UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Matritech, Inc.

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  þ No

     As of October 29, 2004, there were 42,589,373 shares of the Registrant’s Common Stock outstanding.

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MATRITECH, INC.

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

MATRITECH, INC.

CONSOLIDATED BALANCE SHEETS

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The accompanying notes are an integral part of these consolidated financial statements.

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MATRITECH, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

The accompanying notes are an integral part of these consolidated financial statements.

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MATRITECH, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of these consolidated financial statements.

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MATRITECH, INC.

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. 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 approximately $88 million at September 30, 2004. Based on our current rate of cash utilization, our cash at September 30, 2004 is expected to fund operations through at least June 2005 provided we pay interest and principal on our convertible debentures in stock. Our financing plans include continuing to seek to raise additional capital and we will consider various financing alternatives, including equity or debt financings and corporate partnering arrangements. The primary sources of the additional capital we raised in 2002, 2003 and 2004 have been equity and convertible debt, and we expect equity-related instruments will continue to be our principal source of additional capital. After 2004, we will likely need to raise additional capital through third party financing of debt or equity in order to fund our operations. 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 Freiburg, 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:

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     (c) Revenue Recognition

           Deferred revenue consists of the following:

     (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 in other comprehensive income (loss) those foreign currency adjustments related to the translation of the assets and liabilities of Matritech GmbH into US Dollars as the functional currency of Matritech GmbH is the Euro. The composition of accumulated other comprehensive income (loss) is as follows:

     (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:

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     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:

(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 anti-dilutive. At September 30, 2003 and 2004, potential common stock equivalents consisted of stock options, warrants, and convertible debentures. The number of anti-dilutive securities excluded from the computation of diluted loss per share were 5,738,391 and 9,598,418 for the periods ended September 30, 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 per share 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 (the “Convertible Debentures”) and our warrants issued in connection with the Convertible Debenture financing (the “March 2003 Warrants”). As a result, the Convertible Debentures became 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 immediately prior to the transaction. The Convertible Debentures were convertible on September 30, 2004 into 2,419,764 shares of our common stock at a price of $1.51 per share. 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 calculated an additional beneficial conversion charge totaling approximately $1,339,000 (see table below in Note 4) which was recorded as a debt discount in the first quarter of 2004 and is being amortized over the remaining life of the debt.

4. Convertible Debt

     A summary of the Convertible Debt accounting is as follows:

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     The debt discount is being amortized to interest expense using the effective interest method over the term of the debt. For the three and nine month periods ended September 30, 2004, $569,000 and $1,650,000, respectively, 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 three and nine month periods ended September 30, 2004, $51,000 and $166,000, respectively representing amortization of these costs is included in interest expense. As of September 30, 2004, unamortized debt issuance costs totaled $164,000, of which $141,000 is included in other current assets.

     Minimum future payments on the debt are as follows:

The fair value of the Convertible Debt at September 30, 2004 as estimated by management is approximately $3.3 million. The carrying value of the Convertible Debt in the Company’s financial statements reflects discounts related to beneficial conversion charges calculated in accordance with EITF Issue No. 00-27.

     The Convertible Debentures allow the interest and principal to be paid in common stock at a discount to value, 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, second and third quarter of 2004’s interest payments ($98,000, $89,000 and $69,000, respectively) were made in stock and the monthly principal repayments of $192,000 each commencing in March 2004 (totaling $1,346,000 at September 30, 2004) were 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.

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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 payments relating to licensing activities and other grants of rights.

     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 of 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 and other diagnostic products for a third party in Germany, but revenues from these products declined in 2003. Each of these trends continued in the first nine months of 2004. Prior to 2003, our revenues were derived primarily from selling products made by others and through licensing activities and other payments from strategic partnerships or alliances.

     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 and other diagnostic products for third parties in Germany, but revenues from these products declined in 2003 and have continued to decline in the first nine months of 2004. Prior to 2003, our revenues were derived primarily from selling products made by others and through licensing activities and other payments from strategic partnerships or alliances.

     Effective November 2003, we changed our U.S. distributor arrangement with Cytogen Corporation for our most important product, our BladderChek Test, to permit us to sell directly to urologists as we have done in Germany since 2001. This change has resulted 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 third quarter of 2004 from the third quarter of 2003. This increase was caused primarily by the higher costs needed to support the direct distribution of the BladderChek Tests. The increased selling expenditures will likely increase our losses in the short term (See “Results of Operations” below), but our goal is to generate sufficient additional gross profit from sales growth 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 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 sample 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 third quarter of 2004 research and development expenditures were 4% higher than comparable expenses in the third quarter of 2003. In the first nine months of 2004 research and development expenditures were 2% higher than comparable expenses in the first nine months 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 September 30, 2004, we incurred a cumulative net loss of approximately $88 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 this 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.

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Results of Operations

Quarter Ended September 30, 2003 (“Q3 2003”) Compared with Quarter Ended September 30, 2004 (“Q3 2004”)

Revenues

     The increase in revenue from our NMP22 product line is due to a $777,000 sales increase, primarily in the U.S. and Europe, and a $59,000 favorable exchange rate impact. BladderChek Test sales accounted for approximately 83% of sales in the NMP22 product line in the third quarter of 2004, compared to 61% in the third quarter of 2003. The BladderChek Test sales growth is the result of increased selling efforts applied to the 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-doctor selling activity in Germany and obtaining additional reimbursement coverage by Medicare and other health plan insurance payors throughout the United States. We announced in April 2004 that Medicare reimbursement programs in 49 states cover the 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. We include in the category of Lab Test Kit sales the sale by Diagnostic Products Corporation (“DPC”) of a fully automated laboratory test incorporating our NMP22 technology that DPC manufactures for use on its automated laboratory analyzers. The increase in the Lab Test Kit sales is due primarily to increased sales in Germany of this automated laboratory test by DPC offset by a decline in distributor sales in markets other than Germany and the US.

     Revenue from sales of non-NMP22 products decreased by $49,000 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 distribute and research-use products we manufacture. This decrease was offset by a $37,000 favorable exchange rate impact.

     Alliance and collaboration revenue decreased by $60,000 as the 2003 period included alliance revenue related to special projects undertaken on behalf of Sysmex and reimbursed by them. Those projects were essentially completed during 2003.

     During the third quarter of 2004 we sold approximately $62,000 of the 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 September 30, 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:

Cost of Product Sales

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     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 higher margin NMP22 products worldwide as a percentage of total sales.

Research and Development and Clinical Expenses

     Research and development, clinical and regulatory expenses increased slightly over the third quarter of 2003. See discussion under “Research and Development”.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses increased primarily due to a $617,000 increase in payroll costs resulting from increased headcount, mainly to support direct sales efforts described above, and a $142,000 increase in sales-related marketing expenses. In addition, an increase of $75,000 was incurred for the launch of a new website as well as other corporate communications costs, and there was an unfavorable foreign currency exchange rate impact of $51,000 on non-US selling, general and administrative expenses.

     We believe that a decrease in our SG&A expenses as a percentage of our gross profit from 289% in the third quarter of 2003 to 209% in the third quarter of 2004 is a useful measure of our performance. During the remainder of the year, we expect gross profits to increase more rapidly than sales as our higher margin NMP22 products, including our 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. We also expect the growth in gross profits to exceed the growth in SG&A expenses, and that SG&A expenses as a percent of our gross profit should continue to decline.

Operating Loss

     The operating loss increased primarily due to increased selling, general and administrative expenses discussed above offset by higher gross profit.

Interest Income

     Interest income increased slightly over the third quarter of 2003 due to a higher average cash balance offset by lower interest rates.

Interest Expense

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     Interest expense increased substantially in 2004 because we completed a $5 million private placement of Convertible Debentures in March of 2003 and, subsequent to issuance, have recorded an additional $2.4 million of non-cash charges related to the Convertible Debentures which are being charged to our income statement through March 2006. As of September 30, 2004, approximately $2.6 million of the $4.6 million non-cash charges and deferred financing costs have been amortized and charged as interest expense and the remaining $2.0 million will be amortized using the effective interest rate method over the remaining quarters through 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, second and third quarter of 2004’s interest payments ($98,000, $89,000 and $69,000, respectively) were made in stock and the monthly principal repayments of $192,000 each commencing in March 2004 (totaling $1,346,000) were 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:

•		$51,000 of amortized deferred financing costs, which contributed to reducing the original $475,000 balance of deferred financing costs to $164,000 at September 30, 2004;
•		$65,000 of non-cash charges to record the discount to valuation incurred when making the principal and interest repayments in stock rather than cash;
•		$569,000 of amortized debt discount, which contributed to reducing the $4,116,000 of debt discount on our $5,000,000 note to $1,822,000 at September 30, 2004. This debt discount is comprised of the following: the fair value allocated to the warrants issued in conjunction with the convertible debt, the charge to account for the beneficial conversion feature recorded at the date the debt was entered into, and additional charges to account for the beneficial conversion feature recorded in the fourth quarter of 2003 and the first quarter of 2004 as a result of the triggering of the anti-dilution provisions.

     The following table demonstrates the accounting for the Convertible Debentures and related discounts during 2003 and 2004 and the resulting balance at September 30, 2004.

     None of the types of 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. Using our common stock for the above activities 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.”

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Net Loss

     The net loss increased primarily due to increased selling, general and administrative expenses and increased interest expense discussed above, offset by the increase in revenues.

Nine Months Ended September 30, 2003 Compared with Nine Months Ended September 30, 2004

Revenues

     The increase in revenues from our NMP22 product line is due to a $1,810,000 sales increase, primarily in the U.S. and Europe, and a $168,000 favorable exchange rate impact. BladderChek Test sales accounted for approximately 81% of sales in the NMP22 product line in the first nine months of 2004, compared to 57% for the first nine months of 2003. The BladderChek Test sales growth is the result of the factors described in the three month period above. The increase in Lab Test Kit sales is due to continued sales growth in the US partially offset by a decline in distributor sales in markets other than Germany and the US.

     Revenue from sales of non-NMP22 products decreased by $172,000 due to the factors described in the three month period above. This decrease was offset by a $132,000 favorable exchange rate impact.

     Alliance and collaboration revenue decreased by $112,000 due to the factors described in the three month period above. Those projects were essentially completed during 2003.

     During the first nine months of 2004 we sold approximately $160,000 of the 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 September 30, 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). See the deferred revenue chart in the three month period above.

Cost of Product Sales

     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 higher margin NMP22 products worldwide as a percentage of total sales.

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Research and Development and Clinical Expenses

     Research and development, clinical and regulatory expenses remained essentially constant from the first nine months of 2003. See discussion under “Research and Development”.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses increased primarily due to a $1,603,000 increase in payroll costs resulting from increased headcount, mainly to support direct sales efforts described above, and a $698,000 increase in sales-related marketing expenses. In addition, there was a $179,000 increase in recruiting costs, a $157,000 increase in costs incurred to comply with the Sarbanes-Oxley legislation, and an unfavorable foreign currency exchange rate impact of $33,000 on non-US selling, general and administrative expenses. These increases were partially offset by a decrease in outside legal expense of $111,000.

     We believe that a decrease in our SG&A expenses as a percentage of our gross profit from 349% in the first nine months of 2003 to 248% in the first nine months of 2004 is a useful measure of our performance. During the remainder of the year, we expect gross profits to increase more rapidly than sales as our higher margin NMP22 products, including our 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. We also expect the growth in gross profits to exceed the growth in SG&A expenses, and that SG&A expenses as a percent of our gross profit should continue to decline.

Operating Loss

     The operating loss increased primarily due to increased selling, general and administrative expenses discussed above offset by higher gross profit.

Interest Income

     Interest income increased slightly over the first nine months of 2003 due to a higher average cash balance offset by lower interest rates.

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Interest Expense

     Interest expense increased substantially in 2004 due to the factors described in the three month period above.

     Non-Cash Charges to Interest Expense consisted of:

•		$166,000 of amortized deferred financing costs, which contributed to reducing the original $475,000 balance of deferred financing costs to $164,000 at September 30, 2004;
•		$111,000 of non-cash charges to record the discount to valuation incurred when making the principal and interest repayment in stock rather than cash;
•		$1,650,000 of amortized debt discount, which contributed to reducing the $4,116,000 of debt discount on our $5,000,000 note to $1,822,000 at September 30, 2004. This debt discount is comprised of the items listed in the three month period above.

Net Loss

     The net loss increased primarily due to increased selling, general and administrative expenses and increased interest expense discussed above, offset by the increase in revenues.

Liquidity and Capital Resources

     Our operating activities used cash in the first nine months 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

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     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 September 30, 2004, DSO was approximately 39 days versus approximately 43 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 $88 million accumulated deficit, essentially all was financed with various equity-related securities. At September 30, 2004, we had cash and cash equivalents of $7,036,000 and working capital of $5,144,000. Based on our current rate of cash utilization, our cash at September 30, 2004 is expected to fund operations through at least June 2005 provided we pay interest and principal on our Convertible Debenture in stock.

     The primary source of the additional capital we raised in 2002, 2003 and 2004 has been equity and convertible debt, and we expect that equity-related instruments will continue to be our principal source of additional capital. After 2004, we will likely need to raise additional capital through third party financing of 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 18 months 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 our operations, numerous factors could adversely affect our ability to do so in the future and could affect the our 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 September 30, 2004, our fully diluted “as if converted” capital structure was as follows:

     The above table does not include shares we may use for payment of interest on our Convertible Debenture 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 Debenture or other future financings. In the event we have an anti-dilutive issuance, we may not be permitted to make payments of interest or principal on our Convertible Debenture in which case we will require additional financing.

     Our authorized common stock is 90 million shares. Our shareholders authorized 30 million additional shares of stock (from 60 million shares to 90 million shares) at our Annual Meeting of Stockholders held on June 11, 2004. However, if our shareholders do not authorize additional stock 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 sales staff, 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.

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  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 became 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 immediately prior to the transaction. The Convertible Debentures were convertible on September 30, 2004 into 2,419,764 shares of our common stock at a price of $1.51 per share. The March 2003 Warrants are exercisable to purchase shares of our common stock at a price of $1.35 per share. We calculated an additional beneficial conversion charge totaling approximately $1,339,000 which was 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.

Contractual Obligations

     In August 2004, we entered into a sublicense agreement with Abbott Laboratories, effective as of April 1, 2004, to license certain United States and foreign patent rights covering our BladderChek Test point of care product. Pursuant to this sublicense agreement, we have made an initial payment and have committed to making further payments on account of our past and future sales of point of care products.

     In April 2001, we entered into a letter agreement with Unotech Diagnostics, Inc., pursuant to which that company is currently our sole source supplier for certain components and processes for our BladderChek Test, the sales of which now account for more than 50% of our revenues.

Off Balance Sheet Arrangements

     Currently, 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 $44.8 million for the period since our inception in October of 1987 through September 30, 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.

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          Development Programs

     The table below summarizes our development programs, including stage of development and current FDA status.

*		If submitted for a screening or diagnosis application, FDA will likely 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 will likely require an Analyte Specific Reagent notification at a minimum.

     In May 2004, Sysmex Corporation announced the commencement of preclinical trials of a non-slide-based cellular analysis system incorporating our NMP179 technology. If Sysmex’s preclinical and anticipated clinical trials are successful, it is Sysmex’s goal to make this technology commercially available in the U.S. in 2006. It is our goal to begin clinical trials in 2004 using our NMP66 technology.

     Spending on Research and Development Projects. Total research and development spending in the third quarter of 2004 was approximately $662,000. We expect research and development expenditures to be less than $3 million in 2004 and less than $ 4.5 million in 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, 2003 and 2004 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.

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     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 Tests. Development of NMP66 products and services for breast cancer has received 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 and selling efforts. Our accumulated deficit from inception through September 30, 2004 is approximately $88 million. Our product sales and net losses for each of the past three fiscal years and the first nine months of 2004 have been:

     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 September 30, 2004, we had a net loss of $2.7 million, and as of September 30, 2004, we only had $7 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 short-term and 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 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 new investors which are not available to current shareholders.

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     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 substantial indebtedness and may not be able to meet our payment obligations.

     As a result of the 2003 sale of Convertible Debentures, we substantially increased our indebtedness from approximately $475,000 at the end of 2002 to $1.8 million at September 30, 2004. The fair value of the Convertible Debentures at September 30, 2004 as estimated by management is approximately $3.3 million. The $1.8 million carrying value in the Company’s financial statements at September 30, 2004 reflects discounts related to beneficial conversion charges calculated in accordance with EITF Issue No. 00-27.

     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 principal 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. If we make such payments in stock, however, it will result in significant dilution.

     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.

     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 58% of our product sales for the third 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 third quarter of 2004, exchange rate fluctuations were favorable compared to the same quarter last year 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.

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     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 cash requirements have significantly increased to support a larger employee sales force, to pay for order processing, shipping and collection costs normally borne by distributors, to finance the accounts receivable from physician practices that likely will be collected over a longer cycle, and distribution arrangements for sale of our BladderChek Test are not well-established.

     Since November, 2003 we have had the responsibility for sales of BladderChek Tests to urologists in the U.S., including invoicing and collecting the revenue from sales. We have increased our sales and marketing expenditures and added order processing, shipping and collection resources to perform functions which have in the past been performed by our U.S. distributor. We have limited experience in performing these functions in the United States to support sales directly to physicians, and the time and cost to develop these resources combined with the risk that they may not function effectively increases the risk that the rate of sales growth for our BladderChek Test will slow.

     Sales of products directly to physicians may result in larger accounts receivable and longer collection cycles 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 rely primarily on distributors to market BladderChek Tests in territories other than the U.S. 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 U.S. and Germany could have significant adverse effects on our future revenues.

     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 Tests 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 and may become approved for diagnosis of 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 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 cervical specimen collection and analysis systems known as ThinPrep® (Cytyc) and SurePath (TriPath Imaging). 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 in certain territories and make it uneconomical to sell or distribute them.

     Our ability to successfully convert market opportunities into significant sales for our products depends in part on the extent to which adequate reimbursement for the services based on our products will be available from government healthcare reimbursement authorities (such as Medicare in the United States), private health insurers and other third-party payors. In most countries, no reimbursement of any medical device (or a service based on a medical device) is typically provided by any insurance carrier, whether public or private, if the device or service has not received approval for clinical use from that nation’s healthcare product regulatory authorities (such as the FDA in the United States). Even if the use of a device or the performance of a service has been previously approved for reimbursement, some insurance carriers and healthcare plans 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. If we develop a Proprietary Laboratory Procedure for the US market that does not require FDA

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approval, we do not expect third-party reimbursement until we obtain FDA approval for a product which generates similar clinical data.

     Even if we obtain FDA approval for a product in the US, there is no assurance that we will receive similar approvals from national healthcare product regulatory authorities in other countries. If we obtain such approvals in other countries, reimbursement levels could be so low that it would put pressure on us to reduce our prices. Such low reimbursement would make our products much less profitable and, in the extreme, could make it uneconomical for us and/or our distributor to sell the product at all in those countries. If such a low reimbursement were to occur in the United States or in Germany, it could substantially reduce our revenues and increase our losses. On the other hand, reimbursement approval, if provided in a lower but adequate amount, could potentially broaden the number of patients who could afford the product or service. We believe this has occurred in the United States as reimbursement has been obtained in most states. We expect that reimbursement approval will be obtained in some other countries where our products are sold, but do not believe reimbursement rates in all countries will be as favorable as in the US. Reimbursement approval for the BladderChek Test has not yet occurred in the principal countries of Asia and Europe, including Germany, where the BladderChek Tests are being sold or are in the regulatory process to secure approval from national product regulatory authorities.

     Healthcare reform is an area of continuing attention and a priority of many governmental officials. In the United States, Medicare has frozen reimbursement for clinical laboratory tests at 2003 levels and future changes could impose 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 legislative or regulatory proposals will be adopted or the effect that such proposals could have on our business, the announcement or adoption of such proposals could reduce the profitability of our business and as a result could have a negative effect on 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 at their practice. To the extent that we are unable to price our products to achieve physician profit expectations, sales of our devices may suffer.

     We and our distributors are subject to extensive government regulation which adds to the cost and complexity of our business, may result in unexpected delays and difficulties, may impose severe penalties for violations and may prevent the ultimate sale or distribution of our products in certain countries.

     The FDA and many foreign governments stringently regulate the medical devices that we manufacture and that we and our distributors market to physicians or other customers. The FDA regulates the clinical testing, manufacture, labeling, distribution and promotion of medical devices in the United States and agencies in the European Union, Japan and other countries where we sell our products each have their own regulations. If our products do not receive appropriate approvals from medical device regulatory authorities in any country, we can not sell our products in that country, either on our own or through any distributor.

     Any products that we or our suppliers manufacture or distribute in accordance with FDA approvals are subject to stringent regulation by the FDA, including:

•		keeping records and reporting adverse experiences with the use of the devices we make and distribute;
•		registering our establishments and listing our devices with the FDA. Manufacturing establishments are subject to periodic inspections by the FDA and certain state agencies; and
•		requiring our products to be manufactured in accordance with complex regulations known as Quality System Regulations which include procedural and documentation requirements for our manufacturing and quality assurance activities.

     If we fail to comply with any FDA requirement, we may face a number of costly and/or time consuming enforcement actions, including:

•		fines;
•		injunctions;
•		civil penalties;
•		recall or seizure of products;
•		total or partial suspension of production;

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•		delay or refusal of the agency to grant premarket clearance or premarket approval for other devices in our development pipeline;
•		withdrawal of marketing approvals; and
•		criminal prosecution.

     The FDA and foreign governmental agencies have the authority to request the repair, replacement or refund of the cost of any device that we manufacture or distribute if it is faulty. Failure to comply with medical device and quality regulations in countries outside the United States where we sell our products can result in fines, penalties, seizure or return of products and the inability to sell the product in those countries either on our own or through our distributors.

     Labeling and promotional activities are subject to scrutiny in the United States by the FDA and, in certain instances, by the Federal Trade Commission, and by regulatory bodies in most countries outside the United States where we sell products. For example, our 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, for example, we cannot promote the Lab Test Kit or the BladderChek Test for any unapproved use.

     In addition to federal regulations regarding manufacture and promotion of medical devices, we are also subject to a number 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.

     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 disease 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 “Factors That May Affect Future Results – Successful technical development of our products does not guarantee successful commercialization.”) in developing a system which will be approved by the FDA and selling such systems to cervical cancer testing laboratories at a satisfactory price. Our success in cervical disease 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.

     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 and other 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

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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;
•		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 BladderChek Tests, 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 operator-dependent than the technologies involved in products such as Lab Test Kits and BladderChek Tests, the risks regarding successful commercial acceptance are increased in this area.

     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 Lab Test Kits and package our BladderChek Tests in our Newton facility but we rely on subcontractors for certain components and processes for each of these products. We do not currently 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.

     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 nine months of 2004 compared to the first nine months of 2003. Our revenues, profits and market share for these 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.

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     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 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 BladderChek Tests if we cannot obtain a license or a waiver to use the test strip technology.

     Our 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 BladderChek Tests and are attempting to obtain appropriate licenses or waivers. In August, 2004, we entered into a license agreement, effective as of April 1, 2004, with one holder of patent rights, Abbott Laboratories, and we are continuing to explore other licensing arrangements covering our BladderChek Tests. 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 BladderChek Tests 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 BladderChek Tests. We have accrued estimated royalties on sales of the 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 all required licensing agreements.

     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 highly qualified scientific, sales and management personnel. We have at any given time only about 70 employees. The loss of multiple members of our key personnel, such as our scientists or our field sales force, at the

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same time or within close proximity of each other, or the failure to recruit the necessary 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 $1.00 and $2.48 in the fifty-two week period ended September 30, 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 our 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 third quarter of 2004, our shares had an average daily trading volume of only approximately 54,000 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. The primary source of the additional capital we raised in 2002, 2003 and 2004 has been equity and convertible debt, and we expect that equity-related instruments will continue to be our principal source of additional capital. In June 2004, our stockholders approved an increase in our authorized common stock from 60,000,000 to 90,000,000 shares. This approval provides us with greater flexibility in undertaking an additional financing without the expense and delay of obtaining stockholder approval other than as required by state law or American Stock Exchange requirements for the particular transaction. 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 anti-dilution 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 became 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 immediately prior to the transaction. The Convertible Debentures were convertible on September 30, 2004 into 2,419,764 shares of our common stock at a price of $1.51 per share. 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 Convertible 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 anti-dilution protection, so

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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 Convertible 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.

     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 September 30, 2004, these securities totaled $7 million and included money market accounts. 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 $27,000 for the nine months ended September 30, 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 monthly at the average rate for the month. 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 $1,088,000 and $3,077,000, respectively, for the three month and nine month periods ended September 30, 2004 as compared to sales denominated in foreign currency of approximately $722,000 and $2,212,000, respectively, for the three month and nine month periods ended September 30, 2003.

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.

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     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 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 6. Exhibits.

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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: November 3, 2004	By:	/s/ Stephen D. Chubb
		Stephen D. Chubb
		Director, Chairman and Chief Executive Officer (principal executive officer)

Date: November 3, 2004	By:	/s/ Richard A. Sandberg
		Richard A. Sandberg
		Director, Vice President, Chief Financial Officer and Treasurer (principal accounting and financial officer)

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EXHIBIT INDEX

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