You should read the following discussion and analysis in conjunction with our consolidated audited financial statements and related notes for the fiscal year ended June 30, 2009, included elsewhere in this Report. Except for historical information, the following discussion contains forward-looking statements. See "Cautionary Notice Regarding Forward Looking Statements" and "Risk Factors."

Overview

We provide specialty reference laboratory services to support pharmaceutical and laboratory diagnostic manufacturers in the conduct of human clinical research, for use in their drug and diagnostic product development efforts. Our clients include a number of the world's largest multi-national pharmaceutical, biotechnology and diagnostic companies. Our well-recognized specialty areas include cardiovascular disease (dyslipidemia, atherosclerosis, and coronary heart disease), diabetes (and obesity), and bone and joint diseases (osteoporosis as well as osteo and rheumatoid arthritis). We also provide clinical biomarker services for novel biomarkers, as well as custom assay services, to our pharmaceutical and biotech clients. Our company is a Delaware corporation, incorporated in May 1996, and we conduct our operations primarily through our wholly-owned subsidiary, Pacific Biometrics, Inc., a Washington corporation.

Critical Accounting Estimates and Policies

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

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

Revenue Recognition

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

Stock-Based Compensation

Effective January 1, 2006, we adopted the provisions of SFAS No. 123(R), "Share-Based Payment", using the modified prospective transition method. This requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-priced model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in our consolidated income statements. Determining the fair value of equity-based awards at the grant date requires judgment. In addition, judgment is also required in estimating the amount of equity-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, equity-based compensation expense and our results of operations could be materially impacted. We granted 179,392 restricted shares and 192,000 stock options for the fiscal year ended June 30, 2009, compared to 200,000 restricted shares for the fiscal year ended June 30, 2008.

Allowance for Doubtful Accounts

Trade Receivables - While we historically have experienced very low levels of bad debt, we continually monitor our current accounts receivable for past due accounts and adjust the allowance as circumstances warrant. As the recorded bad debt provision is based upon management's judgment, actual bad debt write-offs may be greater than or less than the amount recorded. If we have specific knowledge of a current account that may be uncollectible, we will add that amount to our allowance for doubtful accounts. We are susceptible to changes in the pharmaceutical market as well as to changes in the overall economy. A market downturn or cost reductions from one of our largest clients may influence how we estimate our allowance for bad debt. We incurred bad debt expense of $16,137 in the 2009 fiscal year. The balance of the bad debt allowance was $34,095 and $29,294 for the fiscal years ended June 30, 2009 and June 30, 2008.

Other Receivables - We did not incur any non-trade bad debt in fiscal 2009. In fiscal 2008, we experienced significant non-trade bad debt where we wrote off $100,000 related to our loan and security agreement with Saigene Corporation. Saigene Corporation filed for Chapter 11 bankruptcy and we deemed that 100% of the note receivable from Saigene was uncollectible. During fiscal year 2009, the entire $100,000 was received by us.

Useful Lives of Tangible Assets

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

We depreciate equipment and computers over three to five years, while leasehold improvements are depreciated over the remaining life of the lease or ten years. This estimate of a three to five-year useful life on equipment and computers and a useful life based on the remaining years left on the building lease for leasehold improvements reflects management's judgment that these useful life periods reflect a reasonable estimate of the life over which the equipment, computers and leasehold improvements will be used by us. Software costs incurred in connection with obtaining and developing internal use software ("software costs"), are capitalized in accordance with Statement of Position (SOP) No. 98-1 Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Software costs are amortized over a period not to exceed three years and are included in Property and Equipment (see Note 5). The amount of depreciation and amortization expense we record in any given period will change if our estimates of the useful life of our equipment, computers, and software or leasehold interests were to increase or decrease. We use the discounted cash flow method according to SFAS 144 to test our assets for impairment. The balance of our depreciable assets at June 30, 2009 was $813,258, net of depreciation and amortization.

Operating Expenses

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

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

Revenue:

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

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

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

                        Direct Clinical Services                  Referral        Diagnostic
               Direct Trials Testing            Biomarkers      Laboratories       Services
Fiscal 2009                        46 %                   8 %              45 %             1 %

Fiscal 2008                        65 %                   5 %              24 %             6 %

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

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

In addition, management continues its review of the cholesterol drug development market, which provides a substantial proportion of our revenues. Recently other drugs in the cholesterol drug class have been reactivated and we are cautiously optimistic that the cholesterol testing market will improve in fiscal 2009 and beyond. Moreover, we have also noted recent strong demand in related markets, such as diabetes and obesity.

Laboratory Expense and Cost of Goods Sold:

                                                    Years Ended
                                                     June 30,              $           %
    Dollars in thousands, rounded to nearest
                    thousand                     2009        2008       Change      Change

   Laboratory Expenses and Cost of Goods Sold   $ 5,920     $ 4,841       1,079          22
   Percentage of Revenue                             55 %        59 %

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

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

                                                     Years Ended
                                                      June 30,                            $           %
Dollars in thousands, rounded to                 % of                      % of
        nearest thousand            2009        revenue       2008        revenue      Change       Change
       Fixed Cost Detail
Rent, Utilities, Certain Taxes     $   511             5 %   $   475             6 %   $    36            8 %

      Variable Cost Detail
Wages, Taxes, Benefits               2,391            22 %     1,903            23 %       488           26 %
Reagent Chemicals                    2,402            22 %     1,777            22 %       625           35 %
Other Variable Costs                   616             6 %       686             8 %       (70 )        (10 %)
             Total                   5,409            50 %     4,366            53 %     1,043           24 %

Total Cost of Goods Sold           $ 5,920            55 %   $ 4,841            59 %   $ 1,079           22 %

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

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

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

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

Selling, General and Administrative Expense:

                                                    Years Ended
                                                     June 30,              $            %
   Dollars in thousands, rounded to nearest
                   thousand                      2009        2008        Change      Change

  Selling, General and Administrative Expense   $ 4,347     $ 3,990          357           9
  Percentage of Revenue                              40 %        48 %

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

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

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

Other Income (Expense):

                                                  Years Ended
                                                   June 30,              $            %
    Dollars in thousands, rounded to nearest
                    thousand                    2009       2008        Change      Change

    Other Income/(Expense)                     $   623     $  (5 )         628       11622
    Percentage of Revenue                            6 %      (0 )%

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

Net Income (Loss):

                                                 Years Ended
                                                   June 30,              $           %
   Dollars in thousands, rounded to nearest
                   thousand                    2009        2008       Change       Change

   Net Income (Loss)                          $ 1,236     $ (571 )    $ 1,807          316
   Percentage of Revenue                           11 %       (7 )%

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

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

Liquidity and Capital Resources

At June 30, 2009 our cash and cash equivalents were approximately $1,365,000, compared to approximately $1,196,000 at June 30, 2008. At June 30, 2009, we had approximately $2,239,000 in accounts receivable, compared to approximately $2,146,000 as of June 30, 2008, reflecting timing of revenues billed and . . .