assets to their estimated fair value of $0. The fair value was estimated based upon offers received from third parties to purchase the long-lived assets. The operating costs related to our UK lab, which were previously included in general and administrative expenses, were approximately $2.5 million for 2008 compared to $1.6 million in 2007.

Interest Income. Interest income was $374,659 for the year ended December 31, 2008, compared with $517,645 for the same period in 2007. This $142,986 decrease was due to lower average cash balances and lower rates of return during the period ending December 31, 2008.

Interest Expense. Interest expense was $3,875 for the year ended December 31, 2008 and $28,669 for the same period in the preceding year. In the year ending December 31, 2007 this expense consisted primarily of a fixed amount on notes payable from our stockholders. The notes payable and accrued interest related to these notes payable was converted into shares of our common stock upon the closing of our initial public offering.

Income Taxes

As of December 31, 2008 and 2007, a full valuation allowance has been recorded for the deferred tax assets since we do not believe the recoverability of the deferred income tax assets in the near future is more likely then not.

Liquidity and Capital Resources

We incurred net losses of $5,052,907 and $9,485,538 during the year ended December 31, 2007 and the year ended December 31, 2008, respectively. Since our inception in September 1999, we have incurred cumulative losses and as of December 31, 2008, we had an accumulated deficit of $29,805,729. We expect that our research and development, and general and administrative expenses will continue to increase and, as a result, we will need to generate significant revenues to achieve profitability.

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

We lease office and laboratory space for our location in Los Angeles under noncancelable operating leases that expire through March 2010. Additionally, in 2007, the Company entered into an agreement to lease office and laboratory space for our operations in Scotland. This is an operating lease which expires in March, 2009. As a result of the reduction in workforce implemented by the Company on February 9, 2009, the Company has extended its lease in Scotland for one additional month in order to facilitate the winding down of our UK operations. For additional information see Note 17 for additional information. Rent expense for our facilities was $617,441 and $587,669 for the years ended December 31, 2008 and 2007, respectively. Future minimum lease payments aggregate to approximately $463,333 over the next two years through the expiration of the leases in 2010.

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

· On December 26, 2008, we amended and restated our master service agreement with GlaxoSmith Kline, Ltd. ("GSK"), a leading pharmaceutical manufacturer (the "GSK Agreement"). Pursuant to the amendment, the term of the GSK Agreement has been extended for a two-year period, with the option for the parties to extend the GSK Agreement for additional one-year periods, upon their mutual written agreement. In addition, we will become a preferred provider to GSK and its affiliates of genetic testing services on a fee-for-service basis and, in anticipation of the services to be provided, GSK agreed to make a non-refundable upfront payment of approximately $1,300,000 which was received on January 5, 2009. This payment may be credited against future work undertaken in the period beginning on January 1, 2009 and ending on December 31, 2010.

· On February 9, 2009, we implemented a reduction of workforce ("Reduction of Workforce") pursuant to which we are closing our United Kingdom testing facility to consolidate services at our CLIA-certified laboratory facilities in Los Angeles. Pursuant to the Reduction of Workforce, we have eliminated all of our employees in the United Kingdom, a total of 9 positions. The lease for our United Kingdom testing facility is due to terminate on March 31, 2009. We have arranged to extend the lease, pursuant to its terms, for an additional month, in order to facilitate the winding down of our operations in the United . . .