NEOGENOMICS INC – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

NeoGenomics, Inc., a Nevada corporation (referred to individually as the "Parent Company" or collectively with its subsidiary as "NeoGenomics", "we", "us", "our" or the "Company" in this Form 10-K) is the registrant for SEC reporting purposes. Our common stock is listed on the NASDAQ Capital Market under the symbol "NEO."  

Introduction

  The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements, and the Notes thereto included in this Form 10-K. The information contained below includes statements of management's beliefs, expectations, hopes, goals and plans that, if not historical, are forward-looking statements subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. For a discussion on forward-looking statements, see the information set forth in the Introductory Note to this Annual Report under the caption "Forward Looking Statements", which information is incorporated herein by reference.  

Overview

  We operate a network of cancer-focused testing laboratories whose mission is to improve patient care through exceptional genetic and molecular testing services. Our vision is to become America's premier cancer testing laboratory by delivering uncompromising quality, exceptional service and innovative products and services. The Company has laboratory locations in Ft. Myers and Tampa, Florida; Irvine, California; and Nashville, Tennessee, and currently offers the following types of testing services:  a) Cytogenetics testing - the study of normal and abnormal chromosomes and their relationship to disease. Cytogenetic studies are often utilized to assist in refining treatment options for hematopoietic cancers such as leukemia and lymphoma;  

b) Fluorescence In-Situ Hybridization ("FISH") testing - a branch of cancer genetics that focuses on detecting and locating the presence or absence of specific DNA sequences and genes on chromosomes;

  c) Flow cytometry testing - a rapid way to measure the characteristics of cell populations. Cells from peripheral blood, bone marrow aspirate, lymph nodes, and other areas are labeled with selective fluorescent antibodies and quantified according to their surface antigens. These fluorescent antibodies bind to specific cell surface antigens and are used to identify malignant cell populations. Flow cytometry is typically performed in conjunction with morphology testing which looks at smears on glass slides for abnormal cell populations;  

d) Immunohistochemistry ("IHC") testing - the process of identifying cell proteins in a tissue section utilizing the principle of antibodies binding specifically to antigens. Specific surface cytoplasmic or nuclear markers are characteristic of cellular events such as proliferation or cell death (apoptosis). IHC is also widely used to understand the distribution and localization of differentially expressed proteins; and

  e) Molecular testing - a rapidly emerging cancer diagnostic tool focusing on the analysis of DNA and RNA, as well as the structure and function of genes at the molecular level. Molecular testing employs multiple technologies including bi-directional Sanger sequencing analysis, DNA fragment length analysis, and real-time polymerase chain reaction ("RT-PCR") RNA analysis.  All of these testing services are widely utilized to determine the diagnosis and prognosis of various types and subtypes of cancer and to help predict a patient's potential response to specific therapies. NeoGenomics offers testing services on both a "tech-only" basis, where NeoGenomics performs the technical component of the testing (specimen set-up, staining, imaging, sorting and categorization of cells, chromosomes, genes or DNA) and the client physician performs the related professional interpretation                                           35

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  component (analyzing the laboratory data, developing the diagnosis or prognosis as well as preparing and writing the final report), as well as on a full service or "global" basis where NeoGenomics performs both the technical component and the professional interpretation component.  

Operating Segment

  We have one reportable operating segment that delivers testing services to hospitals, pathologists, oncologists, other clinicians and researchers. Also, at December 31, 2012, all of our services were provided within the United States and all of our assets were located in the United States.  

Market Opportunity

The medical testing laboratory market can be broken down into three primary segments:

     •   Clinical Pathology testing,       •   Anatomic Pathology testing, and       •   Genetic and Molecular testing.  

Clinical Pathology testing covers high volume, highly automated, lower complexity tests on easily procured specimens such as blood and urine. Clinical lab tests often involve testing of a less urgent nature, for example, cholesterol testing and testing associated with routine physical exams.

Anatomic Pathology testing involves evaluation of tissue, as in surgical pathology, or cells as in cytopathology. The most widely performed Anatomic Pathology procedures include the preparation and interpretation of pap smears, skin biopsies, and tissue biopsies.

Genetic and molecular testing typically involves analyzing chromosomes, genes, proteins and/or DNA/RNA sequences for abnormalities. Genetic and molecular testing requires highly specialized equipment and credentialed individuals (typically M.D. or Ph.D. level) to certify results and typically yields the highest reimbursement levels of the three market segments.

  The field of cancer genetics is evolving rapidly and new tests are being developed at an accelerated pace. Based on medical and scientific discoveries over the last 10 years, cancer testing falls into one of three categories: diagnostic testing, prognostic testing and predictive testing. Of the three, the fastest growing area is predictive testing, which is utilized by clinicians to predict a patient's response to the various treatment options in order to deliver "personalized medicine" that is optimized to that patient's particular circumstances.  We estimate that the United States market for genetic and molecular testing is divided among approximately 360 laboratories. Approximately two thirds of these laboratories are attached to academic institutions and primarily provide clinical services to their affiliated university hospitals and associated physicians. We believe that the remaining one third of the market is quite fragmented and that less than 20 laboratories market their services nationally. We estimate that the top 20 laboratories account for approximately 50% of market revenues for genetic and molecular testing.  We believe that the key factors influencing the rapid market growth for cancer testing include: (i) every year more and more genes and genomic pathways are implicated in the development and/or clinical course of cancer; (ii) cancer is primarily a disease of the elderly - one in four senior citizens is likely to develop some form of cancer during the rest of their lifetime once they turn sixty, and now that the baby boomer generation has started to reach this age range, the incidence rates of cancer are rising; and (iii) increasingly, new drugs are being targeted to certain cancer subtypes and pathways which require companion diagnostic testing. Laboratory tests are needed to identify the type and subtype of cancer and the proper treatment regimen for each individual patient in order to deliver "personalized medicine" to the patient. These factors have driven explosive growth in the development of new genetic and molecular tests. We estimate a $10-12 billion total market opportunity for cancer testing in the United States, about $4-5 billion of which is derived from genetic and molecular testing with the remaining portion derived from more traditional anatomic pathology testing services that are complementary to and often ordered with the genetic and molecular testing services we offer.                                           36

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Our Focus

  Our primary focus is to provide high complexity, cancer-related laboratory testing services to hospitals, community-based pathology practices, and clinicians throughout the United States. We currently perform analyses for hematopoietic cancers such as leukemia and lymphoma (blood and lymphoid tumors) and solid tumor cancers such as breast, lung, colon, and bladder cancer. For hematopoietic cancers, we typically analyze bone marrow aspirate and peripheral blood specimens. For solid tumor cancers, we typically analyze formalin fixed, paraffin embedded tissue samples or urine.  The cancer testing services we offer to community-based pathologists are designed to be a natural extension of, and complementary to, the services that they perform within their own practices. We believe our relationship as a non-competitive partner to community-based pathology practices empowers them to expand their breadth of testing and provide a menu of services that matches or exceeds the level of service found in academic centers of excellence around the country. Community-based pathology practices typically order our services on a "tech-only" basis, which allows them to participate in the diagnostic process by performing the professional interpretation services without having to make the investment in laboratory personnel or equipment needed to perform the technical component of the tests.  In areas where we do not provide services to community-based pathology practices, we may directly serve oncology, dermatology, urology and other clinician practices that prefer to have a direct relationship with a laboratory for cancer-related genetic and molecular testing services. We typically service these types of clients with a "global" service offering where we perform both the technical and professional components of the tests ordered. Increasingly, however, larger clinician practices have begun to internalize pathology testing, and our "tech-only" service offering allows these larger clinician practices to also participate in the diagnostic process by performing the professional interpretation services.  We are committed to being a leader in oncology testing, and thus we are also focused on innovation. Our goal is to develop new assays to help physician clients better manage their patients and to enable them to practice evidence-based medicine tailored specifically for each of their patients. During 2012, we introduced 29 new molecular tests, greatly expanding our molecular testing menu. Molecular testing is a rapidly growing part of oncology testing, which allows us to determine specific subtypes of cancer, as well as predict responses to certain therapeutics by isolating certain genetic mutations in DNA and RNA. We also introduced a number of NeoTYPETM panels that combine multiple molecular tests into panels targeting specific types of cancer to help pathologists and oncologists determine cancer types on difficult cases. We use bi-directional sequencing analysis which we believe is superior to many of the molecular tests being offered by our competitors because we are able to pick up mutations that other methods would not detect. We believe we have one of the most comprehensive molecular testing menus in the United States and that we are well-positioned to capitalize on this rapidly growing area.  During 2012, we also introduced a 10 color flow cytometry service offering on both a tech-only and a global basis. 10 color flow cytometry provides approximately 60% more data than previous flow cytometry platforms and allows for better operating efficiencies in test processing. We believe we are the only cancer genetics laboratory in the United States to offer 10 color flow cytometry on a tech-only basis. In addition, we vastly improved our immunohistochemistry offering, brought up a new digital imaging platform and launched several new FISH tests including a very promising new test to aid in the diagnosis of Barrett's Esophagus that we are offering on a semi-exclusive basis. We expect these new tests to drive substantial growth in 2013. We also expect to continue to make investments in R&D that will allow us commercialize a number of new and innovative genetic tests as we move forward.  With the recent advances in genomics, proteomics and digital pathology, frequently large amounts of data are generated and managing this data is difficult without the aid of computer-based algorithms and pattern recognition. We believe that the best system for pattern recognition and data analysis is a technology known as Support Vector Machine or "SVM", especially when combined with a technology called Recursive Feature Elimination or "RFE". Health Discovery Corporation ("HDC") has an extensive array of pending and issued patents surrounding SVM and RFE technology. In January 2012, we entered into a Master License Agreement (the "License Agreement") with HDC, pursuant to which we were granted an exclusive worldwide license to utilize HDC's intellectual property portfolio, including some 84 issued and pending patents related to SVM and RFE as well as certain patents relating to digital image analysis,                                           37

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biomarker discovery, and gene and protein-based diagnostic, prognostic, and predictive testing, to develop and commercialize laboratory developed tests ("LDTs") and other products relating to hematopoietic and solid tumor cancers.

  Under the terms of the License Agreement, we may, subject to certain limitations, use, develop, make, have made, modify, sell, and commercially exploit products and services in the fields of laboratory testing, molecular diagnostics, clinical pathology, anatomic pathology and digital image analysis relating to the development, marketing, production or sale of any LDTs or other products used for diagnosing, ruling out, predicting a response to treatment, and/or monitoring treatment of any hematopoietic and solid tumor cancers excluding cancers affecting the retina and breast cancer; provided, that the exclusion for breast cancer shall be in effect only so long as that certain license agreement between HDC and the licensee of the technology for breast cancer applications is in full force and effect and such licensee is not in material breach of any its obligations under that agreement.  By licensing this technology and combining the expertise that already existed at HDC with our expertise in genomics, proteomics and digital imaging, we believe we are well-positioned to begin developing innovative and proprietary new products. SVM-RFE techniques allow us to combine and analyze data from genomics, proteomics and digital imaging to develop practical, cost-effective and reliable new assays. Using this technology, we believe we will be able to offer a whole line of advanced tests that will help physicians better manage the treatment options for cancer patients. We have prioritized the development of better tests for the diagnosis and prediction of clinical behavior in prostate cancer, pancreatic cancer, breast cancer, leukemia/lymphoma and other solid tumors as part of the License Agreement.  

Competitive Strengths

Turnaround Times

  We strive to provide industry leading turnaround times for test results to our clients nationwide. By providing information to physicians in a rapid manner, they can begin treating their patients as soon as possible. We believe our average 4-5 day turn-around time for our cytogenetics testing services, our average 3-4 day turn-around time for FISH testing services, and our average 1 day turn-around time for flow cytometry testing services are industry-leading benchmarks for national laboratories. Our consistent timeliness of results is a competitive strength and a driver of additional testing requests by our referring physicians. Quick turn-around times allow for the performance of other adjunctive tests within an acceptable diagnosis window in order to augment or confirm results and more fully inform treatment options. We believe that our rapid turnaround times are a key differentiator of NeoGenomics versus other national laboratories, and our clients often cite them as a key factor in their relationship with us.  Medical Team  Our team of medical professionals and Ph.Ds. are specialists in the field of genetics and oncology. Our medical team is led by our Chief Medical Officer, Dr. Maher Albitar, a renowned hematopathologist with extensive experience in molecular and genetic testing. Prior to joining NeoGenomics, Dr. Albitar was Medical Director for Hematopathology and Oncology at the Quest Nichols Institute and Chief R&D Director for Hematopathology and Oncology for Quest Diagnostics. He also served as Section Chief for Leukemia at the University of Texas M. D. Anderson Cancer Center. In addition to Dr. Albitar, we employ several other full-time M.D.s and Ph.Ds.  

Extensive Tech-Only Service Offerings

  We launched the first tech-only FISH testing services in the United States in 2006, and we currently have the most extensive menu of tech-only FISH services in the country. We also offer tech-only flow cytometry and immunohistochemistry testing services. These types of testing services generally allow the professional interpretation component of a test to be billed separately from the technical component. Our NeoFISHTM, NeoFLOWTM and other tech-only service offerings allow properly trained and credentialed community-based pathologists to extend their own practices by performing professional interpretations services, which allows them to better service the needs of their local clientele without the need to invest in the lab equipment and personnel required to perform the technical component of genetic and molecular                                           38

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testing.

  Our tech-only services are designed to give pathologists the option to choose, on a case by case basis, whether they want to order just the technical information and images relating to a specific test so they can perform the professional interpretation, or order "global" services and receive a comprehensive test report which includes a NeoGenomics Pathologist's interpretation of the test results. Our clients appreciate the flexibility to access NeoGenomics' medical staff for difficult or complex cases or when they are otherwise unavailable to perform professional interpretations. We believe this innovative approach to serving the needs of pathology client's results in longer term, more committed client relationships that are more akin to strategic partnerships. Our extensive tech-only service offerings have differentiated NeoGenomics and allowed us to compete more effectively against larger, more entrenched competitors in our niche of the industry.  

Global Service Offerings

  We also offer a full set of global services to meet the needs of those clients who are not credentialed and trained in interpreting genetic tests and who are looking for specialists to interpret the testing results for them. In our global service offerings, our lab performs the technical component of the tests and our M.D.s and Ph.Ds. provide the interpretation services. Our professional staff is also available for post testing consultative services. These clients rely on the expertise of our medical team to give them the answers they need in a timely manner to help inform their diagnoses and treatment decisions. Many of our tech-only clients also rely on our medical team for difficult or challenging cases by ordering our global testing services on a case by case basis or our medical team can serve as a backup to our clients who need overflow or weekend coverage. Our Genetic Pathology Solutions ("GPS") report summarizes all relevant case data from our global services on one summary report. When providing global services, NeoGenomics performs both the technical and professional component of the test, which results in a higher reimbursement level.  

Client Education Programs

  We believe we have one of the most extensive client education programs in the genetic and molecular testing industry. We train pathologists how to use and interpret genetic testing services so that they can then participate in our tech-only service offerings. Our educational programs include an extensive library of on-demand training modules, online courses, and custom tailored on-site training programs that are designed to prepare clients to utilize our tech-only services. Each year, we also regularly sponsor seminars and webinars on emerging topics of interest in our field. Our medical staff is involved in many aspects of our training programs.  

Superior Testing Platforms

  We use some of the most advanced testing platforms in the laboratory industry. Our new 10 color flow cytometry platform was recently launched and we are the first national laboratory to offer this service on a tech-only basis. Most of our competitors only offer between 5 and 8 color Flow Cytometry testing. We believe that this allows us to provide more and better data to our clients. The use of bi-directional sequencing in our molecular testing allows us to detect multiple mutations which can be missed with single point mutation analysis. Our automated FISH and Cytogenetics tools allow us to deliver the highest quality testing to our clients.  

Laboratory Information System (LIS)

  We believe we have a state-of-the-art Laboratory Information System ("LIS") that interconnects our locations and provides flexible reporting solutions to clients. This system allows us to standardize testing and deliver uniform test results and images throughout our network, regardless of the location that any specific portion of a test is performed within our laboratories. This allows us to move specimens and image analysis work between locations to better balance our workload. Our LIS also allows us to offer highly specialized and customizable reporting solutions to our tech-only clients. For instance, our tech-only NeoFISHTM and NeoFLOWTM applications allow our community-based pathologist clients to tailor individual reports to their specifications and incorporate only the images they select and then issue and sign-out such reports from our system with their own logos at the top. Our customized reporting solution even allows our                                           39 

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clients to incorporate test results performed on ancillary tests not performed at NeoGenomics into summary report templates. This feature has been well-received by clients.

National Direct Sales Force

  Our direct sales force has been trained extensively in cancer genetic testing and consultative selling skills to service the needs of clients. Our sales representatives ("Territory Business Managers") are organized into three regions (Northeast, Central and West). These sales representatives all utilize our custom Customer Relationship Management System to manage their territories, and we have integrated all of the important customer care functionality within our LIS into Salesforce.com so that our Territory Business Managers can stay informed of emerging issues and opportunities within their regions. As of January 31, 2013, we had 19 Territory Business Managers, one Managed Care Specialist, and three Regional Managers.  

Geographic Locations

  Many high complexity laboratories within the cancer testing niche have frequently operated a core facility on either the West Coast or the East Coast of the United States to service the needs of their customers around the country. We believe our clients and prospects desire to do business with a laboratory with national breadth and a local presence. We have four facilities, two large laboratory locations in Fort Myers, Florida and Irvine, California and two smaller laboratory locations in Nashville, Tennessee and Tampa, Florida. Our objective is to "operate one lab with four locations" in order to deliver standardized test results. We intend to continue to develop and open new laboratories and/or expand our current facilities as market situations dictate and business opportunities arise.  

Scientific Pipeline

  In the past few years our field has experienced a rapid increase in tests that are tied to specific "genomic pathways". These predictive tests are typically individualized for a small sub-set of patients with a specific subtype of cancer. The therapeutic target in the genomic pathways is typically a small molecule found at the level of the cell surface, within the cytoplasm and/or within the nucleus. These genomic pathways, known as the "Hallmarks of Cancer", contain a target-rich environment for small-molecule "anti-therapies". These anti-therapies target specific mutations in the major cancer pathways such as the Proliferation Pathway, the Apoptotic Pathway, the Angiogenic Pathway, the Metastasis Pathway, and the Signaling Pathways and Anti-Signaling Pathways.  As an example, the FDA approved a small molecule anti-therapy drug (Xalkori) that targets a mutation in the ALK gene for a small sub-set of patients with Non-Small Cell Lung Cancer (NSCLC). Between 50-61% of patients with an ALK gene rearrangement will respond to this therapy. To identify patients eligible for this specific small-molecule therapy, an FDA-approved FISH test that NeoGenomics and certain other laboratories offer, must be performed. This ALK FISH test is considered a companion diagnostic test and it is critical that this test be performed and the patient found to have an ALK mutation before therapy can be administered. Tests such as the ALK FISH test allow our clients to direct individualized treatments to each cancer patient in a timely manner. We are increasingly focused on developing similar predictive tests as part of our new product development pipeline. In 2012 we added 29 new molecular tests to our existing service offerings and we expect to add multiple new tests in the next year including the launch of our NeoSITEtm Barrett's Esophagus Test for surveillance and diagnosis of High Grade Dysplasia and Esophageal Cancer. In addition, in 2012 we expanded our IHC menu and our digital pathology platform, complementary services we believe will help to drive future growth.  

We are working with the technology we licensed from HDC to develop new proprietary cancer tests. We are working on technology that we believe could streamline our workflow and reduce our costs.

Critical Accounting Policies

The preparation of financial statements in conformity with United States generally accepted accounting principles requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results

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  could differ from those estimates. Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. For a complete description of our significant accounting policies, see Note B to our Consolidated Financial Statements included in this Annual Report on Form 10-K.  

Our critical accounting policies are those where we have made difficult, subjective or complex judgments in making estimates, and/or where these estimates can significantly impact our financial results under different assumptions and conditions. Our critical accounting policies are:

     •   Revenue Recognition       •   Accounts Receivable       •   Intangible Assets       •   Stock Based Compensation  

Revenue Recognition

  The Company recognizes revenues when (a) the price is fixed or determinable, (b) persuasive evidence of an arrangement exists, (c) the service is performed and (d) collectability of the resulting receivable is reasonably assured.  The Company's specialized diagnostic services are performed based on a written test requisition form or electronic equivalent and revenues are recognized once the diagnostic services have been performed, and the results have been delivered to the ordering physician. These diagnostic services are billed to various payers, including Medicare, commercial insurance companies, other directly billed healthcare institutions such as hospitals and clinics, and individuals. The Company reports revenues from contracted payers, including Medicare, certain insurance companies and certain healthcare institutions, based on the contractual rate, or in the case of Medicare, published fee schedules. The Company reports revenues from non-contracted payers, including certain insurance companies and individuals, based on the amount expected to be collected. The difference between the amount billed and the amount estimated to be collected from non-contracted payers is recorded as an allowance to arrive at the reported net revenues. The expected revenues from non-contracted payers are based on the historical collection experience of each payer or payer group, as appropriate. The Company does not record revenues from patient pay tests until cash is collected as collectability is not assured at the time services are provided. Our estimates of net revenue are subject to change based on the contractual status and payment policies of the third party payers with whom we deal. We regularly refine our estimates in order to make our estimated revenue as accurate as possible based on our most recent collection experience with each third party payer. The Company regularly reviews its historical collection experience for non-contracted payers and adjusts its expected revenues for current and subsequent periods accordingly. The following is the percentage break-down of net revenue by Payer class:                       Payer Class             FY 2012        FY 2011                    Government                    36 %           43 %                    Commercial Insurance          29 %           29 %                    Client                        33 %           26 %                    Patient                        1 %            1 %                    Unbilled Revenue               1 %            1 %                     Total                        100 %          100 %  

Trade Accounts Receivable and Allowance For Doubtful Accounts

  Accounts receivable are reported, net of an allowance for doubtful accounts, which is estimated based on the aging of accounts receivable with each payer category and the historical data on bad debts in these aging categories. In addition, the allowance is adjusted periodically for other relevant factors, including regularly assessing the state of our billing operations in order to identify issues which may impact the collectability of receivables or allowance estimates. Revisions to the allowance are recorded as an adjustment to bad debt expense within general and administrative expenses. After appropriate collection efforts have been exhausted, specific receivables deemed to be uncollectible are charged against the allowance in the period they are deemed uncollectible. Recoveries of receivables previously written-off are recorded as credits to the allowance.                                           41 

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  The following tables present the dollars and percentage of the Company's gross accounts receivable from customers outstanding by aging category at December 31, 2012 and 2011:                  NEOGENOMICS AGING OF RECEIVABLES BY PAYER GROUP                                 December 31, 2012    Payer Group                                     0-30          %           31-60         %           61-90         %          91-120         %          >120          %           Total           % Client                                       $ 2,481,019       15 %    $

1,903,574 11 % $ 1,824,849 11 % $ 660,358 4 % $ 517,784 3 % $ 7,387,584 44 % Commercial Insurance

                             913,997        5 %        789,529        5 %        714,336        4 %        590,288       3 %      2,496,344       15 %       5,504,494        32 % Medicaid                                          27,664        0 %         33,094        0 %         59,349        0 %         46,358       0 %        326,838        3 %         493,303         3 % Medicare                                         836,619        5 %        541,790        3 %        451,912        3 %        291,509       2 %      1,350,217        7 %       3,472,047        20 % Private Pay                                           -         0 %          8,194        0 %         17,339        0 %             -        0 %            287        0 %          25,820         0 % Unbilled Revenue                                 152,253        1 %             -         0 %             -         0 %             -        0 %             -         0 %         152,253         1 %  Total                                        $ 4,411,552       26 %    $ 3,276,181       19 %    $ 3,067,785       18 %    $ 1,588,513       9 %    $ 4,691,470       28 %    $ 17,035,501       100 %                                   December 31, 2011    Payer Group                                    0-30          %           31-60         %           61-90         %         91-120        %          >120          %           Total           % Client                                      $ 1,016,372       10 %    $ 1,008,912       10 %    $   296,940        3 %    $ 159,387       2 %    $   157,500        2 %    $  2,639,111        27 % Commercial Insurance                            920,210        9 %        652,010        6 %        379,880        4 %      272,969       3 %      1,582,400       16 %       3,807,469        38 % Medicaid                                         24,510        0 %         28,097        0 %         32,425        0 %       46,792       1 %        201,379        2 %         333,203         3 % Medicare                                      1,127,747       11 %        242,574        2 %        206,050        2 %      159,863       2 %        783,755        8 %       2,519,989        25 % Private Pay                                      13,760        0 %        

94,377 1 % 114,766 1 % 113,719 1 % 115,466 1 % 452,088 4 % Unbilled Revenue

                                292,406        3 %             -         0 %             -         0 %           -        0 %             -         0 %         292,406         3 %  Total                                       $ 3,395,005       33 %    $ 2,025,970       19 %    $ 1,030,061       10 %    $ 752,730       9 %    $ 2,840,500       29 %    $ 10,044,266       100 %   

The following table represents our allowance balances at each balance sheet date presented and that allowance as a percentage of gross accounts receivable:

                                                     December 31,                                              2012             2011           Change

Allowance for doubtful accounts $ 2,150,000$ 852,000

     As a % of total accounts receivable          17.6 %           21.4 %   For the year-ended December 31, 2012 our allowance for doubtful accounts increased $852,000 as compared to the year-ended December 31, 2011. The increase is attributed to the overall increase in our accounts receivable balance and our increases in revenue over the previous year. As a percentage of total accounts receivable the allowance for doubtful accounts decreased to 17.6% at December 31, 2012 from 21.4% at December 31, 2011. The decrease in the percentage of allowance for doubtful accounts as compared to total accounts receivable is attributed to a change to the payer mix of our accounts receivable. NeoGenomics has seen an increase in client billings as a result of the TC Grandfather clause expiration. We typically have had much lower bad debt associated with client billings than from insurance or patient billing.  

Intangible Assets

  On January 6, 2012 we acquired approximately $3.0 million of intangible assets related to our Master License Agreement ("the License Agreement") with HDC pursuant to which we were granted an exclusive worldwide license to utilize 84 issued and pending patents to develop and commercialize laboratory developed tests ("LDTs") and other products relating to hematopoietic and solid tumor cancers. The licensed intellectual property and know-how relates to support vector machine ("SVM"), recursive feature elimination ("SVM-RFE"), fractal genomic modeling ("FGM") and other pattern recognition technology as well as certain patents relating to digital image analysis, biomarker discovery, and gene and protein-based diagnostic, prognostic, and predictive testing.                                           42

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  Under the terms of the License Agreement, we may, subject to certain limitations, use, develop, make, have made, modify, sell, and commercially exploit products and services in the fields of laboratory testing, molecular diagnostics, clinical pathology, anatomic pathology and digital image analysis relating to the development, marketing, production or sale of any LDTs or other products used for diagnosing, ruling out, predicting a response to treatment, and/or monitoring treatment of any hematopoietic and solid tumor cancers excluding cancers affecting the retina and breast cancer (collectively, the "Field").  The License Agreement allows us to develop and sell any gene, gene-product or protein-based LDTs based on HDC's technology in the Field and provides for sublicensing rights and the assignment of the License Agreement, in whole or in part, in our discretion. The License Agreement further provides us with access to certain HDC personnel and consulting resources in the fields of mathematics and in genetic and molecular test development. The licensed technology also includes, among other things, certain tests, algorithms and computer software which have already been developed by HDC. Initially, we intend to focus on developing prostate, pancreatic, and colon cancer LDTs. In addition, we plan to develop interpretation software that will help to automate the analysis of cytogenetics and flow cytometry tests.  The intangible assets were valued at fair value based on cost of the assets as we acquired the assets in an arms-length transaction. We present intangible assets net of accumulated amortization in our financial statements. We have three classes of intangible assets and each class of intangible assets is amortized over its estimated service period from service date through the weighted average patent expiration date of each class of patents or the period of economic benefit. We continually review the estimated pattern in which the economic benefits will be consumed and adjust the amortization period and our pattern to match our estimate.  These intangible assets had amortization expense of $182,000 during the year ended December 31, 2012 and a net book value of $2.8 million as of December 31, 2012. The amortization expense is currently included as a research and development expense in the consolidated statement of operations. We will record all amortization of intangibles in that category until the time that we have products, services or cost savings directly attributable to these intangible assets that would require that it be recorded in cost of goods sold.  We review our long-lived assets for recoverability if events or changes in circumstances indicate the assets may be impaired. This circumstance exists when the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposition. At December 31, 2012, we believe the carrying value of our long-lived assets is recoverable.  

Stock Based Compensation.

The Company recognizes compensation costs for all share-based payment awards made to employees and directors based upon the awards' grant-date fair value.

  For stock options, the Company uses a trinomial lattice option-pricing model to estimate the grant-date fair value of stock option awards, and recognizes compensation cost on a straight-line basis over the awards' requisite service periods. The Company's periodic expense is adjusted for actual forfeitures.  See Note B - Summary of Significant Accounting Policies - Stock-Based Compensation and Note H - Stock Options, Stock Purchase Plan and Warrants in the Notes to Consolidated Financial Statements for more information regarding the assumptions used in our valuation of stock-based compensation.  

Results of Operations for the year ended December 31, 2012 as compared with the year ended December 31, 2011

The following table presents the condensed consolidated statements of operations as a percentage of revenue:

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  Table of Contents                                                 For the year  ended                                                     December 31.                                                  2012           2011              NET REVENUE                           100.0 %       100.0 %              COST OF REVENUE                        55.2 %        55.3 %               GROSS PROFIT                           44.8 %        44.7 %               OPERATING EXPENSES:              General and administrative             26.5 %        28.3 %              Research and development                3.8 %         1.3 %              Sales and marketing                    12.5 %        16.0 %                TOTAL OPERATING EXPENSES               42.8 %        45.6 %                Interest (income) expense, net          1.9 %         1.8 %                NET INCOME (LOSS)                       0.1 %        (2.7 )%   

Technical Component Grandfather Clause Expiration

  On February 22, 2012, the Middle Class Tax Relief Act ("MCTRA") was enacted. The MCTRA included a provision that specified that the Centers for Medicare and Medicaid Services ("CMS") Technical Component Grandfather clause ("TC Grandfather") would expire on June 30, 2012. The TC Grandfather clause had allowed independent laboratories like us to bill Medicare directly for the technical component of certain hospital in-patient and out-patient laboratory tests reimbursable off of the Medicare Physician Fee Schedule for hospitals that had a relationship with an independent pathology lab prior to July 22, 1999. As a result of this regulatory change, effective July 1, 2012, we are now required to bill hospitals directly for these technical component services. Our hospital clients, however, receive no incremental reimbursement for in-patient tests and only limited incremental reimbursement for out-patient tests. Thus, the expiration of the TC Grandfather clause created price competition in approximately 18% of our revenue base, where previously there had been none. This resulted in a decline of approximately $2.6 million of revenue for the six months ended December 31, 2012 versus the six months ended December 31, 2011. This decline in revenue also directly impacted gross margin and net income. We believe that over time we can return to the gross margins we experienced before the TC Grandfather expiration as we continue to grow our business and improve the efficiencies of our laboratory operations. The requirement to submit claims to our clients directly, instead of Medicare, has also had an impact on the time it takes for us to collect on the receivables for the tests in question. Medicare typically pays each claim filed within 3 to 4 weeks of filing, however, clients typically get billed only once a month for all claims, and the collection cycle time from clients is generally 30-60 days or more from the time they receive our bill. While we could bill Medicare on a daily basis, many of our Hospital clients want one bill at the end of the month.  

Revenue

  Our revenue, requisition and test metrics for the years ended December 31, 2012 and 2011 are as follows:                                               FY 2012          FY 2011         % Change    Client Requisitions Received (Cases)         73,773           49,235      

49.8 %

   Number of Tests Performed                   114,606           76,288      

50.2 %

   Average Number of Tests/Requisition            1.55             1.55      

0.3 %

    Total Testing Revenue                  $ 59,867,000     $ 43,484,000      

37.7 %

   Average Revenue/Requisition            $        812     $        883           (8.1 )%   Average Revenue/Test                   $        522     $        570           (8.4 )%   Our 38% year-over-year revenue growth is a result of a broad based increase in the number of new clients, including one new client with over 30 locations, and the further penetration of existing clients in 2012. Our average revenue/test decrease of approximately 8% was primarily attributable to the expiration of the TC Grandfather clause. As a result of this regulatory change, effective July 1, 2012, we are not able to bill Medicare directly for the technical component of certain hospital in-patient and out-patient laboratory tests and now must bill our hospital clients directly for such services, and are often reimbursed at lower rates                                           44 

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than what we received from Medicare. Average revenue per test and per requisition was also modestly impacted by an increasing proportion of lower average revenue molecular and immunohistochemistry tests in our test mix.

Cost of Revenue and Gross Profit

  Cost of revenue includes payroll and payroll related costs for performing tests, depreciation of laboratory equipment, rent for laboratory facilities, laboratory reagents, probes and supplies, and delivery and courier costs relating to the transportation of specimens to be tested.                                                For the years ended                                                 December 31.                                           2012                2011              Change            % Change Cost of Revenue                       $ 33,031,000        $ 24,056,000        $ 8,975,000              37.3 % Cost of Revenue as a % of revenue             55.2 %              55.3 %                               (0.2 )% Gross Profit                          $ 26,836,000        $ 19,428,000        $ 7,408,000              38.1 % Gross Profit as a % of revenue                44.8 %              44.7 %                                0.2 % Cost of Revenue per Test              $     288.21        $     315.33        $    (27.12 )            (8.6 )% Gross Profit per Test                 $     234.16        $     254.67        $    (20.51 )            (8.1 )%   Overall cost of revenue increased in 2012 due to the large increases in our testing volumes. The decline in cost of revenue per test for these periods was the result of improved productivity in our laboratory, as we experienced an increase in the amount of tests processed per laboratory FTE (full time equivalent personnel). This was driven by improved capacity planning and utilization along with several process improvements in the laboratory. We also experienced a reduction in test send-outs to other laboratories as a result of our expanded Molecular test services menu and a reduction in our contract labor due to our expanded medical staff. We also saw rapid growth in lower priced and lower cost molecular tests. We continue to focus on improving our laboratory operations in order to continue to drive further improvements in our cost per test. We believe that we will continue to see a reduction in average cost per test in future periods based on the activities of our best practices teams.  

Sales and Marketing

  Sales and marketing expenses relate primarily to the employee related costs of our sales management, sales representatives, sales and marketing consultants, marketing, and customer service personnel.                                      For the year ended                                      December 31.                                 2012             2011           Change       % Change

       Sales and marketing   $ 7,501,000      $ 6,963,000      $ 538,000           7.7 %        As a % of revenue            12.5 %           16.0 %   The approximate 8% increase in sales and marketing for the year ended December 31, 2012</chron> as compared to the year ended December 31, 2011 was primarily the result of increased sales commissions related to the increase in revenue partially offset by decreases in marketing expenses and travel by our sales organization. Our sales and marketing costs as a percentage of revenue declined for the year ended December 31, 2012 as compared to the year ended December 31, 2011 as a result of operating leverage on our increased revenues.  

We expect our overall sales and marketing expenses to increase modestly in 2013. We also anticipate adding additional sales representatives in 2013.

General and Administrative Expenses

General and administrative expenses relate to billing, bad debts, finance, human resources, information technology and other administrative functions. They primarily consist of employee related costs

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(such as salaries, fringe benefits, and stock-based compensation expense), professional services, facilities expense, and depreciation and administrative-related costs allocated to general and administrative expenses.

                                       For the year ended                                        December 31.                                   2012              2011            Change         % Change

General and administrative $ 15,843,000$ 12,331,000$ 3,512,000

           28.5  As a % of revenue                    26.5 %            28.3 %   General and administrative expenses increased approximately 29%, for the year ended December 31, 2012 as compared to the year ended December 31, 2011. This increase is primarily a result of adding information technology and billing personnel to support the increase in our testing volumes as well as health insurance costs, recruiting expenses to hire new employees across the organization and an increase in corporate performance based bonuses.  Bad debt expense increased by approximately 19%, or $0.5 million to $3.1 million for the year ended December 31, 2012 as compared to $2.6 million for the year ended December 31, 2011. This increase was primarily a result of the 37.7% increase in revenue partially offset by a decrease in bad debt as a percentage of revenue. Bad debt as a percentage of revenue decreased 0.80% to 5.10% for the year ended December 31, 2012 from 5.90% of revenue for the year ended December 31, 2011. This decline was the result of managed care contracts we entered into during the year and changes in our payer mix, resulting in more client billing, which historically has less bad debt than patient or insurance billing.  We expect our general and administrative expenses to increase as we add personnel, increase our billing and collections activities; incur additional expenses associated with the expansion of our facilities and backup systems; and continue to build our physical infrastructure to support our anticipated growth. However, we expect general and administrative expenses to continue to decline as a percentage of our revenue as our case volumes increase and as we continue to develop more operating leverage in our business.  

Research and Development Expenses

  Research and development (R&D) expenses relate to cost of developing new proprietary and non-proprietary genetic tests. R&D expenses consist of payroll for our R&D staff, supplies cost, stock compensation expense, as well as cost related to our licensing agreement with Health Discovery Corporation, including amortization of the licensed technology.                                       For the year ended                                       December 31.                                   2012            2011           Change         % Change     Research and development   $ 2,281,000      $ 543,000      $ 1,737,000          319.8     As a % of revenue                  3.8 %          1.3 %   The increases in research and development expenses are primarily a result of increased personnel costs, stock compensation expense and supply costs to develop and launch new molecular tests as well as to develop proprietary testing products and services including those related to our license with HDC. R&D expenses for the year ended December 31, 2012, also included $151,000 and $135,000 of stock based compensation expenses for non-employee options and warrants. We anticipate a substantial investment in research and development as we develop new genetic tests.  Other (Income) Expense  Other income and expense primarily represents the interest expense we incur on our borrowing arrangements, primarily comprised of interest payable on advances under our revolving credit facility with Capital Source and interest paid on capital lease obligations offset by the interest income we earn on cash deposits. Interest expense increased from approximately $0.8 million in 2011 to $1.15 million in 2012,                                           46 

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reflecting higher borrowings, particularly related to our revolving credit facility and capital lease obligations as we acquired additional equipment to support our increasing volume of business.

Net Income (Loss)

  As a result of the foregoing, our net income increased by approximately $1.3 million to approximately $0.1 million for the year ended December 31, 2012 as compared to a net loss of $1.2 million for the year ended December 31, 2011.  

Non-GAAP Measures

  "Adjusted EBITDA" is defined by NeoGenomics as net income (loss) from continuing operations before (i) interest expense, (ii) tax expense and therapeutic discovery tax grants, (iii) depreciation and amortization expense, (iv) non-cash stock-based compensation and warrant amortization expense and (v) other extraordinary or non-recurring charges, such as the costs related to moving our California facility. NeoGenomics believes that Adjusted EBITDA provides a more consistent measurement of operating performance and trends across reporting periods by excluding these cash and non-cash items of expense not directly related to ongoing operations from income. Adjusted EBITDA also assists investors in performing analysis that is consistent with financial models developed by research analysts.  Adjusted EBITDA as defined by NeoGenomics is not a measurement under GAAP and may differ from non-GAAP measures used by other companies. There are limitations inherent in non-GAAP financial measures such as Adjusted EBITDA because they exclude a variety of charges and credits that are required to be included in a GAAP presentation, and do not therefore present the full measure of NeoGenomics recorded costs against its net revenue. Accordingly, investors should consider non-GAAP results together with GAAP results in analyzing NeoGenomics financial performance.  

The following is a reconciliation of GAAP net loss to Non-GAAP EBITDA and Adjusted EBITDA for the years ending December 31, 2012 and 2011:

                                                     For the years ended                                                       December 31,                                                  2012             2011            Net income (loss) (Per GAAP)        $    65,000     $ (1,177,000 )            Adjustments to Net Loss:           Interest expense (income), net        1,146,000          768,000           Amortization of intangibles             182,000               -           Depreciation and amortization         3,637,000        2,086,000            EBITDA (non-GAAP)                     5,030,000        1,677,000            Further Adjustments to EBITDA:           Other non-recurring items               170,000               -           Non-cash stock-based compensation       798,000          457,000            Adjusted EBITDA (non-GAAP)          $ 5,998,000     $  2,134,000   

Liquidity and Capital Resources

  The following table presents a summary of our cash flows provided by (used in) operating, investing and financing activities for the years ended December 31, 2012 and 2011 as well as the period ending cash and cash equivalents and working capital.                                                     For the years ended                                                      December 31,                                                  2012             2011            Net cash provided by (used in):            Operating activities              $   (492,000 )    $   69,000            Investing activities                (3,652,000 )      (897,000 )                                            47 

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  Financing activities                                     3,384,000        

2,359,000

Net increase (decrease) in cash and cash equivalents (760,000 ) 1,531,000

  Cash and cash equivalents, beginning of period           2,628,000        

1,097,000

   Cash and cash equivalents, end of period               $ 1,868,000      $ 

2,628,000

   Working Capital (1), end of period                     $   823,000      $ 1,734,000     

(1) Defined as current assets less current liabilities.

   During the year ended December 31, 2012, our operating activities used approximately $492,000 of cash compared with $69,000 of cash provided in the comparable period in 2011. This increase in cash used from operations was primarily the result of increases in accounts receivable. Our accounts receivable balance has increased as a result of our 38% revenue growth during the year ended December 31, 2012. Aside from our growth, three other factors have contributed to the increase in our accounts receivable balance. First, the American Medical Association introduced new molecular billing codes that went into effect on January 1, 2012. Only some payers had adopted these new codes, which has complicated billing. Complications from the different billing formats have increased our "re-bill rate" for molecular testing and have increased balances in accounts receivable. Second, the expiration of the TC Grandfather clause on June 30, 2012 which now requires us to bill clients for the technical component of our certain testing services was a factor, whereas previously we were able to bill Medicare directly for such services. Historically, Medicare is a much faster payer than our hospital clients, and this change has contributed to the increase in our receivables. Third policy changes made by the Blue Cross and Blue Shield Association ("BCBSA") to the Blue Card program in the fourth quarter of 2012 increased our accounts receivable as it made it more complicated to receive payment from each of the various Blue Cross plans in each state and to receive out of network payments from patients.  

Cash used by investing activities in 2012 arose from the following:

           •    On January 6, 2012, we entered into a Master License

Agreement (the

                 "License Agreement") with HDC (See Note E to the Notes to                 Consolidated Financial Statements). Upon the execution of 

the

                 License Agreement, we paid HDC $1,000,000 in cash and 

issued to HDC

                1,360,000 shares of our common stock which had a market value of                 $1,945,000 using the closing price of $1.43 per share for our                 common stock as quoted on the OTCQB Market on January 6, 2012. We                 have recorded this transaction as a purchase of intangible assets.                •    We have also used approximately $2,600,000 in cash to 

purchase or

                 develop property and equipment. Approximately half of this 

was

                related to our new laboratory facility in Irvine,

California and

                the remaining amounts were primarily for externally developed                 software interfaces and to a lesser extent small equipment                 purchases which could not be leased and internally developed                 software.  

Cash generated by financing activities in 2012 arose primarily from net borrowings of approximately $4,560,000 under our credit facility. The borrowings were necessary because of growth in our receivables.

  On March 26, 2012, the Parent Company, NeoGenomics Laboratories (together with the Parent Company, the "Borrower"), and CapitalSource Finance LLC ("Capital Source") entered into a First Amendment (the "Amendment") to the Amended and Restated Revolving Credit and Security Agreement, dated April 26, 2010 (the "Amended and Restated Credit Agreement" or the "Credit Facility"). The Amended and Restated Credit Agreement amended and restated the original Revolving Credit and Security Agreement dated February 1, 2008, as amended, by and among the Parent Company, Borrower and CapitalSource (the "Original Credit Agreement"). The terms of the Amendment and the Amended and Restated Credit Agreement are substantially similar except that the Amendment, among other things:           I.)  Increased the maximum principal amount of the revolving credit             facility (the "Facility Cap") to $8.0 million from $5.0 million;             provided, that the Borrower may request to increase the

Facility Cap

            twice during the term of the Amended and Restated Credit

Agreement in

            increments of $1.0 million to a maximum of $10,000,000;            II.) Extended the term of the Amended and Restated Credit Agreement to             March 26, 2015;       III.) Revised the definition of "Minimum Termination Fee" to be:                                            48 

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           a.  2.5% of the Facility Cap if the Revolver Termination (as defined in                the Agreement) is at any time before March 26, 2013;                b.  1.5% of the Facility Cap if the Revolver Termination is after                March 26, 2013 but before March 26, 2014;                c.  0.5% of the Facility Cap if the Revolver Termination is on or after                March 26, 2014; and                d.  That there shall be no Minimum Termination Fee if the Revolver                Termination occurs within five (5) days of the end of the term.    

IV.) Modified the definition of "Permitted Indebtedness" and "Fixed Charge

            Coverage Ratio"; and    

V.) Amended Section 3.1 of the Amended and Restated Credit Agreement by

            deleting "the LIBOR shall be not less than 2.0%" and replacing it with             "the LIBOR shall be not less than 1.0%".  

We paid Capital Source a commitment fee of $80,000 in connection with the Amendment.

On July 27, 2012 the Facility Cap was increased from $8.0 million to $9.0 million.

  Interest on outstanding advances under the Credit Facility is payable monthly in arrears on the first day of each calendar month at an effective rate of interest of 5.25%.  

During 2012, SunTrust Bank agreed to remove the requirement of restricted cash with our equipment leases and $500,000 of our cash became unrestricted.

On December 31, 2012 the available credit under the Credit Facility was approximately $0.5 million and the outstanding borrowing was $8.5 million after netting compensating cash on hand.

On January 25, 2013 the Borrower and CapitalSource entered into a Second Amendment (the "Second Amendment") to the Amended and Restated Credit Agreement. The terms of the Second Amendment:

I.) Increased the Facility Cap to $10.0 million from $9.0 million;

            provided, that the Borrower may request to increase the

Facility Cap

            twice during the term of the Amended and Restated Credit

Agreement in

             increments of $1.0 million to a maximum of $12,000,000 on or after             January 31, 2013;       II.) Amended Annex 1 of the Credit Facility as follows:                a)  Deleted Section 2 of the Annex 1 in its entirety and

replaced it

                with the following:   

2. Minimum Cash Velocity

  For each Test Period, measured as of the last day of each calendar month ending on or after December 31, 2012, Collections of Accounts of Borrowers collectively shall not be less than the Cash Velocity Percentage of Borrowers' net revenue for the Revenue Period less the bad debt expense recognized on the income statement for such Revenue Period.               b)  Added the following definition to the definitions set forth in such                Annex in the appropriate alphabetic order:  

"Cash Velocity Percentage" means (a) 80% for the period beginning December 31, 2012 and ending on March 31, 2013 and (b) 87.5% at all other times.

We paid Capital Source a commitment fee of $10,000 in connection with the Second Amendment.

We believe we are in compliance with all covenants to the Credit Facility.

We had unrestricted cash on hand of $1.9 million as of December 31, 2012, along with the unused portion of our credit line. The Capital Source amendment in January 2013 provided us with an additional

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$1.0 million of debt availability. As such, we believe we have adequate resources to meet our operating commitments. In the event existing cash on hand, the unused portion of Credit Facility or our operating cash flows are not sufficient to fully fund our growth, we would look to secure additional borrowing lines, expand our current line or to raise equity capital. There can be no guarantee that we will be successful securing additional debt facilities or raising equity capital at favorable terms. In the event we are unable to fund our operations by existing cash on hand, the unused portion of Credit Facility or by our positive operating cash flows, additional borrowings or raising equity capital, we may be forced to reduce our expenses or slow down our growth.  

Capital Expenditures

  We currently forecast capital expenditures in order to execute on our business plan. The amount and timing of such capital expenditures will be determined by the volume of business, but we currently anticipate that we will need to purchase approximately $5.0 million to $6.0 million of additional capital equipment during the next year. We plan to fund these expenditures with capital lease financing arrangements, cash, and through bank loan facilities. If we are unable to obtain such funding, we will need to pay cash for these items or we will be required to curtail our equipment purchases, which may have an impact on our ability to continue to grow our revenues.  

Recent Accounting Pronouncements

  We have reviewed all recently issued standards and have determined they will not have a material impact on our consolidated financial statements or do not apply to our operations.  Subsequent Event 

Second Amendment to Amended and Restated Credit Agreement

On January 25, 2013 the Borrower and CapitalSource entered into the Second Amendment to the Amended and Restated Revolving Credit and Security Agreement, dated April 26, 2010. The Second Amendment:

I.) Increased the Facility Cap to $10.0 million from $9.0 million;

            provided, that the Borrower may request to increase the

Facility Cap

            twice during the term of the Amended and Restated Credit

Agreement in

             increments of $1.0 million to a maximum of $12,000,000 on or after             January 31, 2013;       II.) Amended Annex 1 of the Credit Facility as follows:                a)  Deleted Section 2 of the Annex 1 in its entirety and

replaced it

                with the following:   

2. Minimum Cash Velocity

  For each Test Period, measured as of the last day of each calendar month ending on or after December 31, 2012, Collections of Accounts of Borrowers collectively shall not be less than the Cash Velocity Percentage of Borrower's net revenue for the Revenue Period less the bad debt expense recognized on the income statement for such Revenue Period.               b)  Added the following definition to the definitions set forth in such                Annex in the appropriate alphabetic order:  

"Cash Velocity Percentage" means (a) 80% for the period beginning December 31, 2012 and ending on March 31, 2013 and (b) 87.5% at all other times.

We paid Capital Source a commitment fee of $10,000 in connection with the Second Amendment.

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