** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**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 June 30, 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         .** |

 

**Commission File Number: 000-50677**

 

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**IMMUNICONCORPORATION**

(Exact name of registrant asspecified in its charter)

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

 

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

(Address of principal executive offices andzip code)

 

**(215) 830-0777**

(Registrant’s telephone number including areacode)

 

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

 

Yes  ý  No  o

 

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

 

Yes  o  No  ý

 

Include the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest possible date.

As of August 10, 2004, there were 22,965,828 shares of CommonStock, $0.001 par value, outstanding.

 

 

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IMMUNICON CORPORATION

 

INDEX

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                                                                                        |   |
|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                                                                                                             |   |
| Item  1.     | Condensed  Consolidated Financial Statements (Unaudited):                                                                                                                                        |   |
|         |                                                                                                                                                                                             |   |
|         | Condensed  Consolidated Balance Sheets:  June 30, 2004 and December 31, 2003                                                                                                           |   |
|         |                                                                                                                                                                                             |   |
|         | Condensed  Consolidated Statements of Operations:Three and Six  Months Ended June 30, 2004 and 2003 and for the period from  August 25, 1983 (date of inception) to June 30, 2004 |   |
|         |                                                                                                                                                                                             |   |
|         | Condensed  Consolidated Statements of Cash Flows:Six Months  Ended June 30, 2004 and 2003 and for the Period from August 25,  1983 (date of inception) to June 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 and  Reports on Form 8-K                                                                                                                                                                |   |

 

Immuniconis a registered trademark of Immunicon Corporation. The Immunicon logo is aregistered trademark of Immunicon Corporation. CellSave, CellTracks and theCellTracks AutoPrep System logo are registered trademarks of ImmunivestCorporation, a wholly owned subsidiary of Immunicon Corporation.  CellTracks EasyCount, EasyCount, CellTracksMagNest, CellPrep, CellSpotter, AutoPrep, IMMC, the CellTracks Analyzer logo, theCellTracks MagNest logo, the CellSave Preservative Tube logo, the CellSave TubeCap logo and the CellSpotter Analyzer logo are trademarks of ImmunivestCorporation, a wholly owned subsidiary of Immunicon Corporation. CellSearch isa registered trademark of Johnson & Johnson. All other trademarksappearing in this filing are the property of their respective holders.

 

2

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Immunicon Corporation and Subsidiaries (ADevelopment Stage Company)

 

**PARTI.****                            FINANCIAL INFORMATION**

**Item  1.****                                Condensed Consolidated FinancialStatements (Unaudited)**

(in thousands, except for share and per share amounts)

 
|                                                                                                                                                                                  |   | **June 30,  2004** |   | **December 31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                                                                                                                                  |   |                    |   |                        |   |
| ASSETS                                                                                                                                                                                |   |                    |   |                        |   |
| Current Assets:                                                                                                                                                                       |   |                    |   |                        |   |
| Cash and cash equivalents                                                                                                                                                             |   | $                       | 66,084 |                        | $      | 30,601 |   |
| Short term investments                                                                                                                                                                |   | 1,508                   |   | —                      |   |
| Accounts receivable                                                                                                                                                                   |   | 11                      |   | 4                           |   |
| Receivable from related party                                                                                                                                                         |   | 405                     |   | 88                          |   |
| Prepaid assets                                                                                                                                                                        |   | 726                     |   | 319                         |   |
| Other current assets                                                                                                                                                                  |   | 17                      |   | 76                          |   |
| Total current assets                                                                                                                                                                  |   | 68,751                  |   | 31,088                      |   |
|                                                                                                                                                                                  |   |                    |   |                        |   |
| Property and equipment, net                                                                                                                                                           |   | 4,071                   |   | 3,561                       |   |
| Assets related to financing activities                                                                                                                                                |   | —                  |   | 674                         |   |
| Other assets                                                                                                                                                                          |   | 203                     |   | 412                         |   |
| Total assets                                                                                                                                                                          |   | $                       | 73,025 |                        | $      | 35,735 |   |
|                                                                                                                                                                                  |   |                    |   |                        |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                             |   |                    |   |                        |   |
| Current Liabilities:                                                                                                                                                                  |   |                    |   |                        |   |
| Current portion of long-term debt                                                                                                                                                     |   | $                       | 3,655  |                        | $      | 3,360 |   |
| Accounts payable                                                                                                                                                                      |   | 1,369                   |   | 1,008                       |   |
| Accrued expenses                                                                                                                                                                      |   | 2,057                   |   | 2,787                       |   |
| Current portion of deferred revenue                                                                                                                                                   |   | 456                     |   | 97                          |   |
| Total current liabilities                                                                                                                                                             |   | 7,537                   |   | 7,252                       |   |
|                                                                                                                                                                                  |   |                    |   |                        |   |
| Long-term debt                                                                                                                                                                        |   | 3,275                   |   | 3,792                       |   |
| Deferred revenue                                                                                                                                                                      |   | 617                     |   | 25                          |   |
|                                                                                                                                                                                  |   |                    |   |                        |   |
| Commitments and contingencies                                                                                                                                                         |   |                    |   |                        |   |
|                                                                                                                                                                                  |   |                    |   |                        |   |
| Shareholders’ equity:                                                                                                                                                            |   |                    |   |                        |   |
| Convertible preferred stock (liquidation  value of $0 as of June 30, 2004 and $87,756 as of December 31,  2003)                                                             |   | —                  |   | 85,115                      |   |
| Common stock, $0.001 par value –100,000,000  authorized, 22,963,163 and 485,820 shares issued and outstanding as of  June 30, 2004 and December 31, 2003, respectively |   | 23                      |   | 1                           |   |
| Additional paid in capital                                                                                                                                                            |   | 141,971                 |   | 7,033                       |   |
| Deferred stock-based compensation                                                                                                                                                     |   | (3,105                  | )      | (3,858                      | )      |
| Loan for stock options                                                                                                                                                                |   | —                  |   | (19                         | )      |
| Deficit accumulated during the development  stage                                                                                                                                     |   | (77,293                 | )      | (63,606                     | )      |
| Total shareholders’ equity                                                                                                                                                       |   | 61,596                  |   | 24,666                      |   |
| Total liabilities and shareholders’ equity                                                                                                                                       |   | $                       | 73,025 |                        | $      | 35,735 |   |

 

See notes to condensed consolidated unauditedfinancial statements.

 

3

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Immunicon Corporation and Subsidiaries (ADevelopment Stage Company)

 

**Condensed Consolidated Statements of Ope****rations (Unaudited)**

Three and six months ended June 30, 2004 and 2003, and for theperiod from August 25, 1983

(date of inception) to June 30, 2004

(in thousands, except for share and per share amounts)

 
|                                                                 |   | **Three Months Ended June 30,** |   | **Six Months  Ended June 30,** |   | **Period  from August  25, 1983 (date of  inception)  to June 30,  2004** |   |
|----------------------------------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|--------------------------------------------------------------------------------|--------|
|                                                                 |   | **2004**                             |   | **2003**                            |   | **2004**                                                                       |   | **2003** |   |   |
|                                                                 |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Revenue:                                                             |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Revenue from related party                                           |   | $                                    | 48     |                                | $      | 548                                                                            |   | $ | 192 |   | $ | 828 |   | $ | 4,197 |   |
| Other revenue                                                        |   | 13                                   |   | 85                                  |   | 26                                                                             |   | 244 |   | 3,935 |   |
| Total revenue                                                        |   | 61                                   |   | 633                                 |   | 218                                                                            |   | 1,072 |   | 8,132 |   |
| Expenses:                                                            |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Research and development                                             |   | 5,604                                |   | 3,496                               |   | 10,583                                                                         |   | 7,442 |   | 65,123 |   |
| General and administrative                                           |   | 1,767                                |   | 993                                 |   | 3,212                                                                          |   | 1,996 |   | 21,652 |   |
| Total operating expenses                                             |   | 7,371                                |   | 4,489                               |   | 13,795                                                                         |   | 9,438 |   | 86,775 |   |
| Operating loss                                                       |   | (7,310                               | )      | (3,856                              | )      | (13,577                                                                        | )      | (8,366 | ) | (78,643 | ) |
|                                                                 |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Other income from related party                                      |   | —                               |   | 250                                 |   | —                                                                         |   | 250 |   | 250 |   |
|                                                                 |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Interest income                                                      |   | 159                                  |   | 31                                  |   | 221                                                                            |   | 117 |   |   |   |
| Interest expense                                                     |   | (168                                 | )      | (138                                | )      | (331                                                                           | )      | (252 | ) |   |   |
| Interest income (expense), net                                       |   | (9                                   | )      | (107                                | )      | (110                                                                           | )      | (135 | ) | 1,100 |   |
| Net loss attributable to common stockholders                         |   | $                                    | (7,319 | )                                   | $      | (3,713                                                                         | )      | $ | (13,687 | ) | $ | (8,251 | ) | $ | (77,293 | ) |
|                                                                 |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Net loss per common share – basic and diluted                   |   | $                                    | (0.39  | )                                   | $      | (8.10                                                                          | )      | $ | (1.42 | ) | $ | (18.35 | ) |   |   |
|                                                                 |   |                                 |   |                                |   |                                                                           |   |   |   |   |   |
| Weighted average common shares outstanding – basic  and diluted |   | 18,673,011                           |   | 458,207                             |   | 9,631,102                                                                      |   | 449,706 |   |   |   |

 

See notes to condensed consolidated unauditedfinancial statements.

 

4

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Immunicon Corporation and Subsidiaries (ADevelopment Stage Company)

 

**Condensed Consolidated Statements of Cas****h Flows (Unaudited)**

Six months ended June 30, 2004 and 2003, and for the period from

August 25, 1983 (date of inception) to June 30, 2004

(in thousands)

 
|                                                                               |   | **Six Months Ended June 30,** |    | **Period  from  Aug. 25, 1983  (date of inception)   to June 30,**

**2004** |   |
|------------------------------------------------------------------------------------|--------|------------------------------------|---------|----------------------------------------------------------------------------------------|--------|
|                                                                               |   | **2004**                           |    | **2003**                                                                               |   |
| Operating activities:                                                              |   | $                                  | (13,687 | )                                                                                      | $      | (8,251 | ) | $ | (77,293 | ) |
| Net loss                                                                           |   |                               |    |                                                                                   |   |   |   |
| Adjustment to reconcile net loss to net cash used  in operating activities:        |   |                               |    |                                                                                   |   |   |   |
| Depreciation and amortization                                                      |   | 690                                |    | 557                                                                                    |   | 5,309 |   |
| Interest expense on warrants                                                       |   | 18                                 |    | 12                                                                                     |   | 90 |   |
| Loss on disposal of property and equipment                                         |   |                               |    | 1                                                                                      |   | 4 |   |
| Compensation expense related to the issuance of  stock,stock options and  warrants |   | 676                                |    | 130                                                                                    |   | 1,705 |   |
| Change in:                                                                         |   |                               |    |                                                                                   |   |   |   |
| Accounts receivable                                                                |   | (7                                 | )       | —                                                                                 |   | (12 | ) |
| Receivable from related party                                                      |   | (317                               | )       | —                                                                                 |   | (312 | ) |
| Prepaid expenses and other                                                         |   | (407                               | )       | (109                                                                                   | )      | (894 | ) |
| Other assets                                                                       |   | 241                                |    | (94                                                                                    | )      | (739 | ) |
| Accounts payable                                                                   |   | 361                                |    | 121                                                                                    |   | 1,369 |   |
| Accrued expenses                                                                   |   | (4                                 | )       | 3,699                                                                                  |   | 2,795 |   |
| Deferred revenue                                                                   |   | 951                                |    | (2,535                                                                                 | )      | 1,061 |   |
| Net cash used in operating activities                                              |   | (11,485                            | )       | (6,469                                                                                 | )      | (66,917 | ) |
| Investing activities:                                                              |   |                               |    |                                                                                   |   |   |   |
| Purchase of investments                                                            |   | (1,508                             | )       | —                                                                                 |   | (56,428 | ) |
| Proceeds from maturities of investments                                            |   | —                             |    | 1,500                                                                                  |   | 54,503 |   |
| Cash proceeds from disposals of property and  equipment                            |   | —                             |    | —                                                                                 |   | 1 |   |
| Purchases of property and equipment                                                |   | (1,190                             | )       | (1,310                                                                                 | )      | (8,951 | ) |
| Net cash provided by (used in) investing activities                                |   | (2,698                             | )       | 190                                                                                    |   | (10,875 | ) |
| Financing activities:                                                              |   |                               |    |                                                                                   |   |   |   |
| Proceeds from term debt                                                            |   | 1,489                              |    | 3,004                                                                                  |   | 17,086 |   |
| Proceeds from sale of preferred stock                                              |   | —                             |    | 16,869                                                                                 |   | 84,115 |   |
| Proceeds from sale of common stock, net of issuance  costs                         |   | 49,427                             |    | —                                                                                 |   | 51,093 |   |
| Proceeds from exercise of stock options and warrants                               |   | 442                                |    | 93                                                                                     |   | 775 |   |
| Loan for stock options                                                             |   | 19                                 |    | —                                                                                 |   | 19 |   |
| Loan issue fees                                                                    |   | —                             |    | —                                                                                 |   | (55 | ) |
| Payments on term debt                                                              |   | (1,711                             | )       | (1,482                                                                                 | )      | (9,157 | ) |
| Net cash provided by financing activities                                          |   | 49,666                             |    | 18,484                                                                                 |   | 143,876 |   |
| Net increase in cash and cash equivalents                                          |   | 35,483                             |    | 12,205                                                                                 |   | 66,084 |   |
| Cash and cash equivalents, beginning of period                                     |   | 30,601                             |    | 18,470                                                                                 |   | — |   |
| Cash and cash equivalents, end of period                                           |   | $                                  | 66,084  |                                                                                   | $      | 30,675 |   | $ | 66,084 |   |
| Supplemental cash flow information:                                                |   |                               |    |                                                                                   |   |   |   |
| Cash paid for interest                                                             |   | $                                  | 286     |                                                                                   | $      | 284 |   |   |   |

 

See notes to condensed consolidated unaudited financial statements.

 

5

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Immunicon Corporation andSubsidiaries (A Development Stage Company)

Notes toCondensed Consolidated Unaudited Financial Statements

 

**Three and six monthsended June 30, 2004 and 2003, and for the period from August 25, 1983(date of inception) to June 30, 2004.**

 

**(1)  Background and basis of presentation**

 

The accompanying unaudited consolidated financial statements of ImmuniconCorporation and Subsidiaries (the “Company”) have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and with the instructions to Form 10-Q andArticle 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 consolidatedfinancial statements reflect all adjustments (consisting only of normalrecurring accruals) necessary to present fairly our financial position atJune 30, 2004 and results of operations and cash flows for the three andsix month periods ended June 30, 2004 and 2003 and for the period frominception to June 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 six months periods endedJune 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 June 30, 2004, as defined in Statement of Financial AccountingStandards (“SFAS”) No. 7, *Accounting and Reporting by Development StageEnterprises*.

 

We completed the initial public offering (“IPO”) of shares of ourcommon stock on April 21, 2004. The proceeds to the Company from the IPO were $49.4 million, net of feesand expenses.  In the IPO, the Companysold 6.9 million shares of its common stock, including the underwriters’ overallotment option, at $8.00 per share. In addition, on March 9, 2004, the Company completed a 2-for-3reverse stock split of its common stock. All share and per share amounts included in these unaudited consolidatedfinancial statements have been retroactively adjusted for all periods presentedto give effect to the reverse stock split.

 

Substantial financing will be needed by the Company to fund itsoperations and to commercially develop its product candidates. There is noassurance that such financing will be available when needed. Operations of theCompany are subject to certain additional risks and uncertainties including, amongothers, dependence on Veridex, LLC (“Veridex”), a Johnson & Johnsoncompany, to market the Company’s cancer diagnostic product candidates, theuncertainty of product development (including clinical trial results),regulatory clearance and approval, supplier and manufacturing dependence,competition, reimbursement availability, dependence on exclusive licenses andother relationships, uncertainties regarding patents and proprietary rights,dependence on key personnel and other risks related to governmental regulationsand approvals. The Company believes, however, that cash and cash equivalentsavailable at June 30, 2004 will be sufficient to maintain operationsthrough at least June 30, 2005.

 

In accordance with the SEC’s Release No. 33-8040, *Cautionary Advice Regarding Disclosureabout Critical Accounting Policies,* the Company has determined thecritical principles by considering accounting policies that involve the mostcomplex or subjective decisions or assessments. The Company states theseaccounting policies in Management’s Discussion and Analysis of FinancialCondition and Results of Operations and in the notes to the consolidatedfinancial statements contained in the Company’s Registration Statement. Therewere no significant changes to the Company’s critical accounting policiesduring the six months ended June 30, 2004.

 

In December 2002, the Financial Accounting Standard Board (“FASB”)issued SFAS No. 148, “Accounting for Stock-based Compensation - Transition andDisclosure, an Amendment of FASB Statement No. 123,” to provide alternativemethods of transition for a voluntary change to the fair value based

 

6

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method of accounting for stock-based compensation. We have adopted thedisclosure requirements of this statement. In March 2004, the FASB issueda proposed SFAS - “Share-based Payment: an Amendment of FASB Statements No. 123and 95.” The proposed standard would require companies to expense share-basedpayments to employees, including stock options, based on the fair value of theaward at the grant date. The proposed statement would eliminate the intrinsicvalue method of accounting for stock options permitted by APB (AccountingPrinciples Board) No. 25, “Accounting for Stock Issued to Employees,” which wecurrently follow. We will continue to monitor the actions of the FASB andassess the impact, if any, on our consolidated financial statements.

 

In March 2004, the FASB approved the consensus reached on theEmerging Issues Task Force (EITF) Issue No. 03-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments.”The objective of this Issue is to provide guidance for identifying impairedinvestments. EITF 03-1 also provides new disclosure requirements for investmentsthat are deemed to be temporarily impaired. The accounting provisions of EITF03-1 are effective for all reporting periods beginning after June 15,2004, while the disclosure requirements are effective only for annual periodsending after June 15, 2004. The company has evaluated the impact of theadoption of EITF 03-1 and does not believe the impact will be significant tothe company’s overall results of operations or financial position.

 

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

 

The Company accounts for stock-based compensation based on theprovisions of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(“APB No. 25”), which states that, for fixed plans, no compensationexpense is recorded for stock options or other stock-based awards to employeesthat are granted with an exercise price equal to or above the estimated fairvalue per share of the Company’s common stock on the grant date. In the eventthat stock options are granted with an exercise price below the estimated fairvalue of the Company’s common stock at the grant date, the difference betweenthe fair value of the Company’s common stock and the exercise price of thestock option is recorded as deferred compensation. Deferred compensation isamortized to compensation expense on a straight-line basis over the vestingperiod of the stock option. The Company has adopted the disclosure requirementsof SFAS No. 123, *Accounting forStock-Based Compensation* (“SFAS No. 123”) and SFASNo. 148, *Accounting for Stock BasedCompensation-Transition and Disclosure-an Amendment of FASB StatementNo. 123* (“SFAS No. 148”), which requires compensationexpense to be disclosed based on the fair value of the options granted at thedate of the grant.

 

Had compensation cost for the Company’s stock option plan beendetermined based on the fair value at the grant dates for awards under the planconsistent with the method required by SFAS No. 123, the Company wouldhave reported the pro forma net loss amounts indicated below.

 
|                                                                                                     |   | **Three Months  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|----------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
| **(in thousands, except per share data)**                                                                |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                                                                                     |   |                                  |   |                                |   |   |   |   |   |
| Net loss, as reported                                                                                    |   | $                                     | (7,319 | )                                   | $      | (3,713 | ) | $ | (13,687 | ) | $ | (8,251 | ) |
| Add: Stock-based compensation expense  included in reported net loss                                     |   | 275                                   |   | 46                                  |   | 676 |   | 130 |   |
| Deduct:   Total stock-based compensation expense determined under fair value  method for all awards |   | (498                                  | )      | (95                                 | )      | (939 | ) | (230 | ) |
| Pro forma net loss                                                                                       |   | $                                     | (7,542 | )                                   | $      | (3,762 | ) | $ | (13,950 | ) | $ | (8,351 | ) |
| Net loss per share - basic and diluted as  reported                                                      |   | $                                     | (0.39  | )                                   | $      | (8.10 | ) | $ | (1.42 | ) | $ | (18.35 | ) |
| Pro forma net loss per share - basic and  diluted                                                        |   | $                                     | (0.40  | )                                   | $      | (8.21 | ) | $ | (1.45 | ) | $ | (18.57 | ) |

 

The fair value of each option is estimated on the date of grant usingthe Black-Scholes model with the following weighted average assumptions:risk-free interest rate of 3.8% and 3.1% and volatility rate of 72.3% and 0%for periods ended June 30, 2004 and 2003, respectively; an expected lifeof five years and a dividend yield of zero for all periods presented.

 

7

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Stock compensation 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 InstrumentsThat Are Issued to Other than Employees for Acquiring, or in Conjunction withSelling, Goods or Services,* using a fair value approach.

 

**(3)  Net loss per share**

 

Basic and diluted net loss per common share is calculated in accordancewith SFAS No. 128, *Earnings Per Share*(“SFAS No. 128”) and SEC Staff Accounting Bulletin No. 98 (“SABNo. 98”). Under the provisions of SFAS No. 128 and SAB No. 98,basic net loss per common share is calculated by dividing the net lossapplicable to common stockholders by the weighted-average number ofunrestricted common shares outstanding during the period. Diluted net loss percommon share is the same as basic net loss per common share, since the effectsof potentially dilutive securities are antidilutive for all periods presented.  Fully diluted shares outstanding for thethree months ended June 30, 2004 and 2003 would have been 20,579,881 and12,868,821, respectively.  Fully dilutedshares outstanding for the six months ended June 30, 2004 and 2003 wouldhave been 11,553,399 and 12,731,181, respectively.

 

The following table sets forth thecomputation of net income (numerator) and shares (denominator) for earnings pershare:

 
|                                                                   |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
| **(in thousands)**                                                     |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
| **Numerator:**                                                         |   |                                  |   |                                |   |   |   |   |   |
| Net loss                                                               |   | $                                     | (7,319 | )                                   | $      | (3,713 | ) | $ | (13,687 | ) | $ | (8,251 | ) |
|                                                                   |   |                                  |   |                                |   |   |   |   |   |
| **Denominator:**                                                       |   |                                  |   |                                |   |   |   |   |   |
| Weighted average shares outstanding used  for basic income per share   |   | 18,673                                |   | 458                                 |   | 9,631 |   | 450 |   |
| Common stock equivalents                                               |   | —                                |   | —                              |   | — |   | — |   |
| Weighted average shares outstanding used  for diluted income per share |   | 18,673                                |   | 458                                 |   | 9,631 |   | 450 |   |
|                                                                        |        |                                       |        |                                     |        |  |  |  |  |  |  |  |  |

 

**(4)  Property and equipment**

 

Property and equipment consists of the following:

 
| **(in thousands)**             |   | **June 30,  2004** |   | **December 31,  2003** |   |
|--------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                           |   |                    |   |                        |   |
| Laboratory equipment           |   | $                       | 1,555  |                        | $      | 1,387 |   |
| Office furniture and equipment |   | 851                     |   | 611                         |   |
| Leasehold improvements         |   | 3,686                   |   | 3,195                       |   |
| Manufacturing equipment        |   | 654                     |   | 632                         |   |
| Computer equipment             |   | 1,440                   |   | 1,170                       |   |
| Property and equipment, gross  |   | 8,186                   |   | 6,995                       |   |
| Less Accumulated depreciation  |   | (4,115                  | )      | (3,434                      | )      |
| Property and equipment, net    |   | $                       | 4,071  |                        | $      | 3,561 |   |

 

Depreciation expense was $353,000 and $281,000 for the three monthsended June 30, 2004 and 2003, respectively; and $681,000 and $522,000 forthe six months ended June 30, 2004 and 2003, respectively.

 

8

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**(5)  Accrued expenses**

 

Accrued expenses consisted of the following:

 
| **(in thousands)**                |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-----------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                              |   |                    |   |                        |   |
| Salary related expense            |   | $                       | 407    |                        | $      | 546 |   |
| Clinical research and trial costs |   | 556                     |   | 607                         |   |
| Contracted research costs         |   | 168                     |   | 165                         |   |
| Deferral loan premium             |   | 181                     |   | 139                         |   |
| Accounting and legal fees         |   | 180                     |   | 664                         |   |
| Leasehold improvements            |   | —                  |   | 40                          |   |
| Other                             |   | 565                     |   | 626                         |   |
| Accrued expenses                  |   | $                       | 2,057  |                        | $      | 2,787 |   |

 

**(6)  Debt**

 

As of June 2004, the Company had an aggregate of $6.9 million ofdebt outstanding under $12.0 million of credit facilities with two lendinginstitutions.  The carrying value of long-term debt is as follows:

 
| **(in thousands)**                                  |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-----------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                |   |                    |   |                        |   |
| The $7.0 million credit facility                    |   | $                       | 2,779  |                        | $      | 3,939 |   |
| The $5.0 million equipment line of credit  facility |   | 4,151                   |   | 3,213                       |   |
|                                                |   | 6,930                   |   | 7,152                       |   |
| Less:   current portion of long-term debt      |   | (3,655                  | )      | (3,360                      | )      |
| Long term debt                                      |   | $                       | 3,275  |                        | $      | 3,792 |   |

 

As of June 30, 2004 and 2003, interest rates in effect foroutstanding obligations under the credit facilities ranged from 6.75% to 9.25%and 6.75% to 9.74%, respectively.

 

In June 2004, the Company amended its loan agreement with one ofits lenders.  As a result, the Companyis no longer required to maintain a minimum percentage of its cash availablefor investing on deposit with the lending institution.  Also, the Company is no longer required tomaintain a minimum level of earnings before interest, taxes, depreciation andamortization.  The Company continues tobe required to maintain at least six months liquidity, as defined.  The Company also is required to provideunaudited monthly financial statements within 30 days following the end of eachmonth and audited financial statements within 120 days after the close of itsfiscal year.  The Company was incompliance with its covenants for the six months ended June 30, 2004.

 

**(7)  Commitments and contingencies**

 

In the ordinary course of its business, the Company makes certainindemnities, commitments and guarantees under which it may be required to makepayments in relation to certain transactions. These include indemnities ofclinical investigators, consultants and contract research organizationsinvolved in the development of the Company’s clinical stage products. Theduration of these indemnities, commitments and guarantees varies, and incertain cases, is indefinite. The majority of these indemnities, commitmentsand guarantees do not provide for any limitation of the maximum potentialfuture payments the Company could be obligated to make. The Company has notrecorded any liability for these indemnities, commitments and guarantees in theaccompanying consolidated balance sheets. However, the Company accrues forlosses for any known contingent liability, including those that may arise fromindemnification provisions, when future payment is probable. No such losseshave been recorded to date.

 

9

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In August 2000, the Company entered into a development, licenseand supply agreement (the “Development Agreement”) with Ortho ClinicalDiagnostics, Inc. (“Ortho”), a subsidiary of Johnson andJohnson, Inc., whereby the Company licensed certain rights to itstechnology and assumed certain development obligations for its cancerdiagnostic product candidates. In exchange, Ortho agreed to market anddistribute the Company’s cancer diagnostic product candidates. OnNovember 10, 2003, the Company executed an amendment to this theDevelopment Agreement whereby all of the rights and responsibilities of Orthowere transferred to Veridex. In addition, the Company and Veridex re-negotiatedcertain clinical development and regulatory milestones. The DevelopmentAgreement has a term of 20 years and may be terminated earlier by eitherparty under certain conditions. The Company is not aware of any intentions byVeridex to terminate the Development Agreement.

 

In connection with the Development agreement, Veridex made a$1.5 million up-front, non-refundable license fee payment to theCompany.  Under this Developmentagreement, Veridex is obligated to pay us approximately 30% of their net salesfrom the sale of reagents, test kits, and certain other consumable products anddisposable items. In addition, the Company will receive additional paymentsfrom Veridex if the Company achieves certain development and sales milestonesas defined in the Development Agreement. Under the terms of the Development Agreement, the Company is required toinvest in related research based on a percentage of sales as defined in theDevelopment Agreement.

 

In addition, 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 Series FPreferred Stock, respectively.

 

In June 2004, the Company entered into an addendum to itsTechnology Development Agreement and License Agreement with Twente University,and Technology Foundation STW (“STW”), a research funding agency of the Dutchgovernment.  Under the modifiedagreement STW will provide Twente University with up to approximately $1million toward developing an affordable and portable instrument to monitorpatients with human immunodeficiency virus (“HIV”).  This instrument represents an additional application of ourexisting technology, specifically the CellTracks EasyCount system, and inconsideration for our contribution of research effort toward the projectincluding personnel, equipment and supplies we will have rights tocommercialize products that result from this agreement.

 

**(8)  Shareholders’ equity**

 

We completed the IPO of shares of our common stock on April 21, 2004.  The proceeds to the Company from the IPOwere $49.4 million, net of fees and expenses. In the IPO, the Company sold 6.9 million shares of its common stock,including the underwriters’ over allotment option, at $8.00 per share.  In addition, on March 9, 2004, theCompany completed 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 4.0 million shares on itsRegistration Statement on Form S-8. This Form S-8 covers shares of common stock of the Company that may beoffered or sold pursuant to the Immunicon Corporation Amended and RestatedEquity Compensation Plan (“ESOP”) and the Immunicon Corporation 2004 EmployeeStock Purchase Plan (“ESPP”).

 

**(9)  Related parties**

 

During the period from August 1, 2000 until December 31,2003, the Company received $4.0 million in license and milestone paymentsfrom Veridex, and the Company recognized the entire amount as license revenuefrom related party during that period. The Company received an additional$500,000 in milestone receipts related to product development during the first quarterof 2004. The Company will recognize these receipts as revenue over theestimated life of the related product which the Company estimates will end onDecember 31, 2007. The Company recognized $32,000 as revenue in the threemonths ended June 30, 2004 and $548,000 for the three months endedJune 30, 2003 under this Development Agreement.  The Company recognized $63,000 as revenue for the six monthsended June 30, 2004, and $828,000 for the six months ended June 30,2003 under this Development Agreement. The

 

10

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Company sold an instrument system to Veridex in January 2004 andrecognized revenue of $103,000 as instrument revenue from related party.  The Company recorded these revenues as“Revenue from related party” in the consolidated statement of operations. Inaddition, the Company initiated a multi-center clinical trial for themonitoring of metastatic colorectal cancer. The initiation of this trial completed a milestone in the Company’sagreement with Veridex and the Company earned a $500,000 milestonepayment.  This milestone payment will berecognized over the estimated trial period. As of June 30, 2004 and December 31, 2003, the Company hadreceivables from Veridex of $400,000 and $88,000, respectively.        These receivables arerecorded in “Receivable from related party” in the consolidated balance sheet.

 

In August 2003, the Company sold Series F Preferred Stock andentered into a License and Supply Agreement (“License and Supply Agreement”)with a company. The Company received $400,000 in proceeds for the combinedtransaction. Because shares of the Company’s 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 amortizes it into income over the period of the exclusive supplyarrangement with this company, which is two years. As of June 30, 2004,the unamortized deferred license revenue related to this arrangement amountedto $45,000, and the Company recognized revenue of $10,000 and $20,000 relatedto the arrangement and recorded it as “Revenue from related party” in theconsolidated statement of operations for the three and six month periods endedJune 30, 2004, respectively.

 

The following table breaks out the revenue from related partiesrecognized over the three and six month periods of 2004 and 2003:

 
| **Revenue from related parties:****(in thousands)** |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|-----------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
| **2004**                                            |   | **2003**                              |   | **2004**                            |   | **2003** |   |
|                                                |   |                                  |   |                                |   |   |   |   |   |
| Contract revenue from related party                 |   | $                                     | 42     |                                | $      | 548 |   | $ | 83 |   | $ | 828 |   |
| Instrument revenue from related party               |   | —                                |   | —                              |   | 103 |   | — |   |
| Other revenue from related party                    |   | 6                                     |   | —                              |   | 6 |   | — |   |
|                                                |   | $                                     | 48     |                                | $      | 548 |   | $ | 192 |   | $ | 828 |   |

 

**(10)  Supplemental expense information**

 

The supplemental expense information below provides additionalinformation about the amounts recorded as research and development expenses andgeneral and administrative expenses in the accompanying statements ofoperations:

 

**Research and development expenses**

 

Research and development expenses consisted of the following:

 
| **(in thousands)**               |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|----------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
| **2004**                         |   | **2003**                              |   | **2004**                            |   | **2003** |   |
|                             |   |                                  |   |                                |   |   |   |   |   |
| Salaries, benefits and taxes     |   | $                                     | 2,347  |                                | $      | 1,632 |   | $ | 4,696 |   | $ | 3,362 |   |
| Laboratory supplies and expenses |   | 1,242                                 |   | 470                                 |   | 2,373 |   | 725 |   |
| Instrument development costs     |   | 131                                   |   | 346                                 |   | 323 |   | 1,229 |   |
| Clinical trial expenses          |   | 481                                   |   | 196                                 |   | 880 |   | 415 |   |
| Contracted research costs        |   | 470                                   |   | 361                                 |   | 782 |   | 857 |   |
| All others                       |   | 933                                   |   | 491                                 |   | 1,529 |   | 854 |   |
|                             |   | $                                     | 5,604  |                                | $      | 3,496 |   | $ | 10,583 |   | $ | 7,442 |   |

 

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**General and administrative expenses**

 

General and administrative expenses consisted of the following:

 
| **(in thousands)**           |     | **Three  Months Ended June 30,** |     | **Six Months  Ended June 30,** |     |
|------------------------------|----------|---------------------------------------|----------|-------------------------------------|----------|
|                         | **2004** |                                  | **2003** |                                | **2004** |   | **2003** |   |
|                         |     |                                  |     |                                |     |   |   |   |   |
| Salaries, benefits and taxes |     | $                                     | 808      |                                | $        | 513 |   | $ | 1,466 |   | $ | 891 |   |
| Depreciation                 |     | 354                                   |     | 282                                 |     | 681 |   | 522 |   |
| Legal and professional fees  |     | 323                                   |     | 175                                 |     | 617 |   | 359 |   |
| All other expenses           |     | 282                                   |     | 23                                  |     | 448 |   | 224 |   |
|                         |     | $                                     | 1,767    |                                | $        | 993 |   | $ | 3,212 |   | $ | 1,996 |   |

 

**(11)  Intellectual property**

 

Protection of the Company’s intellectual property is a strategicpriority for the Company’s business, and the Company relies on a combination ofpatent, trademark, copyright and trade secret laws to protect its interests.The Company’s ability to protect and use its intellectual property rights inthe continued development and commercialization of its technologies andproducts, to operate without infringing the proprietary rights of others and toprevent others from infringing its proprietary rights is crucial to theCompany’s continued success. The Company will be able to protect its productsand technologies from unauthorized use by third parties only to the extent thatits products and technologies are covered by valid and enforceable patents,trademarks or copyrights, or are effectively maintained as trade secrets,know-how or other proprietary information.

 

In connection with the commercial distribution of its products, theCompany also has obtained trademark registrations in the US for “Immunicon” andthe Immunicon logo.  Trademarkregistrations were also obtained for “CellSave”, “CellTracks”, and theCellTracks AutoPrep System logo by Immunivest Corporation, a wholly ownedsubsidiary of the Company.  The Companyhas filed a number of trademark registration applications in preparation forcommercial distribution activities with respect to future products. Much of theproprietary software and related information utilized in the Company’sinstrument systems is protected by the Company’s copyright rights or by suchrights that the Company has licensed.

 

The Company devotes significant resources to obtaining, enforcing anddefending patents and other intellectual property and protecting its otherproprietary information.

 

The Company has a portfolio of issued patents and patent applications,which we believe provides patent coverage for our proprietary technologies andproducts.  As of August 4, 2004,the Company’s intellectual property estate consisted of 53 issued patents, 127pending patent applications, nine registered trademarks and 19 pendingtrademark registrations.

 

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**Item 2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

***Forward-LookingStatements***

 

*The informationcontained in this quarterly report on Form 10-Q includes “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. These forward-looking statements are often preceded by words such as“hope,” “may,” “believe,” “anticipate,” “plan,” “expect,” “intend,” “assume,”“will” and similar expressions.  Wecaution investors not to place undue reliance on the forward-looking statementscontained in this report. Forward-looking statements speak only as of the dateof this report, reflect management’s current expectations and involve certainfactors, such as risks and uncertainties, that may cause actual results to befar different from those 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; and competitivepressures in our industry.*

 

*The foregoingfactors are discussed in more detail in the section entitled “RiskFactors” contained elsewhere in this report and in our filings with the SEC. Wedo not intend to update any of these factors or to publicly announce theresults of any revisions to any of these forward-looking statements other thanas required under the federal securities laws.*

 

**OVERVIEW**

 

We are developing and commercializing proprietary cell-based researchand diagnostic products with an initial focus on cancer. We believe that ourproducts and underlying technology platforms also have applications in thedevelopment of cancer drugs and cancer research. Furthermore, we believe thatour proprietary technologies also have applications in fields of medicineoutside of cancer.

 

We were incorporated in 1983. Since our inception, we have focused ouractivities on life science research and product development. InMarch 1999, we obtained $10.6 million in financing from the sale ofour convertible preferred stock. As a result, we substantially increasedinvestment in our cancer-related products and technologies, hired additionalkey management team members and redefined our business strategy. Since 1999, wehave devoted substantially all of our efforts to the development of our cellanalysis platforms and diagnostic tools for application in cancer. We completedthe IPO of shares of our common stock on April 21, 2004.  The proceeds to the Company from the IPOwere $49.4 million, net of fees and expenses. In the IPO, the Company sold 6.9 million shares of its common stock,including the underwriters’ over allotment option, at $8.00 per share.  We are a development stage company and haveincurred losses in the last five fiscal years. As of June 30, 2004, we had an accumulated deficit of$77.3 million. We expect to incur substantial losses, which may increaseover the next several years as we:

 

•                  conduct clinicaltrials to expand the uses of our technologies in cancers other than metastaticbreast cancer and to earlier stages of the disease in breast and other cancers;

 

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

 

•                  expand andscale-up our manufacturing capability for both instruments and reagent kits;and

 

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

 

We are highly dependent on our collaboration with Veridex. In addition,we expect to continue to generate substantial losses for at least the next twoyears. We will need to obtain additional funding to support the activitiesdescribed above.

 

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**Veridex collaboration**

 

We expect that substantially all of our revenues from product sales forat least the years 2004 and 2005 will be derived from our relationship withVeridex. Our Development Agreement with Veridex provides Veridex with exclusiveworldwide rights to commercialize cell analysis products based on ourtechnologies in the field of cancer. Veridex received 510(k) clearance from the US Food and DrugAdministration (“FDA”) for the use of the CellSearch Circulating Tumor Cell Kitin the management of metastatic breast cancer on January 21, 2004 and forthe CellSearch Circulating Tumor Cell Control Kit which cleared in June 2004.We are responsible for all cellular research and development, including thecosts of clinical development. Upon any sale by Veridex of these products,including reagents, test kits, consumable products and disposable items,Veridex is obligated to pay us approximately 30% of net sales.

 

Beginning with commercialization of the first product under thisDevelopment Agreement, we are obligated to invest in certain research anddevelopment activities an amount equal to at least 10% of Veridex’s net sales,excluding revenues from instrument sales, from these products. However,beginning with the first calendar year after the amount of these net salesexceeds $250 million; we are only required to invest an amount equal to atleast 8.5% of these net sales. We are also responsible for manufacturingreagents for CellSearch kits in bulk and delivering them to Veridex. We areresponsible for all instrument manufacturing and certain ancillary products. Webelieve that we have manufacturing capacity available at our existing facilitiesto satisfy commercial demand through 2005. Veridex is responsible for fillingand packaging costs for the reagents, as well as sales, marketing,distribution, customer and technical support and field service of our cancerproducts, including instrumentation. We have retained worldwidecommercialization rights to all non-cancer applications of our technologies.

 

The pace and outcome of both our commercialization efforts and clinicaldevelopment programs are difficult to predict. As a result, we anticipate thatour quarterly results will fluctuate for the foreseeable future. In view ofthis variability and of our limited operating history, we believe thatperiod-to-period comparisons of our operating results are not meaningful andyou should not rely on them as indicative of our future performance.

 

**Revenues**

 

We have not generated any significant product revenues since ourinception. We initiated sales activities for instrument platforms and reagentkits for research use only (“RUO”) in the first quarter of 2004.  We currently expect that we and Veridex willlaunch products for *in vitro* diagnostic (“IVD”) use in thethird quarter of 2004. We designated the period from August 2000 untilDecember 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. During the first quarter of 2004 we received anadditional $500,000 in milestone receipts as a partial receipt of the milestonefor commercial readiness for breast cancer monitoring. We will recognize thisas revenue over the estimated life of the related product, which we estimatewill end on December 31, 2007. In addition, we initiated a multi-centerclinical trial for the monitoring of metastatic colorectal cancer, for which weearned a $500,000 milestone payment as of June 30, 2004.  This milestone revenue will be recognizedover the estimated clinical trial period, which we estimate will end onDecember 31, 2006.  We recognized$32,000 and $63,000 as milestone revenue in the three and six months endedJune 30, 2004, respectively.

 

As of June 30, 2004 there is an additional $5.5 million inlicense revenue, which we can earn from Veridex for research-relatedmilestones. We estimate that we will earn these license revenues from researchmilestones over 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.

 

Under the 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.

 

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**Research and development expenses**

 

Our research and development expenses consist of expenses incurred indeveloping reagent kits and instrument platforms and ancillary products, aswell as the clinical research and trial costs to test these kits and systems.These expenses consist primarily of:

 

•           salariesand related expenses for personnel;

 

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

 

•           feespaid to professional service providers in conjunction with independentlymonitoring our clinical trials and acquiring and evaluating data in conjunctionwith our clinical trials.

 

We are responsible for making royalty payments of 1% of sales of ourreagents incorporating intellectual property licensed to us under a licenseagreement with the University of Texas. No royalty payments have been made tothe University of Texas as of June 30, 2004.

 

We expense research and development costs as incurred. We believe thatsignificant investment in product development is a competitive necessity andplan to continue these investments in order to realize the potential of ourproduct candidates and proprietary technologies. We expect to continue to incursignificant costs for clinical research and for trials and to make investmentsto improve our instrument platforms and reagents. From inception throughJune 30, 2004, we have incurred $65.1 million in total research anddevelopment expenses, the majority of which relate to our cell-based research anddiagnostic products.

 

**General and administrative expenses**

 

Our general and administrative expenses consist primarily of salariesand other related costs for personnel in executive, finance, accounting,information technology, legal and human resource functions. Other costs includefacility costs not otherwise included in research and development expense andprofessional fees for legal and accounting services. From inception throughJune 30, 2004, we have incurred $21.7 million in general andadministrative expenses.

 

**Stock-based compensation expenses**

 

Stock-based compensation expense, which is a non-cash charge, resultsfrom stock option grants to employees at exercise prices below the fair valueof the underlying common stock resulting in our recording stock-based compensationexpense associated with such grants. Stock-based compensation expense also is recorded for stock option andwarrant grants to non-employees and for restricted stock grants provided todirectors and advisors in lieu of cash compensation. We amortize the deferredstock-based compensation to operating expenses over the vesting periods of theoptions and grants, subject to adjustment for forfeiture during the vestingperiod. As of June 30, 2004, we have recognized $4.8 million in deferredstock-based compensation expense. For the period from inception throughJune 30, 2004, we have recognized cumulative stock-based compensationexpense of $1.7 million.

 

**Interest income and expense**

 

Interest income consists of interest earned on our cash, cash equivalentsand investments. Interest expense consists of interest incurred on equipmentleases and on debt financings.

 

**CRITICAL ACCOUNTING POLICIES**

 

We prepare our consolidated financial statements in accordance withaccounting principles generally accepted in the United States of America. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses. We base our estimates on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions. Our critical accounting policies include:

 

•                                          revenuerecognition;

 

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•                                          accountingfor research and development expenses;

 

•                                          estimatingthe value of our equity instruments for use in deferred stock-basedcompensation calculations; and

 

•                                          accountingfor income taxes.

 

**Revenue recognition**

 

In accordance 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 throughJune 30, 2004, we have not generated any significant product revenue.Since August 2000, we have earned $5.0 million in license andmilestone payments from Veridex and have received $4.5 million as ofJune 30, 2004. License and milestone payments are deferred and amortizedon a straight-line basis over the product development period as defined for eachspecific product. Amounts received as reimbursement for research anddevelopment expenses are recorded as a reduction in research and developmentexpense as the related costs are incurred.

 

**Accounting for research and developmentexpenses**

 

Our research and development expenses consist primarily of costsassociated with product development for our cancer diagnostic tests. Theseexpenses include the development costs for instrument platforms, clinical trialand development costs and the costs associated with non-clinical supportactivities such as manufacturing process development and regulatory services.Clinical development costs represent internal costs for personnel; externalcosts incurred at clinical sites and contracted payments to third party clinicalresearch organizations to perform certain clinical trials. We have a discoveryresearch effort, which is conducted in part on our premises by our scientistsand in part through collaborative agreements with academic laboratories. Mostof our research and development expenses are the result of the internal costsrelated directly to our employees. We accrue external costs for clinical trialsbased on the progress of the clinical trials, including patient enrollment,progress by the enrolled patients through the trial, and contracted costs withclinical research organizations and clinical sites. We record internal costsprimarily related to personnel in clinical development and external costsrelated to non-clinical trials and basic research when incurred. Significantjudgments and estimates must be made and used in determining the accruedbalance in any accounting period. Actual costs incurred may or may not matchthe estimated costs for a given accounting period. We expect that expenses inthe research and development category will increase for the foreseeable futureas we add personnel, expand our clinical trial activities and increase ourdiscovery research capabilities. The amount of the increase is difficult topredict due to the uncertainty inherent in the timing of clinical trialinitiations, progress in our discovery research program, the rate of patientenrollment and the detailed design of future trials. In addition, the resultsfrom each of our trials will influence the number, size and duration of bothplanned and unplanned trials.

 

**Valuation of equity instruments**

 

We record compensation expense related to options issued to consultantsand options 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**

 

We must make significant management judgments when determining ourprovision for income taxes, our deferred tax assets and liabilities and anyvaluation allowance recorded against our net deferred tax assets. AtJune 30, 2004, we recorded a full valuation allowance of $32.8 millionagainst our net deferred tax asset balance, due to uncertainties related to ourdeferred tax assets as a result of our history of operating losses. Thevaluation allowance is based on our estimates of taxable income by jurisdictionin which we operate and the period over which our deferred tax assets will berecoverable. In the event that actual results differ from these estimates or weadjust these estimates in future periods we may need to change the valuationallowance, which could materially impact our financial position and results ofoperations.

 

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**RESULTS OF OPERATIONS**

 

**Three months ended June 30, 2004 and2003**

 

**Revenue**

 

We segregate revenue into revenue from related party and otherrevenue.  Revenue from related partyprimarily consists of instrument revenue and license revenue.  License revenue from related party decreasedby $506,000 to $42,000 for the three months ended June 30, 2004 from$548,000 for the three months ended June 30, 2003. Since August 2000,we have earned $5.0 million in license and milestone receipts and received$4.5 million as of June 30, 2004 under our Development Agreement withVeridex. 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. During the firstquarter of 2004 we received an additional $500,000 in milestone receipts as apartial receipt of the milestone with commercial readiness for breast cancermonitoring. We will recognize this as revenue over the estimated life of therelated product, which we estimate will end on December 31, 2007. Inaddition, we initiated a multi-center clinical trial for the monitoring ofmetastatic colorectal cancer for which we earned a $500,000 milestone paymentas of June 30, 2004.  Thismilestone revenue will be recognized over the estimated clinical trial period,which we estimate will end on December 31, 2006.  We recognized $32,000 in revenue related to this milestone in thethree months ended June 30, 2004. In August 2003, we entered into aLicense and Supply Agreement with a company whereby we licensed the rights tocertain of our technology and sold 80,000 shares of our Series FConvertible Preferred Stock to the same company at $5.00 per share. Werecognized $80,000 of the proceeds from this sale as a deferred license feepayment and are amortizing this fee over the two years ended August 2005.We recognized $10,000 of this license fee in the three months endedJune 30, 2004. Other revenue, including other revenue from related party,decreased by $66,000 to $19,000 in the second quarter of 2004 from $85,000 inthe second quarter of 2003. In 2003 other revenue consisted principally offunds received from government related grants and are expected to fluctuatefrom year to year.

 
|                               |   | **Three  months  ended  June 30,** |   |
|------------------------------------|--------|----------------------------------------------|--------|
|                               |   | **2004**                                     |   | **2003** |   |
|                               |   | **(in  thousands)**                          |   |
|                               |   |                                         |   |   |   |
| License revenue from related party |   | $                                            | 42     |   | $ | 548 |   |
| Other revenue from related party   |   | 6                                            |   | — |   |
| Other revenue                      |   | 13                                           |   | 85 |   |
|                               |   | $                                            | 61     |   | $ | 633 |   |

 

**Research and development expenses**

 

Research and development expenses increased $2.1 million, or by 60.3%,to $5.6 million in the second quarter of 2004 from $3.5 million inthe second quarter of 2003. Salary and salary-related costs were$2.3 million or 43.8% higher in the second quarter of 2004 as compared to2003 principally due to higher staff levels to engage in research activities in2004 than in 2003 as well as higher stock-based compensation expensesrecognized in 2004. We hired additional personnel throughout 2003 and duringthe first half of 2004 to complete the development of certain instrumentplatforms and to complete the development of our initial cancer monitoring test.The portion of stock-based compensation expenses recognized as part of researchand development salaries was $179,000 in the second quarter of 2004 versus$11,000 in the first quarter of 2003. Laboratory supplies and expenses were$1.2 million, or $772,000 higher, in the second quarter of 2004 than in 2003.The increase in costs was related principally to preparation for the launch ofour initial cancer diagnostic products especially instruments for testing andtraining and reagent related expenses. We also continued to invest in thedevelopment of other applications of our technology in areas both within andoutside the field of cancer diagnostics. Instrument development costs decreasedby $215,000 to $131,000 in the three months ended June 30, 2004 from $346,000in the same period ended June 30, 2003. The principal development work onour CellTracks AutoPrep System and our associated CellSpotter Analyzer wascompleted by mid-2003 and costs associated with development of the instrumentsdeclined thereafter. We anticipate that we will continue to engage ininstrument system improvement activities in 2004 and beyond. Therefore, it islikely that instrument development costs will fluctuate in future periods.

 

17

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Clinical trial expenses increased in the second quarter of 2004 by$285,000 to $481,000 from $196,000 in the second quarter of 2003. We completedour initial pivotal clinical trial for breast cancer monitoring in the firstquarter of 2003 and therefore our costs were higher in 2004. The majority ofeffort in this area in 2003 was related to data analysis and preparation of theassociated regulatory filing with the FDA for the breast cancer test. Weanticipate increasing our clinical trial expenditures in the remainder of 2004and beyond in order to expand the uses of our technology to other cancers andto earlier stages of the disease. Contracted research costs were $109,000higher in the second quarter of 2004 than in the second quarter of 2003. Weemployed contracted support in 2004. We increased our efforts in this area in2004 to help with certain validation activities related to preparing ourmanufacturing processes for initial product launch. A summary of the principalcomponents of our research and development costs for the three months endedJune 30, 2004 and 2003 are shown below:

 
|                                    |   | **Three  months ended  June 30,** |   |
|-----------------------------------------|--------|----------------------------------------|--------|
| **Research and development expenses**   |   | **2004**                               |   | **2003** |   |
|                                    |   | **(in  thousands)**                    |   |
|                                    |   |                                   |   |   |   |
| Salaries, benefits and taxes            |   | $                                      | 2,347  |   | $ | 1,632 |   |
| Laboratory supplies and expenses        |   | 1,242                                  |   | 470 |   |
| Instrument development costs            |   | 131                                    |   | 346 |   |
| Clinical trial expenses                 |   | 481                                    |   | 196 |   |
| Contracted research costs               |   | 470                                    |   | 361 |   |
| All others                              |   | 933                                    |   | 491 |   |
| Total research and development expenses |   | $                                      | 5,604  |   | $ | 3,496 |   |

 

We expect salary related expenses to increase in future years as wehire additional 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:

 

•                                          researchand diagnostic products for cancers other than breast cancer;

 

•                                          testsdesigned to diagnose cancer earlier in the disease; and

 

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

 

Although we will continue to invest in instrument development toimprove performance of the various components of the system and to increase thecapabilities of the system to process larger sample volumes, we expectinstrument development costs as a percentage of total research and developmentexpenditures generally to be lower in future years because we completed theprincipal development work on our initial instrument platforms in 2003.

 

We expect clinical 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.

 

Each of our research and development programs is subject to risks anduncertainties, including the requirement to obtain regulatory approval, thatare outside of our control. As a result of these risks and uncertainties, weare unable to predict the period in which we will achieve profitability. Forexample, our clinical trials may be subject to delays or rejections for avariety of reasons, such as our inability to obtain applicable clearances fromthe FDA or institutional or ethical review boards or to enroll patients at therate that we expect. Moreover, the product candidates we are developing mustovercome significant technological and marketing challenges before they can besuccessfully commercialized.

 

18

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**General and administrative expenses**

 

General and administrative expenses increased by $774,000, or 77.9%, to$1.8 million in the second quarter of 2004 from $1.0 million in 2003.Salary related costs increased by $295,000 in the second quarter of 2004, dueprincipally to increases in personnel in the second half of 2003 and the firstquarter of 2004. We hired additional accounting and administrative personnel inorder to prepare for the additional administrative and reporting activitiesresulting from our transition to a publicly-held company and in preparation forthe commercial launch of our initial products. Depreciation expense increasedby $72,000 to $354,000 in the second quarter of 2004 from $282,000 in 2003 as aresult of an expansion of our manufacturing facility in 2003 at a cost of$1.5 million in preparation for the commercial launch of our products.

 

**Interest income**

 

Interest income increased by $128,000, or 412.9% in the quarter endedJune 30, 2004 from $31,000 in 2003 to $159,000 in the second quarter of2004. The increase in interest income was primarily a result of an increase inaverage invested cash balances in 2004. This in turn was the result of the netcash proceeds of $49.4 million from our IPO which was completed onApril 21, 2004.

 

**Interest expense**

 

Interest expense increased by $30,000, or 21.7%, to $168,000 for thefirst quarter of 2004 from $138,000 for 2003. The increase was due to higheraverage debt outstanding in 2004 compared to 2003, principally due to theadditional $7.0 million equipment line of credit that we entered into inApril 2003.

 

**Stock-based compensation expenses**

 

Stock-based compensation expenses were $275,000 and $46,000 for thethree months ended June 30, 2004 and 2003, respectively. This increase wasdue to an increase in the number of options granted to employees andconsultants and an increase in the fair value of our common stock as compared tothe exercise price at issuance. We recognized these expenses as part ofresearch and development expenses and general and administrative expenses asshown below.

 
| **Stock-based compensation  expenses included in:** |     | **Three  Months  Ended  June 30,** |     |
|-----------------------------------------------------|----------|-----------------------------------------|----------|
|                                                | **2004** |                                    | **2003** |   |
|                                                |     | **(in  thousands)**                     |     |
|                                                |     |                                    |     |   |   |
| Research and development expenses                   |     | $                                       | 179      |   | $ | 11 |   |
| General and administrative expenses                 |     | 96                                      |     | 35 |   |
|                                                |     | $                                       | 275      |   | $ | 46 |   |

 

**Income Taxes**

 

We have incurred net operating losses since our inception and haveconsequently not paid any federal, state or foreign taxes. As of June 30,2004, we had approximately $73.4 million of net operating losscarryforwards and approximately $1.9 million in research and development taxcredit carryforwards available to offset future regular and alternative taxableincome. If not utilized, these net operating loss carryforwards and tax creditswill begin to expire in 2005. If we do not achieve profitability, our netoperating loss carryforwards may be lost. In addition, the Internal RevenueCode places certain limitations on the annual amount of net operating losscarryforwards that can be utilized if certain changes in our ownership occur.We are currently not subject to these limitations.

 

**Net loss**

 

The net loss of $7.3 million in the second quarter of 2004 was$3.6 million, or 97.1%, higher than the loss of $3.7 million in the secondquarter of 2003.

 

19

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At the completion on April 21, 2004 of the Company’s initialpublic offering approximately 52.1 million preferred shares were converted into15.5 million shares of common stock.  Asthe result, the net loss per common share of $0.39 in the second quarter of2004 was $7.71 per share, or 95.2%, lower than the loss per common share of$8.10 in the second quarter of 2003. Weighted average common shares outstandingduring the three months ended June 30, 2004 were approximately 18.7million compared to 458,000 for the same period in 2003.

 

**Six months ended June 30, 2004 and 2003**

 

**Revenue**

 

We segregate revenue into license revenue received from related partyand instrument revenue received from related party and other revenue. Licenserevenue from related party decreased by $745,000 to $83,000 for the six monthsended June 30, 2004 from $828,000 for the six months ended June 30,2003. 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, including$828,000 in the six months ended June 30, 2003. During the first quarterof 2004, we received an additional $500,000 in milestone receipts as a partialreceipt of the milestone for commercial readiness for breast cancer monitoring.We will recognize this as revenue over the estimated life of the relatedproduct, which we estimate will end on December 31, 2007. We recognized$63,000 related to this milestone in the six months ended June 30, 2004. Inaddition, we initiated a multi-center clinical trial for the monitoring ofmetastatic colorectal cancer for which we earned a $500,000 milestone paymentas of June 30, 2004.  Thismilestone revenue will be recognized over the estimated clinical trial period,which we estimate will end on December 31, 2006.  In August 2003, we entered into a License and SupplyAgreement with a company whereby we licensed the rights to certain of ourtechnology and sold 80,000 shares of our Series F Convertible PreferredStock to the same company at $5.00 per share. We recognized $80,000 of theproceeds from this sale as a deferred license fee payment and are amortizingthis fee over two years. We recognized $20,000 of this license fee in the sixmonths ended June 30, 2004.

 

We sold an instrument system to Veridex in 2004 and recognized revenueof $103,000 as revenue from related party.

 

Other revenue decreased by $212,000 to $32,000 in the first half of2004, from $244,000 in the first half of 2003. Other revenue consistsprincipally of funds received from government related grants and is expected tofluctuate from year to year.

 
|                                  |   | **Six Months  Ended  June 30,** |   |
|---------------------------------------|--------|--------------------------------------|--------|
|                                  |   | **2004**                             |   | **2003** |   |
|                                  |   | **(in  thousands)**                  |   |
|                                  |   |                                 |   |   |   |
| License revenue from related party    |   | $                                    | 83     |   | $ | 828 |   |
| Instrument revenue from related party |   | 103                                  |   | — |   |
| Other revenue                         |   | 32                                   |   | 244 |   |
|                                  |   | $                                    | 218    |   | $ | 1,072 |   |

 

**Research and development expenses**

 

Research and development expenses increased by $3.2 million, or by42.2%, to $10.6 million in the first half of 2004 from $7.4 millionin the same period in the prior year. Salary and salary related costs were$4.7 million or 39.7% higher in the first half of 2004 as compared to2003, principally due to higher staff levels to engage in research activitiesin 2004 than in 2003 as well as higher stock-based compensation expensesrecognized in 2004. We hired additional personnel throughout 2003 and duringthe first half of 2004 to complete the development of certain instrumentplatforms and to complete the development of our initial cancer monitoringtest. The portion of stock-based compensation expenses recognized as part ofresearch and development salaries was $461,000 in the first half of 2004compared to $30,000 in the first half of 2003. Laboratory supplies and expenseswere $2.4 million, or $1.6 million higher, in the first half of 2004 than in2003. The increase in costs was related principally to preparation for thelaunch of our initial cancer diagnostic products especially instruments fortesting and training and for reagent related expenses. We also continued toinvest in the development of other applications of our technology in areas bothwithin and outside the field of cancer diagnostics.

 

20

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Instrument development costs decreased by $906,000 to $323,000 in thesix month period ended June 30, 2004 from $1.2 million in the prior yearperiod. The principal development work on our CellTracks AutoPrep System andour associated CellSpotter Analyzer was completed by mid-2003 and costsassociated with development of the instruments declined thereafter. Weanticipate that we will continue to engage in instrument system improvementactivities in 2004 and beyond. Therefore, it is likely that instrumentdevelopment costs will fluctuate in future periods.

 

Clinical trial expenses increased in the first half of 2004 by $465,000to $880,000 from $415,000 in the first half of 2003. We completed our initialpivotal clinical trial for breast cancer monitoring in the first quarter of2003 and therefore our costs were higher in 2004. The majority of effort inthis area in 2003 was related to data analysis and preparation of theassociated regulatory filing with the FDA for the breast cancer test. Weanticipate increasing our clinical trial expenditures in the remainder of 2004and beyond in order to expand the uses of our technology to other cancers andto earlier stages of the disease. Contracted research costs were $75,000 lowerin the first half of 2004 than in the first half of 2003. We increased ourefforts in this area in 2003 to help with certain validation activities relatedto preparing our manufacturing processes for initial product launch.

 

A summary of the principal components of our research and developmentcosts for the six months ended June 30, 2004 and 2003 are shown below:

 
|                                    |   | **Six  Months Ended  June 30,** |   |
|-----------------------------------------|--------|-------------------------------------------|--------|
| **Research and development expenses**   |   | **2004**                                  |   | **2003** |   |
|                                    |   | **(in  thousands)**                       |   |
|                                    |   |                                      |   |   |   |
| Salaries, benefits and taxes            |   | $                                         | 4,696  |   | $ | 3,362 |   |
| Laboratory supplies and expenses        |   | 2,373                                     |   | 725 |   |
| Instrument development costs            |   | 323                                       |   | 1,229 |   |
| Clinical trial expenses                 |   | 880                                       |   | 415 |   |
| Contracted research costs               |   | 782                                       |   | 857 |   |
| All others                              |   | 1,529                                     |   | 854 |   |
| Total research and development expenses |   | $                                         | 10,583 |   | $ | 7,442 |   |

 

We expect salary related expenses to increase in future years as wehire additional 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:

 

•                                          researchand diagnostic products for cancers other than breast cancer;

 

•                                          testsdesigned to 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.

 

Although we will continue to invest in instrument development toimprove performance of the various components of the system and to increase thecapabilities of the system to process larger sample volumes, we expectinstrument development costs as a percentage of total research and developmentexpenditures generally to be lower in future years because we completed theprincipal development work on our initial instrument platforms in 2003.

 

We expect clinical 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.

 

Each of our research and development programs is subject to risks anduncertainties, including the requirement to obtain regulatory approval, thatare outside of our control. As a result of these risks and uncertainties, weare unable to predict the period in which we

 

21

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will achieve profitability. For example, our clinical trials may besubject to delays or rejections for a variety of reasons, such as our inabilityto obtain applicable clearances from the FDA or institutional or ethical reviewboards or to enroll patients at the rate that we expect. Moreover, the productcandidates we are developing must overcome significant technological andmarketing challenges before they can be successfully commercialized.

 

**General and administrative expenses**

 

General and administrative expenses increased by $1.2 million, or60.9%, to $3.2 million in the first half of 2004 from $2.0 million in2003. Salary related costs increased by $575,000 in the first half of 2004 dueprincipally to increases in personnel in the second half of 2003 and the firstquarter of 2004. We hired additional accounting and administrative personnel inorder to prepare for the additional administrative and reporting activitiesresulting from our transition to a publicly-held company and in preparation forthe commercial launch of our initial products. Depreciation expense increasedby $159,000 to $681,000 in the first half of 2004 from $522,000 in 2003 as aresult of an expansion of our manufacturing facility in 2003 at a cost of$1.5 million in preparation for the commercial launch of our products.

 

**Interest income**

 

Interest income increased by $104,000 or 88.9% in the first half of2004 to $221,000 from $117,000 in 2003. The increase in interest income wasprimarily a result of an increase in average invested cash balances in 2004.This in turn was the result of the net cash proceeds of $49.4 million from ourIPO, which was completed on April 21, 2004.

 

**Interest expense**

 

Interest expense increased by $79,000, or 31.3%, to $331,000 for thefirst half of 2004 from $252,000 for 2003. The increase was due to higheraverage debt outstanding in 2004 compared to 2003, principally due to theadditional $7.0 million equipment line of credit that we entered into inApril 2003.

 

**Stock-based compensation expenses**

 

Stock-based compensation expenses were $676,000 and $130,000 for thesix months ended June 30, 2004 and 2003, respectively. This increase wasdue to an increase in the number of options granted to employees andconsultants and an increase in the fair value of our common stock as comparedto the exercise price at issuance. We recognized these expenses as part ofresearch and development expenses and general and administrative expenses asshown below.

 
| **Stock-based compensation  expenses included in:** |     | **Six Months  Ended  June 30,** |     |
|-----------------------------------------------------|----------|--------------------------------------|----------|
|                                                | **2004** |                                 | **2003** |   |
|                                                |     | **(in  thousands)**                  |     |
|                                                |     |                                 |     |   |   |
| Research and development expenses                   |     | $                                    | 461      |   | $ | 30 |   |
| General and administrative expenses                 |     | 215                                  |     | 100 |   |
|                                                |     | $                                    | 676      |   | $ | 130 |   |

 

**Income Taxes**

 

We have incurred net operating losses since our inception and haveconsequently not paid any federal, state or foreign taxes. As of June 30,2004, we had approximately $73.4 million of net operating loss carryforwardsand approximately $1.9 million in research and development tax creditcarryforwards available to offset future regular and alternative taxableincome. If not utilized, these net operating loss carryforwards and tax creditswill begin to expire in 2005. If we do not achieve profitability, our netoperating loss carryforwards may be lost. In addition, the Internal RevenueCode places certain limitations on the annual amount of net operating losscarryforwards that can be utilized if certain changes in our ownership occur.We are currently not subject to these limitations.

 

22

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**Net loss**

 

The net loss of $13.7 million in the first half of 2004 was $5.4million, or 65.9%, higher than the loss of $8.3 million in the first halfof 2003.

 

At the completion on April 21, 2004 of our IPO, approximately 52.1million preferred shares were converted into 15.5 million shares of commonstock.  As the result, the net loss percommon share of $1.42 in the six months ended June 30, 2004 was $16.93 pershare, or 92.3%, lower than the loss per common share of $18.35 in the firstsix months of 2003. Weighted average common shares outstanding during the sixmonths ended June 30, 2004 were approximately 9.6 million compared to450,000 for the same period in 2003.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

We are a development stage company. We have financed our operationssince inception through private equity and debt financings, license andmilestone revenues from corporate collaborations, capital equipment andleasehold financing, government grants and interest earned on cash andinvestments. Since our inception, we have generated net losses of$77.3 million from operations.

 

Cash and short term investments increased by $37.0 million in thesix month period ended June 30, 2004 to $67.6 million from$30.6 million as of December 31, 2003, principally due to thecompletion of our IPO on April 21, 2004. The proceeds to the Company from the IPO were $49.4 million, net of feesand expenses.

 

Our operating activities used net cash of $11.5 million in thefirst half of 2004, $6.5 million in 2003 and $66.9 million frominception through June 30, 2004. During these periods, we recognized increases in expenses causedprincipally by increases in research and development and expanded clinicaltrials, which resulted in increasing operating cash outflows.

 

We used cash of $2.7 million in 2004 in our investing activitiesprincipally in the purchases of property and equipment and short terminvestments. Our investing activities provided cash of $190,000 in 2003.  We have used $10.9 million in investingactivities from inception, almost entirely for the purchase of property andequipment.

 

Our financing activitiesprovided cash of $49.7 million in the first half of 2004, $18.5 million in theprior year period and $143.9 million since inception.  On April 21, 2004, we completed our IPO.  In the IPO, we sold 6.9 million shares ofour common stock at $8.00 per share. We raised an aggregate of $49.4 million,net of fees and expenses.  In connectionwith the IPO, we incurred costs totaling $1.9 million and paid these expensesin the current year.  All of the shareswere sold by us.  The net proceeds fromthe IPO will be used for product commercialization, including manufacturing,and for clinical trials, research and development, capital expenditures, andworking capital and other general corporate purposes.  Our common stock trades on The Nasdaq National Market System underthe symbol “IMMC.”  We had proceeds fromnew borrowings of $1.5 million and made principal payments of $1.7 million inthe first half of 2004 as compared to new borrowings of $3.0 million andprincipal payments of $1.5 million in the prior year period.  From inception to June 30, 2004 we raised$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.

 

Since March 1999, we also borrowed $17.1 million throughequipment lines of credit and received $4.5 million in milestone receiptsfrom Veridex. Our liquidity requirements are the result primarily of researchand development expenditures, capital equipment expenditures and payments onoutstanding indebtedness. Sales of our common and preferred stock, includingthe IPO were as follows:

 

23

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| **Summary of all sales of common  and convertible preferred stock** |   | **Year(s)** |   | **Number of  shares** |   | **Price  per share** |   | **Net  proceeds**   |    | **Equivalent  common shares** |       |
|---------------------------------------------------------------------|--------|-------------|--------|-----------------------|--------|----------------------|--------|---------------------|---------|-------------------------------|------------|
|                                                                |   |        |   |                  |   |                 |   | **(in  thousands)** |    |                          |       |
|                                                                |   |        |   |                  |   |                 |   |                |    |                          |       |
| 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 |   |
|                                                                     |        |             |        |                       |        |                      |        |                     |         |                               |            |  |  |

 

As of June 30, 2004, we did not have any off balance sheetfinancing arrangements.

 

The following table summarizes our contractual obligations and relatedinterest charges on lines of credit at June 30, 2004 and the effects suchobligations are expected to have on our liquidity and cash flows in futureperiods.

 
|                                |   | **Payments  due in** |   |
|-------------------------------------|--------|----------------------|--------|
| **Contractual obligations**         |   | **Total**            |   | **2004** |   | **2005 and  2006** |   | **2007 and  2008** |   | **After  2008** |   |
|                                |   | **(in  thousands)**  |   |
|                                |   |                 |   |   |   |   |   |   |   |   |   |
| Lines of credit                     |   | $                    | 7,857  |   | $ | 2,200 |   | $ | 5,246 |   | $ | 411 |   | — |   |
| Operating leases                    |   | 4,890                |   | 537 |   | 1,482 |   | 1,507 |   | 1,364 |   |
| Open purchase order commitments (1) |   | 5,229                |   | 5,229 |   | — |   | — |   | — |   |
| Total contractual obligations       |   | $                    | 17,976 |   | $ | 7,966 |   | $ | 6,728 |   | $ | 1,918 |   | $ | 1,364 |   |
|                                     |        |                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                  The amounts includedin open purchase order commitments are subject to performance under thepurchase order by the supplier of the goods or services and do not become ourobligation until such performance is rendered. The amount shown is principally for the purchase of materials for ourinstrument platforms, which we anticipate will be sold by us to customers.

 

We also have contingent obligations for research and development andclinical trial 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 June 30, 2004 we have not incurred any costsrelated to clinical trials for a product for general population screening, andwe do not anticipate spending any funds on clinical trials toward such aproduct through 2004.

 

In addition, if we achieve certain levels of sales of our reagents wemay receive up to an additional $10.0 million in milestone payments fromVeridex, although we do not expect to receive any milestone payments related tosales goals until at least 2007.

 

The Development 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 ofcertain instrument and clinical trial milestones. We have earned$5.0 million of these milestone payments

 

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and have received $4.5 million as of June 30, 2004. We expect to earnthe remaining $5.5 million over the next three to five years.

 

The following table summarizes certain information pertaining to thesepotential future 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**Completed 6/30/04** | **(2)** |
|                                                             |                                                                                                                                                                | •     Steering  committee approves regulatorysubmission                                                                                                                                                                               |    | 11/30/05           |    | 500,000                      |    |
|                                                             |                                                                                                                                                                |                                                                                                                                                                                                                                                           |    |               |    |                         |    |
| Prostate cancer                                                  |                                                                                                                                                                | •     Feasibility  of large blood volume method demonstrated and product concept proposed                                                                                                                                             |    | 9/30/04            |    | 300,000                      |    |
|                                                             |                                                                                                                                                                | •     First  patient enrolled in 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                      |    |
|                                                             |                                                                                                                                                                | •     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, second product completes production readiness review, and third  product demonstrates proof of principle and acquired antibody |    | 9/30/04            |    | 200,000                      |    |
|                                                             |                                                                                                                                                                |                                                                                                                                                                                                                                                           |    |               |    |                         |    |
| Large volume sample processor                                    |                                                                                                                                                                | •     Steering  committee approves commercial readiness                                                                                                                                                                               |    | 7/31/06            |    | 500,000                      |    |

 

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(1)          $500,000 of the $1,500,000 milestone paymentpertaining to breast cancer therapy monitoring was paid to us by Veridex inFebruary 2004 pursuant to Veridex’s receipt of 510(k) clearance from theFDA in January 2004 for use of the CellSearch Circulating Tumor Cell Kit.The remaining $1,000,000 would become payable upon completion of the paymentcriteria discussed above. In addition, we and Veridex agreed inNovember 2003 that there would be no target date for completion of thismilestone and that in lieu of a target date, Veridex would only be obligated topay us 30.5% of net sales for the cell analysis products related to thisspecific milestone for the term of this agreement, instead of 31% of net salesfor such products. The Company will continue to receive 31% for all otherproducts.

(2)          We initiated a multi-center clinical trial forthe monitoring of metastatic colorectal cancer.  The initiation of this trial completed a milestone in ourDevelopment Agreement with Veridex for which we earned a $500,000 milestonepayment.  This milestone payment will berecognized over the trial period, which we estimate will end onDecember 31, 2006.

 

We do not currently expect that any of the specific milestone paymentsdiscussed above will be materially delayed beyond their applicable targetdates. However, because these milestone payments are related to the successfulcompletion of the payment criteria summarized above, including completion ofclinical trials, development activities and receipt of regulatory clearances,we may be unable to successfully complete the payment criteria in a timelymanner, if at all. Veridex is responsible under the Development Agreement forobtaining all regulatory clearances for indications related to the CellSearchkit, in consultation with us, for these cell analysis products in the field ofcancer.  Also, we and Veridex willcontinue to evaluate our development program in cancer, particularly clinicaldevelopment and may negotiate changes to milestones that have not yet beenachieved, although we do not expect that the aggregate amount of the milestoneswill change.

 

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If we do not successfully complete the payment criteria for a givenfuture milestone, we will not receive the applicable milestone payment. If wedo not successfully complete the payment criteria by the target date for agiven milestone, we will continue to be entitled to receive the milestonepayment in the 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 agency arrangement with Veridex withrespect to our sample preparation and cell analysis systems, such as theCellTracks AutoPrep System and CellSpotter Analyzer. Under this arrangement,Veridex is our exclusive sales, invoicing and collecting agent and exclusiveinstrument and technical service provider for these systems in the field ofcancer. Veridex is responsible for all expenses for marketing, sales and training,and we are responsible for all software development and validation as well asquality control and quality assurance. We are responsible for shipping systemspursuant to purchase orders received by Veridex. We are obligated to payVeridex a commission on each sale or lease of these sample preparation and cellanalysis systems of up to 15% of the invoice price, subject to a minimum grossprofit margin received by us on each system of 27.5%. Some customers may enterinto a reagent rental agreement with Veridex, whereby the reagent price alsocarries an amortized cost of the instrument, based on an agreed test volume. Inthese cases, Veridex will pay us a percentage of the fully loaded cost of theinstrument when it is placed in the account. We are responsible for the costsassociated with the one-year warranty period. Veridex has the option under theagreement to convert the sales agency relationship to a sole distributorshiparrangement upon 12-months’ written notice. However, we do not anticipate earning significant gross margins orincurring significant losses on the sale, lease or rental of our CellTracksAutoPrep System or our CellSpotter Analyzer. We anticipate that the majority ofour future gross margins and future profits derived under our agreement withVeridex will result from the sales of reagents and disposables.

 

Under this distributor arrangement, we would be required to supplyVeridex based on the forecasts provided to us by Veridex and the actual ordersfor these systems placed with us by Veridex. The allocation of costs andexpenses between us and Veridex would remain substantially the same and wewould remain responsible for the costs associated with the one-year warrantyperiod. In addition, instead of Veridex receiving up to a 15% commission afterdeducting the 27.5% gross profit margin on each sale or lease, these systemswould be sold to Veridex at a transfer price that provides a 27.5% gross profitmargin to us, and Veridex would retain the proceeds from their sales of thesesystems, but would be required to remit to us any proceeds from their sales tothe extent that the proceeds of such sales, after deducting 15%, exceed thetransfer price for these systems.

 

Following commercialization, if we and Veridex are able to generateproduct sales under the Development Agreement, we are required to invest anamount ranging from between 8.5% and 10% of total net product sales by Veridex,excluding revenue from cell analysis system sales, in research and developmentactivities for cancer-related cell analysis products. These research anddevelopment activities may consist of any activities, such as productimprovements, product line extensions and clinical trials, conducted to achievethe milestones described above, to advance the development program designed bythe steering committee for this agreement, or to enhance the cancer-relatedcell analysis products or sample preparation and cell analysis systems based onour technologies.

 

Based on our operating plans, we believe that our available cash includingthe net proceeds from our IPO will be sufficient to finance operations andcapital expenditures for at least 18 months from the date of this QuarterlyReport on Form 10-Q. Our future capital requirements include, but are notlimited to, supporting our research and development efforts and our clinicaltrials, although we are not obligated to meet any absolute minimum dollarspending requirements under our current operating agreements. Our futurecapital requirements will depend on many factors, including the scope andprogress made in our research and development activities, our clinical trialsand capital requirements related to our commercialization efforts. We had$67.6 million in cash on hand and short term investments as ofJune 30, 2004 and we do not currently have access to any unused lines ofcredit or other committed sources of financing. We plan to use the proceedsfrom the IPO and our cash on hand to continue to develop our cancer diagnosticproducts beyond breast cancer to other types of solid tissue cancers as well asto explore the uses of our technology in earlier stages of the cancer diseaseprocess. Also, we plan to explore development of uses for our technologyoutside of cancer such as in cardiovascular disease. We plan to use the proceedsfrom the IPO, anticipated funds generated from the sales of our products aswell as additional equity or debt-related offerings to finance our futuredevelopment efforts. We may not be successful in generating sufficient productsales or raising sufficient funds from the sale of equity or debt securities tosupport the research and development expenses necessary to expand the uses ofthe technology into other cancers and in non-cancer diseases. In addition, ifwe are unsuccessful in our product development efforts, additional financingmay not be available in sufficient amounts or on terms acceptable to us, if atall. If we are 

 

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unable to obtain additional financing, we may elect to reduce the scopeof, delay or eliminate some or all of our planned research, development andcommercialization activities, which could harm our financial condition andoperating results.

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-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. We have adopted the disclosure requirements of this statement. InMarch 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 toEmployees,” which we currently follow. We will continue to monitor the actionsof the FASB and assess the impact, if any, on our consolidated financialstatements.

 

In March 2004, the FASB approved the consensus reached on the EITFIssue 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. The accounting provisions of EITF 03-1 are effective for allreporting periods beginning after June 15, 2004, while the disclosurerequirements are effective only for annual periods ending after June 15,2004. The company has evaluated the impact of the adoption of EITF 03-1 anddoes not believe the impact will be significant to the company’s overallresults of operations or financial position.

 

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**Risk factors**

 

**FACTORS THAT MAYAFFECT FUTURE RESULTS**

 

*In addition to otherinformation contained herein 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, expectto continue to incur substantial losses, and might never achieve or maintainprofitability.**

 

We are a development stage company with limited operating history. Wehave incurred significant net losses since we began operations in 1983.  As of June 30, 2004, we had a deficitaccumulated during our development stage of $77.3 million.  For the first half of 2004 and 2003 we hadnet losses of $13.7 million and $8.3 million, respectively.  These losses have resulted principally fromcosts incurred in our research and development programs and from our generaland administrative expenses. Because our operating expenses are likely to increasesignificantly in the near term, we will need to generate significant additionalrevenue to achieve profitability. We do not expect to have any significantoperating revenue from the sales of our products until at least the second halfof 2004. Even after we begin selling our products, we expect our losses tocontinue to increase as a result of ongoing research and development andclinical trial expenses, as well as increased manufacturing, sales andmarketing expenses. These losses, among other things, have had and willcontinue to have an adverse effect on our working capital, total assets and stockholders’ equity. Because ofthe numerous risks and uncertainties associated with our product developmentefforts, 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 isterminated, we may be unable to commercialize effectively certain of ourproducts based on our technologies in the field of cancer.**

 

We entered into a development, license and supply agreement withVeridex, under which we granted to Veridex a worldwide exclusive license in thefield of cancer to commercialize cell analysis products based on ourtechnologies. We also appointed Veridex as our exclusive sales, invoicing andcollection agent for our cell analysis instrumentation in cancer. Prior toshipment for commercial sale of the first product resulting from thisagreement, Veridex may terminate this agreement with or without reason byproviding us with 180 days’ prior written notice. Thereafter, Veridex mayterminate this agreement with or without reason at any time by providing uswith 24 months’ prior written notice. Veridex also may terminate thisagreement if we are in material breach or are acquired by a competitor in theIVD field. In addition, while we have granted Veridex the exclusive right tomarket, 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:

 

•                                          wewould incur significant delays and expense in the commercialization of theseproducts;

 

•                                          wemight be unable to enter into a similar agreement with another company withsimilar resources to commercialize these products and perform these functionson acceptable terms, if at all; and

 

•                                          wemight be unable to commercialize these products or perform these functionssuccessfully ourselves.

 

Any of these outcomes could result in delays in our ability to generaterevenues from the sales of these products, an increase in our expenses and aresulting adverse impact on our operations and financial results, and the valueof our common stock would likely decline.

 

Following commercialization, if we and Veridex are able to generateproduct sales under our agreement, we are required to invest an amount rangingfrom between 8.5% and 10% of total net product sales by Veridex, excludingrevenue from cell analysis system sales, in research and development forcancer-related cell analysis products.

 

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**If our products and Veridex’s products do notachieve market acceptance, we will be unable to generate significant revenuesfrom them.**

 

The future commercial success of our products and of Veridex’s productsbased on our technologies will depend primarily on:

 

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

 

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

 

To accomplish this, we and Veridex will need to convince oncologists,primary care physicians, surgeons, laboratory professionals and other membersof the medical and biotechnology communities of the benefits of these productsthrough published papers, presentations at scientific conferences andadditional clinical trials. If we and Veridex are not successful in theseefforts, the market acceptance for these products could be limited.Additionally, if ongoing or future clinical trials result in unfavorable orinconsistent results, these products may not achieve market acceptance. Otherfactors that might influence market acceptance of these products include thefollowing:

 

•                                          evidenceof clinical utility;

 

•                                          abilityto obtain sufficient third-party coverage or reimbursement;

 

•                                          convenienceand ease of administration;

 

•                                          availabilityof alternative and competing diagnostic products;

 

•                                          cost-effectiveness;

 

•                                          effectivenessof marketing, distribution and pricing strategy; and

 

•                                          publicityconcerning these products or competitive products.

 

If these products are unable to gain broad market acceptance, ourbusiness will suffer.

 

**If we or Veridex are not able to obtain allof the regulatory approvals and clearances required to commercialize ourproducts, our business would be significantly harmed.**

 

The products based on our technologies are generally regulated asmedical devices by the FDA and comparable agencies of other countries. In particular,FDA regulations govern, among other things, the activities that we and Veridexperform, including product development, product testing, product labeling,product storage, pre-market clearance or PMA approval, manufacturing,advertising, promotion, product sales, reporting of certain product failuresand distribution.

 

Most of the products that we plan to develop and commercialize in theUS will require either pre-market notification, or 510(k) clearance, or PMAapproval from the FDA prior to marketing. The 510(k) clearance process usuallytakes from two to twelve months from submission, but can take longer. The PMAprocess is much more costly, lengthy, uncertain and generally takes from one totwo years or longer from submission. On July 1, 2004, we were informed byVeridex that the CellSearch Circulating Tumor Cell Control Kit received U.S.FDA 510(k) clearance for in vitro diagnostic use.

 

All of the products that we or Veridex intend to submit for FDAclearance or approval will be subject to substantial restrictions, including,among other things, restrictions on the indications for which we and Veridexmay market these products, which could result in lower revenues. The marketingclaims we and Veridex will be permitted to make in labeling or advertisingregarding our cancer diagnostic products, if cleared or approved by the FDA,will be limited to those specified in any clearance or approval. We expect that

initially many of these products will be limited to RUO. In addition,both we and Veridex are subject to inspection and marketing

 

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surveillance by the FDA to determine our compliance with regulatoryrequirements. If the FDA finds that we or Veridex have failed to comply withthese requirements, it can institute a wide variety of enforcement actions,ranging from a public warning letter to more severe sanctions, including:

 

•                                          fines,injunctions and civil penalties;

 

•                                          recallor seizure of our products or Veridex’s products;

 

•                                          operatingrestrictions, partial suspension or total shutdown of production;

 

•                                          denialof requests for 510(k) clearances or pre-market approvals of productcandidates;

 

•                                          withdrawalof 510(k) clearances or pre-market approvals already granted;

 

•                                          disgorgementof profits; and

 

•                                          criminalprosecution.

 

Any of these enforcement actions could affect our ability or Veridex’sability to commercially distribute our products in the US and may also harm ourability to conduct the clinical trials necessary to support the marketing,clearance or approval of these products.

 

**If the third-party manufacturers we rely oneither refuse or are unable to successfully manufacture certain of ourproducts, we may be unable to commercialize these products.**

 

We have limited commercial manufacturing experience and capabilities.We currently assemble, test and release the CellSpotter and CellTracks AutoPrepSystem, as well as bulk reagents and other associated products used with theCellTracks AutoPrep System, at our facility located in Huntingdon Valley,Pennsylvania. We currently have adequate manufacturing capacity to meetanticipated demand for 2004 and 2005. However, in order to meet anticipateddemand thereafter, we will have to expand our manufacturing processes andfacilities or increase our reliance on third-party manufacturers. Under ouragreement with Veridex, we might be required to establish a secondmanufacturing facility or qualify a contract manufacturer in the future. Wemight encounter difficulties in expanding our manufacturing processes andfacilities or in expanding our relationships with third-party manufacturers andmight be unsuccessful in overcoming these difficulties. In that event, ourability to meet product demand could be impaired or delayed.

 

We face additional risks inherent in operating a single manufacturingfacility for those products we manufacture ourselves. We do not havealternative production plans in place or alternative facilities available atthis time. If there are unforeseen shutdowns to our facility, we will be unableto satisfy customer orders on a timely basis with respect to these products. Werely currently and intend to continue to rely significantly in the future onthird-party manufacturers to produce some of our products. For example, we aredependent on a small, private, contract design, engineering and manufacturingcompany, Astro Instrumentation, LLC, or Astro, for our CellTracks AutoPrepSystem. If Astro loses key personnel or encounters financial or otherdifficulties, they may be unable to continue to manufacture this system andprovide ongoing design and engineering support for commercialization and futureenhancements of this system, and we may have difficulty replacing them. Inaddition, we currently use a third-party manufacturer for our CellSave PreservativeTube. We are dependent on these third-party manufacturers to perform theirobligations in a timely and effective manner and in compliance with FDA andother regulatory requirements. If these third-party manufacturers fail toperform their obligations,  ourcompetitive position and ability to generate revenue could be adverselyaffected in a number of ways, including:

 

•                                          wemight not be able to initiate or continue clinical trials on products that areunder development;

 

•                                          wemight be delayed in submitting applications for regulatory approvals andclearances for products; and

 

•                                          wemight not be able to meet commercial demands for any approved or clearedproducts.

 

Any failures in manufacturing these products may also result in abreach of our agreement with Veridex.

 

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**If third-party payors do not reimbursecustomers for our products and Veridex’s products, they might not be used orpurchased, which would adversely affect our revenues.**

 

The majority of the sales of our products and Veridex’s products basedon our technologies in the US and other markets will depend, in large part, onthe availability 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 not yet been commercially introduced, third-partypayors have no history of reimbursing for the cost of these products.Third-party payors are often reluctant to reimburse healthcare providers forthe use of medical diagnostic products incorporating new technology. Inaddition, third-party payors are increasingly limiting reimbursement coveragefor medical diagnostic products and, in many instances, are exerting pressureon medical products suppliers to reduce their prices. Consequently, third-partyreimbursement might not be consistently available or adequate to cover the costof our products. This could limit our ability or Veridex’s ability tocommercialize and sell these products or cause the prices of these products tobe reduced, which would adversely affect our operating results.

 

Because each third-party payor individually approves reimbursement,obtaining these approvals is a time-consuming and costly process that willrequire us and Veridex to provide scientific and clinical support for the useof each of these products to each third-party payor separately with noassurance that approval will be obtained. This process could delay the marketacceptance of new products and could have a negative effect on our revenues andoperating results.

 

**If we or any of our third-party manufacturersdo not maintain high standards of manufacturing in accordance with QualitySystem Regulations, our ability to develop, and Veridex’s and our ability tocommercialize our products, could be delayed or curtailed.**

 

We and any third-party manufacturers that we currently rely on or willrely on in the future, including those we rely on to produce our CellTracksAutoPrep System and CellSave Preservative Tube, must continuously adhere to thecurrent good manufacturing practices, or cGMP, set forth in the FDA’s QualitySystem Regulations, or QSR, and enforced by the FDA through its facilities inspectionprogram. In complying with QSR, we and any of our third-party manufacturersmust expend significant time, money and effort in design and development,testing, production, record-keeping and quality control to assure that ourproducts meet applicable specifications and other regulatory requirements. Thefailure to comply with these specifications and other requirements could resultin an FDA enforcement action, including the seizure of products and shuttingdown production. We or any of these third-party manufacturers also may besubject to comparable or more stringent regulations of foreign regulatoryauthorities. In addition, we and Veridex will need to complete validation of some of the manufacturingprocesses for the products we plan to launch for IVD use in the third quarterof 2004 and would be unable to launch these products until this validation iscompleted. If we or any of our third-party manufacturers fail to comply withthese regulations, we might be subject to regulatory action, which could delayor curtail our ability to develop, and Veridex’s and our ability tocommercialize, products based on our technologies.

 

**If we fail to obtain necessary funds for ouroperations, we will be unable to continue to develop and commercialize newproducts and technologies.**

 

We expect capital outlays and operating expenditures to increase overthe next several 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;

 

•                                          expandour technologies into other areas of cancer and medicine;

 

•                                          expandour research and development activities;

 

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•                                          acquireor license technologies;

 

•                                          fundour clinical trial activities;

 

•                                          expandour manufacturing activities; and

 

•                                          financecapital expenditures and our general and administrative expenses.

 

To date, we have raised capital through private equity, public equityand debt financings, license and milestone revenues from corporatecollaborations, capital equipment and leasehold financing, government grantsand interest earned on cash and investments. We believe the net proceeds of theIPO, together with our cash, cash equivalents and investments; will besufficient to meet our operating and capital requirements for at least the next18 months. However, our present and future funding requirements willdepend on many factors, including, among other things:

 

•                                          thelevel of research and development investment required to maintain and improveour technology position;

 

•                                          costsof filing, prosecuting, defending and enforcing patent claims and otherintellectual property rights;

 

•                                          ourneed or decision to acquire or license complementary technologies or acquirecomplementary businesses;

 

•                                          changesin product development plans needed to address any difficulties inmanufacturing or commercialization;

 

•                                          competingtechnological and market developments; and

 

•                                          changesin regulatory policies or laws that affect our operations.

 

We do not know whether additional financing will be available oncommercially acceptable terms when needed. If adequate funds are not availableor are not available on commercially acceptable terms, our ability to fund ouroperations, develop products or technologies or otherwise respond tocompetitive pressures could be significantly delayed or limited, and we mightneed to downsize or halt our operations.

 

If we raise additional funds by issuing equity securities, furtherdilution to our stockholders could result, and new investors could have rightssuperior to those of our existing shareholders of the shares issued in the IPO.Any equity securities issued also may provide for rights, preferences orprivileges senior to those of holders of our common stock. If we raiseadditional funds by issuing debt securities, these debt securities would haverights, preferences and privileges senior to those of holders of our commonstock, and the terms of the debt securities issued could impose significantrestrictions on our operations. If we raise additional funds throughcollaborations and licensing arrangements, we might be required to relinquishsignificant rights to our technologies or products, or grant licenses on termsthat are not favorable to us. If adequate funds are not available, we may haveto delay or may be unable to continue to develop our products.

 

**If the third parties we intend to contractwith for clinical trials do not perform in an acceptable manner, or if wesuffer setbacks in these clinical trials, our business may suffer.**

 

We do not have the ability to independently conduct the clinical trialsrequired to obtain regulatory clearances for our products. We intend to rely onthird-party expert clinical investigators and clinical research organizationsto perform these functions. If we cannot locate and enter into favorableagreements with acceptable third parties, or if these third parties do notsuccessfully carry out their contractual obligations, meet expected deadlinesor follow regulatory requirements, including clinical laboratory, manufacturingand good clinical practice guidelines, then we may be the subject of anenforcement action by the FDA or some other regulatory body, and may be unableto obtain clearances for our products or to commercialize them on a timelybasis, if at all.

 

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The completion of clinical trials of our products may be delayed bymany other factors, including the rate of enrollment of patients. Neither wenor any third-party clinical investigators and clinical research organizationscan control the rate of patient enrollment, nor might this rate not beconsistent with our expectations or sufficient to enable clinical trials of ourproducts to be completed in a timely manner or to be completed at all. Inaddition, regulatory authorities might not permit us to undertake additionalclinical trials for one or more of these products. If we suffer any significantdelays in, setbacks or negative results in or termination of, clinical trialsfor our products, we may be unable to generate product sales from theseproducts in the future.

 

**If we lose key management or scientificpersonnel, scientific collaborators or other advisors, our business wouldsuffer.**

 

Our success depends, in large part, on the efforts and abilities ofEdward L. Erickson, who is our Chairman, President and Chief Executive Officer,Leon W.M.M. Terstappen, who is our Senior Vice President of Research andDevelopment and Chief Scientific Officer, and James G. Murphy, who is ourSenior Vice President of Finance and Administration and Chief FinancialOfficer, as well as the other members of our senior management and ourscientific and technical personnel. Given that the pool of individuals withrelevant experience in biotechnology and diagnostic products in particular islimited, 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 maintainkey-person life insurance on any of our other officers, employees orconsultants. We also depend on our scientific collaborators and other advisors,particularly with respect to our research and development efforts. If we losethe services of one or more of our key officers, employees or consultants, orare unable to retain the services of our scientific collaborators and otheradvisors, our research and development and product development efforts could bedelayed or curtailed.

 

**If Veridex and the other third parties weintend to rely on to perform marketing, sales and distribution services for ourproducts do not successfully perform these services, our business will beharmed.**

 

We have limited marketing, sales and distribution experience andcapabilities. In order to commercialize any of our products, we must eitherinternally develop sales, marketing and distribution capabilities or makearrangements with third parties to perform these services. We intend to relyfor the foreseeable future on sales, marketing and distribution arrangementswith third parties for the commercialization of our products. Specifically, wewill rely on Veridex for the commercialization of the initial cancer diagnosticproducts based on our technologies. We may be unable to enter into sales,marketing and distribution agreements with third parties on acceptable terms,if at all. Also, the sales, marketing, and distribution efforts of these thirdparties might not be successful. Any sales through these third parties might beless profitable to us than direct sales.

 

If we decide to perform any sales, marketing and distribution functionsourselves, we might face a number of risks, including:

 

•                                          ourability to attract and build the significant and skilled marketing staff orsales force necessary to commercialize and gain market acceptance for ourproducts;

 

•                                          theamount of time and cost of establishing a marketing staff or sales force mightnot be justifiable by the revenues generated by any particular product; and

 

•                                          thefailure of our direct sales and marketing personnel to initiate and executesuccessful commercialization activities.

 

**If the limited number of suppliers we rely onfail to supply the raw materials we use in the manufacturing of our reagentproducts, we might be unable to satisfy product demand, which would negativelyimpact our business.**

 

Several raw materials used in the manufacturing of our reagent productsused in several of our platforms and instruments currently are available onlyfrom a limited number of suppliers. We acquire all of these raw materials on apurchase-order basis, which means that the supplier is not required to supplyus with specified quantities of these raw materials over a certain period oftime or to set 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 begin 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.

 

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In addition, if any of these components and raw materials are no longeravailable in the marketplace, we will be forced to further develop ourtechnologies to incorporate alternate components and to do so in compliancewith QSR. If we incorporate new components or raw materials into our productswe might need to seek and obtain additional approvals or clearances from theFDA or foreign regulatory agencies, which could delay the commercialization ofthese products.

 

**If our competitors develop and markettechnologies or research and diagnostic products faster than we or Veridex door if those products are more effective than our products, our commercialopportunities will be reduced or eliminated.**

 

The extent to which any of our technologies and products achieve marketacceptance will depend on many competitive factors, many of which are beyondour control. Competition in the pharmaceutical and biotechnology industries,and the medical devices and diagnostic products segments in particular, isintense and has been accentuated by the rapid pace of technologicaldevelopment. Our competitors include large diagnostics and life sciencescompanies. Most of these entities have substantially greater research anddevelopment capabilities and financial, scientific, manufacturing, marketing,sales and service resources than we do. Some of them also have more experiencethan we do in research and development, clinical trials, regulatory matters,manufacturing, marketing and sales. These organizations also compete with usto:

 

•                                          pursueacquisitions, joint ventures or other collaborations;

 

•                                          licenseproprietary technologies that are competitive with our technologies;

 

•                                          attractfunding; and

 

•                                          attractand hire scientific talent.

 

If we or Veridex cannot successfully compete with new or existingproducts or technologies, sales of our products will suffer and we may neverachieve profitability. Because of their greater experience with commercializingtheir technologies and larger research and development capabilities, ourcompetitors might succeed in developing and commercializing technologies orproducts earlier and obtaining regulatory approvals and clearances from the FDAmore rapidly than Veridex or us. Our competitors also might develop moreeffective technologies or products that are more predictive, more highlyautomated or more cost-effective, which may render our technologies or productsobsolete or non-competitive.

 

**If we experience delays in the development ofnew products or delays in planned improvements to our products, our commercialopportunities will be reduced.**

 

To improve our competitive position, we believe that we will need todevelop new products as well as improve our existing instruments, reagents andancillary products. Improvements in automation and throughput (the number oftests that can be performed in a specified period of time) of our products willbe important to the competitive position of our products as we market to abroader, perhaps less technically proficient, group of customers. Our abilityto develop new products and make improvements in our products may facedifficult technological challenges leading to development delays. For example,we are experiencing delays in connection with the development of our CellTracksAnalyzer cell analysis instrument for use in cancer diagnostic testing. Thesedelays are the result of technical problems associated with reliability of thesystem to detect cancer cells. In response, we are implementing enhancements toour CellSpotter Analyzer, such as adding the ability to detect and evaluatecellular markers using analyte specific reagents, or ASRs. We are alsocontinuing to develop our CellTracks Analyzer because we believe that some ofthe planned features, such as the ability to quantify cellular markers usingASRs, may be required to address future potential research and clinicalapplications and to remain competitive. If we are unable to successfullycomplete development of new products or if we are unable to successfullycomplete the planned enhancements to our products, in each case withoutsignificant delays, our future competitive position may be adversely affected.

 

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**If product liability lawsuits aresuccessfully brought against us, we might incur substantial liabilities andcould be required to limit the commercialization of our products.**

 

Our business exposes us to potential product liability risks that areinherent in the testing, manufacturing, marketing and sale of diagnosticproducts. We might be unable to avoid product liability claims. Productliability insurance generally is expensive for our industry. If we are unableto maintain sufficient insurance coverage on reasonable terms or to otherwiseprotect against potential product liability claims, we may be unable tocommercialize our products. A successful product liability claim broughtagainst us in excess of any insurance coverage we have at that time could causeus to incur substantial liabilities and our business to fail.

 

**If we use biological and hazardous materialsin a manner that causes injury, we could be liable for damages.**

 

Our research and development activities sometimes involve thecontrolled use of potentially harmful biological materials, hazardous materialsand chemicals. We cannot completely eliminate the risk of accidentalcontamination or injury to third parties from the use, storage, handling ordisposal of these materials. In the event of contamination or injury, we couldbe held liable for any resulting damages, and any liability could exceed ourresources or any applicable insurance coverage we may have. Additionally, weare subject on an ongoing basis to federal, state and local laws andregulations governing the use, storage, handling and disposal of these materialsand specified waste products. The cost of compliance with these laws andregulations might be significant and could negatively affect our profitability.

 

**If we are unable to manage growth inconnection with our transition from an early-stage development company to acompany that commercializes research and diagnostic products, our operationswill suffer.**

 

We will need to add a significant number of new personnel and expandour capabilities in order to successfully pursue our commercialization strategyfor our 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 proprietaryrights, we may not be able to compete effectively.**

 

We have obtained patents in the US and in foreign countries relating tomany of the 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 plan to commercialize. In addition, we maintaintrade secrets, especially where we believe patent protection is not appropriateor obtainable, on various aspects of our technologies and that we do not wishto become publicly known. However, obtaining, defending and enforcing ourpatents and other intellectual property rights involve complex legal andfactual questions. For example, many of our key patents relating to our basictechnologies for the separation and isolation of cells for the detection ofcancer contain claims covering our processes for manufacturing and using ourmagnetic separation particles, or ferrofluids. If a competitor were to practiceor use these processes without our knowledge or consent, these patents may beparticularly difficult to defend or enforce because it may not be apparent fromexamination of the competitor’s products that the competitor is using ourpatented processes. In particular, if we were not able successfully to defendor enforce our patents that cover our ferrofluids, which are utilized as a keycomponent of our CellTracks AutoPrep System, competitors could more easilyproduce systems that might be able to perform separation of Circulating TumorCells (“CTCs”) from blood samples in a manner substantially equivalent to ourCellTracks AutoPrep System without compensating us, resulting in substantialdamage to our business.

 

Because the issuance of a patent is not conclusive of its validity orenforceability and can be challenged, we do not know how much protection, ifany, our patents will provide to us if we attempt to enforce them or if otherschallenge their validity or enforceability in court. For example, if ourpatents relating to the separation of CTCs from blood samples were challengedand invalidated, we would not be able to prevent others from utilizing thesekey aspects of our technologies, which would substantially harm our business.Moreover, our patent applications may not result in issued patents, and even ifissued, our patents may not contain claims that are

 

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sufficiently broad to prevent others from practicing our technologiesor developing competing products. Accordingly, we cannot assure you that wewill be able to obtain, defend or enforce our patent rights covering ourtechnologies in the US or in foreign countries. In addition, if others discoveror misappropriate the technologies that we have chosen to maintain as tradesecrets, we may not be able to effectively maintain our technologies asunpatented trade secrets. Although we have taken measures to protect ourunpatented trade secrets and other non-public information such as know-how,including the use of confidentiality and invention assignment agreements withour employees, consultants and some of our contractors, it is possible thatthese persons may unintentionally or willingly breach the agreements or thatour competitors may independently develop or otherwise discover our trade secretsand know-how.

 

A challenge to one or more of our pending patent applications, orissued patents, may result in limiting the coverage of our patents so that acompetitor can effectively avoid our patent claims. In addition, competitorsmay avoid our patents by using technologies that perform substantially as ourtechnologies, but avoid infringing our patent claims. For example, if acompetitor were to use a cell separation technology that performs as well, ornearly as well, as our patented ferrofluids, the competitor may be able tomarket products that may be functionally equivalent and perform as well ornearly as well as our products, thereby diminishing the competitive advantageafforded by our issued patents.

 

Although we may initiate litigation to stop the infringement of ourpatent claims or to attempt to force an unauthorized user of our patentedinventions or trade secrets to compensate us for the infringement orunauthorized use, patent and trade secret litigation is complex and often difficultand expensive, and would consume the time of our management and othersignificant resources. If the outcome of litigation is adverse to us, thirdparties may be able to use our technologies without payments to us. Moreover,some of our competitors may be better able to sustain the costs of litigationbecause they have substantially greater resources. Because of these factorsrelating to litigation, we may be unable effectively to preventmisappropriation of our patent and other proprietary rights.

 

**If the use of our technologies conflicts withthe intellectual 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.**

 

Our competitors or others may have or acquire patent rights that theycould enforce against us. If they do so, we may be required to alter ourtechnologies, pay licensing fees or cease activities. If our technologiesconflict with patent rights of others, third parties could bring legal actionagainst us or our licensees, suppliers, customers or collaborators, claimingdamages and seeking to enjoin manufacturing and marketing of the affectedproducts. If these legal actions are successful, in addition to any potentialliability for damages, we might have to obtain a license in order to continueto manufacture or market the affected products. A required license under therelated patent may not be available on acceptable terms, if at all.

 

We may be unaware of issued patents that our technologies infringe.Because patent applications can take many years to issue, there may becurrently pending applications, unknown to us, that may later result in issuedpatents upon which our technologies may infringe. There could also be existingpatents of which we are unaware upon which our technologies may infringe. Inaddition, if third parties file patent applications or obtain patents claimingtechnology also claimed by us in pending applications, we may have toparticipate in interference proceedings in the US Patent and Trademark Officeto determine priority of invention. If third parties file oppositions inforeign countries, we may also have to participate in opposition proceedings inforeign tribunals to defend the patentability of the filed foreign patentapplications. We may also have to participate in interference proceedingsinvolving our issued patents or our pending applications.

 

If a third party claims that we infringe upon its proprietary rights,any of the following may occur:

 

•                                          wemay become involved in time-consuming and expensive litigation, even if theclaim is without merit;

 

•                                          wemay become liable for substantial damages for past infringement if a courtdecides that our technologies infringe upon a competitor’s patent;

 

•                                          acourt may prohibit us from selling or licensing our product without a licensefrom the patent holder, which may not be available on commercially acceptableterms, if at all, or which may require us to pay substantial royalties or grantcross licenses to our patents; and

 

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•                                          wemay have to redesign our product so that it does not infringe upon others’patent rights, which may not be possible or could require substantial funds ortime.

 

If any of these events occurs, our business will suffer and the marketprice of our common stock will likely decline.

 

**Our rights to use technologies licensed to usby third parties are not within our control, and we may not be able toimplement our products without these technologies.**

 

We have licensed patents and other rights that are necessary tocommercialize our products. Our business will significantly suffer if theselicenses terminate, if the licensors fail to abide by the terms of the licenseor fail to prevent infringement by third parties or if the licensed patents orother rights are found to be invalid.

 

We have exclusively in-licensed significant intellectual property,including patents and know-how, related to our cell analysis instrumentationand cell isolation and enrichment products. In April 1997 we entered intoa license agreement with the University of Twente, or Twente, under which wewere granted exclusive rights to technology developed at Twente relating tooptical analysis of particles similar to cells and cell particles. Thistechnology and the underlying patents and know-how contribute significantly toour CellTracks Analyzer. This agreement will terminate upon the later ofApril 2007 or the expiration date of the last to expire of the patentslicensed under this agreement. In addition, Twente may unilaterally terminatethis agreement if we are in material breach or if we become bankrupt orinsolvent. Twente also may unilaterally terminate the license granted underthis agreement if we do not maintain sufficient general and product liabilityinsurance coverage once we have begun clinical trials and commercialization ofour products. In June 2004, we entered into an addendum to our licenseagreement with Twente, and with STW, a research funding agency of the Dutchgovernment.  Under the modifiedagreement, STW will provide Twente with up to approximately one million dollarstoward developing an affordable and portable instrument to monitor patientswith HIV.  This instrument represents anadditional application of our existing technology, specifically the CellTracksEasyCount system, and in consideration for our contribution of “in kind”research effort toward the project including personnel, equipment and supplieswe will have rights to commercialize products that result from thisagreement.  In addition, inJune 1999, we entered into a license agreement with the University ofTexas, or Texas, under which we were granted exclusive rights to technology,including patents and know-how, which we developed in collaboration with Texas,relating to the isolation, enrichment and characterization of circulatingepithelial cells. Epithelial cells are cells that cover external and internalbody surfaces and give rise to the majority of solid tumors. This technologyand the underlying patents and know-how contribute significantly to our cellanalysis products in the field of cancer diagnostics. We are responsible formaking royalty payments of 1% of our sales of reagents incorporating theintellectual property licensed to us under this agreement. This agreementterminates when all of Texas’s rights to the licensed technologies expire. Inaddition, Texas also may unilaterally terminate this agreement if we are inmaterial breach or become bankrupt or insolvent. Texas also may unilaterallyterminate the license granted under this agreement, or the exclusivity of suchlicense, in any national political jurisdiction if we fail to provide writtenevidence satisfactory to Texas, within 90 days of receiving written notice fromTexas that it intends to terminate this license, that we or our sublicenseeshave commercialized or are actively attempting to commercialize a licensedinvention in these jurisdictions. In addition, in July 2002, we enteredinto a license agreement with Streck Laboratories, Inc., or Streck. Under thisagreement, Streck granted to us a non-exclusive, worldwide, royalty-bearinglicense to practice certain of Streck’s cell preservative technology, includingpatents and know-how, for the research, development, manufacture and sale ofour CellSave Preservative Tube to test for the presence of epithelial cells orCTCs in a sample of fluid from a patient. This agreement will terminate uponthe expiration date of the last to expire of the patents licensed under thisagreement. In addition, either party also may terminate this agreement if theother party is in material breach or becomes involved in financialdifficulties, including bankruptcy and insolvency.

 

If we violate the terms of our licenses, or otherwise lose our rightsto these patents or patent applications, we may be unable to continuedevelopment of our products. Our licensors or others may dispute the scope ofour rights under any of these licenses. Additionally, the licensors under theselicenses might breach the terms of their respective agreements or fail toprevent infringement of the licensed patents by third parties. Loss of any ofthese licenses for any reason could materially harm our financial condition andoperating results.

 

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**If we cannot obtain additional licenses tointellectual property owned by third parties that we desire to incorporate intonew products we plan to develop, we may not be able to develop or commercializethese future products.**

 

We are developing products designed to identify and characterizeadditional types of cells other than CTCs and epithelial cells, such asendothelial cells. We also plan to develop cell profile products using reagentsthat are fluorescently tagged antibodies designed to characterize target cells,which are classified by the FDA as analyte-specific reagents, or ASRs. ASRs canbe used in research as an aid in evaluating new therapies in clinical trials,and we 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 other reagents,including antibodies, that we ultimately may use in the development andcommercialization of these future cell profile products and in our future productsfor identifying additional types of cells may be protected by patent and otherintellectual property rights owned by third parties. If we are unable to obtainrights to use this third party intellectual property under commerciallyreasonable terms, or at all, we may be unable to develop these products, andthis could harm our ability to expand our commercial products offerings and togenerate additional revenue from these products. 

 

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

### ** **

We do not believe that we have material exposure to interest rate,foreign currency exchange rate or other relevant market risks.  We do not use derivative financialinstruments in our investment portfolio and have no foreign exchange contracts.Our financial instruments consist of cash, cash equivalents, short-terminvestments, 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*.  Based on their evaluation of the Company’sdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act of 1934 (the “Exchange Act”)) as ofJune 30, 2004, our president, chief executive officer (principal executiveofficer) and chief financial officer (principal financial officer) have concludedthat our disclosure controls and procedures are designed to ensure thatinformation required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms and areoperating in an effective manner.

 

*Changes in internal controls. *Therehave not been any changes in our internal controls over financial reportingduring the quarter ended June 30, 2004 that materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

**PART II.****                                          OTHERINFORMATION**

 

**Item 6.****                                                     Exhibitsand Reports on Form 8-K**

 

 
| (a) Reports on Form 8-K:                                                 |   |
|--------------------------------------------------------------------------|--------|
|                                                                     |   |
| None                                                                     |   |
|                                                                     |   |
| (b) The following  is a list of exhibits filed as part of the Form 10-Q: |   |
|                                                                     |   |
| 10.1                                                                     |   | Amended License Agreement, dated June 11, 2004, between  Immunivest Corporation and Twente  University. |
|                                                                     |   |   |
| 10.2                                                                     |   | Second Amendment to Loan and Security Agreement dated June 2004 |
|                                                                     |   |   |
| 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:  August 11, 2004 | By:                                                | /s/ EDWARD L ERICKSON |   |
|                             | Edward L. Erickson                                 |
|                             | Chairman of the Board, President and               |
|                             | Chief Executive Officer                            |
|                             |                                               |
|                             |                                               |
| Date:  August 11, 2004 | By:                                                | /s/ 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 License  Agreement, dated June 11, 2004, between Immunivest Corporation and  Twente University.                                              |
| 10.2       |   | Second Amendment to Loan and Security Agreement                                                                                                           |
| 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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