**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

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**Form 10-Q**

 

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**(Mark One)**

 
| ý | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|--------|------------|----------------------------------------------------------------------------------------------|

 

**For the Quarter ended September30, 2004 or**

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

 

**For the transition period from               to            .**

 

**CommissionFile Number: 000-50677**

 

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**IMMUNICON CORPORATION**

(Exactname of registrant as specified in its charter)

 
| **Delaware**                                                     | ** ** | **23-2269490**                      |
|------------------------------------------------------------------|------------|-------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |       | (IRS  Employer  Identification No.) |

 

**3401Masons Mill Road, Suite 100Huntingdon Valley, Pennsylvania  19006**

(Addressof principal executive offices and  zipcode)

 

**(215) 830-0777**

(Registrant’stelephone number including area code)

 

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Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports) and (2)has been subject to such filing requirements for the past 90 days.

Yesý  No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yeso No ý

 

Include the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest possible date. Asof November 8, 2004, there were 23,099,777 shares of Common Stock, $0.001 parvalue, outstanding.

 

 

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IMMUNICONCORPORATION

 

INDEX

 
|         |                                                                                                                                                                                                                    |   |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                                                                                                                                    |   |
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                                                                                                               |   |
|         |                                                                                                                                                                                                                    |   |
| Item 1.      | Condensed  Consolidated Financial Statements (Unaudited):                                                                                                                                                               |   |
|         |                                                                                                                                                                                                                    |   |
|         | Condensed  Consolidated Balance Sheets: September 30, 2004 and December 31, 2003                                                                                                                         |   |
|         |                                                                                                                                                                                                                    |   |
|         | Condensed  Consolidated Statements of Operations:  Three and Nine Months Ended September 30, 2004 and 2003 and for the period from  August 25, 1983 (date of inception)  to September 30, 2004 |   |
|         |                                                                                                                                                                                                                    |   |
|         | Condensed  Consolidated Statements of Cash Flows:Nine Months Ended September 30, 2004 and 2003 and for the Period from August 25,  1983 (date of inception) to September 30, 2004                   |   |
|         |                                                                                                                                                                                                                    |   |
|         | Notes  to Condensed Consolidated Financial Statements                                                                                                                                                                   |   |
|         |                                                                                                                                                                                                                    |   |
| Item  2.     | Management’s  Discussion and Analysis of Financial Condition  and Results of Operations                                                                                                                       |   |
|         |                                                                                                                                                                                                                    |   |
| Item  3.     | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                                                             |   |
|         |                                                                                                                                                                                                                    |   |
| Item 4.      | Controls and  Procedures                                                                                                                                                                                                |   |
|         |                                                                                                                                                                                                                    |   |
| **PART II.** | **OTHER INFORMATION**                                                                                                                                                                                                   |   |
|         |                                                                                                                                                                                                                    |   |
| Item  6.     | Exhibits                                                                                                                                                                                                                |   |
|         |                                                                                                                                                                                                                    |   |

 

 

Immunicon is a registered trademark of Immunicon Corporation. TheImmunicon logo is a registered trademark of Immunicon Corporation. CellSave,CellTracks, CellSpotter, MagNest, the CellTracks AutoPrep System logo and theCellSpotter Analyzer logo are registered trademarks of Immunivest Corporation,a wholly owned subsidiary of Immunicon Corporation.  CellTracks EasyCount, EasyCount, CellTracksMagNest, CellPrep, AutoPrep, IMMC, the CellTracks Analyzer logo, the CellTracksMagNest logo, the CellSave Preservative Tube logo and the CellSave Tube Caplogo are trademarks of Immunivest Corporation, a wholly owned subsidiary ofImmunicon Corporation. CellSearch is a registered trademark ofJohnson & Johnson. All other trademarks appearing in this filing arethe property of their respective holders.  Unless the context provides otherwise, thewords “Immunicon,” “we,” “Company,” “us” and “our” appearing in this filingrefer to Immunicon Corporation and its subsidiaries

 

2

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| **PART I.** | ** ** | **FINANCIAL INFORMATION**                               |
|-------------|------------|---------------------------------------------------------|
| **Item 1.** | ** ** | **Condensed Consolidated  Balance Sheets (Unaudited)**  |
|        |       | (in thousands, except for  share and per share amounts) |

** **
| ** **                                                                                                                                                                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ASSETS                                                                                                                                                                           |       |                    |       |                   |       |
| Current Assets:                                                                                                                                                                  |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                                                                                        |       | $                       | 35,494     |                   | $          | 30,601 |   |
| Short term investments                                                                                                                                                           |       | 24,245                  |       | —                 |       |
| Accounts receivable                                                                                                                                                              |       | 4                       |       | 4                      |       |
| Receivable from related party                                                                                                                                                    |       | 1,431                   |       | 88                     |       |
| Prepaid assets                                                                                                                                                                   |       | 686                     |       | 319                    |       |
| Other current assets                                                                                                                                                             |       | 160                     |       | 76                     |       |
| Total current assets                                                                                                                                                             |       | 62,020                  |       | 31,088                 |       |
|                                                                                                                                                                             |       |                    |       |                   |       |
| Property and equipment, net                                                                                                                                                      |       | 4,085                   |       | 3,561                  |       |
| Long term investments                                                                                                                                                            |       | 514                     |       | —                 |       |
| Assets related to financing activities                                                                                                                                           |       | —                  |       | 674                    |       |
| Other assets                                                                                                                                                                     |       | 340                     |       | 412                    |       |
| Total assets                                                                                                                                                                     |       | $                       | 66,959     |                   | $          | 35,735 |   |
|                                                                                                                                                                             |       |                    |       |                   |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                        |       |                    |       |                   |       |
| Current Liabilities:                                                                                                                                                             |       |                    |       |                   |       |
| Current portion of long-term debt                                                                                                                                                |       | $                       | 3,270      |                   | $          | 3,360 |   |
| Accounts payable                                                                                                                                                                 |       | 1,287                   |       | 1,008                  |       |
| Accrued expenses                                                                                                                                                                 |       | 3,082                   |       | 2,787                  |       |
| Current portion of deferred revenue                                                                                                                                              |       | 1,650                   |       | 97                     |       |
| Total current liabilities                                                                                                                                                        |       | 9,289                   |       | 7,252                  |       |
|                                                                                                                                                                             |       |                    |       |                   |       |
| Long-term debt, less current portion                                                                                                                                             |       | 2,717                   |       | 3,792                  |       |
| Deferred revenue                                                                                                                                                                 |       | 995                     |       | 25                     |       |
|                                                                                                                                                                             |       |                    |       |                   |       |
| Commitments and contingencies                                                                                                                                                    |       |                    |       |                   |       |
|                                                                                                                                                                             |       |                    |       |                   |       |
| Shareholders’ equity:                                                                                                                                                       |       |                    |       |                   |       |
| Convertible preferred stock (liquidation value of $0 as of September  30, 2004 and $87,756 as of December 31, 2003)                                                              |       | —                  |       | 85,115                 |       |
| Common stock, $0.001 par value —100,000,000 authorized, 22,977,829  and 485,820 shares issued and outstanding as of September 30, 2004 and  December 31, 2003, respectively |       | 23                      |       | 1                      |       |
| Additional paid in capital                                                                                                                                                       |       | 142,117                 |       | 7,033                  |       |
| Deferred stock-based compensation                                                                                                                                                |       | (2,573                  | )          | (3,858                 | )          |
| Loan for stock options                                                                                                                                                           |       | —                  |       | (19                    | )          |
| Deficit accumulated during the development stage                                                                                                                                 |       | (85,609                 | )          | (63,606                | )          |
| Total shareholders’ equity                                                                                                                                                  |       | 53,958                  |       | 24,666                 |       |
| Total liabilities and shareholders’ equity                                                                                                                                  |       | $                       | 66,959     |                   | $          | 35,735 |   |

 

See notes to condensed consolidated unaudited financial statements.

 

 

3

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**                Condensed Consolidated Statements ofOperations (Unaudited)**

                Three and nine months ended September 30, 2004 and2003, and for the period from August 25, 1983

                (date of inception) to September 30, 2004

                (in thousands, except for share and per shareamounts)

 

 
| ** **                                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** | **Period from August 25, 1983 (date of inception) to  September 30,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                          | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004**                                                                        | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue:                                                            |       |                                 |       |                                |       |                                                                            |       |   |   |   |   |
| Revenue from related party                                          |       | $                                    | 148        |                                | $          | 901                                                                             |       | $ | 340 |   | $ | 1,729 |   | $ | 4,345 |   |
| Other revenue                                                       |       | 6                                    |       | 67                                  |       | 32                                                                              |       | 311 |   | 3,941 |   |
| Total revenue                                                       |       | 154                                  |       | 968                                 |       | 372                                                                             |       | 2,040 |   | 8,286 |   |
| Expenses:                                                           |       |                                 |       |                                |       |                                                                            |       |   |   |   |   |
| Research and development                                            |       | 6,559                                |       | 4,012                               |       | 17,142                                                                          |       | 11,454 |   | 71,682 |   |
| General and administrative                                          |       | 1,996                                |       | 1,188                               |       | 5,208                                                                           |       | 3,184 |   | 23,648 |   |
| Total operating expenses                                            |       | 8,555                                |       | 5,200                               |       | 22,350                                                                          |       | 14,638 |   | 95,330 |   |
| Operating loss                                                      |       | (8,401                               | )          | (4,232                              | )          | (21,978                                                                         | )          | (12,598 | ) | (87,044 | ) |
|                                                                |       |                                 |       |                                |       |                                                                            |       |   |   |   |   |
| Other income from related party                                     |       | —                               |       | —                              |       | —                                                                          |       | 250 |   | 250 |   |
|                                                                |       |                                 |       |                                |       |                                                                            |       |   |   |   |   |
| Interest income                                                     |       | 238                                  |       | 53                                  |       | 459                                                                             |       | 170 |   |   |   |
| Interest expense                                                    |       | (153                                 | )          | (157                                | )          | (484                                                                            | )          | (409 | ) |   |   |
| Interest income (expense), net                                      |       | 85                                   |       | (104                                | )          | (25                                                                             | )          | (239 | ) | 1,185 |   |
| Net loss attributable to common stockholders                        |       | $                                    | (8,316     | )                                   | $          | (4,336                                                                          | )          | $ | (22,003 | ) | $ | (12,587 | ) | $ | (85,609 | ) |
|                                                                |       |                                 |       |                                |       |                                                                            |       |   |   |   |   |
| Net loss per common share — basic and diluted                  |       | $                                    | (0.36      | )                                   | $          | (9.05                                                                           | )          | $ | (1.56 | ) | $ | (27.39 | ) |   |   |
|                                                                |       |                                 |       |                                |       |                                                                            |       |   |   |   |   |
| Weighted average common shares outstanding — basic and diluted |       | 22,970,191                           |       | 478,984                             |       | 14,126,326                                                                      |       | 459,573 |   |   |   |
|                                                                     |            |                                      |            |                                     |            |                                                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

See notes to condensedconsolidated unaudited financial statements.

 

4

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**Condensed Consolidated Statements of Cash Flows(Unaudited)**

                Nine months ended September 30,2004 and 2003, and for the period from

                August 25, 1983 (date of inception) to September30, 2004

                (in thousands)
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** | **Period from Aug. 25, 1983 (date of inception) to  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                 | ** ** | **2003**                                                                                | ** ** | **2004** | ** ** |
| Operating activities:                                                              |       |                                     |       |                                                                                    |       |   |   |
| Net loss                                                                           |       | $                                        | (22,003    | )                                                                                       | $          | (12,587 | ) | $ | (85,609 | ) |
| Adjustment to reconcile net loss to net cash used in operating  activities:        |       |                                     |       |                                                                                    |       |   |   |
| Depreciation and amortization                                                      |       | 1,088                                    |       | 892                                                                                     |       | 5,707 |   |
| Interest expense on warrants                                                       |       | 27                                       |       | 21                                                                                      |       | 99 |   |
| Loss on disposal of property and equipment                                         |       | —                                   |       | 1                                                                                       |       | 4 |   |
| Compensation expense related to the issuance of stock, stock options  and warrants |       | 1,321                                    |       | 221                                                                                     |       | 2,350 |   |
| Change in:                                                                         |       |                                     |       |                                                                                    |       |   |   |
| Receivable from related party                                                      |       | (1,343                                   | )          | —                                                                                  |       | (1,343 | ) |
| Prepaid expenses and other                                                         |       | (367                                     | )          | 6                                                                                       |       | (853 | ) |
| Other assets                                                                       |       | (53                                      | )          | (151                                                                                    | )          | (1,034 | ) |
| Accounts payable                                                                   |       | 279                                      |       | (147                                                                                    | )          | 1,287 |   |
| Accrued expenses                                                                   |       | 1,021                                    |       | 403                                                                                     |       | 3,820 |   |
| Deferred revenue                                                                   |       | 2,523                                    |       | 343                                                                                     |       | 2,634 |   |
| Net cash used in operating activities                                              |       | (17,507                                  | )          | (10,998                                                                                 | )          | (72,938 | ) |
| Investing activities:                                                              |       |                                     |       |                                                                                    |       |   |   |
| Purchase of investments                                                            |       | (25,279                                  | )          | —                                                                                  |       | (80,199 | ) |
| Proceeds from maturities of investments                                            |       | 500                                      |       | 3,000                                                                                   |       | 55,003 |   |
| Cash proceeds from disposals of property and equipment                             |       | —                                   |       | —                                                                                  |       | 1 |   |
| Purchases of property and equipment                                                |       | (1,576                                   | )          | (1,794                                                                                  | )          | (9,338 | ) |
| Net cash provided by (used in) investing activities                                |       | (26,355                                  | )          | 1,206                                                                                   |       | (34,533 | ) |
| Financing activities:                                                              |       |                                     |       |                                                                                    |       |   |   |
| Proceeds from term debt                                                            |       | 1,489                                    |       | 4,946                                                                                   |       | 17,086 |   |
| Proceeds from sale of preferred stock, net of issuance costs                       |       | —                                   |       | 24,991                                                                                  |       | 84,115 |   |
| Proceeds from sale of common stock, net of issuance costs                          |       | 49,427                                   |       | —                                                                                  |       | 51,093 |   |
| Proceeds from exercise of stock options and warrants                               |       | 476                                      |       | 2                                                                                       |       | 809 |   |
| Loan for stock options                                                             |       | 19                                       |       | —                                                                                  |       | 19 |   |
| Loan issue fees                                                                    |       | (2                                       | )          | (50                                                                                     | )          | (57 | ) |
| Payments on term debt                                                              |       | (2,654                                   | )          | (2,270                                                                                  | )          | (10,100 | ) |
| Net cash provided by financing activities                                          |       | 48,755                                   |       | 27,619                                                                                  |       | 142,965 |   |
| Net increase in cash and cash equivalents                                          |       | 4,893                                    |       | 17,827                                                                                  |       | 35,494 |   |
| Cash and cash equivalents, beginning of period                                     |       | 30,601                                   |       | 18,470                                                                                  |       | — |   |
| Cash and cash equivalents, end of period                                           |       | $                                        | 35,494     |                                                                                    | $          | 36,297 |   | $ | 35,494 |   |
| Supplemental cash flow information:                                                |       |                                     |       |                                                                                    |       |   |   |
| Cash paid for interest                                                             |       | $                                        | 424        |                                                                                    | $          | 520 |   |   |   |
|                                                                                    |            |                                          |            |                                                                                         |            |  |  |  |  |  |  |  |

 

See notes to condensed consolidated unauditedfinancial statements.

 

5

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ImmuniconCorporation and Subsidiaries (A Development Stage Coompany)

Notes to CondensedConsolidated Unaudited Financial Statements

**Threeand nine months ended September 30, 2004 and 2003, and for the period fromAugust 25, 1983 (date of inception) to September 30, 2004.**

 

**(1)  Background and basis ofpresentation**

 

The accompanying unaudited condensed consolidated financial statementsof Immunicon Corporation and Subsidiaries (the “Company”) have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission(“SEC”).  Accordingly, they do notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. In the opinion of our management, the accompanying condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring accruals) necessary to present fairly our financial positionat September 30, 2004 and results of operations and cash flows for the threeand nine month periods ended September 30, 2004 and 2003 and for the periodfrom inception to September 30, 2004. Certain items have been reclassified to conform to current periodpresentation.

 

Certain footnote information has been condensed or omitted from thesefinancial statements.  Therefore, thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and related notes on pages F-1 to F-33 included in theCompany’s Registration Statement on Form S-1 (File No. 333-110996) filed withthe SEC (“Registration Statement”). Results of operations for the three and nine months periods endedSeptember 30, 2004 are not necessarily indicative of results to be expected forthe full year.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of expensesduring the reporting period.  Actualresults could differ from those estimates or assumptions.  The more significant estimates reflected inthese financial statements include judgmentally accrued expenses and thevaluation of stock-based compensation.

 

The Company has generated limited revenues from product sales and hasincurred substantial losses since its inception. The Company anticipatesincurring additional losses over at least the next several years and suchlosses may increase as the Company expands its research and developmentactivities. Accordingly, the Company is considered to be in the developmentstage as of September 30, 2004, as defined in Statement of Financial AccountingStandards (“SFAS”) No. 7, *Accounting and Reportingby Development Stage Enterprises*.

 

The Company completed the initial public offering (“IPO”) of shares ofour common stock on April 21, 2004.  Theproceeds to the Company from the IPO were $49.4 million, net of fees andexpenses.  In the IPO, the Company sold6.9 million shares of its common stock, including the underwriters’ overallotment option, at $8.00 per share.  Inaddition, on March 9, 2004, the Company completed a 2-for-3 reverse stock splitof its common stock.  All share and pershare amounts included in these unaudited condensed consolidated financialstatements have been retroactively adjusted for all periods presented to giveeffect to the reverse stock split.

 

Substantialfinancing will be needed by the Company to fund its operations and to continuecommercially developing its product candidates. There is no assurance that suchfinancing will be available when needed. Operations of the Company are subjectto certain additional risks and uncertainties including, among others,dependence on Veridex, LLC (“Veridex”), a Johnson & Johnson company,to market the Company’s cancer diagnostic product candidates, the uncertaintyof product development (including clinical trial results), regulatory clearanceand approval, supplier and manufacturing dependence, competition, reimbursementavailability, dependence on exclusive licenses and other relationships,uncertainties regarding patents and proprietary rights, dependence on key personneland other risks related to governmental regulations and approvals. The Companybelieves, however, that cash and cash equivalents available at September 30,2004 will be sufficient to maintain operations through at least September 30,2005.

 

In accordance withthe SEC’s Release No. 33-8040, *Cautionary AdviceRegarding Disclosure about Critical Accounting Policies,* the Companyhas determined the critical principles by considering accounting policies thatinvolve the most complex or subjective decisions or assessments. The Companystates these accounting policies in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and in the notes to theconsolidated financial statements contained in the Company’s RegistrationStatement. There were no significant changes to the Company’s criticalaccounting policies during the nine months ended September 30, 2004.

 

6

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In December 2002,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accountingfor Stock-Based Compensation - Transition and Disclosure, an Amendment of FASBStatement No. 123,” to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedcompensation. The Company has adopted the disclosure requirements of thisstatement. In March 2004, the FASB issued a proposed SFAS - “Share-BasedPayment: an Amendment of FASB Statements No. 123 and 95.” The proposed standardwould require companies to expense share-based payments to employees, includingstock options, based on the fair value of the award at the grant date. Theproposed statement would eliminate the intrinsic value method of accounting forstock options permitted by Accounting Principles Board (“APB”) No. 25, “Accountingfor Stock Issued to Employees”.   TheCompany currently follows APB No. 25. The Company will continue to monitor the actions of the FASB and assessthe impact, if any, on its consolidated financial statements.

 

In March 2004, theFASB approved the consensus reached on the Emerging Issues Task Force (EITF)Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments.” The objective of this Issue is to provideguidance for identifying impaired investments. EITF 03-1 also provides newdisclosure requirements for investments that are deemed to be temporarilyimpaired. . In September 2004, the FASB issued a FASB Staff Position (FSP) EITF03-1-1 that delays the effective date of the measurement and recognitionguidance in EITF 03-1 until after further deliberations by the FASB. Thedisclosure requirements of EITF 03-1 are effective beginning with the Company’sfiscal 2004 annual report. Once the FASB reaches a final decision on the measurementand recognition provisions, the company will evaluate the impact of theadoption of EITF 03-1.

 

**(2)  ****Accounting for stock-based compensation**

 

TheCompany accounts for stock-based compensation based on the provisions ofAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB No. 25”),which states that, for fixed plans, no compensation expense is recorded forstock options or other stock-based awards to employees that are grantedwith an exercise price equal to or above the estimated fair value per share ofthe Company’s common stock on the grant date. In the event that stock optionsare granted with an exercise price below the estimated fair value of theCompany’s common stock at the grant date, the difference between the fair valueof the Company’s common stock and the exercise price of the stock option isrecorded as deferred compensation. Deferred compensation is amortized tocompensation expense on a straight-line basis over the vesting period of thestock option. The Company has adopted the disclosure requirements of SFASNo. 123, *Accounting for Stock-BasedCompensation* (“SFAS No. 123”) and SFAS No. 148, *Accounting for Stock Based Compensation-Transitionand Disclosure-an Amendment of FASB Statement No. 123* (“SFASNo. 148”), which requires compensation expense to be disclosed based onthe fair value of the options granted at the date of the grant.

 

Hadcompensation cost for the Company’s stock option plan been determined based onthe fair value at the grant dates for awards under the plan consistent with themethod required by SFAS No. 123, the Company would have reported the proforma net loss amounts indicated below.

 
| ** **                                                                                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(in thousands, except per share data)**                                                         | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss, as reported                                                                             |       | $                                    | (8,316     | )                                   | $          | (4,336 | ) | $ | (22,003 | ) | $ | (12,587 | ) |
| Add: Stock-based compensation expense included in reported net loss                               |       | 645                                  |       | 91                                  |       | 1,321 |   | 221 |   |
| Deduct: Total stock-based compensation expense determined under fair  value method for all awards |       | (724                                 | )          | (140                                | )          | (1,521 | ) | (370 | ) |
| Pro forma net loss                                                                                |       | $                                    | (8,395     | )                                   | $          | (4,385 | ) | $ | (22,203 | ) | $ | (12,736 | ) |
| Net loss per share - basic and diluted as reported                                                |       | $                                    | (0.36      | )                                   | $          | (9.05 | ) | $ | (1.56 | ) | $ | (27.39 | ) |
| Pro forma net loss per share - basic and diluted                                                  |       | $                                    | (0.37      | )                                   | $          | (9.16 | ) | $ | (1.57 | ) | $ | (27.71 | ) |

 

Thefair value of each option is estimated on the date of grant using theBlack-Scholes model with the following weighted average assumptions: risk-freeinterest rate of 4.0% and 3.1% and volatility rate of 70.1% and 0% for periodsended September 30, 2004 and 2003, respectively; an expected life of five yearsand a dividend yield of zero for all periods presented.

 

7

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Stockcompensation arrangements with non-employees are accounted for inaccordance with SFAS No. 123, as amended by SFAS No. 148, and EITF No. 96-18,*Accounting for Equity Instruments That AreIssued to Other than Employees for Acquiring, or in Conjunction with Selling, Goodsor Services,* using a fair value approach.

 

**(3)   Net loss per share**

 

Basicand diluted net loss per common share is calculated in accordance with SFAS No.128, *Earnings Per Share* (“SFASNo. 128”) and SEC Staff Accounting Bulletin No. 98 (“SAB No. 98”).Under the provisions of SFAS No. 128 and SAB No. 98, basic net lossper common share is calculated by dividing the net loss applicable to commonstockholders by the weighted-average number of unrestricted common sharesoutstanding during the period. Diluted net loss per common share is the same asbasic net loss per common share, since the effects of potentially dilutivesecurities are antidilutive for all periods presented.  Fully diluted shares outstanding for the threemonths ended September 30, 2004 and 2003 would have been 24,531,966 and17,345,998, respectively.  Fully dilutedshares outstanding for the nine months ended September 30, 2004 and 2003would have been 15,684,210 and 14,338,126, respectively.

 

The following table sets forth the computation ofnet income (numerator) and shares (denominator) for earnings per share:

 
| ** **                                                            | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(in thousands)**                                                    | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Numerator:**                                                        |       |                                 |       |                                |       |   |   |   |   |
| Net loss                                                              |       | $                                    | (8,316     | )                                   | $          | (4,336 | ) | $ | (22,003 | ) | $ | (12,587 | ) |
|                                                                  |       |                                 |       |                                |       |   |   |   |   |
| **Denominator:**                                                      |       |                                 |       |                                |       |   |   |   |   |
| Weighted average shares outstanding used for basic income per share   |       | 22,970                               |       | 479                                 |       | 14,126 |   | 460 |   |
| Common stock equivalents                                              |       | —                               |       | —                              |       | — |   | — |   |
| Weighted average shares outstanding used for diluted income per share |       | 22,970                               |       | 479                                 |       | 14,126 |   | 460 |   |
|                                                                       |            |                                      |            |                                     |            |  |  |  |  |  |  |  |  |

 

**(4)  ****Property and equipment**

 

Propertyand equipment consists of the following:

 
| **(in thousands)**             | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|------------------------|------------|
| Laboratory equipment           |       | $                       | 1,739      |                   | $          | 1,387 |   |
| Office furniture and equipment |       | 906                     |       | 611                    |       |
| Leasehold improvements         |       | 3,734                   |       | 3,195                  |       |
| Manufacturing equipment        |       | 652                     |       | 632                    |       |
| Computer equipment             |       | 1,541                   |       | 1,170                  |       |
| Property and equipment, gross  |       | 8,572                   |       | 6,995                  |       |
| Less Accumulated depreciation  |       | (4,487                  | )          | (3,434                 | )          |
| Property and equipment, net    |       | $                       | 4,085      |                   | $          | 3,561 |   |

 

Depreciation expense was $372,000 and $292,000 for the three monthsended September 30, 2004 and 2003, respectively; and $1,052,000 and $814,000for the nine months ended September 30, 2004 and 2003, respectively.

 

8

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**(5)  ****Accrued expenses**

 

Accruedexpenses consisted of the following:

 
| **(in thousands)**                | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------|------------|-------------------------|------------|------------------------|------------|
| Salary related expense            |       | $                       | 710        |                   | $          | 546 |   |
| Clinical research and trial costs |       | 900                     |       | 607                    |       |
| Contracted research costs         |       | 162                     |       | 165                    |       |
| Deferral loan premium             |       | 201                     |       | 139                    |       |
| Accounting and legal fees         |       | 135                     |       | 664                    |       |
| Leasehold improvements            |       | 15                      |       | 40                     |       |
| Other                             |       | 959                     |       | 626                    |       |
| Accrued expenses                  |       | $                       | 3,082      |                   | $          | 2,787 |   |

 

**(6)   Debt**

 

Asof September 2004, the Company had an aggregate of $6.0 million of debtoutstanding under $12.0 million of credit facilities with two lendinginstitutions.   The carrying value oflong-term debt is as follows:

 
| **(in thousands)**                                 | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| The $7.0 million credit facility                   |       | $                       | 2,183      |                   | $          | 3,939 |   |
| The $5.0 million equipment line of credit facility |       | 3,785                   |       | 3,213                  |       |
| Other                                              |       | 19                      |       | —                 |       |
|                                               |       | 5,987                   |       | 7,152                  |       |
| Less: current portion of long-term debt            |       | (3,270                  | )          | (3,360                 | )          |
| Long term debt                                     |       | $                       | 2,717      |                   | $          | 3,792 |   |

 

Asof September 30, 2004 and 2003, interest rates in effect for outstandingobligations under the credit facilities ranged from 6.75% to 9.25% and 6.75% to9.74%, respectively.

 

InJune 2004, the Company amended a loan agreement with one of its lenders.  As a result, the Company was no longerrequired to maintain a minimum percentage of its cash available for investingon deposit with the lending institution. Also, the Company was no longer required to maintain a minimum level ofearnings before interest, taxes, depreciation and amortization.  The Company was required to maintain at leastsix months liquidity, as defined.  TheCompany also was required to provide unaudited monthly financial statementswithin 30 days following the end of each month and audited financial statementswithin 120 days after the close of its fiscal year.  The Company was in compliance with itscovenants for the nine months ended September 30, 2004.

 

On October 26 2004, the Company announced theextension of its existing equipment lines of credit with Silicon Valley Bankand with General Electric Capital Life Science and Technology group for anaggregate of $17 million.  See footnote12 Subsequent Event for further information.

 

**(7)  ****Commitments and contingencies**

 

In the ordinary course of its business, theCompany makes certain indemnities, commitments and guarantees under which itmay be required to make payments in relation to certain transactions. Theseinclude indemnities of clinical investigators, consultants and contractresearch organizations involved in the development of the Company’s clinicalstage products. The duration of these

 

9

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indemnities, commitments and guaranteesvaries, and in certain cases, is indefinite. The majority of these indemnities,commitments and guarantees do not provide for any limitation of the maximumpotential future payments the Company could be obligated to make.

The Company has not recorded any liabilityfor these indemnities, commitments and guarantees in the accompanyingconsolidated balance sheets. However, the Company accrues for losses for anyknown contingent liability, including those that may arise from indemnificationprovisions, when future payment is probable. No such losses have been recordedto date.

 

InAugust 2000, the Company entered into a development, license and supplyagreement (the “Development Agreement”) with Ortho Clinical Diagnostics, Inc.(“Ortho”), a subsidiary of Johnson and Johnson, Inc., whereby the Companylicensed certain rights to its technology and assumed certain developmentobligations for its cancer diagnostic product candidates. In exchange, Orthoagreed to market and distribute the Company’s cancer diagnostic productcandidates. On November 10, 2003, the Company executed an amendment tothis the Development Agreement whereby all of the rights and responsibilitiesof Ortho were transferred to Veridex, LLC. In addition, the Company and Veridexre-negotiated certain clinical development and regulatory milestones. TheDevelopment Agreement has a term of 20 years and may be terminated earlierby either party under certain conditions. The Company is not aware of anyintentions by Veridex to terminate the Development Agreement.

 

Inconnection with the Development Agreement, Veridex made a $1.5 millionup-front, non-refundable license fee payment to the Company.  Under this Development Agreement, Veridex isobligated to pay us approximately 30% of their net sales from the sale ofreagents, test kits, and certain other consumable products and disposableitems. In addition, the Company will receive additional payments from Veridexif the Company achieves certain development and sales milestones as defined inthe Development Agreement.  Under theterms of the Development Agreement, the Company is required to invest inrelated research based on a percentage of sales as defined in the DevelopmentAgreement.  Also in connection with theDevelopment Agreement, Johnson & Johnson Development Corporation, also awholly-owned subsidiary of Johnson and Johnson (“J&J Sub”), purchased$5 million of the Company’s Series E Preferred Stock.  In December 2001 and July 2003,J&J Sub purchased $3 million and $3.3 million of additionalSeries F Preferred Stock, respectively.

 

In June 2004, the Company entered into anaddendum to its Technology Development Agreement and License Agreement withTwente University, and Technology Foundation STW (“STW”), a research fundingagency of the Dutch government.  Underthe modified agreement STW will provide Twente University with up toapproximately $1 million toward developing an affordable and portableinstrument to monitor patients with human immunodeficiency virus (“HIV”).  This instrument represents an additionalapplication of our existing technology, specifically the CellTracks EasyCountSystem, and in consideration for our contribution of research effort toward theproject including personnel, equipment and supplies the Company will haverights to commercialize products that result from this agreement.

 

**(8)****         ****Shareholders’ equity**

 

The Company completed its IPO of common stock on April 21, 2004.  The Company received $49.4 million, net offees and expenses from the IPO.  In theIPO, the Company sold 6.9 million shares of its common stock, including theunderwriters’ over allotment option, at $8.00 per share.  In addition, on March 9, 2004, the Companycompleted a 2-for-3 reverse stock split of its common stock.  All share and per share amounts included inthese unaudited consolidated financial statements have been retroactivelyadjusted for all periods presented to give effect to the reverse stock split.

 

On May 24, 2004, the Company registered 4.0million shares on its Registration Statement on Form S-8.  This Form S-8 covers shares of common stockof the Company that may be offered or sold pursuant to the ImmuniconCorporation Amended and Restated Equity Compensation Plan (“ESOP”) and theImmunicon Corporation 2004 Employee Stock Purchase Plan (“ESPP”).

 

**(9)****         ****Related parties**

 

During the period from August 1, 2000 untilDecember 31, 2003, the Company received $4.0 million in license andmilestone payments from Veridex, and the Company recognized the entire amountas license revenue from related party during that period.

 

The Company received $500,000 in milestonereceipts related to product development milestones during the first quarter of2004. The Company will recognize these receipts as revenue over the estimatedlife of the related product development period which the Company estimates willend on December 31, 2007.

 

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InJune 2004 the Company initiated a multi-center clinical trial for themonitoring of metastatic colorectal cancer and completed a developmentmilestone defined in the Veridex agreement. As a result the Company earned a $500,000 milestone payment.  This milestone payment will be recognizedover the estimated product development period which is estimated to becompleted by the end of 2006.

 

****Also the Company and Veridexagreed that as of September 30, 2004 Immunicon has successfully completed threemore development milestones and would be paid $833,000 as a result. They are:****

 

****1.********              ********Prostate cancer — feasibility of a large bloodvolume sample processing method and product concept completed; amount ofmilestone payable to the Company is $300,000****

 

****2.********              ********Tumor cell profiling reagents — product developmentprocess approved by the joint Veridex/Immunicon Steering Committee progress,first product is commercially available, second product completed productionreadiness review, and proof of principle demonstrated for a third product andassociated antibody licensed; amount of milestone payable to the Company is$200,000****

 

****3.********              ********Lung cancer: adjuvant prognosis and recurrencemonitoring — first patient enrolled in clinical trial associated with thisindication; amount of milestone payable to the Company is $333,000.****

 

Veridexpaid us $833,000 in October 2004. The Company will recognize these milestonereceipts as revenue over the estimated product development period which isestimated to end at various points through June 30, 2008.  As of October 31, 2004, the Company hasreceived $1,833,000 from Veridex for achieving development related milestonesin 2004.

 

TheCompany recognized $81,000 as milestone revenue in the three months endedSeptember 30, 2004 and $896,000 for the three months ended September 30, 2003under this Development Agreement.  TheCompany recognized $144,000 as revenue for the nine months ended September 30,2004, and $1,724,000 for the nine months ended September 30, 2003 under thisDevelopment Agreement. As of September 30, 2004 and December 31, 2003, theCompany had receivables from Veridex of $1.4 million and $200,000,respectively.   These receivables arerecorded in “Receivable from related party” in the consolidated balance sheet.

 

TheCompany sold an instrument system to Veridex in January 2004 and recognizedrevenue of $103,000 as instrument revenue from related party.  The Company recorded these revenues as “Revenuefrom related party” in the consolidated statement of operations.

 

Inaddition, in fiscal 2003 the Company sold all of its rights to a trademark toJohnson & Johnson, Inc. for $250,000 and recorded it as Other Income fromRelated party on the consolidated statement of operations.

 

InAugust 2003, the Company sold 80,000 shares of Series F Preferred Stockand entered into a License and Supply Agreement (“License and Supply Agreement”)with another company. The Company received $400,000 in proceeds for thecombined transaction. Because shares of our Series F Preferred Stock werevalued at $4.00 per share in a similar transaction, the same value was appliedto the shares in this transaction. The amount above the $4.00 per share valueof the shares of the Company’s Series F Preferred Stock was deemedattributable to the License and Supply Agreement and recorded as deferredlicense revenue. The Company recorded this $80,000 premium as deferred licenserevenue and is amortizing it into income over the two year period of theexclusive supply arrangement with this company. As of September 30, 2004, theunamortized deferred license revenue related to this arrangement amounted to$34,000, and recognized revenue of $11,000 and $31,000 related to thearrangement and recorded it as “Revenue from related party” in the consolidatedstatement of operations for the three and nine month periods ended September30, 2004, respectively.

 

Thefollowing table breaks out the revenue from related parties recognized over thethree and nine month periods of 2004 and 2003:

 
| **Revenue from related parties:**     | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(in thousands)**                    | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Contract revenue from related party   |       | $                                    | 92         |                                | $          | 901 |   | $ | 175 |   | $ | 1,729 |   |
| Instrument revenue from related party |       | 25                                   |       | —                              |       | 129 |   | — |   |
| Other revenue from related party      |       | 31                                   |       | —                              |       | 36 |   | — |   |
|                                  |       | $                                    | 148        |                                | $          | 901 |   | $ | 340 |   | $ | 1,729 |   |

 

 

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**(10)****  ****Supplemental expense information**

 

Thesupplemental expense information below provides additional information aboutthe amounts recorded as research and development expenses and general andadministrative expenses in the accompanying statements of operations:

 

**Research and development expenses**

 

Researchand development expenses consisted of the following:

 
| ** **                       | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(in thousands)**               | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Salaries, benefits and taxes     |       | $                                    | 2,906      |                                | $          | 1,891 |   | $ | 7,602 |   | $ | 5,253 |   |
| Laboratory supplies and expenses |       | 1,227                                |       | 935                                 |       | 3,600 |   | 1,660 |   |
| Instrument development costs     |       | 284                                  |       | 261                                 |       | 607 |   | 1,490 |   |
| Clinical trial expenses          |       | 882                                  |       | 218                                 |       | 1,762 |   | 633 |   |
| Contracted research costs        |       | 340                                  |       | 435                                 |       | 1,122 |   | 1,292 |   |
| Insurance                        |       | 187                                  |       | 38                                  |       | 421 |   | 97 |   |
| All others                       |       | 733                                  |       | 234                                 |       | 2,028 |   | 1,029 |   |
|                             |       | $                                    | 6,559      |                                | $          | 4,012 |   | $ | 17,142 |   | $ | 11,454 |   |

 

 

**General and administrative expenses**

 

Generaland administrative expenses consisted of the following:

 
| ** **                   | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(in thousands)**           | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Salaries, benefits and taxes |       | $                                    | 902        |                                | $          | 450 |   | $ | 2,368 |   | $ | 1,341 |   |
| Depreciation                 |       | 371                                  |       | 292                                 |       | 1,052 |   | 814 |   |
| Legal and professional fees  |       | 407                                  |       | 319                                 |       | 1,024 |   | 678 |   |
| Insurance                    |       | 47                                   |       | 7                                   |       | 101 |   | 18 |   |
| All other expenses           |       | 269                                  |       | 120                                 |       | 663 |   | 333 |   |
|                         |       | $                                    | 1,996      |                                | $          | 1,188 |   | $ | 5,208 |   | $ | 3,184 |   |

 

**(11)****  ****Intellectual property**

 

Protection of the Company’s intellectualproperty is a strategic priority for the Company’s business, and the Companyrelies on a combination of patent, trademark, copyright and trade secret lawsto protect its interests. The Company’s ability to protect and use itsintellectual property rights in the continued development and commercializationof its technologies and products, to operate without infringing the proprietaryrights of others and to prevent others from infringing its proprietary rightsis crucial to the Company’s continued success. The Company will be able toprotect its products and technologies from unauthorized use by third partiesonly to the extent that its products and technologies are covered by valid andenforceable patents, trademarks or copyrights, or are effectively maintained astrade secrets, know-how or other proprietary information.

 

Inconnection with the commercial distribution of its products, the Company alsohas obtained trademark registrations in the US for “Immunicon” and theImmunicon logo.  Trademark registrationswere also obtained for “CellSave”, “CellTracks”, “CellSpotter”, “Magnest” andthe CellTracks AutoPrep System logo, and the CellSpotter Analyzer logo byImmunivest Corporation, a wholly owned subsidiary of the Company.  The Company has filed a number of trademarkregistration applications in preparation for commercial distribution activitieswith respect to future products. Much of the proprietary software and relatedinformation utilized in the Company’s instrument systems is protected by theCompany’s copyright rights or by such rights that the Company has licensed.

 

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TheCompany devotes significant resources to obtaining, enforcing and defendingpatents and other intellectual property and protecting its other proprietaryinformation.

 

The Company has a portfolio of issued patentsand patent applications, which we believe provides patent coverage for ourproprietary technologies and products. As of November 4, 2004, the Company’s intellectual property estateconsisted of 54 issued patents, 134 pending patent applications, eleven issuedtrademarks and 20 pending trademarks registrations.

 

**(12)****  ****Subsequent events**

 

On October 22, 2004, theCompany entered into a $12 million extension to its existing line of creditwith Silicon Valley Bank (“SVB”) and amended certain terms of the creditagreement (the “SVB Amendment”).  Theloan is secured by a first-priority security interest in all of our assetsexcept for our intangible intellectual property and the assets pledged underthe equipment line of credit with General Electric Capital Corporation (“GE”)described below.  Borrowings under thisextension bear interest at a per annum rate of 0.5% above the prime lendingrate.  Interest accrues from the date ofeach equipment advance and is payable on a monthly basis in 48 equal monthlyinstallments.  However, upon theoccurrence of any event of default, SVB may accelerate and declare all or anyportion of the Company’s obligations to SVB immediately due and payable.

The SVB Amendment alsocontains certain covenants that require us to, among other things, maintain acertain level of earnings or loss before interest, taxes, depreciation andamortization, maintain a minimum amount of our available funds on deposit withSVB and deliver periodic financial statements and reports within a prescribedtimeframe.  The Company also agreed torestrict our ability to among other things, dispose of property (includingintellectual property), change our business, ownership, management or businesslocations, merge with or acquire certain other entities, create or incurcertain liens or encumbrances on any of its property, incur or amend the termsof certain indebtedness, engage in transactions with affiliates, declare or paycertain dividends or redeem, retire or purchase shares of any capital stock.

In October, 2004, theCompany extended our existing equipment line of credit with GE by $5 millionbut did not otherwise amend the terms of this line of credit, except for theapplicable rate of interest and repayment period.  Interest on this line of credit ranges from8.65% to 9.25% and is repayable over 36 to 60 months. However, upon theoccurrence of any event of default, GE may accelerate and declare all or anyportion of its obligations to GE immediately due and payable.  This line of credit is secured by a firstpriority security interest on the assets specifically pledged under the line ofcredit and a second priority security interest on all other assets except forour intangible intellectual property.

The equipment line ofcredit with GE also contains certain covenants, which require us to, amongother things, deliver periodic financial statements and reports within aprescribed timeframe and maintain and preserve the collateral; and whichrestrict our ability to, among other things, dispose of the collateral orcreates or incurs certain liens or encumbrances on the collateral.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

***Forward-Looking Statements***

 

*The information contained in thisquarterly report on Form 10-Q includes “forward-looking statements” within themeaning of the Private Securities Litigation Reform Act of 1995. Theseforward-looking statements are often preceded by words such as “hope,” “may,” “believe,”“anticipate,” “plan,” “expect,” “intend,” “assume,” “will” and similarexpressions.  We caution investors not toplace undue reliance on the forward-looking statements contained in thisreport.  Forward-looking statementsincluded in this report relate to financing and capital needs and resources,product development, our relationship with Twente University, our relationshipwith Veridex, research, development and sales based milestones and relatedpayments from Veridex, expansion of research and development activities andincreases in research and development costs, instrument system and platformimprovement activities and costs, expansion of clinical trials and relatedcosts, use of IPO net proceeds and other funds, and other statements regardingmatters that are not historical facts.  Forward-looking statements speak only as of the date of this report,reflect management’s current expectations and involve certain factors, such asrisks and uncertainties, that may cause actual results to be far different fromthose suggested by our forward-looking statements.  These factors include, but are not limitedto, risks associated with our dependence on Veridex; our capital and financingneeds; research and development and clinical trial expenditures;commercialization of the our product candidates; our ability to use licensedproducts and to obtain new licenses from third parties; our ability to managegrowth; obtaining necessary regulatory approvals; reliance on third partymanufacturers and suppliers; reimbursement by third party payors to ourcustomers for our products; compliance with applicable manufacturing standards;the ability to earn license and milestone payments under our agreement withVeridex; retaining key management or scientific personnel; delays in thedevelopment of new products or to planned improvements to our products;effectiveness of our products compared to competitors’ products; protection ofour intellectual property and other proprietary rights; conflicts with theintellectual property of third parties; product liability lawsuits that may bebrought against us; labor, contract or technical difficulties;  competitive pressures in our industry; otherrisks and uncertainties discussed under the caption “Factors That may Affect FutureResults” and elsewhere in this report; and other risks and uncertainties, asmay be detailed from time to time in our public announcements and SEC filings.*

 

*We do not intend to update any ofthese factors or to publicly announce the results of any revisions to any ofthese forward-looking statements other than as required under the federalsecurities laws.*

 

**OVERVIEW**

 

Weare developing and commercializing proprietary cell-based diagnostic andresearch products with an initial focus on cancer. We believe that our productsand underlying technology platforms also have applications in the developmentof cancer drugs and cancer research. Furthermore, we believe that ourproprietary technologies also have applications in fields of medicine outsideof cancer.

 

Wewere incorporated in 1983. Since our inception, we have focused our activitieson product development and life science research. In March 1999, we obtained$10.6 million in financing from the sale of our convertible preferredstock. As a result, we substantially increased investment in our cancer-relatedproducts and technologies, hired additional key management team members andredefined our business strategy. Since 1999, we have devoted substantially allof our efforts to the development of our cell analysis platforms and diagnostictools for application in cancer. We completed the initial public offering (“IPO”)of shares of our common stock on April 21, 2004. In the IPO, we sold 6.9million shares of our common stock, including the underwriters’ over allotmentoption, at $8.00 per share and received proceeds of $49.4 million, net of feesand expenses.   We are a developmentstage company and have incurred losses in the last five fiscal years.   As of September 30, 2004, we had anaccumulated deficit of $85.6 million. We expect to incur substantiallosses, which may increase over the next several years as we:

 

•                  conductclinical trials to expand the uses of our technologies in metastatic cancersother than metastatic breast cancer and to earlier stages of the disease inbreast and other cancers;

 

•                  incur costs toplace our cell analysis systems with customers and to support othercommercialization activities;

 

•                  expand andscale-up our manufacturing capability for instruments, bulk reagents, reagentkits and other consumable products; and

 

•                  developapplications of our technologies for diseases other than cancer, such ascardiovascular, inflammatory and infectious diseases and for products tosupport drug development in cancer.

 

14

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Weare highly dependent on our collaboration with Veridex. In addition, we expectto continue to generate substantial losses for at least the next two years. Wewill need to obtain additional funding to support the activities describedabove.

 

**Veridex collaboration**

 

Weexpect that substantially all of our revenues from product sales for at leastthe years 2004 and 2005 will be derived from our relationship with Veridex. OurDevelopment Agreement with Veridex provides Veridex with exclusive worldwiderights to commercialize cell analysis products based on our technologies in thefield of cancer.  Veridex received 510(k)clearance from the U.S. Food and Drug Administration (“FDA”) for the use of theCellSearch Circulating Tumor Cell Kit in the management of metastatic breastcancer on January 21, 2004 and for the CellSearch Circulating Tumor CellControl Kit in September 2004. We are responsible for all cellular research anddevelopment, including the costs of clinical development. Upon any sale byVeridex of certain of our  products,including reagents, test kits, consumable products and disposable items,Veridex is obligated to pay us approximately 30% of net sales.

 

Beginningwith commercialization of the first product under this Development Agreement,we are obligated to invest in certain research and development activities anamount equal to at least 10% of Veridex’s net sales, excluding revenues frominstrument sales, from these products. However, beginning with the firstcalendar year after the amount of these net sales exceeds $250 million; we areonly required to invest an amount equal to at least 8.5% of these net sales. Weare also responsible for manufacturing reagents for CellSearch kits in bulk anddelivering them to Veridex. We are responsible for all instrument manufacturingand certain ancillary products. We believe that we have manufacturing capacityavailable at our existing facilities to satisfy commercial demand through 2005.Veridex is responsible for filling and packaging costs for the reagents, aswell as sales, marketing, distribution, customer and technical support andfield service of our cancer products, including instrumentation. We haveretained worldwide commercialization rights to all non-cancer applications ofour technologies.

 

Thepace and outcome of both our commercialization efforts and clinical developmentprograms are difficult to predict. As a result, we anticipate that ourquarterly results will fluctuate for the foreseeable future. In view of this variabilityand of our limited operating history, we believe that period-to-periodcomparisons of our operating results are not meaningful and you should not relyon them as indicative of our future performance.

 

**Revenues**

 

We have not generated any significant productrevenues since our inception. We initiated sales activities for instrumentplatforms and reagent kits for research use only (“RUO”) in the first quarterof 2004 and for *in vitro* diagnostic (“IVD”) usein the third quarter of 2004. As of September 30, we have shipped twelvecomplete systems each consisting of a CellTracks® AutoPrep System andCellSpotter® Analyzer.  Seven systemswere shipped to laboratory customers and five systems were placed with affiliatesof Johnson & Johnson.  We now have instrumentsin the USA, Europe and Japan.  However,the recognition of revenue related to instrument shipments is typically delayedfor a period of several months due to final validation and testing of thesesystems at customer locations.

 

We designated the period from August 2000until December 31, 2003 as the initial product development period. During thatperiod, we received $4.0 million in license and milestone payments fromVeridex, and we recognized the entire amount as license revenue from relatedparty during that period.

 

We received $500,000 in milestone receiptsrelated to product development milestones during the first quarter of 2004. TheCompany will recognize these receipts as revenue over the estimated life of therelated product development period which we estimate will end on December 31,2007.

 

InJune 2004, we initiated a multi-center clinical trial for the monitoring ofmetastatic colorectal cancer and completed a development milestone defined inthe Veridex agreement.  As a result weearned a $500,000 milestone payment. This milestone payment will be recognized over the estimated productdevelopment period which we estimate will end at the end of 2006.

 

****Also we and Veridex agreed thatas of September 30, 2004 we had successfully completed three more developmentmilestones and would be paid $833,000 as a result. They are:****

 

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****1********                 ********Prostate cancer — feasibility of a large bloodvolume sample processing method and product concept completed; amount payableto us is $300,000****

 

****2.********              ********Tumor cell profiling reagents — product developmentprocess approved by the joint Veridex/Immunicon Steering Committee, firstproduct is commercially available, second product completed productionreadiness review, and proof of principle demonstrated for a third product andassociated antibody licensed; amount payable to us is $200,000****

 

****3.********              ********Lung cancer: adjuvant prognosis and recurrencemonitoring — first patient enrolled in clinical trial associated with thisindication; amount of milestone payable to us is $333,000.****

 

Veridexpaid us $833,000 in October 2004. We will recognize these milestone receipts asrevenue over the estimated product development period which we estimate willend on December 31, 2008. As of October 31, 2004 we have received $1,833,000from Veridex for achieving development related milestones in 2004.

 

Werecognized $81,000 as milestone revenue in the three months ended September 30,2004 and $896,000 for the three months ended September 30, 2003 and we recognized$144,000 as milestone revenue for the nine months ended September 30, 2004, and$1,724,000 for the nine months ended September 30, 2003 under this DevelopmentAgreement.

 

Asof September 30, 2004, there is an additional $4.7 million in licenserevenue, which we can earn from Veridex for research-related milestones.We estimate that we will earn these license revenues from research milestonesover the next three to five years. Therefore, we expect that the trend of license revenue will fluctuate.Also, we expect to continue to invest significant amounts in research anddevelopment, particularly in clinical trials and manufacturing development, andtherefore we do not believe that these expenses will fluctuate in relation towhen we expect to earn the milestone revenue referenced to above.

 

Underthe Development Agreement with Veridex, we also can earn up to$10.0 million in revenue for achieving defined sales targets. Ouragreement with Veridex provides for payments to us by Veridex of$2.0 million, $3.0 million and $5.0 million in the first yearthat sales recognized by Veridex of the CellSearch reagent products to thirdparties, excluding sales of instruments, reach $250 million,$500 million and $1 billion, respectively. We do not estimate that wewill reach any of these sales targets until at least 2007 and therefore do notanticipate earning any sales-based milestone revenues until then.

 

**Research and development expenses**

 

Ourresearch and development expenses consist of expenses incurred in developingreagents and instrument platforms and ancillary products, as well as theclinical research and trial costs to test these kits and systems. Theseexpenses consist primarily of:

 

•                  salaries andrelated expenses for personnel;

 

•              fees paid to professionalservice providers in conjunction with independently monitoring our clinicaltrials and acquiring and evaluating data in conjunction with our clinicaltrials.

 

•                  payments tothird parties for instrument development activities and for research relatedsupport, expenses for materials consumed in research experiments and clinicalresearch and clinical trials; and

 

We are responsible for making royaltypayments of 1% of sales of our reagents incorporating intellectual propertylicensed to us under a license agreement with the University of Texas. Noroyalty payments have been made to the University of Texas as of September 30,2004.

 

Weexpense research and development costs as incurred. We believe that significantinvestment in product development is a competitive necessity and plan tocontinue these investments in order to realize the potential of our productcandidates and proprietary technologies. We expect to continue to incursignificant costs for clinical research and for trials and to make investments toimprove our instrument platforms and reagents. From inception throughSeptember 30, 2004, we have incurred $71.7 million in total researchand development expenses, the majority of which relate to our cell-basedresearch and diagnostic products.

 

16

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**General and administrative expenses**

 

Ourgeneral and administrative expenses consist primarily of salaries and otherrelated costs for personnel in executive, finance, accounting, informationtechnology, legal and human resource functions. Other costs include facilitycosts not otherwise included in research and development expense andprofessional fees for legal and accounting services. From inception throughSeptember 30, 2004, we have incurred $23.6 million in general andadministrative expenses.

 

**Stock-based compensation expenses**

 

Stock-basedcompensation expense, which is a non-cash charge to expenses, results fromstock option grants to employees at exercise prices below the fair value of theunderlying common stock resulting in our recording stock-basedcompensation expense associated with such grants.  Stock-based compensation expense alsois recorded for stock option and warrant grants to non-employees and forrestricted stock grants provided to directors and advisors in lieu of cashcompensation. We amortize the deferred stock-based compensation tooperating expenses over the vesting periods of the options and grants, subjectto adjustment for forfeiture during the vesting period. As ofSeptember 30, 2004, we have recognized $4.9 million in deferred stock-basedcompensation expense. For the period from inception through September 30,2004, we have recognized cumulative stock-based compensation expense$2.4 million.

 

**Interest income and expense**

 

Interestincome consists of interest earned on our cash, cash equivalents andinvestments. Interest expense consists of interest incurred on equipment leasesand on debt financings.

 

**CRITICAL ACCOUNTING POLICIES**

 

Weprepare our consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses. Webase our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions. Ourcritical accounting policies include:

 

•                                          revenuerecognition;

 

•                                          accounting forresearch and development expenses;

 

•                                          estimating thevalue of our equity instruments for use in deferred stock-basedcompensation calculations; and

 

•                                          accounting forincome taxes.

 

**Revenue recognition**

 

Inaccordance with the SEC, Staff Accounting Bulletin No. 101, *Revenue Recognition in Financial Statements,*up-front non-refundable license fees are recorded as deferred revenue andrecognized over the estimated development period. From inception throughSeptember 30, 2004, we have not generated any significant product revenue.Since August 2000, we have earned $5.8 million in license and milestonepayments from Veridex and have received $5.0 million as of September 30, 2004.License and milestone payments are deferred and amortized on a straight-linebasis over the product development period as defined for each specific product.Amounts received as reimbursement for research and development expenses arerecorded as a reduction in research and development expense as the relatedcosts are incurred.

 

Also, in accordance with the SEC, StaffAccounting Bulletin No. 101, RevenueRecognition in Financial Statements, we recognize revenue for instrumentplacements at the time that all necessary conditions for the recognition ofrevenue have been met. Specifically, we may place instruments with customersand allow the customer a period of time for training and validation as iscommon in our industry. Therefore there may be a delay between the time that aninstrument is placed with a customer and the point at which the revenue for theinstrument placement is recognized. Also in certain instances the customer maybe provided with an opportunity to 

 

17

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return the instrument to us prior toacceptance. We therefore recognize the revenue associated with these instrumentplacements only at the point when it is clear that all revenue recognitioncriteria have been met and that no continuing right of return remains.

 

**Accounting for research and development expenses**

 

Ourresearch and development expenses consist primarily of costs associated withproduct development for our cancer diagnostic tests. These expenses include thedevelopment costs for instrument platforms, clinical trial and developmentcosts and the costs associated with non-clinical support activities such as manufacturingprocess development and regulatory services. Clinical development costsrepresent internal costs for personnel; external costs incurred at clinicalsites and contracted payments to third party clinical research organizations toperform certain clinical trials. We have a discovery research effort, which isconducted in part on our premises by our scientists and in part throughcollaborative agreements with academic laboratories. Most of our research anddevelopment expenses are the result of the internal costs related directly toour employees. We accrue external costs for clinical trials based on theprogress of the clinical trials, including patient enrollment, progress by theenrolled patients through the trial, and contracted costs with clinicalresearch organizations and clinical sites. We record internal costs primarilyrelated to personnel in clinical development and external costs related tonon-clinical trials and basic research when incurred. Significant judgments andestimates must be made and used in determining the accrued balance in anyaccounting period. Actual costs incurred may or may not match the estimatedcosts for a given accounting period. We expect that expenses in the researchand development category will increase for the foreseeable future as we addpersonnel, expand our clinical trial activities and increase our discoveryresearch capabilities. The amount of the increase is difficult to predict dueto the uncertainty inherent in the timing of clinical trial initiations, progressin our discovery research program, the rate of patient enrollment and thedetailed design of future trials. In addition, the results from each of ourtrials will influence the number, size and duration of both planned andunplanned trials.

 

**Valuation of equity instruments**

 

Werecord compensation expense related to options issued to consultants andoptions issued to employees at less than the fair value. These expenses arebased on the fair value of the options and common stock. Because, prior to ourIPO, there was no public market for our common stock, we have estimated thefair value of equity instruments, issued prior to our IPO, using variousvaluation methods, including the minimum value and the Black-Scholesmethods.  When stock options are grantedwith an exercise price below the estimated fair value of our common stock atthe grant date, the difference between the fair value of our common stock andthe exercise price of the stock option is recorded as deferred compensation.Deferred compensation is amortized to compensation expense on a straight-linebasis over the vesting period of the stock option.

 

**Accounting for income taxes**

 

Wemust make significant management judgments when determining our provision forincome taxes, our deferred tax assets and liabilities and any valuationallowance recorded against our net deferred tax assets. At September 30,2004, we recorded a full valuation allowance of $36.1 million against our netdeferred tax asset balance, due to uncertainties related to our deferred taxassets as a result of our history of operating losses. The valuation allowanceis based on our estimates of taxable income by jurisdiction in which we operateand the period over which our deferred tax assets will be recoverable. In theevent that actual results differ from these estimates or if we adjust theseestimates in future periods we may need to change the valuation allowance,which could materially impact our financial position and results of operations.

 

 

**RESULTS OF OPERATIONS**

 

**Three months ended September 30, 2004 and 2003**

 

**Revenue**

 

Wesegregate revenue into revenue from related party and other revenue.  Revenue from related party is composed oflicense and milestone revenue, instrument revenue and other revenue. Licenseand milestone revenue from related party decreased by $809,000 to $92,000 forthe three months ended September 30, 2004 from $901,000 for the threemonths ended September 30, 2003. From August 2000 to September 30,2004, we earned $5.8 million in license and milestone receipts under ourDevelopment Agreement with Veridex and have received $5.0 million as ofSeptember 30, 2004. License and milestone receipts have been deferred andamortized

 

 

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on a straight-line basis over the productdevelopment period as defined for each specific product. We recognized $4.0million in license and milestone revenue in the period from August 2000 toDecember 31, 2003.

 

Duringthe first quarter of 2004 we received an additional $500,000 in milestonereceipts as a partial receipt of the milestone for commercial readiness forbreast cancer monitoring. We will recognize this as revenue over the estimatedlife of the related product development period, which we estimate will end onDecember 31, 2007. In the second quarter, we initiated a multi-center clinicaltrial for the monitoring of metastatic colorectal cancer for which we earned a$500,000 milestone payment.  Thismilestone revenue will be recognized over the estimated product developmentperiod, which we estimate will end on December 31, 2006.

 

****Also we and Veridex agreed thatas of September 30, 2004 we had successfully completed three more developmentmilestones and would be paid $833,000 as a result. They are:****

 

****•********                 ********Prostate cancer — feasibility of a large bloodvolume sample processing method and product concept completed; amount payableto us is $300,000****

 

****•********                 ********Tumor cell profiling reagents — product developmentprocess approved by the joint Veridex/Immunicon Steering Committee, firstproduct is commercially available, second product completed productionreadiness review, and proof of principle demonstrated for a third product andassociated antibody licensed; amount payable to us is $200,000****

 

****•********                 ********Lung cancer: adjuvant prognosis and recurrencemonitoring — first patient enrolled in clinical trial associated with thisindication; amount payable to us is $333,000.****

 

 

Veridexpaid us $833,000 in October 2004. We will recognize these milestone receipts asrevenue over the estimated product development period which we estimate willend on December 31, 2008. As of October 31, 2004 we have received $1,833,000from Veridex for achieving development related milestones in 2004.

 

Werecognized $81,000 as milestone revenue in the three months ended September 30,2004 and $896,000 for the three months ended September 30, 2003 under thisDevelopment Agreement.

 

InAugust 2003, we sold 80,000 shares of Series F Preferred Stock and enteredinto a License and Supply Agreement (“License and Supply Agreement”) withanother company. We received $400,000 in proceeds for the combined transaction.Because shares of our Series F Preferred Stock were valued at $4.00 pershare in a similar transaction, the same value was applied to the shares inthis transaction. The amount above the $4.00 per share value of the shares ofour Series F Preferred Stock was deemed attributable to the License andSupply Agreement and recorded as deferred license revenue. We recorded this$80,000 premium as deferred license revenue and we are amortizing it intoincome over the two year period of the exclusive supply arrangement with thiscompany. As of September 30, 2004, the unamortized deferred license revenuerelated to this arrangement amounted to $34,000, and we recognized revenue of$11,000 and $5,000 related to the arrangement and recorded it as “Revenue fromrelated party” in the consolidated statement of operations for the three monthperiod ended September 30, 2004 and September 30, 2003, respectively.

 

Otherrevenue, including other revenue from a related party, decreased by $5,000 to$62,000 in the third quarter of 2004 from $67,000 in the third quarter of 2003.In 2003 other revenue consisted principally of funds received from governmentrelated grants and are expected to fluctuate from year to year.

 
| ** **                         | ** ** | **Three months ended  September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                         | ** ** | **(in thousands)**                    | ** ** |
| License revenue from related party |       | $                                     | 92         |   | $ | 901 |   |
| Other revenue from related party   |       | 56                                    |       | — |   |
| Other revenue                      |       | 6                                     |       | 67 |   |
| Total revenue                      |       | $                                     | 154        |   | $ | 968 |   |

 

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**Research and development expenses**

 

Researchand development expenses increased by $2.5 million, or 63.5%, to$6.5 million in the third quarter of 2004 from $4.0 million in thethird quarter of 2003. Salary and salary-related costs were $2.9 millionin third quarter of 2004 compared to $1.9 million in 2003. This increase of$1.0 million or 53.7% is due principally to higher staff levels necessary tocomplete the development of certain instrument platforms and to complete thedevelopment of our initial cancer monitoring test. We hired additionalpersonnel throughout 2003 and during the first half of 2004 to prepare for thecommercial launch of our initial products, increased clinical development toexpand applications of our cancer diagnostic technology and increases inresearch personnel to expand uses of our technology beyond cancer to otherdisease states, as well as higher stock-based compensation expensesrecognized in 2004.  The portion of stock-basedcompensation expenses recognized as part of research and development salarieswas $205,000 in the third quarter of 2004 versus $20,000 in the third quarterof 2003.

 

Laboratorysupplies and expenses were $1.2 million, or $292,000 higher, in the thirdquarter of 2004 than in 2003. This increase was related principally topreparation for the launch of our initial cancer diagnostic products especiallyfor prototype instruments for testing and training purposes and reagentdevelopment expenses. We also continued to invest in the development of otherapplications of our technology in areas both within and outside the field ofcancer diagnostics.

 

Instrumentdevelopment costs increased by $23,000 to $284,000 in the three months endedSeptember 30, 2004 from $261,000 in the same period ended September 30, 2003 aswe invested in improvements to our instrument platforms for future versions ofour CellTracks AutoPrep System and our associated CellSpotter Analyzer. Weanticipate that we will continue to engage in instrument system improvementactivities for the remainder of 2004 and beyond. Therefore, it is likely thatinstrument development costs will fluctuate in future periods.

 

Clinical trial expenses increased in thethird quarter of 2004 by $664,000 to $882,000 from $218,000 in the thirdquarter of 2003 as we expanded our clinical development program beyond ourinitial pivotal clinical trial for breast cancer monitoring. In June 2004 weinitiated a clinical trial for the monitoring of metastatic colorectal cancerand in the third quarter of 2004 we initiated a pilot study to monitorrecurrence of lung cancer.  Also, in October we initiated a pivotalclinical trial for the monitoring of metastatic prostate cancer which webelieve, if it is successful, should result in a regulatory submission to theFDA.  The majority of effort andcosts incurred in clinical development in 2003 was related to data analysis andpreparation of the associated regulatory filing with the FDA which were not ascostly as efforts to accrue patients and manage the initial multi-centeredtrial for the breast cancer test. We anticipate increasing our clinical trialexpenditures in the remainder of 2004 and beyond in order to expand the uses ofour technology to other cancers and to earlier stages of the disease.

 

Contractedresearch costs were $95,000 lower in the third quarter of 2004 than in thethird quarter of 2003 as validation efforts related to preparing ourmanufacturing processes for initial product launch were completed earlier in2004. Therefore these expenses declined in the third quarter of 2004.

 

Insuranceexpenses increased by $149,000 in the third quarter of 2004 over the sameperiod in 2003 related principally to allocated costs of Directors and Officersliability insurance which increased as a result our completion of our IPO inApril 2004.

 

Asummary of the principal components of our research and development costs forthe three months ended September 30, 2004 and 2003 are shown below:

 
| ** **                              | ** ** | **Three months ended  September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| **Research and development expenses**   | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(in thousands)**                    | ** ** |
| Salaries, benefits and taxes            |       | $                                     | 2,906      |   | $ | 1,891 |   |
| Laboratory supplies and expenses        |       | 1,227                                 |       | 935 |   |
| Instrument development costs            |       | 284                                   |       | 261 |   |
| Clinical development expenses           |       | 882                                   |       | 218 |   |
| Contracted research costs               |       | 340                                   |       | 435 |   |
| Insurance expense                       |       | 187                                   |       | 38 |   |
| All others                              |       | 733                                   |       | 234 |   |
| Total research and development expenses |       | $                                     | 6,559      |   | $ | 4,012 |   |

 

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Weexpect salary related expenses to increase in future years as we hireadditional personnel and continue to invest in research and clinical trialactivities. We believe that costs related to laboratory supplies and expenseswill be higher in future periods as we develop:

 

•                                          research anddiagnostic products for cancers other than breast cancer;

 

•                                          tests designedto diagnose cancer earlier in the disease; and

 

•                                          otherdiagnostic tools for use in diseases such as cardiovascular and infectiousdiseases, and for use in drug development.

 

Althoughwe will continue to invest in instrument development to improve performance ofthe various components of the system and to increase the capabilities of thesystem to process larger sample volumes, we expect instrument development costsas a percentage of total research and development expenditures generally to belower in future years because we completed the principal development work onour initial instrument platforms in 2003.

 

Weexpect clinical development expenses to be higher in future years as we expandour clinical trials to investigate the effectiveness of our cancer diagnosticproducts on cancers other than breast cancer and in earlier stages of thedisease in breast and other cancers, and as we develop other diagnostic toolsfor use in diseases such as cardiovascular, inflammatory and infectiousdiseases and for use in tools for drug development.

 

 

Eachof our research and development programs is subject to risks and uncertainties,including the requirement to obtain regulatory approval, that are outside ofour control. As a result of these risks and uncertainties, we are unable topredict the period in which we will achieve profitability. For example, ourclinical trials may be subject to delays or rejections for a variety ofreasons, such as our inability to obtain applicable clearances from the FDA orinstitutional or ethical review boards or to enroll patients at the rate thatwe expect. Moreover, the product candidates we are developing must overcomesignificant technological and marketing challenges before they can besuccessfully commercialized.

 

**General and administrative expenses**

 

Generaland administrative expenses increased by $808,000, or 68.0%, to$2.0 million in the third quarter of 2004 from $1.2 million in 2003.Salary related costs increased by $452,000 in the third quarter of 2004, dueprincipally to increases in personnel throughout the period from October 2003through September 2004. The full effect of the costs for the personnel hiredfrom October 2003 through September 2004 appear in the third quarter of 2004.We hired additional accounting and administrative personnel in order to preparefor the additional administrative and reporting activities resulting from ourtransition to a publicly-held company and in preparation for the commerciallaunch of our initial products, both of which occurred in 2004. Legal fees andinsurance expenses increased by $128,000 as a result of increased patentlicense fees and for the allocated portion of the increase in Directors andOfficers liability insurance which increased as a result our completion of ourIPO in April 2004. Depreciation expense increased by $79,000 to $371,000 in thethird quarter of 2004 from $292,000 in 2003 as a result of an expansion of ourmanufacturing facility in the second half of 2003 at a cost of$1.5 million in preparation for the commercial launch of our products.

 

**Interest income**

 

Interestincome increased by $185,000, or 349.1% to $238,000 in the quarter endedSeptember 30, 2004 from $53,000 in the quarter ended September 30, 2003.  The increase in interest income was primarilya result of an increase in average invested cash balances in 2004. Our increasein invested cash balances resulted from our IPO which provided net cashproceeds of $49.4 million and which was completed on April 21, 2004.

 

**Interest expense**

 

Interestexpense decreased by $4,000, or 2.5%, to $153,000 for the third quarter of 2004from $157,000 for 2003. The decrease was due to lower average debt outstandingin the third quarter of 2004 compared to 2003.

 

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**Stock-based compensation expenses**

 

Stock-basedcompensation expenses were $644,000 and $91,000 for the three months endedSeptember 30, 2004 and 2003, respectively. This increase was due to an increasein the number of options granted to employees and consultants and an increasein the fair value of our common stock as compared to the exercise price atissuance. We recognized these expenses as part of research and developmentexpenses and general and administrative expenses as shown below.

 

 
| ** **                                         | ** ** | **Three Months  Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|----------------------------------------|------------|
| **Stock-based compensation expenses included in:** | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | **(in thousands)**                     | ** ** |
| Research and development expenses                  |       | $                                      | 577        |   | $ | 20 |   |
| General and administrative expenses                |       | 67                                     |       | 71 |   |
| Total stock-based compensation expenses            |       | $                                      | 644        |   | $ | 91 |   |

 

**Income Taxes**

 

Wehave incurred net operating losses since our inception and have consequentlynot paid any federal, state or foreign taxes. As of September 30, 2004, wehad approximately $84.1 million of net operating loss carryforwards andapproximately $2.0 million in research and development tax credit carryforwardsavailable to offset future regular and alternative taxable income. If notutilized, these net operating loss carryforwards and tax credits will begin toexpire in 2005. If we do not achieve profitability, our net operating losscarryforwards may be lost. In addition, the Internal Revenue Code placescertain limitations on the annual amount of net operating loss carryforwardsthat can be utilized if certain changes in our ownership occur. We arecurrently not subject to these limitations.

 

**Net loss and net loss per common share**

 

Thenet loss of $8.3 million in the third quarter of 2004 was $4.0 million, or91.7%, higher than the loss of $4.3 million in the third quarter of 2003.

 

Atthe completion of the Company’s initial public offering on April 21, 2004approximately 52.1 million preferred shares were converted into 15.5 millionshares of common stock.  As the result,the net loss per common share of $0.36 in the third quarter of 2004 was $8.69per share, or 96.0%, lower than the loss per common share of $9.05 in the thirdquarter of 2003. Weighted average common shares outstanding during the threemonths ended September 30, 2004 were approximately 23.0 million compared to479,000 for the same period in 2003.

 

**Nine months ended September 30, 2004 and 2003**

 

**Revenue**

 

Wesegregate revenue into revenue received from related party and other revenue.Revenue from related party is composed of license and milestone revenue,instrument revenue and other revenue. From August 2000 to September 30,2004, we earned $5.8 million in license and milestone receipts under ourDevelopment Agreement with Veridex and have received $5.0 million as of September30, 2004. License and milestone receipts have been deferred and amortized on astraight-line basis over the product development period as defined for eachspecific product. We recognized $4.0 million in license and milestone revenuein the period from August 2000 to December 31, 2003. License and milestonerevenue from related party decreased by $1.5 million to $175,000 for the ninemonths ended September 30, 2004 from $1.7 million for the nine monthsended September 30, 2003.

 

Duringthe first quarter of 2004, we received an additional $500,000 in milestonereceipts as a partial receipt of the milestone for commercial readiness forbreast cancer monitoring. We will recognize this as revenue over the estimatedlife of the related product development period which we estimate will end onDecember 31, 2007.  In the second quarterwe initiated a multi-center clinical trial

 

22

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forthe monitoring of metastatic colorectal cancer for which we earned a $500,000milestone payment. This milestone revenue will be recognized over the estimatedproduct development period, which we estimate will end on December 31, 2006.

 

****Also we and Veridex agreed thatas of September 30, 2004 we had successfully completed three more developmentmilestones and would be paid $833,000 as a result. They are:****

 

****•********                 ********Prostate cancer — feasibility of a large bloodvolume sample processing method and product concept completed; amount payableto us is $300,000****

 

****•********                 ********Tumor cell profiling reagents — product developmentprocess approved by the joint Veridex/Immunicon Steering Committee, firstproduct is commercially available, second product completed productionreadiness review, and proof of principle demonstrated for a third product andassociated antibody licensed; amount payable to us is $200,000****

 

****•********                 ********Lung cancer: adjuvant prognosis and recurrencemonitoring — first patient enrolled in clinical trial associated with thisindication; amount payable to us is $333,000.****

 

Veridexpaid us $833,000 in October 2004. We will recognize these milestone receipts asrevenue over the estimated product development period which we estimate willend on December 31, 2008. As of October 31, 2004 we have received $1,833,000from Veridex for achieving development related milestones in 2004.

 

Werecognized $144,000 related to milestones in the nine months ended September30, 2004 under the Veridex Development Agreement.

 

InAugust 2003, we sold 80,000 shares of Series F Preferred Stock and enteredinto a License and Supply Agreement (“License and Supply Agreement”) withanother company. We received $400,000 in proceeds for the combined transaction.Because shares of our Series F Preferred Stock were valued at $4.00 pershare in a similar transaction, the same value was applied to the shares inthis transaction. The amount above the $4.00 per share value of the shares ofour Series F Preferred Stock was deemed attributable to the License andSupply Agreement and recorded as deferred license revenue. We recorded this$80,000 premium as deferred license revenue and we are amortizing it intoincome over the two year period of the exclusive supply arrangement with thiscompany. As of September 30, 2004, the unamortized deferred license revenuerelated to this arrangement amounted to $34,000, and we recognized revenue of$31,000 and $5,000 related to the arrangement and recorded it as “Revenue fromrelated party” in the consolidated statement of operations for the nine monthperiod ended September 30, 2004 and September 30, 2003, respectively.

 

Wesold an instrument system to Veridex in 2004 and recognized revenue of $103,000as a portion of instrument revenue from related party.

 

Otherrevenue decreased by $279,000 to $32,000 in the nine months ended September 30,2004, from $311,000 in the same period in 2003. Other revenue consistsprincipally of funds received from government related grants and is expected tofluctuate from year to year.

 
| ** **                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|
| ** **                            | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                            | ** ** | **(in thousands)**                   | ** ** |
| License revenue from related party    |       | $                                    | 175        |   | $ | 1,729 |   |
| Instrument revenue from related party |       | 129                                  |       | — |   |
| Other revenue from related party      |       | 36                                   |       | — |   |
| Other revenue                         |       | 32                                   |       | 311 |   |
|                                  |       | $                                    | 372        |   | $ | 2,040 |   |

 

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**Research and development expenses**

 

Researchand development expenses increased by $5.7 million, or by 49.7%, to$17.1 million in the nine months ended September 30, 2004 from$11.4 million in the same period in 2003. Salary and salary-related costswere $7.6 million in this nine months ended September 30, 2004 compared to $5.3million in comparable period in 2003. This increase of $2.3 million or44.7% is due principally to higher staff levels necessary to complete thedevelopment of certain instrument platforms and to complete the development ofour initial cancer monitoring test.  Wehired additional personnel throughout 2003 and during the first half of 2004 toprepare for the commercial launch of our initial products, increased clinicaldevelopment to expand applications of our cancer diagnostic technology andincreases in research personnel to expand uses of our technology beyond cancerto other disease states, as well as higher stock-based compensationexpenses recognized in 2004. The portion of stock-based compensationexpenses recognized as part of research and development salaries was $1.0million in the nine months ended September 30, 2004 compared to $50,000 in2003.

 

Laboratorysupplies and expenses were $3.6 million, or $1.9 million higher, in 2004 thanin 2003. This increase was related principally to preparation for the launch ofour initial cancer diagnostic products especially for prototype instruments fortesting and training purposes and reagent development expenses. We alsocontinued to invest in the development of other applications of our technologyin areas both within and outside the field of cancer diagnostics.

 

Instrumentdevelopment costs decreased by $883,000 to $607,000 in the nine month periodended September 30, 2004 from $1.5 million in the prior year period. Theprincipal development work on our CellTracks AutoPrep System and our associatedCellSpotter Analyzer was completed by mid-2003 and costs associated withdevelopment of the instruments declined thereafter. However, we continue toinvest in improvements to our instrument platforms for future versions of ourCellTracks AutoPrep System and our associated CellSpotter Analyzer. Weanticipate that we will continue to engage in instrument system improvementactivities for the remainder of 2004 and beyond. Therefore, it is likely thatinstrument development costs will fluctuate in future periods.

 

Clinicaltrial expenses increased in the nine months ended September 30, 2004 by $1.1million to $1.8 million from $633,000 in 2003 as we expanded our clinicaldevelopment program beyond our initial pivotal clinical trial for breast cancermonitoring. In June 2004 we initiated a clinical trial for the monitoring ofmetastatic colorectal cancer and in the third quarter of 2004 we initiated apilot study to monitor recurrence of lung cancer.  The majority of effort and costs incurred inthis area in 2003 was related to data analysis and preparation of theassociated regulatory filing with the FDA which were not as costly as effortsto accrue patients and manage the initial multi-centered trial for the breastcancer test. We anticipate increasing our clinical trial expenditures in theremainder of 2004 and beyond in order to expand the uses of our technology toother cancers and to earlier stages of the disease.

 

Insuranceexpenses increased by $324,000 principally related to allocated costs ofDirectors and Officers liability insurance which increased as a result ourcompletion of our IPO in April 2004.

 

Contractedresearch costs were $170,000 lower in 2004 than in 2003. We increased our effortsin this area in 2003 to help with certain validation activities related topreparing our manufacturing processes for initial product launch.

 

Asummary of the principal components of our research and development costs forthe nine months ended September 30, 2004 and 2003 are shown below:

 
| ** **                              | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|
| **Research and development expenses**   | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(in thousands)**                   | ** ** |
| Salaries, benefits and taxes            |       | $                                    | 7,602      |   | $ | 5,253 |   |
| Laboratory supplies and expenses        |       | 3,600                                |       | 1,660 |   |
| Instrument development costs            |       | 607                                  |       | 1,490 |   |
| Clinical trial expenses                 |       | 1,762                                |       | 633 |   |
| Contracted research costs               |       | 1,122                                |       | 1,292 |   |
| Insurance expense                       |       | 421                                  |       | 97 |   |
| All others                              |       | 2,028                                |       | 1,029 |   |
| Total research and development expenses |       | $                                    | 17,142     |   | $ | 11,454 |   |

 

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Weexpect salary related expenses to increase in future years as we hireadditional personnel and continue to invest in research and clinical trialactivities. We believe that costs related to laboratory supplies and expenseswill be higher in future periods as we develop:

 

•                                          research anddiagnostic products for cancers other than breast cancer;

 

•                                          tests designedto diagnose cancer earlier in the disease; and

 

•                                          otherdiagnostic tools for use in diseases such as cardiovascular, inflammatory andinfectious diseases, and for use in drug development.

 

Althoughwe will continue to invest in instrument development to improve performance ofthe various components of the system and to increase the capabilities of thesystem to process larger sample volumes, we expect instrument development costsas a percentage of total research and development expenditures generally to belower in future years because we completed the principal development work onour initial instrument platforms in 2003.

 

Weexpect clinical development expenses to be higher in future years as we expandour clinical trials to investigate the effectiveness of our cancer diagnosticproducts on cancers other than breast cancer and in earlier stages of thedisease in breast and other cancers, and as we develop other diagnostic toolsfor use in diseases such as cardiovascular and infectious diseases and for usein tools for drug development.

 

Eachof our research and development programs is subject to risks and uncertainties,including the requirement to obtain regulatory approval, that are outside ofour control. As a result of these risks and uncertainties, we are unable topredict the period in which we

willachieve profitability. For example, our clinical trials may be subject todelays or rejections for a variety of reasons, such as our inability to obtainapplicable clearances from the FDA or institutional or ethical review boards orto enroll patients at the rate that we expect. Moreover, the product candidateswe are developing must overcome significant technological and marketingchallenges before they can be successfully commercialized.

 

**General and administrative expenses**

 

Generaland administrative expenses increased by $2.0 million, or 63.6%, to$5.2 million in the nine months ended September 30, 2004 from $3.2 millionin 2003. Salary related costs increased by $1.0 million in 2004 due principallyto increases in personnel in the second half of 2003 and the first nine monthsof 2004. We hired additional accounting and administrative personnel in orderto prepare for the additional administrative and reporting activities resultingfrom our transition to a publicly-held company and in preparation for thecommercial launch of our initial products. Legal fees and insurance expensesincreased by $428,000 as a result of increased patent license fees and for theallocated portion of the increase in Directors and Officers liability insurancewhich increased as a result our completion of our IPO in April 2004.

 

Depreciationexpense increased by $238,000 to $1.1 million in the nine months endedSeptember 2004 from $814,000 in 2003 as a result of an expansion of ourmanufacturing facility in 2003 at a cost of $1.5 million in preparationfor the commercial launch of our products.

 

**Other income from related party**

 

Infiscal 2003 the Company sold all of its rights to a trademark to Johnson &Johnson, Inc. for $250,000 and recorded it as Other Income from Related partyon the consolidated statement of operations.

 

**Interest income**

 

Interestincome increased by $289,000 or 170.0% in the nine months ended September 30,2004 to $459,000 from $170,000 in 2003. The increase in interest income wasprimarily a result of an increase in average invested cash balances in 2004.Our increase in invested cash balances resulted from our IPO which provided netcash proceeds of $49.4 million and which was completed on April 21, 2004.

 

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**Interest expense**

 

Interestexpense increased by $75,000, or 18.3%, to $484,000 in 2004 from $409,000 in2003. The slight increase was due to higher average debt outstanding in 2004compared to 2003, principally due to the additional $7.0 million equipmentline of credit that we entered into in April 2003.

 

**Stock-based compensation expenses**

 

Stock-basedcompensation expenses were $1.3 million and $221,000 for the nine months endedSeptember 30, 2004 and 2003, respectively. This increase was due to an increasein the number of options granted to employees and consultants and an increasein the fair value of our common stock as compared to the exercise price atissuance. We recognized these expenses as part of research and developmentexpenses and general and administrative expenses as shown below. 
| ** **                                         | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| **Stock-based compensation expenses included in:** | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | **(in thousands)**                    | ** ** |
| Research and development expenses                  |       | $                                     | 1,039      |   | $ | 50 |   |
| General and administrative expenses                |       | 282                                   |       | 171 |   |
|                                               |       | $                                     | 1,321      |   | $ | 221 |   |

 

**Income Taxes**

 

Wehave incurred net operating losses since our inception and have consequentlynot paid any federal, state or foreign taxes. As of September 30, 2004, we hadapproximately $84.1 million of net operating loss carryforwards andapproximately $2.0 million in research and development tax credit carryforwardsavailable to offset future regular and alternative taxable income. If notutilized, these net operating loss carryforwards and tax credits will begin toexpire in 2005. If we do not achieve profitability, our net operating losscarryforwards may be lost. In addition, the Internal Revenue Code placescertain limitations on the annual amount of net operating loss carryforwardsthat can be utilized if certain changes in our ownership occur. We arecurrently not subject to these limitations.

 

**Net loss and net loss per common share**

 

Thenet loss of $22.0 million in the nine months ended September 30, 2004 was$9.4 million, or 74.8%, higher than the loss of $12.6 million in the 2003period.

 

Atthe completion on April 21, 2004 of our IPO, approximately 52.1 millionpreferred shares were converted into 15.5 million shares of common stock.  As the result, the net loss per common shareof $1.56 in the nine months ended September 30, 2004 was $25.83 per share, or94.3%, lower than the loss per common share of $27.39 in the first nine monthsof 2003. Weighted average common shares outstanding during the nine monthsended September 30, 2004 were approximately 14.1 million compared to 460,000for the same period in 2003.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Weare a development stage company. We have financed our operations sinceinception through private equity and debt financings, license and milestonerevenues from corporate collaborations, capital equipment and leaseholdfinancing, government grants and interest earned on cash and investments. Sinceour inception, we have generated net losses of $85.6 million fromoperations.

 

Cashand short term investments increased by $29.1 million in the nine monthperiod ended September 30, 2004 to $59.7 million from $30.6 millionas of December 31, 2003, principally due to the completion of our IPO on April21, 2004.  The proceeds to the Companyfrom the IPO were $49.4 million, net of fees and expenses.

 

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Weused $17.5 million in our operating activities in the nine months endedSeptember 30, 2004 compared to $11.0 million in same period in 2003 and$72.9 million from inception through September 30, 2004.  Our operating activities during these periodsconsisted principally of research and development efforts and the conduct ofclinical trials.

 

Weused cash of $26.4 million in our investing activities in the nine months endedSeptember 30, 2004. We purchased $25.3 million in short term investments andspent $1.6 million on capital expenditures. Our investing activities providedcash of $1.2 million in 2003 as a result of the maturity of $3 million ofinvestments which was offset by $1.8 million in capital expenditures.  We have used $34.5 million in investingactivities from inception, resulting principally from the net investment of$25.2 million in short term investments which have been offset by purchases of$9.3 million of property and equipment.

 

We generated cash of $48.8 million from our financingactivities in the nine months ended September 30, 2004, $27.6 million in thesame period in 2003 and $143.0 million from inception.  On April 21, 2004, we completed our IPO.  In the IPO, we sold 6.9 million shares of ourcommon stock at $8.00 per share. We raised a total of $49.4 million, net offees and expenses.  In connection withthe IPO, we incurred costs totaling $1.9 million and paid these expenses in thecurrent year.  All of the shares weresold by us.  The net proceeds from theIPO will be used for product commercialization, including manufacturing, andfor clinical trials, research and development, capital expenditures, andworking capital and other general corporate purposes.  Our common stock trades on The NasdaqNational Market System under the symbol “IMMC.” We had proceeds from new borrowings of $1.5 million and made principalpayments of $2.7 million in the nine months ended September 30, 2004 ascompared to proceeds from new borrowings of $4.9 million and principal paymentsof $2.3 million in the nine months ended September 30, 2003.  From inception to September 30, 2004 we haveraised $53.0 million from the sale of our common stock, including our IPO,$1.5 million from the sale of 10,000 shares of our common stock to threeinvestors in 1984 and $85.1 million, net of issuance costs of$2.1 million, from the sale of our preferred stock.

 

SinceMarch 1999, we have also borrowed $17.1 million through equipmentlines of credit and have received $5.0 million in milestone receipts fromVeridex. Our liquidity requirements are the result primarily of research anddevelopment and other operating expenditures, capital equipment expendituresand payments on outstanding indebtedness. Sales of our common and preferredstock,

includingthe IPO, were as follows:

 

 
| **Summary of all sales of common and convertible preferred stock** | ** ** | **Year(s)** | ** ** | **Number of  shares** | ** ** | **Price  per share** | ** ** | **Net proceeds  (in thousands)** | ** ** | **Equivalent  common shares** | ** ** |
|--------------------------------------------------------------------|------------|-------------|------------|-----------------------|------------|----------------------|------------|----------------------------------|------------|------------------------------------|------------|
| Initial sale of common stock (private)                             |       | 1984        |       | 10,000                |       | $                    | 150.00     |                             | $          | 1,500                              |       | 10,000 |   |
| **Convertible preferred stock**                                    |       |        |       |                  |       |                 |       |                             |       |                               |       |
| Series A                                                           |       | 1988        |       | 36,350                |       | 10.00                |       | 364                              |       | 669,343                            |       |
| Series B                                                           |       | 1989        |       | 30,000                |       | 10.00                |       | 300                              |       | 236,952                            |       |
| Series C                                                           |       | 1990        |       | 30,000                |       | 10.00                |       | 300                              |       | 296,016                            |       |
| Series D                                                           |       | 1999,  2004 |       | 33,971,098            |       | 0.32                 |       | 10,829                           |       | 2,264,744                          |       |
| Series E                                                           |       | 2000        |       | 4,588,612             |       | 4.74                 |       | 21,612                           |       | 3,059,083                          |       |
| Series F                                                           |       | 2001,  2003 |       | 13,454,500            |       | 4.00                 |       | 51,942                           |       | 8,969,677                          |       |
|                                                               |       |        |       |                  |       |                 |       |                             |       |                               |       |
| Initial public offering                                            |       | 2004        |       | 6,900,000             |       | 8.00                 |       | 49,400                           |       | 6,900,000                          |       |
|                                                               |       |        |       |                  |       |                 |       | $                                | 136,247    |                               | 22,405,815 |   |
|                                                                    |            |             |            |                       |            |                      |            |                                  |            |                                    |            |  |  |

 

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As of September 30, 2004, we did nothave any off balance sheet financing arrangements.

 

                The following table summarizesour contractual obligations and related interest charges on lines of credit atSeptember 30, 2004 and the effects such obligations are expected to haveon our liquidity and cash flows in future periods.

 

 
| ** **                          | ** ** | **Payments due in** | ** ** |
|-------------------------------------|------------|---------------------|------------|
| **Contractual obligations**         | ** ** | **Total**           | ** ** | **2004** | ** ** | **2005 and  2006** | ** ** | **2007 and  2008** | ** ** | **After  2008** | ** ** |
| ** **                          | ** ** | **(in thousands)**  | ** ** |
| Lines of credit                     |       | $                   | 6,779      |   | $ | 1,101 |   | $ | 5,255 |   | $ | 420 |   | $ | 3 |   |
| Operating leases                    |       | 4,535               |       | 182 |   | 1,482 |   | 1,507 |   | 1,364 |   |
| Open purchase order commitments (1) |       | 5,223               |       | 5,223 |   | — |   | — |   | — |   |
| Total contractual obligations       |       | $                   | 16,537     |   | $ | 6,506 |   | $ | 6,737 |   | $ | 1,927 |   | $ | 1,367 |   |

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(1)                                  The amountsincluded in open purchase order commitments are subject to performance underthe purchase order by the supplier of the goods or services and do not becomeour obligation until such performance is rendered.  The amount shown is principally for the purchaseof materials for our instrument platforms, which we anticipate will be sold byus to customers and for various items such as contingent patient accrualcommitments related to our clinical trials. Most patient accrual costs arepayable only after successful completion of patient accrual.

 

Wealso have contingent obligations for research and development and clinicaltrial expenditures under our Development Agreement with Veridex.  Specifically, we must pay the first$5.0 million in clinical trial costs for the first cellular analysisproduct for general population screening for a major cancer, and Veridex isresponsible for the next $5.0 million of such clinical trial costs. Wehave agreed to negotiate in good faith for the allocation of costs in excess of$10.0 million. As of September 30, 2004 we have not incurred anycosts related to clinical trials for a product for general populationscreening, and we do not anticipate spending any funds on clinical trialstoward such a product through 2004.

 

Inaddition, if we achieve certain levels of sales of our reagents we may receiveup to an additional $10.0 million in milestone payments from Veridex,although we do not expect to receive any milestone payments related to salesgoals until at least 2007.

 

TheDevelopment Agreement with Veridex provides for a total of up to$10.5 million in non-refundable license and milestone payments related toresearch and development activities including up to $1.5 million for theinitial license and up to $9.0 million related to the completion of certaininstrument and clinical trial milestones. We have earned $5.8 million ofthese milestone payments

andhave received $5.0 million as of September 30, 2004. We expect to earn theremaining $4.7 million over the next three to five years.

 

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Thefollowing table summarizes certain information pertaining to these potentialfuture milestone payments. 
| **Milestone**                                                    | ** ** | **Payment  criteria**                                                                                                                                                                                                                                               | ** ** | **Target****Date** | ** ** | **Amount**                            |
|------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------------------------|
| Commercial readiness for breast cancer therapy  monitoring       |       | •      Steering committee approves product release for  sale of an FDA-approved breast cancer therapy monitoring system                                                                                                               |       | None               |       | 1,500,000  **(1)**                    |
| Metastatic colorectal or prostate cancer monitoring              |       | •      First patient enrolled in clinical trial                                                                                                                                                                                       |       | 6/30/04            |       | 500,000  **(2)****Completed 6/30/04** |
|                                                             |       | •      Steering committee approves regulatory submission                                                                                                                                                                              |       | 11/30/05           |       | 500,000                               |
| Prostate cancer                                                  |       | •      Feasibility of large blood volume sample processing  method demonstrated and product concept proposed                                                                                                                          |       | 9/30/04            |       | 300,000  **(3)****Completed 9/30/04** |
|                                                             |       | •      First patient enrolled in companion biopsy clinical  trial                                                                                                                                                                     |       | 6/30/05            |       | 333,000                               |
|                                                             |       | •      Steering committee approves regulatory submission                                                                                                                                                                              |       | 12/31/07           |       | 500,000                               |
| Lung cancer: adjuvant prognosis and recurrence  monitoring       |       | •      First patient enrolled in clinical trial                                                                                                                                                                                       |       | 10/31/04           |       | 333,000  **(3)****Completed 9/30/04** |
|                                                             |       | •      Steering committee approves progress and data  review for clinical trial after significant percentage of patients properly  enrolled                                                                                           |       | 3/31/06            |       | 250,000                               |
|                                                             |       | •      Steering committee approves regulatory submission                                                                                                                                                                              |       | 12/31/07           |       | 500,000                               |
| Colorectal cancer: adjuvant prognosis and  recurrence monitoring |       | •      First patient enrolled in clinical trial                                                                                                                                                                                       |       | 1/31/05            |       | 334,000                               |
|                                                             |       | •      Steering committee approves progress and data  review for clinical trial after significant percentage of patients properly  enrolled                                                                                           |       | 6/30/06            |       | 250,000                               |
| Tumor cell profiling reagents                                    |       | •      Steering committee approves regulatory submission                                                                                                                                                                              |       | 12/31/07           |       | 500,000                               |
|                                                             |       | •      Steering committee approves product development  process, first product commercially available, third product completes  production readiness review, and third product demonstrates proof of  principle and acquired antibody |       | 9/30/04            |       | 200,000  **(3)****Completed 9/30/04** |
| Large volume sample processor                                    |       | •      Steering committee approves commercial readiness                                                                                                                                                                               |       | 7/31/06            |       | 500,000                               |

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(1)          $500,000 of the $1,500,000milestone payment pertaining to breast cancer therapy monitoring was paid to usby Veridex in February 2004 pursuant to Veridex’s receipt of 510(k)clearance from the FDA in January 2004 for use of the CellSearchCirculating Tumor Cell Kit. The remaining $1,000,000 would become payable uponsuccessful introduction of the CellTracks Analyzer II as determined by theSteering Committee.  In addition, we andVeridex agreed in November 2003 that there would be no target date forcompletion of this milestone and that in lieu of a target date, Veridex wouldonly be obligated to pay us 30.5% of net sales for the cell analysis productsrelated to this specific milestone for the term of this agreement, instead of31% of net sales for such products. The Company will continue to receive 31%for all other products.

(2)          We initiated a multi-centerclinical trial for the monitoring of metastatic colorectal cancer.  The initiation of this trial completed amilestone in our Development Agreement with Veridex for which we earned a$500,000 milestone payment.  Thismilestone payment will be recognized over the trial period, which we estimatewill end on December 31, 2006.

****(3)********         ****In September2004,****we and Veridex haveagreed that Immunicon has successfully completed three development milestonesas of September 30, 2004 totaling $833,000. The total of $833,000 was paid tous in October 2004.****

 

****i.********                      ********Prostate cancer — feasibility of a large blood volume sample processingmethod and product concept completed; amount payable to the Company is $300,000****

****ii.********                   ********Tumor cell profiling reagents — product development process approved bythe joint Veridex/Immunicon Steering Committee, first product ready to be madecommercially available, third product completed production readiness review, andproof of principle for a third product demonstrated and associated antibodylicensed; amount payable to the Company is $200,000****

iii.                 ****Lung cancer: adjuvant prognosis and recurrence monitoring — first patientenrolled in clinical trial associated with this indication; amount of milestonepayable to the Company is $333,000.****

 

Wedo not currently expect that any of the specific milestone payments discussedabove will be materially delayed beyond their applicable target dates. However,because these milestone payments are related to the successful completion ofthe payment criteria

 

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summarizedabove, including completion of clinical trials, development activities andreceipt of regulatory clearances, we may be unable to successfully complete thepayment criteria in a timely manner, if at all. Veridex is responsible underthe Development Agreement for obtaining all regulatory clearances forindications related to the CellSearch kit, in consultation with us, for thesecell analysis products in the field of cancer. Also, we and Veridex will continue to evaluate our development programin cancer, particularly clinical development and may negotiate changes tomilestones that have not yet been achieved, although we do not expect that theaggregate amount of the milestones will change.

 

Ifwe do not successfully complete the criteria as defined for a given futuremilestone, we will not receive the applicable milestone payment. If we do notsuccessfully complete the criteria as defined by the target date for a givenmilestone, we will continue to be entitled to receive the milestone payment inthe future upon successful completion of the criteria. However, Veridex’sobligation to pay us a percentage of the net sales for the cell analysisproduct to which the milestone relates would be reduced by 0.5% for theten-year period beginning with the shipment for commercial sale of the firstproduct resulting from this agreement. In no event, however, would reductionsdue to missed target dates reduce our proportionate percentage share of netsales that we would otherwise be entitled to receive from Veridex for sales ofall cell analysis products by Veridex under this Development Agreement by morethan 0.5% in the aggregate.

 

We have also established a sales agencyarrangement with Veridex with respect to our sample preparation and cellanalysis systems, such as the CellTracks AutoPrep System and CellSpotterAnalyzer. Under this arrangement, Veridex is our exclusive sales, invoicing andcollecting agent and exclusive instrument and technical service provider forthese systems in the field of cancer. Veridex is responsible for all expensesfor marketing, sales and training, and we are responsible for all softwaredevelopment and validation as well as quality control and quality assurance. Weare responsible for shipping systems pursuant to purchase orders received byVeridex. We are obligated to pay Veridex a commission on each sale or lease ofthese sample preparation and cell analysis systems of up to 15% of the invoiceprice, subject to a minimum gross profit margin received by us on each systemof 27.5%. Some customers may enter into a reagent rental agreement withVeridex, whereby the reagent price also carries an amortized cost of theinstrument, based on an agreed test volume. In these cases, Veridex will pay usa percentage of the fully loaded cost of the instrument when it is placed inthe account. We are responsible for the costs associated with the one-yearwarranty period. Veridex has the option under the agreement to convert thesales agency relationship to a sole distributorship arrangement upon 12-months’written notice.  However, we do notanticipate earning significant gross margins or incurring significant losses onthe sale, lease or rental of our CellTracks AutoPrep System or our CellSpotterAnalyzer. We anticipate that the majority of our future gross margins andfuture profits derived under our agreement with Veridex will result from thesales of reagents and disposables.

 

Underthis distributor arrangement, we would be required to supply Veridex based onthe forecasts provided to us by Veridex and the actual orders for these systemsplaced with us by Veridex. The allocation of costs and expenses between us andVeridex would remain substantially the same and we would remain responsible forthe costs associated with the one-year warranty period. In addition,instead of Veridex receiving up to a 15% commission after deducting the 27.5%gross profit margin on each sale or lease, these systems would be sold toVeridex at a transfer price that provides a 27.5% gross profit margin to us,and Veridex would retain the proceeds from their sales of these systems, butwould be required to remit to us any proceeds from their sales to the extentthat the proceeds of such sales, after deducting 15%, exceed the transfer pricefor these systems.

 

Followingcommercialization, if we and Veridex are able to generate product sales underthe Development Agreement, we are required to invest an amount ranging frombetween 8.5% and 10% of total net product sales by Veridex, excluding revenuefrom cell analysis system sales, in research and development activities forcancer-related cell analysis products. These research and developmentactivities may consist of any activities, such as product improvements, productline extensions and clinical trials, conducted to achieve the milestonesdescribed above, to advance the development program designed by the steeringcommittee for this agreement, or to enhance the cancer-related cellanalysis products or sample preparation and cell analysis systems based on ourtechnologies.

 

 

On October 22, 2004, weentered into a $12 million extension to its existing line of credit withSilicon Valley Bank (“SVB”) and amended certain terms of the credit agreement(the “SVB Amendment”).  The loan issecured by a first-priority security interest in all of our assets except forour intangible intellectual property and the assets pledged under the equipmentline of credit with General Electric Capital Corporation (“GE”) describedbelow.  Borrowings under this extensionbear interest at a per annum rate of 0.5% above the prime lending rate.  Interest accrues from the date of eachequipment advance and is payable on a monthly basis in 48 equal monthlyinstallments.  However, upon theoccurrence of any event of default, SVB may accelerate and declare all or anyportion of the Company’s obligations to SVB immediately due and payable.

 

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The SVB Amendment alsocontains certain covenants that require us to, among other things, maintain acertain level of earnings or loss before interest, taxes, depreciation andamortization, maintain a minimum amount of our available funds on deposit withSVB and deliver periodic financial statements and reports within a prescribedtimeframe.  The Company also agreed torestrict our ability to among other things, dispose of property (includingintellectual property), change our business, ownership, management or businesslocations, merge with or acquire certain other entities, create or incurcertain liens or encumbrances on any of its property, incur or amend the termsof certain indebtedness, engage in transactions with affiliates, declare or paycertain dividends or redeem, retire or purchase shares of any capital stock.

In October, 2004, theCompany extended our existing equipment line of credit with GE by $5 millionbut did not otherwise amend the terms of this line of credit, except for theapplicable rate of interest and repayment period.  Interest on this line of credit ranges from8.65% to 9.25% and is repayable over 36 to 60 months. However, upon theoccurrence of any event of default, GE may accelerate and declare all or anyportion of its obligations to GE immediately due and payable.  This line of credit is secured by a firstpriority security interest on the assets specifically pledged under the line ofcredit and a second priority security interest on all other assets except forour intangible intellectual property.

The equipment line ofcredit with GE also contains certain covenants, which require us to, amongother things, deliver periodic financial statements and reports within aprescribed timeframe and maintain and preserve the collateral; and whichrestricts our ability to, among other things, dispose of the collateral orcreates or incurs certain liens or encumbrances on the collateral.

Asof October 3, 2004, we had $17 million in available borrowing capability underthese equipment lines of credit.

 

Basedon our operating plans, we believe that our available cash including the netproceeds from our IPO will be sufficient to finance operations and capitalexpenditures until at least December 31, 2005. Our future capital requirements include, but are not limited to,supporting our research and development efforts and our clinical trials,although we are not obligated to meet any absolute minimum dollar spendingrequirements under our current operating agreements. Our future capital requirementswill depend on many factors, including the scope and progress made in ourresearch and development activities, our clinical trials and capitalrequirements related to our commercialization efforts. We had$59.7 million in cash on hand and short term investments, as well as $17.0million in available lines of credit as of September 30, 2004.  We plan to use the proceeds from the IPO, ourcash on hand and our available lines of credit to continue to develop ourcancer diagnostic products beyond breast cancer to other types of solid tissuecancers as well as to explore the uses of our technology in earlier stages ofthe cancer disease process. Also, we plan to explore development of uses forour technology outside of cancer such as in cardiovascular disease. We plan touse the proceeds from the IPO, anticipated funds generated from the sales ofour products as well as additional equity or debt-related offerings tofinance our future development efforts. We may not be successful in generatingsufficient product sales or raising sufficient funds from the sale of equity ordebt securities to support the research and development expenses necessary toexpand the uses of the technology into other cancers and in non-cancerdiseases. In addition, if we are unsuccessful in our product developmentefforts, additional financing may not be available in sufficient amounts or onterms acceptable to us, if at all. If we are unable to obtain additionalfinancing, we may elect to reduce the scope of, delay or eliminate some or allof our planned research, development and commercialization activities, whichcould harm our financial condition and operating results.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

In December 2002,the FASB issued SFAS No. 148, “Accounting for Stock-based Compensation -Transition and Disclosure, an Amendment of FASB Statement No. 123,” to providealternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based compensation. We have adopted thedisclosure requirements of this statement. In March 2004, the FASB issued a proposed SFAS - “Share-based Payment: an Amendment of FASBStatements No. 123 and 95.” The proposed standard would require companies toexpense share-based payments to employees, including stock options, based onthe fair value of the award at the grant date. The proposed statement wouldeliminate the intrinsic value method of accounting for stock options permittedby APB (Accounting Principles Board) No. 25, “Accounting for Stock Issued to Employees,”which we currently follow. We will continue to monitor the actions of the FASBand assess the impact, if any, on our consolidated financial statements.

 

In March 2004, theFASB approved the consensus reached on the Emerging Issues Task Force (EITF)Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments.” The objective of this Issue is to provideguidance for identifying impaired investments. EITF 03-1 also provides newdisclosure requirements for investments that are deemed to be temporarilyimpaired. . In September 2004, the FASB issued a FASB Staff Position (FSP) EITF03-1-1 that delays the effective date of the measurement and recognitionguidance in EITF 03-1 until after further deliberations by the FASB. Thedisclosure requirements of 

 

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EITF 03-1 areeffective beginning with the Company’s fiscal 2004 annual report. Once the FASBreaches a final decision on the measurement and recognition provisions, thecompany will evaluate the impact of the adoption of EITF 03-1.

 

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**FACTORS THAT MAY AFFECT FUTURE RESULTS**

 

*In addition to other information contained in this report  you should carefully consider the followingfactors in evaluating our company. Any of the following factors couldmaterially and adversely affect our business, financial position and results ofoperations.*

 

**RISKS RELATING TO OUR BUSINESS**

 

**We have a history of operating losses, expect to continue toincur substantial losses, and might never achieve or maintain profitability.**

 

Weare a development stage company with limited operating history. We haveincurred significant net losses since we began operations in 1983.  As of September 30, 2004, we had adeficit accumulated during our development stage of $85.6 million.  For the nine months ended September 30, 2004and 2003 we had net losses of $22.0 million and $12.6 million,respectively.  These losses have resultedprincipally from costs incurred in our research and development programs andfrom our general and administrative expenses. Because our operating expensesare likely to increase significantly in the near term, we will need to generatesignificant additional revenue to achieve profitability. We do not expect tohave any significant operating revenue from the sales of our products until atleast 2005, and we expect our losses to continue to increase as a result ofongoing research and development and clinical trial expenses, as well asincreased manufacturing, sales and marketing expenses. These losses, amongother things, have had and will continue to have an adverse effect on ourworking capital, total assets and stockholders’ equity. Because of the numerousrisks and uncertainties associated with our product development efforts, marketacceptance and uncertainties concerning the success of sales efforts by us andVeridex, we are unable to predict when we will become profitable, and we maynever become profitable. Even if we do achieve profitability, we may not beable to sustain or increase profitability on a quarterly or annual basis. If weare unable to achieve and then maintain profitability, the market value of ourcommon stock will decline.

 

**If our relationship with Veridex is terminated, we may beunable to continue to commercialize effectively certain of our products basedon our technologies in the field of cancer.**

 

Weentered into a development, license and supply agreement with Veridex, underwhich we granted to Veridex a worldwide exclusive license in the field ofcancer to commercialize cell analysis products based on our technologies. Wealso appointed Veridex as our exclusive sales, invoicing and collection agentfor our cell analysis instrumentation in cancer. Veridex may terminate thisagreement with or without reason at any time by providing us with24 months’ prior written notice. Veridex also may terminate this agreementif we are in material breach or are acquired by a competitor in the IVD field.In addition, while we have granted Veridex the exclusive right to market,distribute and conduct field, technical, customer service and certainmanufacturing finishing operations for these products, this agreement providesthat Veridex has very limited obligations to perform these functions. Forexample, the agreement does not require Veridex to meet any minimum levels withrespect to sales, marketing personnel or other marketing expenditures. IfVeridex were to terminate, fail to meet its obligations under this agreement orfail to deploy adequate resources to commercialize products under thisagreement:

 

•                                          we would incursignificant delays and expense in the commercialization of these products;

 

•                                          we might beunable to enter into a similar agreement with another company with similarresources to commercialize these products and perform these functions onacceptable terms, if at all; and

 

•                                          we might beunable to commercialize these products or perform these functions successfullyourselves.

 

Anyof these outcomes could result in delays in our ability to generate revenuesfrom the sales of these products, an increase in our expenses and a resultingadverse impact on our operations and financial results, and the value of ourcommon stock would likely decline.

 

Ifwe and Veridex are able to generate product sales under our agreement, we arerequired to invest an amount ranging from between 8.5% and 10% of total netproduct sales by Veridex, excluding revenue from cell analysis system sales, inresearch and development for cancer-related cell analysis products.

 

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**If our products and Veridex’s products do not achieve marketacceptance, we will be unable to generate significant revenues from them.**

 

Thefuture commercial success of our products and of Veridex’s products based onour technologies will depend primarily on:

 

•                                          convincingresearch, reference and clinical laboratories to conduct validation studiesusing these products and to offer these products as research tools for scientistsand clinical investigators and as diagnostic products to physicians, laboratoryprofessionals and other medical practitioners; and

 

•                                          convincingphysicians, laboratory professionals and other medical practitioners to ordertests for their patients involving our technologies.

 

Toaccomplish this, we and Veridex will need to convince oncologists, primary carephysicians, surgeons, laboratory professionals and other members of the medicaland biotechnology communities of the benefits of these products throughpublished papers, presentations at scientific conferences and additionalclinical trials. If we and Veridex are not successful in these efforts, themarket acceptance for these products could be limited. Additionally, if ongoingor future clinical trials result in unfavorable or inconsistent results, theseproducts may not achieve market acceptance. Other factors that might influencemarket acceptance of these products include the following:

 

•                                          evidence ofclinical utility;

 

•                                          ability toobtain sufficient third-party coverage or reimbursement;

 

•                                          convenience andease of administration;

 

•                                          availability ofalternative and competing diagnostic products;

 

•                                          cost-effectiveness;

 

•                                          effectivenessof marketing, distribution and pricing strategy; and

 

•                                          publicityconcerning these products or competitive products.

 

Ifthese products are unable to gain broad market acceptance, our business willsuffer.

 

**If we or Veridex are not able to obtain all of the regulatoryapprovals and clearances required to commercialize our products, our businesswould be significantly harmed.**

 

Theproducts based on our technologies are generally regulated as medical devicesby the FDA and comparable agencies of other countries. In particular, FDAregulations govern, among other things, the activities that we and Veridexperform, including product development, product testing, product labeling,product storage, pre-market notification clearance (or 510(k)) orpre-market approval (or PMA), manufacturing, advertising, promotion, productsales, reporting of certain product failures and distribution.

 

Mostof the products that we plan to develop and commercialize in the US willrequire either 510(k) clearance, or PMA approval from the FDA prior tomarketing. The 510(k) clearance process usually takes from two to twelve monthsfrom submission, but can take longer. The PMA process is much more costly,lengthy, uncertain and generally takes from one to two years or longer fromsubmission.

 

Allof the products that we or Veridex intend to submit for FDA clearance orapproval will be subject to substantial restrictions, including, among otherthings, restrictions on the indications for which we and Veridex may marketthese products, which could result in lower revenues. The marketing claims weand Veridex will be permitted to make in labeling or advertising regarding ourcancer diagnostic products, if cleared or approved by the FDA, will be limitedto those specified in any clearance or approval. We expect that

initiallymany of these products will be limited to research use only (or RUO). Inaddition, both we and Veridex are subject to inspection and marketing

 

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surveillanceby the FDA to determine our compliance with regulatory requirements. If the FDAfinds that we or Veridex have failed to comply with these requirements, it caninstitute a wide variety of enforcement actions, ranging from a public warningletter to more severe sanctions, including:

 

•                                          fines,injunctions and civil penalties;

 

•                                          recall orseizure of our products or Veridex’s products;

 

•                                          operatingrestrictions, partial suspension or total shutdown of production;

 

•                                          denial ofrequests for 510(k) clearances or PMAs of product candidates;

 

•                                          withdrawal of510(k) clearances already granted;

 

•                                          disgorgement ofprofits; and

 

•                                          criminalprosecution.

 

Anyof these enforcement actions could affect our ability or Veridex’s ability tocommercially distribute our products in the U.S. and may also harm our abilityto conduct the clinical trials necessary to support the marketing, clearance orapproval of these products.

 

**If the third-party manufacturers we rely on eitherrefuse or are unable to successfully manufacture certain of our products, wemay be unable to commercialize these products.**

 

Wehave limited commercial manufacturing experience and capabilities. We currentlyassemble or perform final assembly, test and release the CellSpotter andCellTracks AutoPrep System, as well as bulk reagents and other associatedproducts used with the CellTracks AutoPrep System, at our facility located inHuntingdon Valley, Pennsylvania. We currently have adequate manufacturingcapacity to meet anticipated demand for 2004 and 2005. However, in order tomeet anticipated demand thereafter, we will have to expand our manufacturingprocesses and facilities or increase our reliance on third-partymanufacturers. Under our agreement with Veridex, we might be required toestablish a third manufacturing facility or qualify a contract manufacturer inthe future. We might encounter difficulties in expanding our manufacturingprocesses and facilities or in expanding our relationships with third-partymanufacturers and might be unsuccessful in overcoming these difficulties. Inthat event, our ability to meet product demand could be impaired or delayed.

 

Weface additional risks inherent in operating a single manufacturing facility forthose products we manufacture ourselves. We do not have alternative productionplans in place or alternative facilities available at this time. If there areunforeseen shutdowns to our facility, we will be unable to satisfy customerorders on a timely basis with respect to these products. We rely currently andintend to continue to rely significantly in the future on third-partymanufacturers to produce some of our products. For example, we are dependent ona small, private, contract design, engineering and manufacturing company, AstroInstrumentation, LLC, or Astro, for our CellTracks AutoPrep System. If Astroloses key personnel or encounters financial or other difficulties, they may beunable to continue to manufacture this system and provide ongoing design andengineering support for commercialization and future enhancements of thissystem, and we may have difficulty replacing them. In addition, we currentlyuse a third-party manufacturer for our CellSave Preservative Tube. We aredependent on these third-party manufacturers to perform their obligationsin a timely and effective manner and in compliance with FDA and otherregulatory requirements. If these third-party manufacturers fail toperform their obligations, our competitive position and ability to generaterevenue could be adversely affected in a number of ways, including:

 

•                                          we might not beable to initiate or continue clinical trials on products that are underdevelopment;

 

•                                          we might bedelayed in submitting applications for regulatory approvals and clearances forproducts; and

 

•                                          we might not beable to meet commercial demands for any approved or cleared products.

 

Anyfailures in manufacturing these products may also result in a breach of ouragreement with Veridex.

 

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**If third-party payors do not reimburse customers forour products and Veridex’s products, they might not be used or purchased, whichwould adversely affect our revenues.**

 

Themajority of the sales of our products and Veridex’s products based on ourtechnologies in the US and other markets will depend, in large part, on theavailability of adequate reimbursement to users of these products fromgovernment insurance plans, including Medicare and Medicaid in the US, managedcare organizations, private insurance plans and other third-party payors.Because these products have only recently been commercially introduced, third-partypayors have no history of reimbursing for the cost of these products. Third-partypayors are often reluctant to reimburse healthcare providers for the use ofmedical diagnostic products incorporating new technology. In addition, third-partypayors are increasingly limiting reimbursement coverage for medical diagnosticproducts and, in many instances, are exerting pressure on medical productssuppliers to reduce their prices. Consequently, third-party reimbursementmight not be consistently available or adequate to cover the cost of ourproducts. This could limit our ability or Veridex’s ability to sell theseproducts or cause the prices of these products to be reduced, which wouldadversely affect our operating results.

 

Becauseeach third-party payor individually approves reimbursement, obtainingthese approvals is a time-consuming and costly process that will require us andVeridex to provide scientific and clinical support for the use of each of theseproducts to each third-party payor separately with no assurance thatapproval will be obtained. This process could delay the market acceptance ofnew products and could have a negative effect on our revenues and operatingresults.

 

**If we or any of our third-party manufacturers do notmaintain high standards of manufacturing in accordance with Quality SystemRegulations, our ability to develop, and Veridex’s and our ability tocommercialize our products, could be delayed or curtailed.**

 

Weand any third-party manufacturers that we currently rely on or will relyon in the future, including those we rely on to produce our CellTracks AutoPrepSystem and CellSave Preservative Tube, must continuously adhere to the currentgood manufacturing practices, or cGMP, set forth in the FDA’s Quality SystemRegulations, or QSR, and enforced by the FDA through its facilities inspectionprogram. In complying with QSR, we and any of our third-partymanufacturers must expend significant time, money and effort in design anddevelopment, testing, production, record-keeping and quality control toassure that our products meet applicable specifications and other regulatoryrequirements. The failure to comply with these specifications and otherrequirements could result in an FDA enforcement action, including the seizureof products and shutting down production. We or any of these third-partymanufacturers also may be subject to comparable or more stringent regulationsof foreign regulatory authorities.   Ifwe or any of our third-party manufacturers fail to comply with theseregulations, we might be subject to regulatory action, which could delay orcurtail our ability to develop, and Veridex’s and our ability to commercialize,products based on our technologies.

 

**If we fail to obtain necessary funds for our operations, wewill be unable to continue to develop and commercialize new products andtechnologies.**

 

Weexpect capital outlays and operating expenditures to increase over the nextseveral years as we expand our infrastructure, commercialization,manufacturing, clinical trials and research and development activities.Specifically, we will need to raise additional capital to, among other things:

 

•                                          sustaincommercialization with Veridex of our initial products;

 

•                                          pursueregulatory approvals and clearances;

 

•                                          expand ourtechnologies into other areas of cancer and medicine;

 

•                                          expand ourresearch and development activities;

 

•                                          acquire orlicense technologies;

 

•                                          fund ourclinical trial activities;

 

•                                          expand ourmanufacturing activities; and

 

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•                                          finance capitalexpenditures and our general and administrative expenses.

 

Todate, we have raised capital through private equity, public equity and debtfinancings, license and milestone revenues from corporate collaborations,capital equipment and leasehold financing, government grants and interestearned on cash and investments. However, our present and future fundingrequirements will depend on many factors, including, among other things:

 

•                                          the level ofresearch and development investment required to maintain and improve ourtechnology position;

 

•                                          costs offiling, prosecuting, defending and enforcing patent claims and otherintellectual property rights;

 

•                                          our need ordecision to acquire or license complementary technologies or acquirecomplementary businesses;

 

•                                          changes inproduct development plans needed to address any difficulties in manufacturingor commercialization;

 

•                                          competingtechnological and market developments; and

 

•                                          changes inregulatory policies or laws that affect our operations.

 

Wedo not know whether additional financing will be available on commerciallyacceptable terms when needed. If adequate funds are not available or are notavailable on commercially acceptable terms, our ability to fund our operations,develop products or technologies or otherwise respond to competitive pressurescould be significantly delayed or limited, and we might need to downsize orhalt our operations.

 

Ifwe raise additional funds by issuing equity securities, further dilution to ourstockholders could result, and new investors could have rights superior tothose of our existing shareholders of the shares issued in the IPO. Any equitysecurities issued also may provide for rights, preferences or privileges seniorto those of holders of our common stock. If we raise additional funds byissuing debt securities, these debt securities would have rights, preferencesand privileges senior to those of holders of our common stock, and the terms ofthe debt securities issued could impose significant restrictions on ouroperations. If we raise additional funds through collaborations and licensingarrangements, we might be required to relinquish significant rights to ourtechnologies or products, or grant licenses on terms that are not favorable tous. If adequate funds are not available, we may have to delay or may be unableto continue to develop our products.

 

**If the third parties we intend to contract with for clinicaltrials do not perform in an acceptable manner, or if we suffer setbacks inthese clinical trials, our business may suffer.**

 

Wedo not have the ability to independently conduct the clinical trials requiredto obtain regulatory clearances for our products. We intend to rely on third-partyexpert clinical investigators and clinical research organizations to performthese functions. If we cannot locate and enter into favorable agreements withacceptable third parties, or if these third parties do not successfully carryout their contractual obligations, meet expected deadlines or follow regulatoryrequirements, including clinical laboratory, manufacturing and good clinicalpractice guidelines, then we may be the subject of an enforcement action by theFDA or some other regulatory body, and may be unable to obtain clearances forour products or to commercialize them on a timely basis, if at all.

 

Thecompletion of clinical trials of our products may be delayed by many otherfactors, including the rate of enrollment of patients. Neither we nor any third-partyclinical investigators and clinical research organizations can control the rateof patient enrollment, and this rate might not be consistent with ourexpectations or sufficient to enable clinical trials of our products to becompleted in a timely manner or to be completed at all. In addition, regulatoryauthorities might not permit us to undertake additional clinical trials for oneor more of these products. If we suffer any significant delays, setbacks ornegative results in, or termination of, clinical trials for our products, wemay be unable to generate product sales from these products in the future.

 

**If we lose key management or scientific personnel, scientificcollaborators or other advisors, our business would suffer.**

 

Oursuccess depends, in large part, on the efforts and abilities of Edward L. Erickson,who is our Chairman, President and Chief Executive Officer, Byron D. Hewett,who is our Chief Operating Officer and General Manager, Cancer Products, LeonW.M.M. Terstappen, who is our Senior Vice President of Research and Developmentand Chief Scientific Officer, and James G. Murphy, who is our Senior VicePresident of Finance and Administration and Chief Financial Officer, as well asthe other members of our senior

 

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managementand our scientific and technical personnel. Given that the pool of individualswith relevant experience in biotechnology and diagnostic products in particularis limited, it would be costly and time-consuming to replace any of our seniormanagement or scientific personnel. Although we maintain key-person lifeinsurance on Mr. Erickson and Dr. Terstappen, we do not maintain key-personlife insurance on any of our other officers, employees or consultants.  We also depend on our scientific collaboratorsand other advisors, particularly with respect to our research and developmentefforts. If we lose the services of one or more of our key officers, employeesor consultants, or are unable to retain the services of our scientificcollaborators and other advisors, our research and development and productdevelopment efforts could be delayed or curtailed.

 

**If Veridex and the other third parties we intend to rely onto perform marketing, sales and distribution services for our products do notsuccessfully perform these services, our business will be harmed.**

 

Wehave limited marketing, sales and distribution experience and capabilities. Inorder to commercialize any of our products, we must either internally developsales, marketing and distribution capabilities or make arrangements with thirdparties to perform these services. We intend to rely for the foreseeable futureon sales, marketing and distribution arrangements with third parties for thecommercialization of our products. Specifically, we will rely on Veridex forthe commercialization of the initial cancer diagnostic products based on ourtechnologies. We may be unable to enter into sales, marketing and distributionagreements with third parties on acceptable terms, if at all. Also, the sales,marketing, and distribution efforts of these third parties might not besuccessful. Any sales through these third parties might be less profitable tous than direct sales.

 

Ifwe decide to perform any sales, marketing and distribution functions ourselves,we might face a number of risks, including:

 

•                                          our ability toattract and build the significant and skilled marketing staff or sales forcenecessary to commercialize and gain market acceptance for our products;

 

•                                          the amount oftime and cost of establishing a marketing staff or sales force might not bejustifiable by the revenues generated by any particular product; and

 

•              the failure of our direct salesand marketing personnel to initiate and execute successful commercializationactivities.

 

**If the limited number of suppliers we rely on fail to supplythe raw materials we use in the manufacturing of our reagent products, we mightbe unable to satisfy product demand, which would negatively impact ourbusiness.**

 

Severalraw materials used in the manufacturing of our reagent products used in severalof our platforms and instruments currently are available only from a limitednumber of suppliers. We acquire all of these raw materials on a purchase-orderbasis, which means that the supplier is not required to supply us withspecified quantities of these raw materials over a certain period of time or toset aside part of its inventory for our forecasted requirements. Additionally,for certain of these raw materials, we have not arranged for alternativesuppliers, and it might be difficult to find alternative suppliers in a timelymanner and on terms acceptable to us. Consequently, as we continue ourcommercialization efforts, if we do not forecast properly, or if our suppliersare unable or unwilling to supply us in sufficient quantities or oncommercially acceptable terms, we might not have access to sufficientquantities of these raw materials on a timely basis and might not be able tosatisfy product demand.

 

Inaddition, if any of these components and raw materials are no longer availablein the marketplace, we will be forced to further develop our technologies toincorporate alternate components and to do so in compliance with QSR. If weincorporate new components or raw materials into our products we might need toseek and obtain additional approvals or clearances from the FDA or foreignregulatory agencies, which could delay the commercialization of these products.

 

**If our competitors develop and market technologies orresearch and diagnostic products faster than we or Veridex do or if thoseproducts are more effective than our products, our commercial opportunitieswill be reduced or eliminated.**

 

 

Theextent to which any of our technologies and products achieve market acceptancewill depend on many competitive factors, many of which are beyond our control.Competition in the pharmaceutical and biotechnology industries, and the medicaldevices and diagnostic products segments in particular, is intense and has beenaccentuated by the rapid pace of technological development. Our competitorsinclude large diagnostics and life sciences companies. Most of these entitieshave substantially greater research and development capabilities and financial,scientific, manufacturing, marketing, sales and service resources than we do. Someof them 

 

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alsohave more experience than we do in research and development, clinical trials,regulatory matters, manufacturing, marketing and sales. These organizationsalso compete with us to:

 

•                                          pursueacquisitions, joint ventures or other collaborations;

 

•                                          licenseproprietary technologies that are competitive with our technologies;

 

•                                          attractfunding; and

 

•                                          attract andhire scientific talent.

 

Ifwe or Veridex cannot successfully compete with new or existing products ortechnologies, sales of our products will suffer and we may never achieveprofitability. Because of their greater experience with commercializing theirtechnologies and larger research and development capabilities, our competitorsmight succeed in developing and commercializing technologies or productsearlier and obtaining regulatory approvals and clearances from the FDA morerapidly than Veridex or us. Our competitors also might develop more effectivetechnologies or products that are more predictive, more highly automated ormore cost-effective, which may render our technologies or products obsolete ornon-competitive.

 

**If weexperience delays in the development of new products or delays in plannedimprovements to our products, our commercial opportunities will be reduced.**

 

To improve our competitive position, webelieve that we will need to develop new products as well as improve ourexisting instruments, reagents and ancillary products. Improvements inautomation and throughput (the number of tests that can be performed in aspecified period of time) of our products will be important to the competitiveposition of our products as we market to a broader, perhaps less technicallyproficient, group of customers. Our ability to develop new products and makeimprovements in our products may face difficult technological challengesleading to development delays. For example, we had experienced delays inconnection with the development of our CellTracks Analyzer cell analysisinstrument for use in cancer diagnostic testing. These delays were the resultof technical problems associated with reliability of the system to detectcancer cells. In response, we are implementing enhancements to our CellSpotterAnalyzer, such as adding the ability to detect and evaluate cellular markersusing analyte specific reagents, or ASRs. We are also continuing to develop ouranalyzer platforms further because we believe that some of the plannedfeatures, such as the ability to quantify cellular markers using ASRs, may berequired to address future potential research and clinical applications and toremain competitive. If we are unable to successfully complete development ofnew products or if we are unable to successfully complete the plannedenhancements to our products, in each case without significant delays, ourfuture competitive position may be adversely affected.

 

**If product liability lawsuits are successfully broughtagainst us, we might incur substantial liabilities and could be required tolimit the commercialization of our products.**

 

Ourbusiness exposes us to potential product liability risks that are inherent inthe testing, manufacturing, marketing and sale of diagnostic products. We mightbe unable to avoid product liability claims. Product liability insurancegenerally is expensive for our industry. If we are unable to maintainsufficient insurance coverage on reasonable terms or to otherwise protectagainst potential product liability claims, we may be unable to commercializeour products. A successful product liability claim brought against us in excessof any insurance coverage we have at that time could cause us to incursubstantial liabilities and our business to fail.

 

**If we use biological and hazardous materials in a manner thatcauses injury, we could be liable for damages.**

 

Ourresearch and development activities sometimes involve the controlled use ofpotentially harmful biological materials, hazardous materials and chemicals. Wecannot completely eliminate the risk of accidental contamination or injury tothird parties from the use, storage, handling or disposal of these materials.In the event of contamination or injury, we could be held liable for anyresulting damages, and any liability could exceed our resources or anyapplicable insurance coverage we may have. Additionally, we are subject on anongoing basis to federal, state and local laws and regulations governing theuse, storage, handling and disposal of these materials and specified wasteproducts. The cost of compliance with these laws and regulations might besignificant and could negatively affect our profitability.

 

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**If we are unable to manage growth in connection with ourtransition from an early-stage development company to a company thatcommercializes research and diagnostic products, our operations will suffer.**

 

Wewill need to add a significant number of new personnel and expand ourcapabilities in order to successfully pursue our commercialization strategy forour initial IVD products as well as our research and development efforts.Certain aspects of our operations must be scaled up, for example, to increasethe batch sizes of antibodies and other bulk components that we will need toprovide for use in the test kits manufactured by Veridex and the number ofinstrument systems we can manufacture per quarter. Organizational growth andscale-up of operations could strain our existing managerial, operational,financial and other resources. If we fail to manage this growth effectively, wemay not be able to achieve our research and development and commercializationgoals.

 

**RISKS RELATED TO OUR INTELLECTUAL PROPERTY**

 

**If we are unable to protect our proprietary rights, we maynot be able to compete effectively.**

 

Wehave obtained patents in the US and in foreign countries relating to many ofthe technologies that are the basis of our products, such as the basictechnologies relating to the separation and isolation of cells for thedetection of cancer and the various aspects of the reagents, methods andinstrument platforms that we are commercializing or plan to commercialize. Inaddition, we maintain trade secrets, especially where we believe patentprotection is not appropriate or obtainable, on various aspects of ourtechnologies and that we do not wish to become publicly known. However,obtaining, defending and enforcing our patents and other intellectual propertyrights involve complex legal and factual questions. For example, many of ourkey patents relating to our basic technologies for the separation and isolationof cells for the detection of cancer contain claims covering our processes formanufacturing and using our magnetic separation particles, or ferrofluids. If acompetitor were to practice or use these processes without our knowledge orconsent, these patents may be particularly difficult to defend or enforcebecause it may not be apparent from examination of the competitor’s productsthat the competitor is using our patented processes. In particular, if we werenot able successfully to defend or enforce our patents that cover ourferrofluids, which are utilized as a key component of our CellTracks AutoPrepSystem, competitors could more easily produce systems that might be able toperform separation of Circulating Tumor Cells (“CTCs”) from blood samples in amanner substantially equivalent to our CellTracks AutoPrep System withoutcompensating us, resulting in substantial damage to our business.

 

Becausethe issuance of a patent is not conclusive of its validity or enforceabilityand can be challenged, we do not know how much protection, if any, our patentswill provide to us if we attempt to enforce them or if others challenge theirvalidity or enforceability in court. For example, if our patents relating tothe separation of CTCs from blood samples were challenged and invalidated, wewould not be able to prevent others from utilizing these key aspects of ourtechnologies, which would substantially harm our business. Moreover, our patentapplications may not result in issued patents, and even if issued, our patentsmay not contain claims that are

sufficientlybroad to prevent others from practicing our technologies or developingcompeting products. Accordingly, we cannot assure you that we will be able toobtain, defend or enforce our patent rights covering our technologies in the USor in foreign countries. In addition, if others discover or misappropriate thetechnologies that we have chosen to maintain as trade secrets, we may not beable to effectively maintain our technologies as unpatented trade secrets.Although we have taken measures to protect our unpatented trade secrets andother non-public information such as know-how, including the use ofconfidentiality and invention assignment agreements with our employees, consultantsand some of our contractors, it is possible that these persons mayunintentionally or willingly breach the agreements or that our competitors mayindependently develop or otherwise discover our trade secrets and know-how.

 

Achallenge to one or more of our pending patent applications, or issued patents,may result in limiting the coverage of our patents so that a competitor caneffectively avoid our patent claims. In addition, competitors may avoid ourpatents by using technologies that perform substantially as our technologies,but avoid infringing our patent claims. For example, if a competitor were touse a cell separation technology that performs as well, or nearly as well, asour patented ferrofluids, the competitor may be able to market products thatmay be functionally equivalent and perform as well or nearly as well as ourproducts, thereby diminishing the competitive advantage afforded by our issuedpatents.

 

Althoughwe may initiate litigation to stop the infringement of our patent claims or toattempt to force an unauthorized user of our patented inventions or tradesecrets to compensate us for the infringement or unauthorized use, patent andtrade secret litigation is complex and often difficult and expensive, and wouldconsume the time of our management and other significant resources. If theoutcome of litigation is adverse to us, third parties may be able to use ourtechnologies without payments to us. Moreover, some of our competitors may bebetter able to sustain the costs of litigation because they have substantiallygreater resources. Because of these factors relating to litigation, we may beunable effectively to prevent misappropriation of our patent and otherproprietary rights.

 

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**If the use of our technologies conflicts with theintellectual property rights of third-parties, we may incur substantialliabilities and we may be unable to commercialize products based on thesetechnologies in a profitable manner, if at all.**

 

Ourcompetitors or others may have or acquire patent rights that they could enforceagainst us. If they do so, we may be required to alter our technologies, paylicensing fees or cease activities. If our technologies conflict with patentrights of others, third parties could bring legal action against us or ourlicensees, suppliers, customers or collaborators, claiming damages and seekingto enjoin manufacturing and marketing of the affected products. If these legalactions are successful, in addition to any potential liability for damages, wemight have to obtain a license in order to continue to manufacture or marketthe affected products. A required license under the related patent may not beavailable on acceptable terms, if at all.

 

Wemay be unaware of issued patents that our technologies infringe. Because patentapplications can take many years to issue, there may be currently pendingapplications, unknown to us, that may later result in issued patents upon whichour technologies may infringe. There could also be existing patents of which weare unaware upon which our technologies may infringe. In addition, if thirdparties file patent applications or obtain patents claiming technology alsoclaimed by us in pending applications, we may have to participate in interferenceproceedings in the US Patent and Trademark Office to determine priority ofinvention. If third parties file oppositions in foreign countries, we may alsohave to participate in opposition proceedings in foreign tribunals to defendthe patentability of the filed foreign patent applications. We may also have toparticipate in interference proceedings involving our issued patents or ourpending applications.

 

 

Ifa third party claims that we infringe upon its proprietary rights, any of thefollowing may occur:

 

•                                          we may becomeinvolved in time-consuming and expensive litigation, even if the claim iswithout merit;

 

•                                          we may becomeliable for substantial damages for past infringement if a court decides thatour technologies infringe upon a competitor’s patent;

 

•                                          a court mayprohibit us from selling or licensing our product without a license from thepatent holder, which may not be available on commercially acceptable terms, ifat all, or which may require us to pay substantial royalties or grant cross licensesto our patents; and

 

•                                          we may have toredesign our product so that it does not infringe upon others’ patent rights,which may not be possible or could require substantial funds or time.

 

Ifany of these events occurs, our business will suffer and the market price ofour common stock will likely decline.

 

**Our rights to use technologies licensed to us by thirdparties are not within our control, and we may not be able to implement ourproducts without these technologies.**

 

Wehave licensed patents and other rights that are necessary to commercialize ourproducts. Our business will significantly suffer if these licenses terminate,if the licensors fail to abide by the terms of the license or fail to preventinfringement by third parties or if the licensed patents or other rights arefound to be invalid.

 

Wehave exclusively in-licensed significant intellectual property, includingpatents and know-how, related to our cell analysis instrumentation and cellisolation and enrichment products. In April 1997 we entered into a licenseagreement with the University of Twente, or Twente, under which we were grantedexclusive rights to technology developed at Twente relating to optical analysisof particles similar to cells and cell particles. This technology and theunderlying patents and know-how contribute significantly to our cell analysisplatforms. This agreement will terminate upon the later of April 2007 or theexpiration date of the last to expire of the patents licensed under thisagreement. In addition, Twente may unilaterally terminate this agreement if weare in material breach or if we become bankrupt or insolvent. Twente also mayunilaterally terminate the license granted under this agreement if we do notmaintain sufficient general and product liability insurance coverage once wehave begun clinical trials and commercialization of our products. In June 2004,we entered into an addendum to our license agreement with Twente, and with STW,a research funding agency of the Dutch government.  Under the modified agreement, STW willprovide Twente with up to approximately one million dollars toward developingan affordable and portable instrument to monitor patients with HIV.  This instrument represents an additional

 

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applicationof our existing technology, specifically the CellTracks EasyCount system, andin consideration for our contribution of “in kind” research effort toward theproject including personnel, equipment and supplies we will have rights to commercializeproducts that result from this agreement. In addition, in September 1999, we entered into a license agreementwith the University of Texas, or Texas, under which we were granted exclusiverights to technology, including patents and know-how, which we developed incollaboration with Texas, relating to the isolation, enrichment andcharacterization of circulating epithelial cells. Epithelial cells are cellsthat cover external and internal body surfaces and give rise to the majority ofsolid tumors. This technology and the underlying patents and know-howcontribute significantly to our cell analysis products in the field of cancerdiagnostics. We are responsible for making royalty payments of 1% of our salesof reagents incorporating the intellectual property licensed to us under thisagreement. This agreement terminates when all of Texas’s rights to the licensedtechnologies expire. In addition, Texas also may unilaterally terminate thisagreement if we are in material breach or become bankrupt or insolvent. Texasalso may unilaterally terminate the license granted under this agreement, orthe exclusivity of such license, in any national political jurisdiction if wefail to provide written evidence satisfactory to Texas, within 90 days ofreceiving written notice from Texas that it intends to terminate this license,that we or our sublicensees have commercialized or are actively attempting tocommercialize a licensed invention in these jurisdictions. In addition, in July2002, we entered into a license agreement with Streck Laboratories, Inc., orStreck. Under this agreement, Streck granted to us a non-exclusive,worldwide, royalty-bearing license to practice certain of Streck’s cellpreservative technology, including patents and know-how, for the research,development, manufacture and sale of our CellSave Preservative Tube to test forthe presence of epithelial cells or CTCs in a sample of fluid from a patient.This agreement will terminate upon the expiration date of the last to expire ofthe patents licensed under this agreement. In addition, either party also mayterminate this agreement if the other party is in material breach or becomesinvolved in financial difficulties, including bankruptcy and insolvency.

 

Ifwe violate the terms of our licenses, or otherwise lose our rights to thesepatents or patent applications, we may be unable to continue development of ourproducts. Our licensors or others may dispute the scope of our rights under anyof these licenses. Additionally, the licensors under these licenses mightbreach the terms of their respective agreements or fail to prevent infringementof the licensed patents by third parties. Loss of any of these licenses for anyreason could materially harm our financial condition and operating results.

 

**If we cannot obtain additional licenses to intellectualproperty owned by third parties that we desire to incorporate into new productswe plan to develop, we may not be able to develop or commercialize these futureproducts.**

 

Weare developing products designed to identify and characterize additional typesof cells other than CTCs and epithelial cells, such as endothelial cells. Wealso plan to develop cell profile products using reagents that arefluorescently tagged antibodies designed to characterize target cells, whichare classified by the FDA as analyte specific reagents, or ASRs. ASRs can beused in research as an aid in evaluating new therapies in clinical trials, andwe plan to develop a family of ASRs for profiling of each rare cell type ofinterest. However, many, if not all, of the target-specific and otherreagents, including antibodies, that we ultimately may use in the developmentand commercialization of these future cell profile products and in our futureproducts for identifying additional types of cells may be protected by patentand other intellectual property rights owned by third parties. If we are unableto obtain rights to use this third party intellectual property undercommercially reasonable terms, or at all, we may be unable to develop theseproducts, and

thiscould harm our ability to expand our commercial products offerings and togenerate additional revenue from these products.

 

**RISKSRELATING TO OUR COMMON STOCK**

 

**If our principal stockholders,executive officers and directors choose to act together, they may be able tocontrol our management and operations.**

 

Our executive officers, directors andprincipal stockholders, and entities affiliated with them, beneficially ownedin the aggregate approximately 39% of our common stock as of immediatelyfollowing the completion of our IPO. This significant concentration of shareownership may adversely affect the trading price of our common stock becauseinvestors often perceive disadvantages in owning stock in companies withcontrolling stockholders. These stockholders, acting together, will have theability to exert substantial influence over all matters requiring approval byour stockholders, including the election and removal of directors and anyproposed merger, consolidation or sale of all or substantially all of ourassets. In addition, they could dictate the management of our business andaffairs. This concentration of ownership could have the effect of delaying,deferring or preventing a change in control of us or impeding a merger orconsolidation, takeover or other business combination that could be favorableto you.

 

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**The future sale of our commonstock and the exercise of outstanding options and warrants could negativelyaffect our stock price and cause dilution.**

 

Substantially all of the shares of our commonstock outstanding are available for public sale, subject in some cases tovolume, manner of sale and other limitations imposed under the securitieslaws.  If our common stockholders sellsubstantial amounts of common stock in the public market, or the marketperceives that such sales may occur, the market price of our common stock couldfall.  Immediately following thecompletion of our IPO, the holders of approximately 14,597,151 shares of ourcommon stock, the holders of options to purchase 55,334 shares of our commonstock and the holders of warrants to purchase 182,017 shares of our commonstock maintained rights, subject to some conditions, to require us to fileregistration statements covering their shares or to include their shares inregistration statements that we may file for ourselves or other stockholders.Furthermore, if we were to include in a company-initiated registrationstatement shares held by those holders pursuant to the exercise of theirregistrations rights, the sale of those shares could impair our ability toraise needed capital by depressing the price at which we could sell our commonstock.  In addition, we will need toraise substantial additional capital in the future to fund our operations. Ifwe raise additional funds by issuing equity securities, our stock price maydecline and our existing stockholders may experience significant dilution.

 

As of September 30, 2004, options to purchase2,827,939 shares of our common stock and warrants to purchase 99,566 shares ofour common stock were outstanding.  Atotal of 2,927,905 of the outstanding options and warrants are “in the money”and exercisable as of September 30, 2004. “In the money” means that the currentmarket price of the common stock is above the exercise price of the sharessubject to the warrant or option.  Theissuance of common stock upon the exercise of these options and warrants couldadversely affect the market price of the common stock or result in substantialdilution to our existing stockholders.

 

**If the price and volume of ourcommon stock experience fluctuations, this could lead to costly litigation forus.**

 

Because we are a development-stage companywith limited operating history and operate within the medical devices anddiagnostic products segments of the pharmaceutical and biotechnologyindustries, our stock price is likely to be volatile. The market price of ourcommon stock may fluctuate substantially due to a variety of factors, including:

 

•                  results of our clinicaltrials related to developing multiple indications for our cancer diagnosticproducts, such as those related to colorectal, lung or other solid tissuecancers, or expanding the applications of our technologies to fields ofmedicine other than cancer, such as cardiovascular and infectious diseases;

 

•                  changes in reimbursementpolicies concerning the diagnostic products that we or our competitors offer;

 

•                  media reports andpublications and announcements about cancer or diagnostic products or newcancer treatments or innovations that could compete with our products;

 

•                  announcements concerning ourcompetitors or the medical devices and diagnostic products segments in general;

 

•                  new regulatorypronouncements, changes in regulatory guidelines, such as adverse changes inreimbursement for cancer diagnostic products, and timing of regulatoryapprovals concerning the products in our pipeline;

 

•                  market conditions or trendsrelated to the medical diagnostics and biotechnology industries or the marketin general;

 

•                  additions to or departuresof our key personnel, in particular, the loss of Edward L. Erickson, our ChiefExecutive Officer, Byron D. Hewett, our Chief Operating Officer, Leon W.M.M.Terstappen, our Chief Scientific Officer, and James G. Murphy, our ChiefFinancial Officer;

 

•                  disputes or otherdevelopments relating to proprietary rights, including patents, litigationmatters and our ability to obtain patent protection for our technologies;

 

•                  changes in financialestimates or recommendations by securities analysts;

 

•                  variations in our quarterlyfinancial and operating results; and

 

•                  changes in accountingprinciples.

 

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The market prices of the securities ofbiotechnology and diagnostic companies, particularly companies like ourswithout consistent product revenues and earnings, have been highly volatile andare likely to remain highly volatile in the future. This volatility has oftenbeen unrelated to the operating performance of particular companies. Moreover,market prices for stocks of biotechnology-related companies, particularlyfollowing an initial public offering, frequently reach levels that bear norelationship to the operating performance of these companies. These marketprices generally are not sustainable and are highly volatile. In the past,companies that experience volatility in the market price of their securitieshave often faced securities class action litigation. Whether or notmeritorious, litigation brought against us could result in substantial costs,divert our management’s attention and resources and harm our ability to growour business.

 

 

**Anti-takeover provisions in ourcertificate of incorporation and bylaws and under Delaware law could inhibit achange in control or a change in management that holders of our common stockconsider favorable.**

 

Provisions in our certificate ofincorporation and bylaws could delay or prevent a change of control or changein management that would provide holders of our common stock with a premium tothe market price of our common stock. These provisions include those:

 

•                  authorizing the issuancewithout further approval of “blank check” preferred stock that could be issuedby our board of directors to increase the number of outstanding shares andthwart a takeover attempt;

 

•                  prohibiting cumulativevoting in the election of directors, which would otherwise allow less than amajority of stockholders to elect director candidates;

 

•                  limiting the ability toremove directors;

 

•                  limiting the ability ofstockholders to call special meetings of stockholders;

 

•                  prohibiting stockholderaction by written consent, thereby requiring all stockholder actions to betaken at a meeting of stockholders; and

 

•                  establishing advance noticerequirements for nominations for election to the board of directors or forproposing matters that can be acted upon by stockholders at stockholdermeetings.

 

In addition, Section 203 of the DelawareGeneral Corporation Law limits business combination transactions with 15%stockholders that have not been approved by our board of directors. Theseprovisions and others could make it difficult for a third party to acquire us,or for members of our board of directors to be replaced, even if doing so wouldbe beneficial to our stockholders. Because our board of directors isresponsible for appointing the members of our management team, these provisionscould in turn affect any attempt to replace the current management team. If achange of control or change in management is delayed or prevented, holders ofour common stock may lose an opportunity to realize a premium on their sharesof common stock or the market price of our common stock could decline.

 

**We do not expect to pay dividendsin the foreseeable future. As a result, holders of our common stock must relyon stock appreciation for any return on their investment.**

 

We do not anticipate paying cash dividends onour common stock in the foreseeable future. Certain of our existing creditagreements prohibit the payment of cash dividends without lender consent. Anypayment of cash dividends will also depend on our financial condition, resultsof operations, capital requirements and other factors and will be at thediscretion of our board of directors. Accordingly, holders of our common stockwill have to rely on capital appreciation, if any, to earn a return on theirinvestment in our common stock. Furthermore, we may in the future becomesubject to contractual restrictions on, or prohibitions against, the payment ofdividends.

 

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### **Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

#  

We do not believe that we have materialexposure to interest rate, foreign currency exchange rate or other relevantmarket risks.  We do not use derivativefinancial instruments in our investment portfolio and have no foreign exchangecontracts. Our financial instruments consist of cash, cash equivalents, andshort-term investments, accounts payable and long-term obligations. We considerinvestments that, when purchased, have a remaining maturity of 90 days orless to be cash equivalents. We invest in marketable securities in accordancewith our investment policy. The primary objectives of our investment policy areto preserve principal, maintain proper liquidity to meet operating needs andmaximize yields. Our investment policy specifies credit quality standards forour investments.

 

 

**Item 4.  Controls and Procedures**

 

*Evaluation of disclosure controls and procedures*. The Company’smanagement, with the participation of the Company’s Chief Executive Officer andChief Financial Officer, evaluated the effectiveness of the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport.  Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport have been designed and are functioning effectively to provide reasonableassurance that the information required to be disclosed by the Company inreports filed under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms.  The Company believes that acontrols system, no matter how well designed and operated, cannot provideabsolute assurance that the objectives of the controls system are met, and noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within a company have been detected.

 

*Change in internal control over financial reporting.*No change inthe Company’s internal control over financial reporting occurred during theCompany’s most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

 

**PART II.                OTHER INFORMATION**

 

 

**Item 6.                    Exhibits**

 

             (b)
| 10.1   |   | Amended and Restated Loan and Security  Agreement entered into on October 22, 2004, among Immunicon Corporation, its  subsidiaries and Silicon Valley Bank. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                        |
| 31.1   |   | Certification of Chief Executive  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                        |
|   |   |                                                                                                                                                        |
| 31.2   |   | Certification of Chief Financial  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                        |
|   |   |                                                                                                                                                        |
| 32.1   |   | Certification of Chief Executive  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.        |
|   |   |                                                                                                                                                        |
| 32.2   |   | Certification of Chief Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.        |

 

 

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**SIGNATURES**

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|   |               | IMMUNICON CORPORATION                               |
|--------|--------------------|-----------------------------------------------------|
|   |               |                                                |   |
|   |               |                                                |   |
|   |               |                                                |   |
|   |               |                                                |   |
| Date:  | November  12, 2004 | By:                                                 | EDWARD L ERICKSON |
|   |               | Edward L. Erickson                                  |
|   |               | Chairman of the Board,  President and               |
|   |               | Chief Executive Officer                             |
|   |               |                                                |   |
|   |               |                                                |   |
|   |               |                                                |   |
|   |               |                                                |   |
| Date:  | November  12, 2004 | By:                                                 | JAMES G. MURPHY |
|   |               | James G. Murphy                                     |
|   |               | Senior Vice President,  Finance and Administration, |
|   |               | Chief Financial Officer                             |
|   |               | (Principal financial and  accounting officer)       |

 

 

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EXHIBIT INDEX

 
| **Number** | ** ** | **Description**                                                                                                                                             |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1       |       | Amended and Restated Loan and Security  Agreement entered into on October 22, 2004, among Immunicon Corporation, its  subsidiaries and Silicon Valley Bank. |
| 31.1       |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                        |
| 31.2       |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                        |
| 32.1       |       | Certification of Edward L.  Erickson pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.             |
| 32.2       |       | Certification of James G.  Murphy pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                |

 

 

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