TRANSGENOMIC INC – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations

 Forward-Looking Information This report, including Management's Discussion & Analysis, contains forward-looking statements. These statements are based on management's current views, assumptions or beliefs of future events and financial performance and are subject to uncertainty and changes in circumstances. Readers of this report should understand that these statements are not guarantees of performance or results. Many factors could affect our actual financial results and cause them to vary materially from the expectations contained in the forward-looking statements. These factors include, among other things: our expected revenue, income (loss), receivables, operating expenses, supplier pricing, availability and prices of raw materials, Medicare/Medicaid/Insurance reimbursements, product pricing, foreign currency exchange rates, sources of funding operations and acquisitions, our ability to raise funds, sufficiency of available liquidity, future interest costs, future economic circumstances, industry conditions, our ability to execute our operating plans, the success of our cost savings initiatives, competitive environment and related market conditions, actions of governments and regulatory factors affecting our business and other risks as described in our reports filed with the Securities and Exchange Commission. In some cases these statements are identifiable through the use of words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "project," "target," "can," "could," "may," "should," "will," "would" and similar expressions. You are cautioned not to place undue reliance on these forward-looking statements. The forward-looking statements we make are not guarantees of future performance and are subject to various assumptions, risks and other factors that could cause actual results to differ materially from those suggested by these forward-looking statements. Actual results may differ materially from those suggested by the forward-looking statements that we make for a number of reasons including those described in Part II, Item 1A, "Risk Factors," of this report and in Part I, Item 1A "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which we filed with the Securities and Exchange Commission on March 14, 2012. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. The following discussion should be read together with our financial statements and related notes contained in this report and with the financial statements, related notes, and Management's Discussion & Analysis included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which we filed with the Securities and Exchange Commission on March 14, 2012. Results for the three and nine months ended September 30, 2012 are not necessarily indicative of results that may be attained in the future.  

Overview

 We are a global biotechnology company advancing personalized medicine in the detection and treatment of cancer and inherited diseases through our proprietary molecular technologies and clinical and research services. We have three complementary business segments: •        Clinical Laboratories. Our clinical laboratories specialize in genetic          testing for cardiology, neurology, mitochondrial disorders, and          oncology. Located in New Haven, Connecticut and Omaha, Nebraska the          molecular clinical reference laboratories are certified under the          Clinical Laboratory Improvement Amendment (CLIA) as high complexity labs          and our Omaha facility is also accredited by the College of American          Pathologists (CAP).   •        Pharmacogenomics Services. Our Contract Research Organization located in          Omaha, Nebraska provides pharmacogenomics research services supporting          Phase II and Phase III clinical trials conducted by our pharmaceutical          customers. This lab specializes in pharmacogenomic, biomarker and          mutation discovery research testing that serves the pharmaceutical and          biomedical industries world-wide for disease research, drug and          diagnostic development and                                           21

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  clinical trial support. The lab employs a variety of genomic testing service technologies including ICE COLD-PCR technology. ICE COLD-PCR is a proprietary platform technology that can be run in any laboratory with standard PCR technology and which enables detection of mutations from virtually any sample type including tissue biopsies, blood, and circulating tumor cells (CTCs) at levels greater than 1,000-fold higher than standard DNA sequencing techniques. •        Diagnostic Tools. Our proprietary product is the WAVE® System which has          broad applicability to genetic variation detection in both molecular          genetic research and molecular diagnostics. There is a worldwide          installed base of more than 1,550 WAVE Systems as of September 30, 2012.          We also distribute bioinstruments produced by other manufacturers ("OEM          Equipment") through our sales and distribution network. Service          contracts to maintain installed systems are sold and supported by our          technical support personnel. The installed WAVE base and some OEM          Equipment platforms generate a demand for consumables that are required          for the continued operation of the bioinstruments. We develop,          manufacture and sell these consumable products. In addition, we          manufacture and sell consumable products that can be used on multiple,          independent platforms. These products include SURVEYOR® Nuclease and a          range of chromatography columns.     In our Clinical Laboratories segment, one of our key products is our new proprietary C-GAAP (Clopidogrel Genetic Absorption Activation Panel) test. In July of 2012, we successfully secured Medicare coverage for C-GAAP, which is a simple but comprehensive saliva test that accurately predicts whether or not a patient has the appropriate genetic make up to receive a therapeutic benefit from Plavix® (clopidogrel). This innovative test analyzes markers in two important genes to identify patients who are at a genetically increased risk of major adverse cardiovascular events due to diminished effectiveness of Plavix® (clopidogrel). As a result of this coverage, the 48 million Americans currently covered by Medicare will have access to this important genetic test. Plavix® is the most widely prescribed antiplatelet drug used to reduce the risks of death, stroke and heart attack in heart disease patients. Patients with dysfunctional CYP2C19 and ABCB1 genes treated with clopidogrel exhibit a 50% increase in major adverse cardiovascular event rates than do patients with normal CYP2C19 and ABCB1 genetic function. Transgenomic's C-GAAP is the only one on the market that includes both genes in the test. In September, we announced the completion of the acquisition of global rights to the ScoliScore™ Adolescent Idiopathic Scoliosis (AIS) Prognostic Test from Axial Biotech. This acquisition provides Transgenomic with the ScoliScore™ assay technology and intellectual property, an established revenue and customer base, and access to a testing market estimated at more than 400,000 patients in the United States alone. ScoliScore™ is the first clinically validated and commercially available saliva-based multi-gene test that provides a highly accurate assessment of the likelihood of spinal curve progression for individuals diagnosed with AIS, or an abnormal lateral curve of the spine. ScoliScore™ has the ability to identify patients that will not progress to a severe curvature of the spine and reduces those patients' need for repeated doctor visits, and more importantly, years of exposure to radiation from frequent X-Rays which significantly increases these patients' risk for cancer. The health economic benefits of the ScoliScore™ Test are considerable for patients, physicians, and payors, when taking into account the time and expense associated with repeated radiography and the costs related to treating AIS. ScoliScore™ is emblematic of the kind of value-added, proprietary genetic test that Transgenomic seeks to provide to patients. In August, we announced a new commercial collaboration with the Medical College of Wisconsin Laboratories (MCW), a world-renowned institution with a robust presence in genomics and genetic testing. In addition to traditional sequencing services, MCW is the first lab to offer Transgenomic's proprietary NuclearMitome Test which employs next-generation sequencing technology to identify mutations in 448 genes and, to date, represents the most comprehensive genetic test available for mitochondrial disorders. Mitochondrial disorders are notoriously difficult to diagnose because they affect multiple organ systems, including the liver, the brain and nervous system, kidneys, and cardiovascular system. We expect that MCW will commence processing commercial tests in the 4th quarter of 2012. In our Pharmacogenomics Services Unit, we continue to perform cancer pathway gene mutation analysis and other associated genomics service testing for a number of pharmaceutical companies: both for pre-clinical drug discovery projects and phase II and III clinical trials. ICE COLD-PCR enables detection of mutations from virtually any sample type including tissue biopsies, blood, and circulating tumor cells (CTCs). The broad use of this innovative technology has the potential to benefit cancer screening, diagnosis, monitoring, and therapy selection since it has the ability to perform safer, less invasive, and more frequent assessments of a cancer and its mutations, all through a simple blood draw. In addition to our on-going study in several cancer types with MD Anderson, we have initiated two new collaborations for clinical validation of our advanced platform technology. ?            Collaboration with NYU Langone Medical Center to better understand              molecular events that drive non-small cell lung cancer and validate              the use of ICE COLD-PCR mutation detection in blood (which we refer              to as a "blood biopsy") for determining the appropriate response to              existing and novel therapies in NSCLC.                                           22

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  ?            Collaboration with the University of Nebraska Medical Center for              employing ICE COLD-PCR for the early detection of Pancreatic Cancer.              Transgenomic was awarded an NIH STTR Grant to support this work.    The breakthrough ICE COLD-PCR technology, exclusively licensed by Transgenomic for DNA sequencing analysis, was developed in collaboration with the Dana-Farber Cancer Institute and is supported by multiple validation studies confirming reproducible mutation detection up to 1,000 to 10,000 times more sensitive than traditional sequencing techniques and significantly improves the detection of mutations in biological samples. The technology is also being evaluated in an ongoing study with The University of Texas MD Anderson Cancer Center to characterize tumor-derived DNA in blood and DNA isolated from circulating tumor cells (CTCs) from patients with a variety of cancers to choose therapies shown to target specific mutations. Finally, in September, we announced the appointment of Mark P. Colonnese as Executive Vice President and Chief Financial Officer of Transgenomic. Mr. Colonnese has nearly 30 years of experience in leading business growth and financial strategies for life sciences companies. In this new role, Mr. Colonnese will be a key player in Transgenomic's expansion through strategic corporate development, new collaborations, and future acquisitions. He will also lead our financial and capital markets strategy and advise on business development and transactional activities. Uncertainties We have historically operated at a loss and have not consistently generated sufficient cash from operating activities to cover our operating and other cash expenses. We have been able to historically finance our operating losses through borrowings or from the issuance of additional equity. At September 30, 2012 we had cash, cash equivalents and short term investments of $8.7 million. We believe that existing sources of liquidity are sufficient to meet expected cash needs for at least the next 12 months. The uncertainty of the current general economic conditions could negatively impact our business in the future. There are many factors that affect the market demand for our products and services that we cannot control. Demand for our Diagnostic Tools business is affected by the needs and budgetary resources of research institutions, universities and hospitals. The instrument purchase represents a significant expenditure by these types of customers and often requires a long sales cycle. These customers may not have the funding available to purchase our instruments. Competition and new instruments in the marketplace also may impact our sales. We have translation risk that occurs when transactions are consummated in a currency other than British Pound Sterling, which is the functional currency of our foreign subsidiary. These transactions, which are most often consummated in Euros, must be translated into British Pound Sterling. In addition, results of operations and the balance sheet of our foreign subsidiary are translated from British Pound Sterling to our reporting currency, which is the U.S. Dollar. As a result we are subject to exchange rate risk. Fluctuations in foreign exchange rates could impact our business and financial results.                                          23 

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Results of Operations Net sales for the nine months ended September 30, 2012 increased by $0.8 million, or 3% compared to the same period in 2011. During the nine months ended September 30, 2012, net sales from our Clinical Laboratories segment increased by $1.9 million compared to the same nine month period in 2011. Net sales from our Pharmacogenomics Services segment decreased by $0.6 million for the nine months ended September 30, 2012 compared to the same period in 2011. Net sales in our Diagnostic Tools segment decreased $0.5 million for the nine months ended September 30, 2012 compared to the same period in 2011. Our gross profit margin decreased to 47% for the nine months ended September 30, 2012 from 56% for the nine months ended September 30, 2011. Loss from operations was $6.2 million for the nine months ended September 30, 2012 compared to $10.0 million for the nine months ended <chron>September 30, 2011.

Three Months Ended September 30, 2012 and 2011 Net Sales. Net sales for the three months ended September 30, 2012decreased by $0.4 million, or 4% compared to the same period of 2011. Net sales performance in each of the segments was as follows:

                                        Dollars in Thousands                               Three Months Ended                                  September 30,               Change                                 2012           2011       $          % Clinical Laboratories     $    4,498         $ 4,085    $  413      10  % Pharmacogenomics Services        220             552      (332 )   (60 )% Diagnostic Tools               3,171           3,616      (445 )   (12 )% Total Net Sales           $    7,889         $ 8,253    $ (364 )    (4 )%  

Clinical Laboratories net sales of $4.5 million increased $0.4 million, or 10% during the three months ended September 30, 2012 compared to the same period in 2011. Revenue increased compared to last year due to higher test volumes, largely reflecting the introduction of our C-GAAP diagnostic test, and a modest shift towards higher priced tests. Pharmacogenomics Services net sales of $0.2 million during the three months ended September 30, 2012 decreased by $0.3 million compared to the same period of 2011 due to a decrease in the volume of genetic testing performed in connection with various clinical trials by our pharmaceutical company clients. Pharmacogenomics Services net sales trends are more volatile than our other segments due to the nature of patient enrollment patterns and the timing of clinical trials. While the revenue generated from genetic testing related to clinical trials can be significant, it is usually earned over the duration of the trial. Therefore, each period for Pharmacogenomics Services should be considered on a standalone basis and is not indicative of future net sales.

Diagnostic Tools net sales of $3.2 million decreased $0.4 million, or 12%, during the three months ended September 30, 2012 as compared to the same period in 2011. We sold more instruments in the third quarter of 2012 than in the third quarter of 2011, but there was a shift this quarter to lower priced instruments. Cost of Goods Sold. Cost of goods sold includes material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs, rent, supplies and depreciation) associated with our Clinical Laboratories and Pharmacogenomics Services operations.

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  Gross Profit. Gross profit and gross margins for each of our business segments were as follows:                                      Dollars in Thousands                              Three Months Ended                                September 30,            Margin %                               2012          2011      2012    2011 Clinical Laboratories     $    2,385      $ 2,456     53  %    60 % Pharmacogenomics Services        (38 )        241    (17 )%    44 % Diagnostic Tools               1,453        1,748     46  %    48 % Gross Profit              $    3,800      $ 4,445     48  %    54 %   Gross profit was $3.8 million, or 48% of total net sales during the third quarter of 2012, compared to $4.4 million, or 54% of total net sales during the same period of 2011. During the three months ended September 30, 2012, the gross margin for Clinical Laboratories was 53% as compared to 60% in the same period of 2011. The change in Clinical Laboratories gross margin is attributable to a change in the mix of tests performed and higher operating supplies, wages and software costs, which we are investing in a project to improve the efficiency of our lab operations. Pharmacogenomics Services gross margin decreased from 44% for the three months ended September 30, 2011 to (17)% for the three months ended September 30, 2012. Pharmacogenomics Services has a relatively fixed-cost base and any increase or decrease in revenue directly impacts gross margins. Diagnostic Tools gross margin decreased to 46% for the three months ended September 30, 2012 from 48% in the same period of 2011 due to the mix of instruments sold. Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily consist of personnel costs, marketing, travel costs, professional fees, and facility costs. In addition, the effects of foreign currency revaluation are included in selling, general and administrative expenses. Our selling, general and administrative costs increased $1.2 million to $5.6 million from $4.4 million during the three month period ended September 30, 2012 compared to the same period in 2011. We had higher bad debt expenses and stock compensation costs during the three months ended September 30, 2012. We also had higher recruiting fees, which were incurred to increase the size of our sales force to support C-GAAP and the launch of ScoliScoreTM, and higher marketing materials expenses. Included in our selling, general and administrative expenses for the three month period ended September 30, 2012 were $0.1 million in costs related to our acquisition of the ScoliScoreTM test from Axial. Research and Development Expenses. Research and development expenses primarily include personnel costs, intellectual property fees, outside services, collaboration expenses, supplies, and facility costs and are expensed in the period in which they are incurred. For the three months ended September 30, 2012 and 2011, these costs totaled $0.7 million and $0.5 million, respectively. Research and development expenses totaled 8% and 6% of net sales during the three months ended September 30, 2012 and 2011, respectively. Other Income (Expense). Other expense for the three months ended September 30, 2012 and 2011 includes interest expense of $0.2 million. Income Tax Expense (Benefit). Income tax expense for the three months ended September 30, 2012 was $0.1 million, primarily related to income reported in the financial statements of our foreign subsidiary. Income tax benefit for the three months ended September 30, 2011 was nominal.                                          25 

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Nine Months Ended September 30, 2012 and 2011 Net Sales. Net sales for the nine months ended September 30, 2012 increased by $0.8 million, or 3%., compared to the same period of 2011. Net sales performance in each of the segments was as follows:

                                       Dollars in Thousands                              Nine Months Ended                                September 30,              Change                              2012         2011         $          %

Clinical Laboratories$ 13,329$ 11,435$ 1,894 17 % Pharmacogenomics Services 1,198 1,824 (626 ) (34 )% Diagnostic Tools

               9,661      10,141       (480 )    (5 )% Total Net sales           $   24,188    $ 23,400    $   788       3  %   

Clinical Laboratories net sales of $13.3 million increased $1.9 million, or 17% during the nine months ended September 30, 2012 compared to the same period in 2011 due to a higher volume of tests, including new tests such as our NuclearMitome test and our C-GAAP test as well as the mix of tests performed. Pharmacogenomics Services net sales of $1.2 million during the nine months ended September 30, 2012 decreased by $0.6 million compared to the same period of 2011 due to the lower volume of genetic testing performed in connection with various clinical trials by our pharmaceutical company clients. Pharmacogenomics Services net sales trends are more volatile than our other segments due to the nature of patient enrollment patterns and the timing of clinical trials. While the revenue generated from genetic testing related to clinical trials can be significant, it is usually earned over the duration of the trial. Therefore, each period for Pharmacogenomics Services should be considered on a standalone basis and is not indicative of future net sales.

Diagnostic Tools net sales of $9.7 million decreased $0.5 million during the nine months ended September 30, 2012 as compared to the same period in 2011. We sold more instruments at a lower average sales price per instrument during the nine months ended September 30, 2012 compared to 2011. Cost of Goods Sold. Cost of goods sold includes material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs, rent, supplies and depreciation) associated with our Clinical Laboratories and Pharmacogenomics Services operations. Gross Profit. Gross profit and gross margins for each of our business segments were as follows:

                                     Dollars in Thousands                              Nine Months Ended                                September 30,          Margin %                              2012         2011      2012    2011 Clinical Laboratories     $    6,693    $  6,787     50 %    59 % Pharmacogenomics Services        418         764     35 %    42 % Diagnostic Tools               4,355       5,601     45 %    55 % Gross Profit              $   11,466    $ 13,152     47 %    56 %   

Gross profit was $11.5 million or 47% of total net sales during the nine months ended September 30, 2012, compared to $13.2 million, or 56% of total net sales during the same period of 2011. During the nine months ended September 30, 2012, the gross margin for Clinical Laboratories was 50% as compared to 59% in the same period of 2011 due to the mix of tests performed and higher operating supplies, wages and software costs incurred both in connection with repairing and improving the Laboratory Information Management System (LIMS) at our New Haven facility following its software failure in the first quarter of 2012, including processing our sample backlog, and in connection with an important project to improve the efficiency of our lab operations.

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  Pharmacogenomics Services gross margin decreased from 42% for the nine months ended September 30, 2011 to 35% for the nine months ended September 30, 2012. Pharmacogenomics Services has a relatively fixed-cost base and any increase or decrease in revenue directly impacts gross margins. Diagnostic Tools gross margin decreased to 45% in the nine months ended September 30, 2012 from 55% in the nine months ended September 30, 2011 due to the mix of instruments sold. Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily consist of personnel costs, marketing, travel costs, professional fees, and facility costs. In addition, the effects of foreign currency revaluation are included in selling, general and administrative expenses. Our selling, general and administrative costs increased $1.6 million from $14.3 million to $15.8 million during the nine month period ended September 30, 2012 compared to the same period in 2011. We had higher bad debt expense, marketing materials and employment fees , partially offset by lower stock compensation costs for the nine months ended September 30, 2012 as compared to the same period of 2011. Included in our higher outside services for the nine month period ended September 30, 2012 were the costs related to our acquisition of the ScoliScoreTM test of $0.1 million. Research and Development Expenses. Research and development expenses primarily include personnel costs, legal fees, outside services, collaboration expenses, supplies, and facility costs and are expensed in the period in which they are incurred. For the nine months ended September 30, 2012 and 2011, these costs totaled $1.9 million and $1.7 millionSeptember 30, 2012 and 7% during the same period in 2011. Other Income (Expense). Other expense for the nine months ended September 30, 2012 and 2011 includes interest expense of $0.7 million and the income associated with the change in fair value of our Common Stock Warrant Liability of $1.0 million. Other expense in 2011 also includes the expense associated with the change in fair value of the Preferred Stock conversion feature and warrants of 6.9 million. The income or expense associated with the change in fair values of our Common Stock Warrant Liability and the preferred stock conversion feature and warrants are non-cash items. Income Tax Expense (Benefit). Income tax expense for the nine months ended September 30, 2012 was $0.1 million. This is primarily comprised of taxes on income earned by our foreign subsidiary. Income tax benefit for the nine months ended September 30, 2011 was $0.1 million.  Liquidity and Capital Resources Our working capital positions at September 30, 2012 and December 31, 2011 were as follows:                                                                 Dollars in Thousands                                                   September 30,      December 31,                                                       2012               2011             Change Current assets (including cash, cash equivalents and short term investments of $8,745 and $4,946, respectively)                $        22,494     $       17,198     $    5,296 Current liabilities                                      16,600             16,328            272 Working capital                                 $         5,894     $          870     $    5,024   

On February 7, 2012, we entered into a definitive agreement with institutional and other accredited investors and raised approximately $22.0 million in a private placement financing which included $3.0 million in convertible notes issued in December 2011 that were converted into shares of our common stock as part of the private placement financing. Net proceeds of the private placement financing were $17.4 million. Pursuant to our equity financing completed in February 2012, we are obligated to pay PGxHealth, LLC ("PGx") an aggregate of $5.5 million as a prepayment under the senior secured promissory note (the "Note"). We have accounted for the full prepayment amount as a current liability as of September 30, 2012. We have contacted PGx on numerous occasions to make arrangements for the prepayment to PGx in accordance with the terms of the Note, as well as to coordinate the timing of the prepayment. However, PGx has not responded to any of our outreach efforts. We made our initial payment of $1.2 million under the Note in June 2012, and intend to continue to comply with the original terms of the Note. On September 21, 2012, we acquired certain intangible assets from Axial Biotech, Inc (Axial) related to the ScoliScoreTM assay. In consideration for the purchase of the intangible assets, we made a cash payment of approximately $3.4 million to Axial and certain of its creditors. In addition, within ten days following the transfer of all of the assets related to the ScoliScoreTM assay and confirmation that the ScoliScoreTM assay operates, within our laboratories pursuant to protocol agreed upon by us and Axial,

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we will pay an additional $1.0 million to Axial and certain of its creditors, $0.1 million of which will be placed into escrow for a period of one year from the closing of the transaction to secure Axial's indemnification obligations for, among other things, any breach of, or default under, any of Axial's representations, warranties, covenants or agreements contained in the asset purchase agreement. We have historically operated at a loss and have not consistently generated sufficient cash from operating activities to cover our operating and other cash expenses. Historically, we have been able to finance our operating losses through borrowings or from the issuance of additional equity. At September 30, 2012, we had cash, cash equivalents and short term investments of $8.7 million. We believe that existing sources of liquidity are sufficient to meet expected cash needs for at least the next 12 months. However, we cannot be certain that we will be able to increase our net sales, further reduce our expenses or raise additional capital. Accordingly, we may not have sufficient sources of liquidity to continue our operations indefinitely.

  Analysis of Cash Flows Nine Months Ended September 30, 2012 and 2011 Net Change in Cash and Cash Equivalents. Cash and cash equivalents decreased by $0.2 million during the nine months ended September 30, 2012 compared to a decrease of $2.0 million during the nine months ended September 30, 2011. During the nine months ended September 30, 2012 we used cash of $7.8 million in operating activities, $8.4 million in investing activities, which was offset by cash provided by financing activities of $15.9 million. In the nine months ended September 30, 2011, net cash used in operating activities was $0.9 million, $0.4 million was used in investing activities and $0.8 million was used in financing activities. Cash Flows Used In Operating Activities. Cash flows used in operating activities totaled $7.8 million during the nine months ended September 30, 2012 compared to cash flows used in operating activities of $0.9 million during the nine months ended September 30, 2011. The cash flows used in operating activities in 2012 include the net loss, increase in accounts receivable of $2.2 million and decrease in accounts payable of $1.1 million, offset by non-cash items including the warrant revaluation of $1.0 million, provision for losses on doubtful accounts of $1.6 million, stock option expense of $0.6 million and depreciation and amortization of $1.6 million. The cash flows used in operating activities in 2011 include the net loss and increase in accounts receivable of $1.4 million, offset by the non-cash items, which include revaluation of the preferred stock conversion feature and warrant liability of $6.9 million, provision for losses on doubtful accounts of $1.4 million and depreciation and amortization of $1.5 million. Cash Flows Used In Investing Activities. Cash flows used in investing activities totaled $8.4 million during the nine months ended September 30, 2012 compared to cash flows used in investing activities of $0.4 million during the same period of 2011. Cash flows used in investing activities in 2012 included purchases of short term investments of $9.0 million, acquisition of ScoliScoreTM assets of $3.4 million, purchases of property and equipment of $0.6 million and additions to our patents of $0.3 million , offset by proceeds from the sale of short term investments of $5.0 million. Cash flows used in investing activities in 2011 include purchases of property and equipment of $0.1 million and additions to our patents of $0.3 million. Cash Flows Provided by or Used in Financing Activities. Cash flows provided by financing activities were $15.9 million for the nine months ended September 30, 2012. Cash provided by financing activities during the nine months ended September 30, 2012 included the proceeds from the issuance of 19.0 million shares of our common stock and from the issuance of our common stock in connection with the exercise of stock options for 20,000 shares. Cash flows used in financing activities were for payments on debt and capital lease obligations. Cash flows used in financing activities were $0.8 million for the nine months ended September 30, 2011. Cash flows used in financing activities were for payments on debt and capital lease obligations offset by the cash received from issuance of common stock in connection with the exercise of stock options for 10,000 shares during the first nine months of 2011.  

Off-Balance Sheet Arrangements At September 30, 2012 and December 31, 2011, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies and Estimates Accounting policies used in the preparation of the consolidated financial statements may involve the use of management judgments and estimates. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial statements and they require significant or complex judgments on the part of management. Our judgments and estimates

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are based on experience and assumptions that we believe are reasonable under the circumstances. Further, we evaluate our judgments and estimates from time to time as circumstances change. Actual financial results based on judgments or estimates may vary under different assumptions or circumstances. Our critical accounting policies are discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the Securities and Exchange Commission on March 14, 2012.

Recently Issued Accounting Pronouncements Please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 filed with the Securities and Exchange Commission on March 14, 2012. There have been no changes to those accounting pronouncements listed except as noted in Footnote B - Summary of Significant Accounting Policies to the notes to unaudited condensed consolidated financial statements contained in this report.

Impact of Inflation We do not believe that price inflation or deflation had a material adverse effect on our financial condition or results of operations during the periods presented.