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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) x
    
    Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934:For the quarterly period ended March 31,
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: 001-12128
 Matritech, Inc. 
  Delaware
    
    04-2985132(State or Other Jurisdiction of
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)
 330 Nevada Street, Newton, Massachusetts 02460 
  (617) 928-0820 
  Indicate by check mark whether the registrant:(1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). o Yes x No As of May 1, 2004, there were 41,297,184 shares of the Registrants Common
Stock outstanding.




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##### Table of Contents



MATRITECH, INC. INDEX PagePART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsConsolidated Balance Sheets as of December 31, 2003
and March 31, 2004
    
    
    3Consolidated Statements of Operations for the three
months ended March 31, 2003 and 2004
    
    
    4Consolidated Statements of Cash Flows for the three
months ended March 31, 2003 and 2004
    
    
    5Notes to Unaudited, Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures About
Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    25PART II
    
    OTHER INFORMATIONItem 2.
    
    Changes in Securities and Use of Proceeds
    
    
    26Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    26SIGNATURES
    
    
    
    
    27EX-31.1 CERTIFICATION OF CEOEX-31.2 CERTIFICATION OF CFOEX-32.1 906 CERTIFICATION OF CEOEX-32.2 906 CERTIFICATION OF CFO




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements. MATRITECH, INC. 
 CONSOLIDATED BALANCE SHEETS (UNAUDITED) December 31,
    
    March 31,2003
    
    2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    7,518,124
    
    
    $
    11,206,138Accounts receivable less allowance of $23,591 in 2003 and 2004
    
    
    556,624
    
    
    
    813,157Inventories, net
    
    
    609,211
    
    
    
    524,687Prepaid expenses and other current assets
    
    
    390,090
    
    
    
    413,684Total current assets
    
    
    9,074,049
    
    
    
    12,957,666Property and equipment, at cost:Laboratory equipment
    
    
    2,437,430
    
    
    
    2,445,940Office equipment
    
    
    408,153
    
    
    
    410,074Laboratory furniture
    
    
    62,739
    
    
    
    62,738Leasehold improvements
    
    
    88,865
    
    
    
    97,365Automobiles
    
    
    47,053
    
    
    
    45,8853,044,240
    
    
    
    3,062,002Less  Accumulated depreciation and amortization
    
    
    2,107,544
    
    
    
    2,150,887936,696
    
    
    
    911,115Goodwill
    
    
    132,615
    
    
    
    132,615Other assets
    
    
    246,706
    
    
    
    207,073Receivable from related party
    
    
    28,254
    
    
    
    28,254Total assets
    
    $
    10,418,320
    
    
    $
    14,236,723LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Current maturities of notes payable
    
    $
    301,647
    
    
    $
    261,847Current maturities of convertible debt
    
    
    1,554,067
    
    
    
    1,069,135Accounts payable
    
    
    281,697
    
    
    
    323,746Accrued expenses
    
    
    976,242
    
    
    
    1,090,732Deferred revenue
    
    
    525,940
    
    
    
    515,280Total current liabilities
    
    
    3,639,593
    
    
    
    3,260,740Notes payable, less current maturities
    
    
    25,202
    
    
    
    24,592Convertible debt, less current maturities
    
    
    1,312,860
    
    
    
    712,543Deferred revenue
    
    
    642,435
    
    
    
    645,143Total liabilities
    
    
    5,620,090
    
    
    
    4,643,018Commitments and ContingenciesStockholders Equity:Preferred stock, $1.00 par valueAuthorized4,000,000 sharesIssued and outstandingno shares
    
    
    
    
    
    
    Common stock, $0.01 par valueAuthorized60,000,000 sharesIssued and outstanding36,121,934 shares in 2003 and 41,156,470 shares in 2004
    
    
    361,219
    
    
    
    411,564Additional paid-in capital
    
    
    83,316,769
    
    
    
    90,762,680Accumulated other comprehensive income (loss)
    
    
    119,119
    
    
    
    110,582




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December 31,
    
    March 31,2003
    
    2004Accumulated deficit
    
    
    (78,998,877
    )
    
    
    (81,691,121
    )Total stockholders equity
    
    
    4,798,230
    
    
    
    9,593,705Total liabilities and stockholders equity
    
    $
    10,418,320
    
    
    $
    14,236,723
 The accompanying notes are an integral part of these consolidated financial statements.




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##### Table of Contents



MATRITECH, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months EndedMarch 31,2003
    
    2004Revenue:Product sales
    
    $
    864,554
    
    
    $
    1,385,672Alliance and collaboration revenue
    
    
    50,973
    
    
    
    47,955Total revenue
    
    
    915,527
    
    
    
    1,433,627Expenses:Cost of product sales
    
    
    546,731
    
    
    
    539,376Research, development and clinical expense
    
    
    731,682
    
    
    
    715,446Selling, general and administrative expense
    
    
    1,606,606
    
    
    
    2,268,995Total operating expenses
    
    
    2,885,019
    
    
    
    3,523,817Loss from operations
    
    
    (1,969,492
    )
    
    
    (2,090,190
    )Interest income
    
    
    21,479
    
    
    
    19,958Interest expense
    
    
    6,587
    
    
    
    622,012Net loss
    
    $
    (1,954,600
    )
    
    $
    (2,692,244
    )Basic and diluted net loss per common share
    
    $
    (0.06
    )
    
    $
    (0.07
    )Basic and diluted weighted average number of common shares outstanding
    
    
    32,119,981
    
    
    
    36,715,762
 The accompanying notes are an integral part of these consolidated financial statements.




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MATRITECH, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months EndedMarch 31,2003
    
    2004Cash Flows from Operating Activities:Net loss
    
    $
    (1,954,600
    )
    
    $
    (2,692,244
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    64,093
    
    
    
    54,945Amortization of deferred compensation
    
    
    17,858
    
    
    
    Amortization of debt discount
    
    
    
    
    
    
    445,729Amortization of deferred charges
    
    
    
    
    
    
    59,003Issuance of common stock for interest on debt
    
    
    
    
    
    
    98,687Noncash interest expense
    
    
    
    
    
    
    14,373Changes in assets and liabilities:Accounts receivable
    
    
    268,408
    
    
    
    (256,533
    )Inventories
    
    
    (61,007
    )
    
    
    84,524Prepaid expenses and other assets
    
    
    23,960
    
    
    
    (42,964
    )Accounts payable
    
    
    (83,654
    )
    
    
    42,049Accrued expenses
    
    
    (86,914
    )
    
    
    114,490Deferred revenue
    
    
    95,099
    
    
    
    (7,952
    )Net cash used in operating activities
    
    
    (1,716,757
    )
    
    
    (2,085,893
    )Cash Flows from Investing Activities:Purchases of property and equipment
    
    
    (100,971
    )
    
    
    (31,692
    )Net cash used in investing activities
    
    
    (100,971
    )
    
    
    (31,692
    )Cash Flows from Financing Activities:Payments on notes payable
    
    
    (38,752
    )
    
    
    (38,751
    )Proceeds from convertible debentures and warrants, net
    
    
    4,556,083
    
    
    
    Proceeds from sale of common stock and warrants
    
    
    
    
    
    
    5,846,969Proceeds from issuance of common stock under employee stock purchase plan
    
    
    7,000
    
    
    
    5,250Net cash provided by financing activities
    
    
    4,524,331
    
    
    
    5,813,468Effect of foreign exchange on cash and cash equivalents
    
    
    48,459
    
    
    
    (7,869
    )Increase in cash and cash equivalents
    
    
    2,755,062
    
    
    
    3,688,014Cash and cash equivalents, beginning of period
    
    
    4,172,013
    
    
    
    7,518,124Cash and cash equivalents, end of period
    
    $
    6,927,075
    
    
    $
    11,206,138Supplemental Cash Flow Information:Cash paid during the year for interest
    
    $
    6,587
    
    
    $
    4,221Stock issued for debt retirement
    
    
    
    
    
    
    206,681Stock issued for interest payments
    
    
    
    
    
    
    98,688
 The accompanying notes are an integral part of these consolidated financial statements.




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MATRITECH, INC. 
 NOTES TO UNAUDITED, CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Operations and Basis of Presentation The quarterly financial statements included herein have been prepared by
the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC) and include, in the opinion of
management, all adjustments, consisting of normal, recurring adjustments
necessary for a fair presentation of interim period results on a going-concern
basis. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted pursuant
to such rules and regulations. The results for the interim periods presented
are not necessarily indicative of results to be expected for any future period.
These consolidated financial statements should be read in conjunction with the
audited financial statements and notes thereto included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2003 filed with the SEC
(File No. 001-12128). We have incurred losses from operations since our inception. We have an
accumulated deficit of $82 million at March 31, 2004. We believe that our
existing capital resources combined with our financing plans will be sufficient
to fund operations through at least December 31, 2004. Our financing plans
include continuing to seek to raise additional capital and will consider
various financing alternatives, including equity or debt financings and
corporate partnering arrangements. However, we may not be able to raise needed
capital on terms that are acceptable to us, or at all. If we raise funds on
unfavorable terms, we may provide rights and preferences to new investors which
are not available to current shareholders. In addition, our existing financing
arrangements contain anti-dilutive provisions which may require us to issue
additional securities if certain conditions are met. If we do not receive
additional financing or do not receive an adequate amount of additional
financing, we will be required to curtail our expenses by reducing research
and/or marketing or by taking other steps that could hurt our future
performance, including but not limited to, the premature sale of some or all of
our assets or product lines on undesirable terms, merger with or acquisition by
another company on unsatisfactory terms or the cessation of operations. Any
future equity financings will dilute the ownership interest of our existing
investors and may have an adverse impact on the price of our common stock. Any
of the foregoing steps will have a material adverse effect on our business,
financial condition and results of operations. There can be no assurance that
capital will be available on terms acceptable to us, if at all. 2. Summary of Significant Accounting Policies  (a)
    
    Principles of Consolidation The consolidated financial statements include the accounts of Matritech,
Inc., a Delaware corporation and our wholly-owned subsidiary Matritech GmbH
based in Freiberg, Germany. All significant intercompany balances and
transactions have been eliminated at consolidation level.  (b)
    
    Inventories Inventories are stated at the lower of cost (determined on a first-in
first-out basis) or market and consist of the following: December 31,
    
    March 31,2003
    
    2004Raw materials
    
    $
    147,192
    
    
    $
    156,699Work-in-process
    
    
    4,327
    
    
    
    5,571Finished goods
    
    
    400,735
    
    
    
    303,021Consignment inventory
    
    
    56,957
    
    
    
    59,396$
    609,211
    
    
    $
    524,687
  (c)
    
    Revenue Recognition Deferred revenue consists of the following:




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December 31,
    
    March 31,2003
    
    2004Collaboration fees
    
    $
    828,048
    
    
    $
    805,091Deferred product revenue
    
    
    340,327
    
    
    
    355,332$
    1,168,375
    
    
    $
    1,160,423
  (d)
    
    Comprehensive Loss Comprehensive loss is comprised of net loss and certain changes in
stockholders equity that are excluded from net loss. The Company includes
foreign currency translation adjustments in other comprehensive income (loss)
for Matritech GmbH as the functional currency is not the U.S. dollar. The
composition of accumulated other comprehensive income (loss) is as follows: Three Months EndedMarch 31,2003
    
    2004Reported net loss
    
    $
    (1,954,600
    )
    
    $
    (2,692,244
    )Other comprehensive income (loss)Foreign currency translation adjustments
    
    
    48,017
    
    
    
    (8,537
    )Comprehensive loss
    
    $
    (1,906,583
    )
    
    $
    (2,700,781
    )
  (e)
    
    Stock-Based Compensation We have elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees(APB 25) and related
interpretations, in accounting for our stock-based compensation plans, rather
than the alternative fair value accounting method provided for under Statement
of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation,(SFAS No. 123). In accordance with Emerging Issues Task Force
(EITF) Issue No. 96-18, we record compensation expense equal to the fair
value of options granted to non-employees over the vesting period, which is
generally the period of service. The following table illustrates the effect on net loss and loss per share
if the Company had applied the fair value recognition provisions of SFAS No.
123 to stock-based employee compensation: Three Months EndedMarch 31,2003
    
    2004Net loss
    
    $
    (1,954,600
    )
    
    $
    (2,692,244
    )Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards
    
    
    (267,854
    )
    
    
    (263,103
    )Pro forma net loss
    
    $
    (2,222,454
    )
    
    $
    (2,955,347
    )Net loss per common share:Basic and diluted  as reported
    
    $
    (0.06
    )
    
    $
    (0.07
    )Basic and diluted  pro forma
    
    $
    (0.07
    )
    
    $
    (0.08
    )
 The fair value of stock options and common shares issued pursuant to the
stock option and stock purchase plans at the date of grant were estimated using
the Black-Scholes model with the following weighted-average assumptions: 2003
    
    2004Risk-free interest rate
    
    
    3.58
    %
    
    
    3.74  4.19
    %Expected dividend yield
    
    
    
    
    
    
    Expected life
    
    7 years
    
    7 yearsExpected volatility
    
    
    110
    %
    
    
    144
    %




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(f)
    
    Net Loss per Common Share We compute earnings per share in accordance with SFAS No. 128, Earnings
per Share. Basic net loss per common share is computed by dividing net loss by
the weighted average number of common shares outstanding during the year.
Diluted loss per share is the same as basic loss per share as the effects of
our potential common stock equivalents are antidilutive. At March 31, 2003,
potential common stock equivalents consisted of stock options, warrants, and
convertible debentures as well as 12,262 contingently issuable shares of common
stock held in escrow in connection with the Matritech GmbH acquisition. The
number of antidilutive securities excluded from the computation of diluted loss
per share were 5,880,804 and 10,646,081 for the periods ended March 31, 2003
and 2004, respectively. 3. Stockholders Equity On March 19, 2004 we completed a private placement of 4,858,887 shares of
our common stock at a price of $1.35 and warrants to purchase 1,214,725 shares
of our common stock at a price of $2.00 per share for an aggregate
consideration of $6,559,500 (before cash commissions and expenses of
approximately $713,000). In addition we issued warrants to various placement
agents for a total of 434,475 shares at an exercise price of $2.00 per share.
These warrants are valued at approximately $560,000. The warrants issued as
part of this private placement are exercisable until March 19, 2009. This transaction has also been deemed to be a dilutive issuance under the
terms of the Convertible Debentures we issued in March 2003 and our warrants
issued in connection with the Convertible Debenture financing (the March 2003
Warrants). As a result, the Convertible Debentures are currently convertible
into 3,183,902 shares of our common stock at a price of $1.51 per share,
representing an increase of 612,944 shares from the conversion terms of the
debenture at December 31, 2003, and the March 2003 Warrants are exercisable to
purchase shares of our common stock at a price of $1.35 per share representing
a decrease in purchase price of $0.32 per share. We have calculated an
additional beneficial conversion charge totaling approximately $1,339,000 (see
table below) which has been recorded as a debt discount in the first quarter of
2004 and will be amortized over the remaining life of the debt. 4. Convertible Debt A summary of the Convertible Debt accounting is as follows: Proceeds at closing
    
    $
    5,000,000Less:Fair value ascribed to the warrants and recorded as debt discount
    
    
    (950,000
    )Fair value ascribed to placement agent warrant and recorded as debt discount
    
    
    (131,000
    )Beneficial conversion feature calculated on date of closing and recorded as
debt discount
    
    
    (199,000
    )Additional beneficial conversion feature recorded in the fourth quarter of
2003 as debt discount
    
    
    (1,497,000
    )Additional beneficial conversion feature recorded in the first quarter of
2004 as debt discount
    
    
    (1,339,000
    )Principal payment made in stock
    
    
    (192,000
    )Add back:Amortization of debt discount and beneficial conversion features
    
    
    1,090,000Balance, March 31, 2004
    
    $
    1,782,000
 The debt discount is being amortized to interest expense using the
effective interest method over the term of the debt. For the period ended
March 31, 2004, $445,729 representing amortization of these costs is included
in interest expense. Debt issuance costs attributable to the Convertible Debentures, which
totaled approximately $475,000, have been capitalized as other assets and other
current assets on the consolidated balance sheet and will be amortized based on
the effective interest method over the term of the debt. For the period ended
March 31, 2004, $59,000, representing amortization of these costs is included
in interest expense. As of March 31, 2004, unamortized debt issuance costs totaled
$270,000, of which $191,000 is included in other current assets. Minimum future payments on the debt are as follows:




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2004
    
    $
    1,947,0002005
    
    
    2,445,0002006
    
    
    776,000Total payments
    
    $
    5,168,000Less: Portion related to periodic interest payments
    
    
    (360,000
    )Non-cash interest related to debt discount
    
    
    (3,026,000
    )Balance, March 31, 2004
    
    $
    1,782,000Less current portion
    
    
    1,069,000Long-term portion
    
    $
    713,000
 The Convertible Debentures allow the interest and principal to be paid in
common stock at a discount to valuation, but only if (i) we are not in default
under the terms of the Convertible Debentures, (ii) there is an effective
registration statement covering such shares, (iii) our common stock is listed
on one of American Stock Exchange, New York Stock Exchange, Nasdaq National
Market or Nasdaq SmallCap Market, (iv) we have provided proper notice of our
election to make payments in stock and have made payment of all other amounts
then due under the Convertible Debentures, (v) the issuance of such shares
would not cause the holders to own more than 9.999% of the outstanding shares
of our common stock, (vi) no public announcement of a change of control or
other reclassification transaction has been made and (vii) we have sufficient
authorized but unissued and unreserved shares to satisfy all share issuance
obligations under the March 2003 financing. The first quarter of 2004s
$98,000 interest payment was made in stock and the March, 2004 principal
repayment of $192,308 was made in stock and unless a default occurs, the
remaining payments scheduled for both interest and principal are expected to be
made in stock. 
 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations. This Quarterly Report on Form 10-Q, our other reports and communications
to our securityholders, as well as oral statements made by our officers or
agents may contain forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
statements may relate to, among other things, our future revenue, operating
income and the plans and objectives of management. In particular, certain
statements contained in the Managements Discussion and Analysis of Financial
Condition and Results of Operations, including Factors That May Affect Future
Results constitute forward-looking statements. Actual events or results may
differ materially from those stated in any forward-looking statement. Factors
that may cause such differences are discussed below and in our other reports
filed with the SEC. Overview Matritech, Inc. is a biotechnology company principally engaged in the
development, manufacture, marketing, distribution and licensing of cancer
diagnostic technologies, products and services. We are focused primarily on the
early detection of various types of cancer because treatment options may be
greater and/or more successful and treatment costs may be lower when tumors are
detected in their early stages. Our revenues are derived from product sales,
milestone payments for development work, and royalties from licensing. The products we have developed are based on our proprietary nuclear matrix
protein (NMP) technology. The nuclear matrix, a three-dimensional protein
framework within the nucleus of cells, plays a fundamental role in determining
cell type by physically organizing the contents of the nucleus, including DNA.
We focus our research on finding differences in the types and amounts of
proteins found in the tissue, blood and urine in patients with and without
cancer. We design our products to detect these differences and to generate
medically useful information in order to assist physicians in their diagnosis
and treatment of patients. Products developed by our scientists and based upon our proprietary NMP
technology became our most important source of revenue and revenue growth in
2003. NMP22® product sales exceeded sales from other products for the first
time in 2003, and we expect them to be our largest and most important source of
revenue for the foreseeable future. We continue to distribute allergy products
for a third party in Europe, but revenues from these products declined in 2003.
These trends continued in the first quarter of 2004. Prior to 2003, our
revenues were derived primarily from selling products made by others and
through licensing fees and other payments from strategic partnerships or
alliances.




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Effective November 2003, we changed our U.S. distributor arrangement with
Cytogen Corporation for our most important product, our NMP22 BladderChek®
Test, to permit us to sell directly to urologists, as we have done in Germany
since 2001. This change is expected to result in increased sales, increased
revenue per test, improvement in our gross profit margin and increased selling,
general and administrative (SG&A) expenses in 2004 compared to 2003. SG&A expenses substantially increased in the first quarter of 2004 from
the first quarter of 2003. This increase was caused primarily by the larger
costs needed to support the direct distribution of the NMP22 BladderChek Tests.
The increased selling expenditures will likely increase our losses in the
short term (See Results of Operations below), but thereafter we expect they
will generate sufficient gross profit to cover our increased selling expenses
and achieve our goal of profitability. In addition, because the financial
future of Matritech is so closely related to increasing the sales of NMP22
BladderChek Tests, we are taking steps to ensure we can meet anticipated demand
for these devices in the future. We are continuing our collaboration with Sysmex Corporation, a leading
manufacturer of automated laboratory instruments based in Kobe, Japan, in the
field of cervical tissue testing. We are also continuing the development of
our core diagnostic technology in breast cancer. We measure our progress in
such programs by achievements such as entering into new strategic partnerships
or alliances, obtaining positive clinical trial results, and ultimately
securing regulatory approvals such as our four FDA approvals for NMP22
products. If we can successfully leverage our strategic partnerships, we
expect to meet our goal of limiting the increase in our own annual research and
development expenditures to less than 20% per year over the next few years. In
the first quarter of 2004 research and development expenditures were 2% lower
than comparable expenses in the first quarter of 2003. We have been unprofitable since inception and expect to incur significant
additional operating losses for at least the next several years. For the
period from inception to March 31, 2004, we incurred a cumulative net loss of
approximately $82 million. To provide funds to support our new distribution
arrangements and our ongoing research and development efforts, we raised
additional capital in the first quarter of 2004 and may raise additional
capital later in the year. A failure to adequately finance the Company could
have a material adverse impact on our ability to achieve our objectives.
Success in raising equity to fund the cost of these product distribution and
development programs is an important element of our strategy. Results of
OperationsQuarter Ended March 31, 2003 (Q1 2003) Compared with Quarter Ended March
31, 2004 (Q1 2004) Revenues Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeProduct Sales:NMP22 Product Sales
    
    $
    362,000
    
    
    $
    929,000
    
    
    $
    567,000
    
    
    
    157
    %Other Product Sales
    
    
    503,000
    
    
    
    457,000
    
    
    
    (46,000
    )
    
    
    (9
    %)Total Product Sales
    
    
    865,000
    
    
    
    1,386,000
    
    
    
    521,000
    
    
    
    60
    %Alliance and Collaboration
Revenue
    
    
    51,000
    
    
    
    48,000
    
    
    
    (3,000
    )
    
    
    (6
    %)Total Revenue
    
    $
    916,000
    
    
    $
    1,434,000
    
    
    $
    518,000
    
    
    
    57
    %
 The NMP22 product line increase is due to a $494,000 sales increase,
primarily in the U.S. and Europe, and a $73,000 favorable exchange rate impact.
This sales growth is the result of increased selling efforts applied to the
NMP22 BladderChek Test, principally through initiating a direct-to-the-doctor
selling effort in the United States in the fourth quarter of 2003, continuing
our direct-to-the-urologist selling activity in Germany and obtaining
additional reimbursement coverage by Medicare and other health plan insurance
insurers throughout the United States. We announced in April, 2004 that
Medicare reimbursement programs in 49 states cover the NMP22 BladderChek Test
for both monitoring and diagnosis of bladder cancer, giving our customers
reimbursement coverage for nearly all 39 million Medicare-eligible lives in the
United States. Since most people who suffer from bladder cancer are over the
age of 65, the majority of those in the U.S. being treated or at risk for
bladder cancer are Medicare insured. Product sales of non-NMP22 products decreased by $106,000 due to the
implementation by regulatory authorities of a new patient fee structure in
Germany in the first quarter of 2004 and due to decreased customer demand for
the allergy products we




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##### Table of Contents



distribute. This decrease was offset by a $60,000 favorable exchange rate
impact. During the first quarter of 2004 we shipped approximately $54,000 of the
NMP22 BladderChek Test to distributors for which we did not have sufficient
history to estimate returns. Accordingly, this amount is recorded as deferred
revenue and is included in the balance at March 31, 2004, and will be
recognized as revenue when the distributor reports to us that it has either
shipped or disposed of the devices (indicating that the possibility of return
is remote). Deferred revenue consists of the following: Q4 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeCollaboration fees
    
    $
    828,000
    
    
    $
    805,000
    
    
    $
    (23,000
    )
    
    
    (3
    %)Deferred product revenue
    
    
    340,000
    
    
    
    355,000
    
    
    
    15,000
    
    
    
    4
    %$
    1,168,000
    
    
    $
    1,160,000
    
    
    $
    (8,000
    )
    
    
    (1
    %)
 Cost of Product Sales Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeProduct Sales
    
    $
    865,000
    
    
    $
    1,386,000
    
    
    $
    521,000
    
    
    
    60
    %Cost of Product Sales
    
    
    547,000
    
    
    
    539,000
    
    
    
    (8,000
    )
    
    
    (1
    %)Gross Profit
    
    $
    318,000
    
    
    $
    847,000
    
    
    
    529,000
    
    
    
    166
    %Gross Profit Margin
    
    
    37
    %
    
    
    61
    %
 The decrease in cost of product sales on a percentage basis and the
increase in our gross profit margin is largely the result of (i) higher price
per unit in the United States we receive because we are now selling NMP22
products directly rather than through a distributor and (ii) increased sales of
NMP22 products worldwide which carry higher margins than other products. Research and Development and Clinical Expenses Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeResearch andDevelopment, Clinical andRegulatory Expenses
    
    $
    732,000
    
    
    $
    715,000
    
    
    $
    (17,000
    )
    
    
    (2
    %)
 Research and development, clinical and regulatory expenses remained
essentially constant from the first quarter of 2003. Selling, General and Administrative Expenses Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeGross Profit
    
    $
    318,000
    
    
    $
    847,000
    
    
    $
    529,000
    
    
    
    166
    %Selling, General and
Administrative Expenses
    
    
    1,607,000
    
    
    
    2,269,000
    
    
    
    662,000
    
    
    
    41
    %SG&A as % of Gross Profit
    
    
    505
    %
    
    
    268
    %
 Selling, general and administrative expenses increased primarily due to a
$413,000 increase in payroll costs resulting from increased headcount, mainly
to support direct sales efforts described above, and an unfavorable foreign
currency exchange rate impact of $84,000. We believe that a decrease in our SG&A expenses as a percentage of our
gross profit from 505% in the first quarter of 2003 to 268% in the first
quarter of 2004 is a useful measure of our performance. During the second
half of the year, we expect gross profits will continue to grow more rapidly
than sales as our higher margin NMP22 products, including our NMP22 Test Kit
(Lab Test Kit) and our BladderChek Test become a larger percentage of our
sales and the lower margin non-NMP22 products decrease as a percentage of
sales. Because we expect an increase in SG&A expenses in the first half of
2004, due to the expansion of our sales forces and the costs to comply with
Sarbanes-Oxley legislation, the growth of gross profits may not start exceeding
the growth of SG&A expenses until the second half of the year.




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##### Table of Contents



Operating Loss Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeOperating Loss
    
    $
    1,969,000
    
    
    $
    2,090,000
    
    
    $
    121,000
    
    
    
    6
    %
 The operating loss increased primarily due to increased selling, general
and administrative expenses explained above. Interest Income Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeInterest Income
    
    $
    21,000
    
    
    $
    20,000
    
    
    $
    (1,000
    )
    
    
    (5
    %)
 Interest Expense Q1 2003
    
    Q1 2004
    
    $ Change
    
    % ChangeInterest Related to Convertible Debt:Interest Paid (or to be Paid) in Stock
    
    
    
    
    
    $
    99,000
    
    
    $
    99,000
    
    
    
    Non-Cash Charges to Interest Expense
    
    
    
    
    
    
    519,000
    
    
    
    519,000
    
    
    
    Total
    
    
    
    
    
    $
    618,000
    
    
    $
    618,000
    
    
    
    Interest Related to Other Debt:Interest Paid in Cash
    
    $
    7,000
    
    
    $
    4,000
    
    
    $
    (3,000
    )
    
    
    (43
    %)Total Interest
    
    $
    7,000
    
    
    $
    622,000
    
    
    $
    615,000
    
    
    
    8786
    %
 Interest expense increased substantially in 2004 because we completed a $5
million private placement of Convertible Debentures in March of 2003 and, upon
and subsequent to issuance, have provided for $4.1 million of non-cash charges
and $475,000 of deferred financing costs related to the Convertible Debentures
to be charged to our income statement prior to March, 2006. As of March 31,
2004, approximately $1.3 million of these non-cash charges and deferred
financing costs have been amortized and charged as interest expense and the
remaining $3.3 million will be amortized using the effective interest rate
method over the remaining quarters until March, 2006. The Convertible Debentures allow the interest and principal to be paid in
common stock at a discount to valuation, but only if (i) we are not in default
under the terms of the Convertible Debentures, (ii) there is an effective
registration statement covering such shares, (iii) our common stock is listed
on one of American Stock Exchange, New York Stock Exchange, Nasdaq National
Market or Nasdaq SmallCap Market, (iv) we have provided proper notice of our
election to make payments in stock and have made payment of all other amounts
then due under the Convertible Debentures, (v) the issuance of such shares
would not cause the holders to own more than 9.999% of the outstanding shares
of our common stock, (vi) no public announcement of a change of control or
other reclassification transaction has been made and (vii) we have sufficient
authorized but unissued and unreserved shares to satisfy all share issuance
obligations under the March 2003 financing. The first quarter of 2004s
$98,000 interest payment was made in stock and the March, 2004 principal
repayment of $192,308 was made in stock and, unless a default occurs, the
remaining payments scheduled for both interest and principal are expected to be
made in stock. Non-Cash Charges to Interest Expense consisted of  
    
    $59,000 of amortized deferred financing costs, which
reduced the original $475,000 balance of deferred financing costs
to $270,000 at March 31, 2004;
    
    $14,000 of non-cash charges to record the discount to
valuation incurred when making the principal repayment in stock
rather than cash;
    
    $446,000 of amortized debt discount, which reduced the
$4,116,000 of debt discount on our $5,000,000 note to $3,026,000
at March 31, 2004. This debt discount is comprised of the
following: the fair value allocated to the warrants issued in
conjunction with the convertible debt, the beneficial conversion
feature recorded at the date the debt was entered into and the
additional beneficial conversion features recorded in the fourth
quarter of 2003 and the first quarter of 2004 in connection with
the anti-dilution provisions triggered by the financings.




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##### Table of Contents



The following table demonstrates the accounting for the Convertible
Debentures and related discounts during 2003 and the resulting balance at March
31, 2004. Value ofDebenturesOriginal Value of Debt
    
    $
    5,000,000Discounts Recorded in 2003
    
    
    (2,777,000
    )2003 Amortization of Discounts
    
    
    644,000Carrying Value of Debt at 12/31/2003
    
    $
    2,867,000Discounts Recorded in 2004
    
    
    (1,339,000
    )2004 Amortization of Discounts
    
    
    446,000Payment in Stock
    
    
    (192,000
    )Carrying Value of Debt at 3/31/2004
    
    $
    1,782,000
 None of these activities listed in the above table is expected to affect
our cash balances unless we are unable to use our common stock to make
principal and interest payments. If we use our common stock for the above
activities, they will result in additional dilution. See Factors That May
Affect Future Results  We have substantially increased our indebtedness and
may not be able to meet our payment obligation. Liquidity and Capital Resources Our operating activities used cash in the first quarter of 2003 and 2004
primarily to fund our Net Losses excluding Non-cash Charges. The Non-cash
Charges are due to amortization of debt discount and deferred charges related
to our convertible debt. Summary Cash Flow Q1 2003
    
    Q1 2004Net Loss
    
    $
    (1,955,000
    )
    
    $
    (2,692,000
    )Non-cash Charges
    
    
    82,000
    
    
    
    672,000Changes in Assets and Liabilities
    
    
    156,000
    
    
    
    (66,000
    )Net Operating Uses
    
    
    (1,717,000
    )
    
    
    (2,086,000
    )Net Investment Uses
    
    
    (101,000
    )
    
    
    (32,000
    )Net Financing Sources
    
    
    4,524,000
    
    
    
    5,814,000Foreign exchange effect
    
    
    49,000
    
    
    
    (8,000
    )Change in cash and cash equivalents
    
    $
    2,755,000
    
    
    $
    3,688,000
 To the extent our direct sales represent a larger percentage of total
sales, U.S. accounts receivable will have different characteristics in the
future because they will represent receivables from physicians rather than from
distributors. While we do not have enough data to be certain, we expect that
the Days Sales Outstanding (DSO) may increase due to this trend. As of the
quarter ended March 31, 2004, DSO was approximately 53 days versus
approximately 47 days for the comparable period of 2003. With more regular and
smaller shipments to individual physicians, we will be exposed to a greater
volume of transactions in the future which we expect to improve our
concentration of credit risk but this benefit may be offset by an extended
collection cycle. We have incurred losses from operations since our inception. We have
financed our operations primarily through private and public offerings of our
equity securities, through funded development and marketing agreements and
through product sales. Of our $82,000,000 accumulated deficit, essentially all
was financed with various equity securities. At March 31, 2004, we had cash
and cash equivalents of $11,206,000 and working capital of $9,697,000. Based
on our current rate of cash utilization, our cash at March 31, 2004 is expected
to fund operations through at least December 2004 provided we pay interest and
principal on our convertible debentures in stock. The primary source of the additional capital we raised in 2002, 2003 and
2004 has been equity, and we expect that will continue to be the case. Equity
and convertible debt were our principal sources of cash in 2003 and equity is
expected to be our principal source of cash in 2004. After 2004, we will
likely need to raise additional capital through third party financing of




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debt or equity in order to fund our operations. We will continue to seek to
raise additional capital and will consider various financing alternatives,
including equity or debt financings convertible into equity and corporate
partnering arrangements. We do not expect to raise significant debt capital
over the next two years because our convertible debenture has a prohibition
against any debt having a ranking senior to the convertible debenture. Since
we are obliged to retire the convertible debenture over the next two years and
are permitted to do so with common stock under certain circumstances, this
constraint on our financing choices should be removed by the end of the first
quarter of 2006. While we have been successful in raising adequate equity
capital to fund Company operations, numerous factors could adversely affect our
ability to do so in the future and could affect the Companys operations
adversely. See Factors That May Affect Future Results    We will need to
obtain additional capital in the future and if we are unable to obtain such
capital on acceptable terms, or at the appropriate time, we may not be able to
continue our existing operations. Any future equity financings will dilute the ownership interest of our
existing investors and may have an adverse impact on the price of our common
stock. As of March 31, 2004, our fully diluted as if converted capital
structure was as follows: Common stock outstanding
    
    
    41,156,000Stock reserved for converting debentures
    
    
    3,184,000Stock reserved for warrant exercises
    
    
    4,765,000Stock reserved for outstanding stock options
    
    
    2,697,000Stock reserved for employee stock purchase plan issuances
    
    
    215,000Stock reserved for existing stock option and incentive plans
    
    
    2,341,000Total
    
    
    54,358,000
 The above table does not include shares we may use for payment of interest
on our Convertible Debentures or the extra shares which may be required if we
redeem the debenture rather than the holder converting it. We plan to use our
common stock to pay such interest and to redeem the debenture if it is not
converted, and such use of our common stock will result in further dilution,
particularly if our share price declines significantly. The above chart also
does not include any additional shares we may be required to issue if we engage
in a financing transaction which is deemed to be an anti-dilutive issuance
under the terms of our Convertible Debentures or other future financings. Our authorized common stock is 60 million shares. If our shareholders do
not authorize additional stock in accordance with our proposal to be presented
at our upcoming annual meeting of stockholders to be held on June 11, 2004 or
at other times when we may request such authorization, we may be unable to
issue adequate amounts of additional equity to finance the Company
appropriately. If we do not receive additional financing or do not receive an
adequate amount of additional financing, we will be required to curtail our
expenses by reducing research and/or marketing or to take other steps that
could hurt our future performance, including but not limited to, the premature
sale of some or all of our assets or product lines on undesirable terms, merger
with or acquisition by another company on unsatisfactory terms or the cessation
of operations. Any of the foregoing steps will have a material adverse effect
on our business, financial condition and results of operations. There can be
no assurance that capital will be available on terms acceptable to us, if at
all. Financings On March 19, 2004 we completed a private placement of 4,858,887 shares of
our common stock at a price of $1.35 and warrants to purchase 1,214,725 shares
of our common stock at a price of $2.00 per share for an aggregate
consideration of $6,559,500 (before cash commissions and expenses of
approximately $713,000). In addition we issued warrants to various placement
agents for a total of 434,475 shares at an exercise price of $2.00 per share.
The warrants issued as part of this private placement are exercisable until
March 19, 2009. This sale has also been deemed to be a dilutive issuance under
the terms of the Convertible Debentures and our March 2003 Warrants. As a
result, the Convertible Debentures are currently convertible into 3,183,902
shares of our common stock at a price of $1.51 per share, representing an
increase of 612,944 shares from the conversion terms of the debenture at
November 6, 2003, and the March 2003 Warrants are exercisable to purchase
shares of our common stock at a price of $1.35 per share. We have calculated
an additional beneficial conversion charge totaling approximately $1,340,000
which has been recorded as an additional debt discount in the first quarter of
2004 and will be amortized over the remaining life of the debt. We have no material capital expenditure commitments. Off Balance Sheet Arrangements




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##### Table of Contents



We have no off balance sheet arrangements. Critical Accounting Policies and Estimates These financial statements have been prepared in conformity with
accounting principles generally accepted in the United States. Preparation of
these statements requires management to make judgments and estimates. Some
accounting policies have a significant impact on amounts reported in these
financial statements. A summary of our significant accounting policies and a
description of accounting policies that are considered critical is contained in
our 2003 Annual Report on Form 10-K, filed on March 30, 2004, in the Notes to
Consolidated Financial Statements, Note 1 and the Critical Accounting Policies
section. Research and Development We are engaged in the research, production and marketing of cancer
diagnostic products. All of our research and development expenditures, whether
conducted by our own staff or by external scientists on our behalf and at our
expense, are recorded as expenses as incurred and amounted to approximately
$43.4 million for the period since our inception in October of 1987 through
March 31, 2004. Research and development expenses include the salaries and
related overhead of our research personnel, laboratory supplies, payments to
third parties to help us execute clinical trials, depreciation of research
related equipment, legal expenses related to filing and prosecuting patents,
other direct expenses and an allocation of our occupancy and related expenses
based on the square footage occupied by our research and development staff and
their laboratories. Our research and development scientists typically are assigned to one
project at a time but may also provide support for other projects. In
addition, our various programs share a substantial amount of our common fixed
costs such as facility depreciation, utilities and maintenance. All of our
research and development programs are similar in nature as they are based on
our common protein discovery technology and a significant finding in any one
cancer type may provide a similar benefit across all programs. Accordingly, we
do not track our research and development costs by individual research and
development programs. Development Programs The table below summarizes our development programs, including stage of
development and current FDA status. ClinicalProgram
    
    Technology Format
    
    Application
    
    Stage of Development
    
    FDA Status
    
    
    
    NMP22
Bladder
    
    Lab Test Kit
    
    Monitoring
    
    Commercialized
    
    ApprovedNMP22
Bladder
    
    Lab Test Kit
    
    Diagnosis
    
    Commercialized
    
    ApprovedNMP22
Bladder
    
    POC Test
Device
    
    Monitoring
    
    Commercialized
    
    ClearedNMP22
Bladder
    
    POC Test
Device
    
    Diagnosis
    
    Commercialized
    
    ApprovedNMP179
Cervical
    
    Non-Slide-Based Cellular
Analysis System
    
    Screening
    
    Licensee Sysmex is conducting
further product development
    
    *NMP48
Prostate
    
    Proprietary Laboratory
Procedure
    
    Not Determined
    
    Research & Development
    
    **NMP48
Prostate
    
    Lab Test Kit
    
    Not Determined
    
    Research & Development
    
    *NMP48
Prostate
    
    POC Test
Device
    
    Not Determined
    
    Research & Development
    
    *NMP66
Breast
    
    Proprietary Laboratory
Procedure
    
    Not Determined
    
    Development Agreement with
MKI
    
    **NMP66
Breast
    
    Lab Test Kit
    
    Not Determined
    
    Research & Development
    
    *NMP66
Breast
    
    POC Test
Device
    
    Not Determined
    
    Research & Development
    
    *NMP35
    
    All
    
    Not Determined
    
    Inactive
    
    ** *Colon




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##### Table of Contents



*
    
    If submitted for a screening or diagnosis application, FDA will require Premarket Approval (PMA). If submitted as a
monitoring test, FDA may only require Premarket Clearance (510(k)).**
    
    If offered (as intended) as a service, an FDA submission may not be required. If the service includes a reagent such as an antibody
provided by a party other than the laboratory conducting the test, the FDA requires an Analyte Specific Reagent notification at a minimum. We anticipate that in 2004 Sysmex Corporation will undertake preclinical
trials of a non-slide-based cellular analysis system incorporating our NMP179
technology. If Sysmexs anticipated preclinical and clinical trials are
successful, we expect that Sysmex will make this technology commercially
available in the U.S. in 2006. We also anticipate that either Mitsubishi
Kagaku Iatron, Inc. or another clinical partner will undertake clinical trials
in 2004 of services or products incorporating our NMP66 technology. Spending on Research and Development Projects.Total research and
development spending in the first quarter of 2004 was approximately $715,000.
We expect research and development expenditures to be less than $7.5 million
over 2004 and 2005 and to be devoted to our various programs as discussed
below. NMP22  Bladder.Except for sponsoring additional clinical trials to
demonstrate different ways to use the information generated by the products, we
do not currently plan to incur any significant additional research spending on
any of these products. We do expect to spend, from time to time, funds for
product support and manufacturing improvement which are not expected to exceed
$750,000 over 2004 and 2005. NMP179  Cervical.Discovery research on this product was completed prior
to 2000 and our expenditures in 2002 and 2003 have been principally for
technical support of the licensing activity. Substantially all future costs to
support additional research and development of this product are expected to be
paid for by Sysmex. If we incur any additional costs in connection with this
program, we expect such costs to be aimed at licensing this technology to a
company with a slide-based cervical cancer detection system. Breast and Prostate Cancer.Over the next two years, research and
development funds will be spent principally to develop both products and
services for breast and prostate cancer, to improve the controls,
reproducibility and costs of our mass spectrometry technology and to further
develop our ligand binding based technology for Lab Test Kits and Point-of-Care
Test Devices. We expect that development of NMP66 products and services for
breast cancer will have greater emphasis in 2004 than development of products
and services for our NMP48 technology. Depending on the ongoing results of our programs we will make decisions on
how to proceed and will consider options including, but not limited to,
terminating certain activities, licensing the technology to third parties or
selling the technology to third parties. As a result of these uncertainties
surrounding these projects we cannot reasonably estimate the likelihood of
reaching commercialization goals set forth in the table above. The nature,
timing and costs of the efforts to reach those goals, and the amount or timing
of the net cash inflows of our individual programs are not possible to predict. Factors That May Affect Future Results Our future financial and operational results are subject to a number of
material risks and uncertainties that may affect such results or conditions,
including: We have a history of operating losses, are continuing to lose money and
may never be profitable. We have incurred operating losses since we began operations in 1987.
These losses have resulted principally from costs incurred in research and
development and from selling, general and administrative costs associated with
our market development. Our accumulated deficit from inception through March
31, 2004 is $81,691,000. Our revenue and net losses for each of the past three
fiscal years and the first quarter of 2004 have been: Q1 04
    
    2003
    
    2002
    
    2001Product Sales
    
    $
    1,386,000
    
    
    $
    4,018,000
    
    
    $
    3,094,000
    
    
    $
    2,341,000Net Losses
    
    $
    2,692,000
    
    
    $
    7,878,000
    
    
    $
    8,278,000
    
    
    $
    8,731,000




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##### Table of Contents



We expect to continue to incur additional operating losses in the future
as we continue to develop new products and seek to commercialize the results of
our research and development efforts. Our ability to achieve long-term
profitability is dependent upon our success in those development and
commercializing efforts. We do not believe we will be profitable in the
foreseeable future. We will need to obtain additional capital in the future and if we are
unable to obtain such capital on acceptable terms, or at the appropriate time,
we may not be able to continue our existing operations. We do not currently generate revenues sufficient to operate our business
and do not believe we will do so in the foreseeable future. In our quarter
ended March 31, 2004, we had a net loss of $2.7 million, and as of March 31,
2004, we only had $11.2 million of cash and cash equivalents. As a result, we
must rely on our ability to raise capital from outside sources in order to
continue operations in the long-term. In March, 2003 we completed a sale of
convertible debentures and accompanying warrants, in October and November, 2003
we completed a sale of common stock and accompanying warrants, and in March,
2004 we completed a sale of common stock and accompanying warrants. We will
continue to seek to raise additional capital through various financing
alternatives, including equity or debt financings and corporate partnering
arrangements. However, we may not be able to raise needed capital on terms
that are acceptable to us, or at all. The terms of our 2003 sales of convertible debentures and common stock
greatly restrict our ability to raise capital. Under the terms of our
convertible debenture financing, we are prohibited from entering into
obligations that are senior to the debentures. The purchasers of the
convertible debentures and common stock sold in the fall of 2003 also have
rights, under the terms of those financings, to participate in our future
financings. These provisions may severely limit our ability to attract new
investors and raise additional financing on acceptable terms. In addition, in
order to attract such new investors and obtain additional capital, we may be
forced to provide rights and preferences to the new investors which are not
available to current shareholders. If we do not receive an adequate amount of additional financing in the
future, we may be unable to meet any cash payment obligations required by the
convertible debentures, or we may be required to curtail our expenses or to
take other steps that could hurt our future performance, including but not
limited to, the premature sale of some or all of our assets or product lines on
undesirable terms, merger with or acquisition by another company on
unsatisfactory terms or the cessation of operations. We have substantially increased our indebtedness and may not be able to
meet our payment obligations. As a result of the 2003 sale of convertible debentures, we have
substantially increased our indebtedness from approximately $475,000 at the end
of 2002 to approximately $2.1 million at the end of the first quarter of 2004. The convertible debentures permit us to make interest and principal
payments in shares of common stock instead of cash, but only if (i) we are not
in default under the terms of the convertible debentures, (ii) there is an
effective registration statement covering such shares, (iii) our common stock
is listed on one of American Stock Exchange, New York Stock Exchange, Nasdaq
National Market or Nasdaq SmallCap Market, (iv) we have provided proper notice
of our election to make payments in stock and have made payment of all other
amounts then due under the convertible debentures, (v) the issuance of such
shares would not cause the holders to own more than 9.999% of the outstanding
shares of our common stock, (vi) no public announcement of a change of control
or other reclassification transaction has been made and (vii) we have
sufficient authorized but unissued and unreserved shares to satisfy all share
issuance obligations under the March 2003 financing. If we are not able to
make interest and redemption payments on the debentures in shares of stock,
such payments must be made in cash and, unless we are able to raise additional
capital from another source, we may not have sufficient funds to make such
payments. In addition, the convertible debentures require us to pay interest and
liquidated damages and may become immediately due and payable at a premium of
120% of the outstanding principal amount plus accrued interest and damages in
the event we default under their terms. Potential defaults would include,
among other things:  
    
    our inability to make payments as they become due;
    
    failure to remain listed on any of the Nasdaq SmallCap Market,
New York Stock Exchange, American Stock Exchange or the Nasdaq
National Market;
    
    sale or disposition of our assets in excess of 33% of our total assets;
    
    failure to timely deliver stock certificates upon conversion; and
    
    default on our existing or future liabilities in excess of $150,000.




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If we default under the terms of the convertible debentures, we probably
will not be able to meet our payment obligations. In addition, the increased
level of our indebtedness could, among other things:  
    
    make it difficult for us to make payment on this debt and other obligations;
    
    make it difficult for us to obtain future financing;
    
    require redirection of significant amounts of cash flow from operations to service our indebtedness;
    
    require us to take measures such as the reduction in scale of
our operations that might hurt our future performance in order to
satisfy our debt obligations; and
    
    make us more vulnerable to bankruptcy. The operations of our European subsidiary involve currency exchange
variability and other risks. Matritech GmbH, our European subsidiary, accounted for approximately 72%
of our sales for the first quarter of 2004. Accounts of our European
subsidiary are maintained in Euros and are translated into U.S. Dollars. To
the extent that foreign currency exchange rates fluctuate in the future, we may
be exposed to significant financial variability, both favorable and
unfavorable. During the first quarter of 2004, exchange rate fluctuations were
favorable as indicated in the Managements Discussion and Analysis of
Financial Condition and Results of Operations. However, rate changes in the
future may lead to unfavorable results. In addition, although we have integrated the operations of this subsidiary
since its acquisition in June 2000, we still must coordinate geographically
separate organizations, manage personnel with disparate business backgrounds
and conduct business in a different regulatory and corporate culture. It
remains to be seen whether the use of this subsidiary to spearhead the
marketing effort of our products in Europe will be successful in the long-term. Our distribution arrangements for sale of our NMP22 BladderChek Test are
not well-established, and our near-term cash requirements will significantly
increase to support a larger employee sales force, to pay for order processing,
shipping and collection costs normally borne by distributors and to finance the
accounts receivable from physician practices. We rely primarily on distributors to market NMP22 BladderChek Tests in
territories other than the United States and Germany, but our history with our
distributors is limited and we do not know whether they will achieve
substantial sales levels of our products. The failure of our distributors to
successfully market our products in territories other than the US and Germany
could have significant adverse effects on our future revenues. We recently amended our distribution agreement with our U.S. distributor
and we now have the responsibility for sales of NMP22 BladderChek Tests to
urologists in the US, including invoicing and collecting the revenue from
sales. We are increasing our sales and marketing expenditures and adding order
processing, shipping and collection resources to perform functions which have,
until recently, been performed by our U.S. distributor. We have little
experience in performing these functions in the United States to support sales
directly to physicians, and the time and cost to create these resources
combined with the risk that they may not be implemented effectively increases
the risk that the rate of sales growth for our NMP22 BladderChek Test will
slow. Sales of products directly to physicians may result in larger accounts
receivable than sales to distributors and increases the risk that accounts
receivable will not be collected. Carrying larger accounts receivable balances
and assuming greater collection risk may also increase our financing
requirements. We compete with other methods of diagnosing cancer that are in existence
or may be successfully developed by others and our technology may not prevail. Although we are not aware of any other company using nuclear matrix
protein technology in commercial diagnostic or therapeutic products,
competition in the development and marketing of cancer diagnostics and
therapeutics, using a variety of technologies, is intense. Many pharmaceutical
companies, biotechnology companies, public and private universities and
research organizations actively engage in the research and development of
cancer diagnostic products. Many of these organizations have greater
financial, manufacturing, marketing and human resources than we do. We expect that our Lab Test Kits and our Point-of-Care Test Devices will
compete with existing FDA-approved tests, such as tests known as BTA and
UroVysion bladder cancer tests, which have been approved for monitoring bladder
cancer; a test known as CEA, which is used primarily for monitoring colorectal
and breast cancers; a test known as CA19.9, which is used




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primarily for monitoring colorectal and gastric cancers; a test known as
PSA, which is used primarily for monitoring and screening prostate cancer;
tests known as TRUQUANT® BR RIA, CA15.3 and CA27.29, which are used for
monitoring breast cancer; and specimen collection and analysis systems known as
ThinPrep® (Cytyc) and SurePath(TriPath). We are also aware of a number of
companies that have announced that they are engaged in developing cancer
diagnostic products based upon oncogene technology. Our diagnostic products
will also compete with more invasive or expensive procedures such as minimally
invasive surgery, bone scans, magnetic resonance imaging and other in vivo
imaging techniques. In addition, other companies may introduce competing
diagnostic products based on alternative technologies that may adversely affect
our competitive position. As a result, our products may become less
competitive, obsolete or non-competitive. Healthcare reform measures, third-party reimbursement policies and
physician or hospital preferences could limit the per-product revenues for our
products. Our ability to commercialize our planned products successfully will depend
in part on the extent to which reimbursement for the services based on our
products will be available from government health administration authorities,
private health insurers and other third-party payors. In the case of private
insurers, the reimbursement of any medical device (or a service based on a
medical device) approved either solely for investigational use or for research
use is at the discretion of the patients individual carrier. Even if use of a
device or the performance of a service has been previously approved for
reimbursement, the insurance carrier may decide not to continue to reimburse it
at all, not to continue to reimburse it for certain medical applications and/or
to decrease the reimbursement amount. In addition, even if we are able to
successfully sell our products to managed care providers, it is possible that
these sales will involve significant pricing pressure and keep our per-product
revenues low. If we develop a Proprietary Laboratory Procedure that does not
require FDA approval, we do not expect third-party reimbursement until we
obtain FDA approval for a product which generates similar information. Healthcare reform is an area of continuing attention and a priority of
many governmental officials. Future changes could impose additional
limitations on the prices we will be able to charge for our products or the
amount of reimbursement available for our products from governmental agencies
or third-party payors. While we cannot predict whether any of these
legislative or regulatory proposals will be adopted or the effect that these
proposals may have on our business, the announcement or adoption of these
proposals could hurt our business by reducing demand for our products or
increasing the pressure on the prices we charge and could hurt our stock price
because of investor reactions. The preferences of physicians, hospitals, clinics and other customers may
also limit our per-product revenue because their profit expectations when
purchasing our product may influence their use and ordering behavior.
Physicians have developed an expectation for generating profits when they
purchase devices for use in their practice. To the extent that we are not able
to price our product to provide such an opportunity, sales of our devices may
suffer. We are subject to extensive government regulation which adds to the cost
and complexity of our business, may result in unexpected delays and
difficulties, and may impose severe penalties for violations. The FDA and, in some instances, foreign governments, extensively regulate
the medical devices that we market and manufacture. The FDA regulates the
clinical testing, manufacture, labeling, distribution and promotion of medical
devices in the United States. Any products that we or our suppliers
manufacture or distribute in accordance with FDA approvals are subject to
pervasive and continuing regulation by the FDA, including:  
    
    we and our distributors are required to comply with record
keeping requirements and to report adverse experiences with the use
of the devices we make and distribute;
    
    we are required to register our establishments and list our
devices with the FDA and are subject to periodic inspections by the
FDA and certain state agencies; and
    
    our products are required to be manufactured in accordance with
a series of complex regulations known as Quality System Regulations
which impose procedural and documentation requirements on us with
respect to manufacturing and quality assurance activities. If we fail to comply with the FDAs requirements, including those listed
above, we may face a number of costly and/or time consuming consequences,
including:  
    
    fines;
    
    injunctions;
    
    civil penalties;
    
    recall or seizure of products;




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
    
    total or partial suspension of production;
    
    failure of the government to grant premarket clearance or premarket approval for devices;
    
    withdrawal of marketing approvals; and
    
    criminal prosecution. The FDA also has the authority to request the repair, replacement or refund of
the cost of any device that we manufacture or distribute. Labeling and promotional activities are also subject to scrutiny in the
United States by the FDA and, in certain instances, by the Federal Trade
Commission. For example, our NMP22 Lab Test Kit has received FDA approval and
may be promoted by us only as an aid in the management of patients with bladder
cancer or as a diagnostic aid for use for previously undiagnosed individuals
who have symptoms of or are at risk for bladder cancer. The FDA actively
enforces regulations prohibiting the promotion of devices for unapproved uses
and the promotion of devices for which premarket approval has not been
obtained. Consequently, we cannot currently promote the NMP22 Lab Test Kit for
any unapproved use. If we or our suppliers fail to comply with these
manufacturing or promotional requirements, we may face regulatory enforcement
action by the FDA that would prevent us or our suppliers from manufacturing or
selling our products, hurt our ability to conduct testing necessary to obtain
market approval for these products and reduce our potential sales revenues. In addition to federal regulations regarding manufacture and promotion of
medical devices, we are also subject to a variety of state laws and regulations
which may hinder our ability to market our products in those states or
localities. Manufacturers in general are also subject to numerous federal,
state and local laws relating to such matters as safe working conditions,
manufacturing practices, environmental protection, fire hazard control, and
disposal of hazardous or potentially hazardous substances. We may be required
to incur significant costs to comply with these laws and regulations in the
future, which could increase future losses or reduce future profitability. Our inability to develop and commercialize additional products may
adversely affect our ability to achieve profitability. We believe that our ability to achieve profitability in the future is
greatly dependent on producing additional revenue-generating products. Other
than the NMP22 products and allergy diagnostic products distributed by our
European subsidiary, none of our products is close enough to commercialization
to be expected to generate revenue in the foreseeable future, if at all. If we
are unable to successfully develop and commercialize other products, the future
prospects for our business, sales and profits will be materially impaired. In
addition, if we are unable to develop and commercialize additional products and
diversify our revenue streams, greater pressure will be placed on the
performance of existing products and our business success will be directly
related to success or failure of these few products. We may incur substantially greater costs and timing delays than we
currently expect in the development process. From time to time, we have encountered unexpected technical obstacles and
may encounter additional ones in the course of the development process that we
may not be able to overcome or may only overcome if we expend additional funds
and time. For example, in 1997 we elected to terminate development of a
blood-based Lab Test Kit for PC1, a candidate marker for prostate cancer, due
to unexpected difficulties. Despite encouraging initial results from an
earlier low throughput research testing method, we were unable to develop such
a kit for use in testing prostate cancer patients even when we employed 1997
state-of-the-art detection methods. We have subsequently announced that a
different set of proteins (NMP48), discovered using a different research
method, would be the primary candidates in our prostate cancer program. More
recently, we and others have observed that the testing methodologies of a low
throughput research mass spectrometry instrument are not readily reproducible
or transferable to high throughput mass spectrometry instruments. This has
required us to try a number of changes in our procedures to improve controls,
reproducibility and costs in order to measure these proteins. Such changes in
our technology and procedures may result in products or services that cannot
reproduce our original discovery results or that do not perform at all or do
not perform as well as the results reported using our discovery research
procedure. The research results we obtain in the laboratory frequently cannot be
replicated in clinical trials. Investors should not expect products that we commercialize to perform as
well as preliminary discovery research results in the small numbers of samples
reported by us. In large-scale clinical trials, such as those required by the
FDA, we expect to encounter greater variability and risks including but not
limited to:  
    
    obtaining acceptable specimens from patients and healthy
individuals;




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
    
    testing a much larger population of individuals than we tested in
early discovery which will be likely to demonstrate the inherent
biologic variability;
    
    preparing the specimens properly for testing using lower cost, high
throughput methods which may be less reliable than those used in early
discovery; and
    
    developing an economic and reproducible test method for the
substance to be measured. We believe that testing the final product in a clinical setting will
result in product performance which may not be as accurate as the results
reported from the discovery phase. Therefore, the best comparative data to be
used in evaluating our product development programs are the results of
physician trials of commercial products such as those reported since 1996 for
products based on NMP22 proteins. We have no demonstrated success in developing Proprietary Laboratory
Procedures as a profitable service business and any future success will be
dependent upon satisfaction and approval of our clinical lab partners. We believe the future success of our business will depend not only on the
successful commercialization of our Lab Test Kits and Point-Of-Care Test
Devices, but also in part upon developing a service business based on
Proprietary Laboratory Procedures which will be custom designed to the
instrumentation and techniques of a specific clinical laboratory to measure
clinically useful proteins. We are currently working on development of such
Proprietary Laboratory Procedures using our technologies for breast cancer, but
we have no demonstrated success in this area. In addition, because we expect
that use of our Proprietary Laboratory Procedures will likely be confined to a
limited number of licensed clinical laboratories who would be expected to
invest in the development and marketing of a lab testing service specific to
their equipment, processes and personnel, the success of these procedures will
be dependent upon acceptance by the applicable laboratories. Although we may
complete our product development efforts to our satisfaction, we may not obtain
the agreement and approval from our clinical lab partner that the technology
works adequately in their laboratory environment or that it has the medical
performance and information value that they originally expected. Because
Proprietary Laboratory Procedures utilize technologies which are, by their
nature, more sensitive and more operator-dependent than the technologies
involved in products such as Lab Test Kits and Point-of-Care Test Devices, the
risks regarding successful commercial acceptance are increased in this area. We have no demonstrated success in developing cellular analysis systems
and any future success in this area will be highly dependent upon Sysmex. We believe the future success of our business will also depend, in part,
upon Sysmex Corporation developing a satisfactory Cellular Analysis System to
be used to measure clinically useful cervical cancer proteins. Even if Sysmex
completes its product development efforts to its satisfaction, it is expected
to face significant obstacles (including but not limited to those set forth in
the following paragraph) in developing a system which will be approved by the
FDA and selling such systems to cervical cancer smear laboratories at a
satisfactory price. Our success in cervical cancer Cellular Analysis Systems
is almost completely dependent on the success of Sysmex in utilizing our
technology and on its ability to educate physicians, patients, insurers and its
distributors about the medical utility of the new products. Even if Sysmex
successfully educates the market, competing products may prevent Sysmex from
gaining wide market acceptance of its products. Successful technical development of our products does not guarantee
successful commercialization. We may successfully complete technical development for one or all of our
product development programs, but still fail to develop a commercially
successful product for a number of other reasons, such as the following:  
    
    failure to obtain the required regulatory approvals for their use;
    
    prohibitive production costs;
    
    clinical trial results might differ from discovery phase data; and
    
    variation of perceived value of products from physician to physician. Our success in the market for the diagnostic products we develop will also
depend greatly on our ability to educate physicians, patients, insurers and our
distributors on the medical utility of our new products. Even if we
successfully educate the market, competing products may prevent us from gaining
wide market acceptance of our products. If we are unable to manufacture the product volumes we need, we will be
unable to achieve profitability.




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We have been manufacturing and assembling our Lab Test Kits for commercial
sales since 1995 but have not yet manufactured these products in the large
volumes which will eventually be necessary for us to achieve profitability. We
may encounter difficulties in scaling up production of new products, including
problems involving:  
    
    production yields;
    
    quality control and assurance;
    
    component supply; and
    
    shortages of qualified personnel. These problems could make it very difficult to produce sufficient product
to satisfy customer needs and could result in customer dissatisfaction. We may
not be able to achieve reliable, high-volume manufacturing at a commercially
reasonable cost. In addition, numerous governmental authorities extensively
regulate our manufacturing operations. Failure to satisfy our future
manufacturing needs could result in decreased sales, loss of market share and
potential loss of certain distribution rights. If we lose the services of our suppliers or assemblers for any reason it
may be difficult for us to find replacements,
we may be forced to modify or cease production of our products and we may be
unable to meet customer commitments. We currently manufacture our NMP22 Lab Test Kits and package our NMP22
BladderChek Tests in our Newton facility but we rely on subcontractors for
certain components and processes for each of these products. We do not have
alternative suppliers for certain key components and processes which are
provided by some subcontractors. If the units or components from these
suppliers or the services of these assemblers should become unavailable for
any reason, including their failure to comply with FDA regulations, we would
need to seek alternative sources of supply or assembly. In order to maintain
the FDA acceptance of our manufacturing process, we would have to demonstrate
to the FDA that these alternative sources of supply are equivalent to our
current sources. Although we attempt to maintain an adequate level of
inventory to provide for these and other contingencies, if our manufacturing
processes are disrupted because key components are unavailable, because new
components must be revalidated or because an assembler fails to meet our
requirements, we may be forced to modify our products to enable another
subcontractor to meet our sales requirements or we may be required to cease
production of such products altogether until we are able to establish an
adequate replacement supplier. Disruptive changes such as these may make us
unable to meet our sales commitments to customers. Our failure or delay in
meeting our sales commitments could cause sales to decrease and market share
to be lost permanently, and could result in significant expenses to obtain
alternative sources of supply or assembly with the necessary facilities and
know-how. Our activities involve the use of hazardous materials, and we may be held
liable for any accidental injury from these hazardous materials. Our research and development and assembly activities involve the
controlled use of hazardous materials, including carcinogenic compounds.
Although we believe that our safety procedures for handling and disposing of
our hazardous materials comply with the standards prescribed by federal, state
and local laws and regulations, the risk of accidental contamination or injury
from these materials cannot be completely eliminated. In the event of an
accident, we could be held liable for damages that result, and significant and
unexpected costs, including costs related to liabilities and clean-up, costs
from increased insurance premiums or inability to obtain adequate insurance at
a reasonable price and costs from loss of operations during clean-up. If the products we distribute which are made by other companies should
become unavailable or not meet quality standards, we may lose revenues and
market share and may face liability claims. If the products we distribute, but do not manufacture, should become
unavailable for any reason, we would need to seek alternative sources of
supply. If we are unable to find alternative sources of an equivalent product
we may be required to cease distribution of this type of product, which could
cause revenues to decrease and market share to be lost permanently.
Furthermore, if products which we distribute, but do not manufacture, should be
found defective, we could be sued for product liability or other claims. During 2003, we received reports from customers that one of the products
we sell through our German subsidiary failed to perform correctly and provided
false readings on patients conditions. We believe the product performance
problems are being addressed by the manufacturer of the products and that the
manufacturer will accept responsibility for defective products. We have not
sought an alternate source of supply for this product line, but we have seen
decreased customer demand for these products during the first quarter of 2004
compared to the first quarter of 2003. Our revenues, profits and market share
for these




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products may be further adversely affected, and we may face product
liability and other claims if the manufacturer fails to satisfactorily address
all issues raised by our customers and the patients affected. If we are sued for product-related liabilities, the cost could be
prohibitive to us. The testing, marketing and sale of human healthcare products entail an
inherent exposure to product liability, and third parties may successfully
assert product liability claims against us. Although we currently have
insurance covering our products, we may not be able to maintain this insurance
at acceptable costs in the future, if at all. In addition, our insurance may
not be sufficient to cover large claims. Significant product liability claims
could result in large and unexpected expenses as well as a costly distraction
of management resources and potential negative publicity and reduced demand for
our product. If our intellectual property is not adequately protected, we could lose
our ability to compete in the marketplace. Protection of our intellectual property is necessary for the success of
our products. Patent protection can be limited and not all intellectual
property is or can be patent protected. We rely on a combination of patent,
trade secret and trademark laws, nondisclosure and other contractual provisions
and technical measures to protect the proprietary rights in our current and
planned products. We have little protection where we must rely on trade
secrets and nondisclosure agreements and our competitors independently develop
technologies that are substantially equivalent or superior to our technology.
If our competitors develop such technology and are able to produce products
similar to or better than ours, our market share could be reduced and our
revenue potential may decrease. While we have obtained patents where advisable, patent law relating to the
scope of certain claims in the biotechnology field is still evolving. In some
instances we have taken an aggressive position in seeking patent protection for
our inventions and in those cases the degree of future protection for our
proprietary rights is uncertain. In addition, the laws of certain countries in
which our products are, or may be, licensed or sold do not protect our products
and intellectual property rights to the same extent as the laws of the United
States. If our intellectual property infringes on the rights of others, we may be
forced to modify or cease production of our products. We believe that the use of the patents for nuclear matrix protein
technology owned by us or licensed to us and the use of our trademarks and
other proprietary rights, do not infringe upon the proprietary rights of third
parties. However, we may not prevail in any challenge of third-party
intellectual property rights, and third parties may successfully assert
infringement claims against us in the future. In addition, we may be unable to
acquire licenses to any of these proprietary rights of third parties on
reasonable terms. If our intellectual property is found to infringe upon other
parties proprietary rights and we are unable to come to terms with such
parties, we may be forced to modify our products to make them non-infringing or
to cease production of such products altogether. We may need to stop selling our Point-of-Care Test Devices if we cannot
obtain a license or a waiver to use the test strip technology. Our NMP22 BladderChek Test uses test strips composed of an absorbent
material that will soak up urine from a small reservoir at one end of the
container housing the test strip and expose the urine to chemicals and
antibodies arranged on the surface of or imbedded in the test strip. After a
short period of time and after a reaction with our proprietary antibodies, a
test result will appear in a window located on the container housing the test
strip. The manufacture, use, sale, or import of point-of-care products which
include this test strip technology in certain jurisdictions will require us to
obtain patent licenses. We are currently selling NMP22 BladderChek Tests and
are attempting to obtain appropriate licenses or waivers. If we are unable to
obtain patent licenses to permit us to make, use, sell, or import such products
in the United States or in certain other jurisdictions, we will have to stop
selling our Point-of-Care Test Device until the expiration of the relevant
patents or until we are able to arrive at a design solution that uses a
different technology. In addition, we may also be subject to litigation that
seeks a percentage of the revenues we have received from the sale of our
Point-of-Care Test Device. We have accrued estimated royalties on sales of the
NMP22 BladderChek Test based on our estimates of customary royalty rates but
have received no assurances that such accruals will be adequate to pay any
royalties due if and when we complete a licensing agreement. If we lose or are unable to recruit and retain key management, scientific
and sales personnel, we may be unable to achieve our objectives in a timely
fashion. We need to attract and retain a highly qualified scientific and management
team. We have at any given time only about sixty employees. While no
individual is irreplaceable, the loss of multiple members of our key personnel,
such as our scientists or our field sales force, at the same time or within
close proximity of each other, or the failure to recruit the necessary




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additional personnel when needed with specific qualifications and on
acceptable terms might harm our research and development efforts and/or our
direct-to-the-urologist marketing strategy. We face intense competition for
qualified personnel from other companies, research and academic institutions,
government entities and other organizations. Our success is also greatly dependent on the efforts and abilities of our
management team. The simultaneous loss of multiple members of senior
management might delay achievement of our business objectives due to the time
that would be needed for their replacements to be recruited and become familiar
with our business. Market volatility and fluctuations in our stock price and trading volume
may cause sudden decreases in the value of an investment in our common stock. The market price of our common stock has historically been, and we expect
it to continue to be, volatile. This price has ranged between $1.34 and $2.88
in the fifty-two week period ended March 31, 2004. The stock market has from
time to time experienced extreme price and volume fluctuations, particularly in
the biotechnology sector, which have often been unrelated to the operating
performance of particular companies. Factors such as announcements of
technological innovations or new products by our competitors or disappointing
results by third parties, as well as market conditions in our industry, may
significantly influence the market price of our common stock. For example, in
the past our stock price has been affected by announcements of clinical trial
results and technical breakthroughs at other biotechnology companies. Our
stock price has also been affected by our own public announcements regarding
such things as quarterly earnings, regulatory agency actions and corporate
partnerships. Consequently, events both within and beyond our control, may
cause shares of Matritech stock to lose their value rapidly. In addition, sales of a substantial number of shares of our common stock
by stockholders could adversely affect the market price of our shares. In the
first quarter of 2004, our shares had an average daily trading volume of only
approximately 81,000 shares. In connection with our March 2004 private
placement of common stock and accompanying warrants, we filed a resale
registration statement covering up to 7,121,031 shares for the benefit of our
investors. In 2003, we filed resale registration statements covering up to
5,371,332 shares for the benefit of our investors in connection with the sale
of convertible debentures and accompanying warrants and an additional
approximately 5,419,000 shares for the benefit of our investors in a private
placement of common stock and accompanying warrants. We have also filed resale
registration statements in connection with previous private placements. The
actual or anticipated resale by such investors under these registration
statements may depress the market price of our common stock. Bulk sales of
shares of our common stock in a short period of time could also cause the
market price for our shares to decline. Future financings will result in additional dilution of the ownership
interest of our existing investors and may have an adverse impact on the price
of our common stock. We will need to raise additional capital in the future to continue our
operations. Any future equity financings will dilute the ownership interest of
our existing investors and may have an adverse impact on the price of our
common stock. In addition, the terms of the convertible debentures provide for
antidilution adjustments. On October 15, 2003 and on November 6, 2003 we
completed a sale of 3,893,295 shares of our common stock and warrants to
purchase 1,362,651 shares of our common stock at a price of $2.45 per share for
an aggregate consideration of $6,501,801 (before cash expenses of approximately
$855,000). This sale was deemed to be a dilutive issuance under the terms of
the convertible debentures and our March 2003 Warrants. On March 19, 2004 we
completed a sale of 4,858,887 shares of our common stock and warrants to
purchase 1,214,725 shares of our common stock at a price of $2.00 per share for
an aggregate consideration of $6,559,500 (before cash expenses of approximately
$713,000). This sale has also been deemed to be a dilutive issuance under the
terms of the convertible debentures and our March 2003 Warrants. As a result,
the convertible debentures are currently convertible into 3,183,902 shares of
our common stock at a price of $1.51 per share, representing an increase of
612,944 shares from the conversion terms of the debenture at November 6, 2003,
and the March 2003 Warrants are exercisable to purchase shares of our common
stock at a price of $1.35 per share. If we do a future financing at a price less than $1.35 per common share
(the New Base Price), the conversion rate of the debentures will be adjusted
down to 112% of the New Base Price and additional shares of our common stock
would be issuable upon such conversion. The terms of the March 2003 Warrants
also provide for antidilution protection, so that the exercise price for such
warrants would be adjusted down to the New Base Price in the event of a
dilutive financing, or on a weighted-average basis if there are no longer any
convertible debentures outstanding. The issuance of additional shares upon
conversion of the debentures would result in further dilution of the ownership
interest of our other existing investors, and a decrease in the warrant
exercise price may cause a decline in our stock price.




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Conviction of our previous auditing firm means that we will not be able to
obtain a consent for inclusion of their auditor report in future SEC filings. Prior to July 17, 2002, Arthur Andersen LLP served as our independent
auditors. On March 14, 2002, Arthur Andersen was indicted on federal
obstruction of justice charges arising from the governments investigation of
Enron Corporation and on June 15, 2002, Arthur Andersen was found guilty and
subsequently has ceased practicing before the SEC. On July 17, 2002, we
dismissed Arthur Andersen and retained PricewaterhouseCoopers LLP as our
independent auditors for our fiscal year ended December 31, 2002. SEC rules
require us to present historical audited financial statements in various SEC
filings, such as registration statements, along with Arthur Andersens consent
to our inclusion of Arthur Andersens audit report in those filings. In light
of the cessation of Arthur Andersens practice, we will not be able to obtain
the consent of Arthur Andersen to the inclusion of Arthur Andersens audit
report in our future filings. The SEC has provided regulatory relief designed
to allow companies that file reports with the SEC to dispense with the
requirement to file a consent of Arthur Andersen in certain circumstances, but
purchasers of securities sold under our registration statements which were not
filed with the consent of Arthur Andersen to the inclusion of Arthur Andersens
audit report will not be able to sue Arthur Andersen pursuant to Section
11(a)(4) of the Securities Act of 1933 and therefore the purchasers right of
recovery under that section may be limited as a result of the lack of our
ability to obtain Arthur Andersens consent. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk. Investment Portfolio.We own financial instruments that are sensitive to
market and interest rate risks as part of our investment portfolio. The
investment portfolio is used to preserve our capital until it is required to
fund operations including our research and development activities. None of
these market risk sensitive instruments is held for trading purposes. Our
investment policy prohibits investing in derivatives, and we stringently adhere
to this policy. The interest rate on our
Convertible Debentures is fixed and therefore not subject to interest rate
risk. It is suggested that this paragraph be read in conjunction with Note 1
of Notes to the Consolidated Financial Statements  Operations and Significant
Accounting Policies of our Annual Report on Form 10-K for the year ended
December 31, 2003 filed with the SEC (File No. 001-12128). We invest our cash in securities classified as cash and cash equivalents.
At March 31, 2004, these securities totaled $11.2 million and included money
market accounts and certificates of deposit that are classified as
held-to-maturity securities. Changes in interest rates affect the investment
income we earn on our investments and, therefore, impact our cash flows and
results of operations. A hypothetical 50 basis point decrease in interest
rates would result in a decrease in annual interest income and a corresponding
increase in net loss of approximately $12,000 for the period ended March 31,
2004. Foreign Exchange.The financial statements of Matritech
GmbH are translated in accordance with SFAS No. 52, Foreign Currency
Translation. The functional currency of our foreign subsidiary is the local
currency (Euro), and accordingly, all assets and liabilities of the foreign
subsidiary are translated using the exchange rate at the balance sheet date
except for intercompany receivables which are of long-term-investment nature,
and capital accounts which are translated at historical rates. Revenues and
expenses are translated at average rates during the period. Adjustments
resulting from the translation from the financial statements of the Matritech
GmbH into U.S. Dollars are excluded from the determination of net income and
are accumulated in a separate component of stockholders equity. Foreign
currency transaction gains and losses are reported in the accompanying
consolidated statements of operations and are immaterial to the results of
operations. We had sales denominated in foreign currency of approximately
$997,000 for the three month period ended March 31, 2004. 
 Item 4. Controls and Procedures. Evaluation of Disclosure Controls and Procedures. Our management, with the
participation of our Chief Executive Officer and Chief Financial Officer, has
evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the Exchange Act)), as of the end of the period covered by
this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that as of such
date, our disclosure controls and procedures were designed to ensure that
information required to be disclosed by us in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in applicable SEC rules and forms and were
effective. Changes in Internal Control Over Financial Reporting. There was no change in
our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) that occurred during the period covered
by this Quarterly




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Report on Form 10-Q that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. 
 PART II. OTHER INFORMATION 
 Item 2. Changes in Securities and Use of Proceeds. During the fiscal quarter ended March 31, 2004, we issued the following
securities that were not registered under the Securities Act of 1933, as
amended (the Securities Act): On March 19, 2004, we completed a private placement of 4,858,887 shares of
our common stock and accompanying five-year warrants (the Investor Warrants)
exercisable for an aggregate of 1,214,725 shares of our common stock at an
exercise price of $2.00 per share. The aggregate purchase price for the common
stock and the Investor Warrants sold in this transaction (the Private
Placement) was approximately $6,560,000. We also issued warrants to placement agents in connection with the Private
Placement (the Placement Agent Warrants) exercisable for 434,475 shares of
our common stock. The Placement Agent Warrants are immediately exercisable over
a five-year term at an exercise price of $2.00 per share. The Private Placement triggered the anti-dilution provisions in our 7.5%
Convertible Debentures due March 31, 2006 and in the March 2003 Warrants issued
in connection with the Convertible Debentures financing. As a result, the
Convertible Debentures are now convertible into an additional 612,944 shares of
our common stock, and the March 2003 Warrants may now be exercised at an
exercise price of $1.35. We received net proceeds of approximately $5.85 million after deducting
the estimated expenses and commissions in connection with the Private
Placement, including a cash payment of approximately $610,542 to placement
agents. We intend to use the net proceeds from this private placement for
increasing our marketing and sales efforts and for ongoing in vitro diagnostic
development, clinical trials, working capital, capital expenditures and general
corporate purposes. The offer and sale of securities in the transaction described above was
exempt from registration under the Securities Act in reliance upon Section 4(2)
of the Securities Act and Regulation D promulgated thereunder, as a transaction
by an issuer not involving any public offering. The recipients of securities in
this transaction were accredited investors and represented their intentions to
acquire the securities for investment only and not with a view to or for sale
in connection with any distribution thereof and appropriate legends were
affixed to the securities issued in this Private Placement. We did not repurchase any shares of our common stock during the first
quarter of 2004. 
 Item 6. Exhibits and Reports on Form 8-K. (a)
    
    Exhibits:31.1
    
    
    Certification of Chief Executive Officer Pursuant
to Rule 13a-14(a) under the Securities Exchange
Act of 1934.31.2
    
    
    Certification of Chief Financial Officer Pursuant
to Rule 13a-14(a) under the Securities Exchange
Act of 1934.32.1
    
    
    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.(b)
    
    Reports on Form 8-K:On February 3, 2004, we filed a Current Report on Form 8-K furnishing information on Items 7 and 12.On March 22, 2004, we filed a Current Report on Form 8-K reporting on Items 5 and 7.On April 7, 2004, we filed a Current Report on Form 8-K reporting on Items 5 and 7.On May 4, 2004, we filed a Current Report on Form 8-K reporting on Items 7 and 12.




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized. MATRITECH, INC.Date: May 7, 2004
    By:
    /s/ Stephen D. ChubbStephen D. ChubbDirector, Chairman and Chief Executive Officer

(principal executive officer) Date: May 7, 2004
    By:
    /s/ Richard A. SandbergRichard A. SandbergDirector, Vice President, Chief Financial

Officer and Treasurer
(principal accounting and financial officer)