UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

                      Commission file number: 001-12128

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 þ 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 May 1, 2005, there were 43,911,431 shares of the Registrant’s Common Stock outstanding.

MATRITECH, INC.

INDEX

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

MATRITECH, INC.

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

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

3

MATRITECH, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

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

4

MATRITECH, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

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

5

MATRITECH, INC.

1. Operations and Basis of Presentation

     The quarterly consolidated 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 consolidated 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 consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC (File No. 001-12128).

     We have incurred losses from operations since our inception. We have an accumulated deficit of $92 million at March 31, 2005. Based on our current rate of cash utilization, our cash at March 31, 2005 is expected to fund operations through at least December 31, 2005, provided we pay interest and principal on our convertible debentures in stock. We will, as we deem necessary or prudent, 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. However, we may not be able to raise needed capital on terms that are acceptable to us, or at all. If we raise funds on unfavorable terms, we may provide rights and preferences to new investors which are not available to current shareholders. In addition, our existing financing arrangements contain anti-dilutive provisions which may require us to issue additional securities if certain conditions are met. If we do not receive additional financing or do not receive an adequate amount of additional financing, we will be required to curtail our expenses by reducing research and/or marketing or by taking other steps that could hurt our future performance, including but not limited to, the premature sale of some or all of our assets or product lines on undesirable terms, merger with or acquisition by another company on unsatisfactory terms or the cessation of operations. Any future equity financings or retirements of debt with common stock 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 may 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 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:

6

(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 loss those foreign currency adjustments related to the translation of the assets and liabilities of Matritech GmbH into U.S. Dollars as the functional currency of Matritech GmbH is the euro. The composition of comprehensive 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:

7

     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 attributable to common shareholders 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 March 31, 2004, potential common stock equivalents consisted of stock options, warrants, and convertible debentures. At March 31, 2005, potential common stock equivalents consisted of stock options, warrants, convertible debentures and Series A Convertible Preferred Stock. The number of anti-dilutive securities excluded from the computation of diluted loss per share were 10,646,081 and 22,667,729 for the periods ended March 31, 2004 and 2005, respectively.

     3. Stockholders’ Equity

     On March 4, 2005, we entered into a purchase agreement (the “Purchase Agreement”) which provides for the sale through a Private Placement of an aggregate of 1,426,124 shares of our Series A Convertible Preferred Stock, par value $1.00 per share (the “Series A Preferred Stock”) and the issuance to the investors of warrants to purchase 4,991,434 shares of our common stock at a price of $1.47 per share (the “2005 Warrants”). Each share of our Series A Preferred Stock is convertible into ten shares of our common stock (the “Conversion Shares”). The Purchase Agreement provides for two closings (the “First Closing” and the “Second Closing”) because we cannot issue all shares of the Series A Preferred Stock that we have agreed to sell without obtaining stockholder approval because the resulting Conversion Shares would exceed 20% of our outstanding common stock.

     The table below provides highlights of the Private Placement including the First Closing which has occurred and the Second Closing which is subject to stockholder approval.

     On March 4, 2005, we completed the First Closing which consisted of 670,272 shares of Series A Preferred Stock and the 2005 Warrants to purchase 4,991,434 shares of our common stock, for an aggregate consideration of $5,898,394 (before cash commissions and expenses of approximately $573,000). In addition, we issued warrants to a placement agent for a total of 656,920 shares of common stock (with a value of approximately $562,000). Both the 2005 Warrants and the placement agent warrants have an exercise price of $1.47 per share, become exercisable on September 5, 2005 and expire on March 4, 2010. Each share of Series A Preferred Stock is convertible into ten shares of our common stock, which equates to a conversion price of $ .88 per share of common stock. This conversion price and the exercise price of the warrants are subject to adjustment in the event of subsequent dilutive issuances. The holders of Series A Preferred Stock are entitled to a liquidation preference and have the benefit of covenants of the Company not to liquidate, merge, sell control or substantially all its assets, issue debt or senior equity securities, or amend the charter in any way adverse to the holders. We are obligated not to issue other securities that would be senior to the Series A Preferred Stock, not to incur indebtedness in excess of $2,000,000 except in limited forms, and not to enter into or consummate a transaction which would result in the holders of all the voting power of our outstanding

8

capital stock having less than a majority of voting power of a surviving entity after a merger, consolidation, share exchange or sale. We are further required to reserve sufficient shares of common stock for issuance of the Conversion Shares and the Warrant Shares and to list such common shares with the American Stock Exchange.

     We will seek stockholder approval of this financing transaction at our Annual Meeting of Stockholders to be held on May 25, 2005 or such other date to which such meeting may be adjourned. Under the Purchase Agreement and under American Stock Exchange Rule 713, we need stockholder approval to sell additional shares of Series A Preferred Stock. Stockholder approval is also necessary to enable us to issue more Conversion Shares at a conversion price below the current conversion floor of $.70 per share or to issue shares upon exercise of the warrants at an exercise price below $1.34 per share if the anti-dilution provisions to which we have agreed are triggered.

     If stockholder approval is received, we intend to complete a second closing for the sale of an additional 755,852 shares of Series A Preferred Stock for an aggregate consideration of $6,651,498 (before cash commissions and expenses), and will issue additional five year placement agent warrants for a further 740,796 shares of common stock at an exercise price of $1.47 per share.

     The net cash proceeds of $5,325,000 from the First Closing, further reduced by the fair value of the placement agent warrants totaling $562,000, were allocated between the Series A Preferred Stock (approximately $869,000) and the 2005 Warrants (approximately $3,894,000). In this allocation, the 2005 Warrants are recorded as a liability at their fair value as set forth below and the Series A Preferred Stock is allocated the remaining balance of the net proceeds. The value of the 2005 Warrants was calculated using the Black-Scholes pricing model with the following assumptions: dividend yield of zero percent; expected volatility of 85%; risk free interest rate of approximately 4% and a term of five years.

     In connection with the issuance of the Series A Preferred Stock, we recorded a beneficial conversion feature of $1,627,000. A beneficial conversion feature is recorded when the consideration allocated to the convertible security, divided by the number of common shares into which the security converts, is below the fair value of the common stock into which the Series A Preferred Stock can convert at the date of issuance. The amount of the beneficial conversion feature has been immediately accreted as a deemed dividend because the preferred stock is immediately convertible. The value of the beneficial conversion feature has been reflected as an adjustment to the net loss attributable to common shareholders on our Consolidated Statement of Operations.

     As part of the Private Placement, we entered into a Registration Rights Agreement committing to timely file a registration statement covering the resale of the Conversion Shares and the shares for which the 2005 Warrants may be exercised (the “Warrant Shares”). If we fail to timely file a registration statement, if the registration statement is not declared effective within certain time limits or if the registration statement does not remain effective, we are obligated to pay liquidated damages in an amount equal to 1.5% of the consideration paid for the Series A Preferred Stock for each thirty day period during which the failure persists. In accordance with Emerging Issues Task Force (“EITF”) 00-19, Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled in a Company’s Own Stock, (“EITF 00-19”), a transaction which includes a potential for net-cash settlement, including liquidated damages, requires that derivative financial instruments, including warrants, be recorded at fair value as a liability and that subsequent changes in fair value be reflected in the statement of operations. We concluded that the Registration Rights Agreement liquidated damages provision applicable to the Warrant Shares meets the definition of net cash settlement under EITF 00-19. In accordance with EITF 00-19, the fair value of the warrants of $4,271,000 was accounted for as a liability at March 4, the date of the First Closing, and the subsequent changes in the fair value of the 2005 Warrants as of March 31 (approximately $1,091,000) are reflected on our Consolidated Statement of Operations as mark to market warrant adjustments. Transaction costs of $377,000 were allocated to the warrants and expensed upon closing of the transaction, offsetting subsequent mark to market warrant adjustments.

     On April 18, 2005, we amended the Registration Rights Agreement to eliminate any liquidated damage provision with respect to a failure to maintain the effectiveness of a registration statement covering resale of the Warrant Shares. On May 9, 2005 the registration statement covering resale of the Warrant Shares became effective and the 2005 Warrants were reclassified as equity because there is no future potential for a net-cash settlement with regard to the 2005 Warrants. The resulting mark to market adjustments and the reclassification of the 2005 Warrants will be presented in the Company’s financial statements for the quarter ending June 30, 2005.

     This sale has been deemed to be a dilutive issuance under the terms of our Convertible Debentures and our March 2003 Warrants. As a result, as of March 4, 2005, the Convertible Debentures are currently exercisable into 2,525,253 shares of our common stock at a price of $ .99 per share, representing a current increase of 869,623 shares from the conversion terms of the Debentures at December 31, 2004, and the March 2003 Warrants are exercisable to purchase shares of our common stock at a price of $ .88 per share. We have calculated an additional beneficial conversion charge totaling approximately $442,000 which are being recorded as a debt discount in the first quarter of 2005 and amortized over the remaining life of the Debentures.

9

4. Convertible Debt

     A summary of the Convertible Debt accounting is as follows:

     The debt discount is being amortized to interest expense using the effective interest method over the term of the debt. For the three month periods ended March 31, 2004 and 2005, $446,000 and $484,000, 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 are being amortized based on the effective interest method over the term of the debt. For the three month periods ended March 31, 2004 and 2005, $59,000 and $39,000, respectively representing amortization of these costs is included in interest expense. As of March 31, 2004 and 2005, unamortized debt issuance costs totaled $270,000 and $80,000, of which $191,000 and $80,000 is included in other current assets, respectively.

     Minimum future payments on the debt are as follows:

     The fair value of the Convertible Debt at March 31, 2005 as estimated by management is approximately $2.3 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

10

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 $54,000 interest payment for the first quarter of 2005 was made in stock and the January, February and March, 2005 principal repayments of $192,000 each 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” including “Factors That May Affect Future Results” constitute forward-looking statements. Actual events or results may differ materially from those stated in any forward-looking statement. Factors that may cause such differences are discussed below and in our other reports filed with the SEC.

Overview

     Currently, our most important source of revenue and revenue growth are our NMP22 products developed by our scientists and based upon our proprietary NMP technology. After eight consecutive quarters of increasing NMP22 product sales, our sales of those products decreased in the first quarter compared to the fourth quarter of 2004. The decrease resulted primarily from sales force customer focus and field management issues with our direct-to-the-physician sales staff, as well as quarter-to-quarter variations in reported revenues from distributors. We do not believe this decrease reflects any trend or any seasonal aspect of our business. We continue to distribute allergy and other diagnostic products for a variety of third parties in Europe, but revenues from these products have generally been decreasing as a percentage of our revenues.

     Selling, general and administrative expenses, or SG&A, continue to increase as a result of the higher costs needed to support the direct distribution of the NMP22 BladderChek Tests. The increased selling expenditures will likely increase our losses in the short term (see “Results of Operations” below), but 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 NMP22 BladderChek Tests, we are taking steps to ensure we can meet anticipated demand for these devices in the future.

     We are continuing our collaboration with Sysmex Corporation, a leading manufacturer of automated laboratory instruments based in Kobe, Japan, in the field of cervical 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 (see “Agreements” below), obtaining positive clinical trial results (see “Products”), 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. Research and development expenditures were 2% higher in the first quarter of 2005 than for the same period in 2004.

     We have been unprofitable since inception and expect to incur significant additional operating losses for at least the next few years. For the period from inception to March 31, 2005, we incurred a cumulative net loss of approximately $92 million. To provide funds to support our new direct sales force and our ongoing research and development efforts, we raised additional capital in 2004 and in March 2005 as we have in past years. 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.

11

Results of Operations

Quarter Ended March 31, 2004 (“Q1 2004”) Compared with Quarter Ended March 31, 2005 (“Q1 2005”)

Revenues

     The increase in revenue from our NMP22 product line is due to a $697,000 sales increase, primarily in the U.S. and Europe, and a $39,000 favorable exchange rate impact. BladderChek Test sales accounted for approximately 89% of sales in the NMP22 product line in the first quarter of 2005, compared to 79% in the first quarter of 2004. The BladderChek Test sales growth is the result of increased selling efforts, 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 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 revenue from our non-NMP22 products is due to a favorable exchange rate impact.

     Alliance and collaboration revenue decreased by $17,000 principally because the amortization of prepaid marketing fees for a distribution agreement ended in 2004.

     During the first quarter of 2005 we sold approximately $35,000 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 at March 31, 2005, 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), or when we are able to reasonably estimate and reserve for returns. BladderChek Test revenue in the fourth quarter of 2004 included approximately $60,000 of previously deferred revenue resulting from the termination of our distribution agreement with Cytogen as well as $80,000 of revenue recognized for products shipped to a number of distributors in 2002, which were no longer considered at risk for return given their expired shelf life.

     During the first quarter we evaluated our distributor return history and determined that we have sufficient history to estimate product returns for many of our distributors and therefore are now recognizing revenue when we ship BladderChek Tests to these distributors. We have also recognized all deferred revenue relating to BladderChek Test shipments to these distributors at March 31, 2005. This has resulted in our recognizing $70,000 of BladderChek Test shipments to distributors, which previously would have been recorded as deferred revenue. As of March 31, 2005 our deferred product revenue balance totaling $251,000 includes approximately $166,000 of deferred BladderChek Test revenue for distributors for which we do not have sufficient history to estimate returns. The balance is related to a distributor order which was prepaid but not yet shipped.

     Deferred revenue consists of the following:

Cost of Product Sales

12

     The decrease in cost of product sales on a percentage basis and the increase in our gross profit margin is largely the result of 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 first quarter of 2004.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses increased primarily due to a $245,000 increase in payroll costs resulting from increased headcount, mainly to support direct sales efforts described above, a $198,000 increase in sales-related marketing expenses and a $33,000 unfavorable foreign currency exchange rate impact on non-U.S. selling, general and administrative expenses.

     We believe that a decrease in our SG&A expenses as a percentage of our gross profit from 268% in the first quarter of 2004 to 203% in the first quarter of 2005 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 quarter of 2004 due to higher interest rates.

Interest Expense

     We completed a $5 million private placement of Convertible Debentures in March of 2003 and, subsequent to issuance, have recorded an additional $4.6 million of non-cash charges related to the Convertible Debentures which are being charged to our income statement through March 2006. As of March 31, 2005, approximately $3.7 million of the $5.0 million non-cash charges and deferred financing costs have been amortized and charged as interest expense and the remaining $1.3 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

13

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 $54,000 interest payment for the first quarter of 2005 was made in stock and the January, February and March, 2005 principal repayments of $192,000 each 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:

	•	$39,000 of amortized deferred financing costs, which contributed to reducing the original $475,000 balance of deferred financing costs to $80,000 at March 31, 2005;
	•	$98,000 of non-cash charges to record the discount to valuation incurred when making the principal and interest repayments in stock rather than cash;
	•	$484,000 of amortized debt discount, which contributed to reducing the $4,558,000 of debt discount on our $5,000,000 note to $1,280,000 at March 31, 2005. 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, the first quarter of 2004 and the first quarter of 2005 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, 2004 and 2005 and the resulting balance at March 31, 2005.

     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.”

Mark to market adjustment from warrants

Mark to market adjustment from warrants represents the net decrease in fair value of the 2005 Warrants we issued in connection with our Series A Preferred Stock issuance in March, 2005. The adjustment was driven by a reduction of our stock price from the date of the closing of the financing as compared to the stock price as of March 31, 2005. Transaction costs of $377,000 were allocated to the warrants and expensed upon closing of the transaction, offsetting subsequent mark to market warrant adjustments.

14

Net Loss

     The net loss decreased primarily due to increased selling, general and administrative expenses and increased interest expense discussed above, offset by the increase in revenues and mark to market adjustment from warrants. The net loss attributable to common shareholders increased due to the preferred stock beneficial conversion feature associated with the Series A Preferred Stock issuance in March, 2005. The amounts of the beneficial conversion feature has been immediately accreted as a deemed dividend since the preferred stock is immediately convertible. The deemed dividends have been reflected as an adjustment to net loss attributable to common shareholders on our Consolidated Statements of Operations.

Liquidity and Capital Resources

     Our operating activities used cash in the first three months of 2004 and 2005 primarily to fund our Net Losses excluding non-cash charges. The non-cash charges are comprised of depreciation and amortization expenses, amortization of debt discounts and deferred charges related to our convertible debt offset by mark to market adjustments related to the warrants issued in our Series A Preferred Stock financing.

Summary Cash Flow

     Our operating activities used cash in 2004 and 2005 primarily to fund our operating losses excluding non-cash charges. The non-cash charges in 2004 and 2005 were due to amortization of debt discount and deferred charges related to our convertible debt offset by mark to market adjustments related to the 2005 Warrants issued in our Series A Preferred Stock financing.

     We expect that the Days Sales Outstanding (“DSO”) is likely to be higher in the future than the 39 days measured at March 31, 2005. The comparable measurement at March 31, 2004 was 53 days.

     We will, as we deem necessary or prudent, 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 year because our Convertible Debenture has a prohibition against any debt having a ranking senior to the Convertible Debenture. In addition, after the Convertible Debenture is retired we will still face constraints imposed by our Series A Preferred Stock.

     If we raise funds on unfavorable terms, we may provide rights and preferences to new investors which are not available to current shareholders or debt holders. For example, the Convertible Debenture financing granted the holders anti-dilution rights which were not granted to any other equity or warrant holder. When we completed our financing in March, 2005, the conversion price of the debentures was adjusted downward from $1.51 to $.99 which resulted in 869,623 shares of additional dilution or about 1% of the fully diluted stock on an “if converted” basis in the table below. Future sales of common stock below $.99 could result in additional dilution for which we would receive no additional consideration.

15

     Any future equity financings will dilute the ownership interest of our existing investors and may have an adverse impact on the price of our common stock. As of March 31, 2005, our fully diluted if converted common shares were:

     The above table includes shares for converting the Convertible Debentures. We plan to use our common stock to pay 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.

     Since our authorized common stock is 90 million shares, if our shareholders do not authorize additional stock when requested, we may be unable to issue adequate amounts of additional equity to finance our operations appropriately.

     Financings

     On March 4, 2005, we entered into a purchase agreement which provides for the sale through a Private Placement of an aggregate of 1,426,124 shares of our Series A Preferred Stock, par value $1.00 per share and the issuance to the investors of warrants to purchase 4,991,434 shares of our common stock at a price of $1.47 per share. Each share of our Series A Preferred Stock is convertible into ten shares of our common stock. We cannot issue all shares of the Series A Preferred Stock that we have agreed to sell without obtaining stockholder approval because the shares into which the Series A Preferred Stock are convertible would exceed 20% of our outstanding common stock.

     The table below provides highlights of the Private Placement including the First Closing which has occurred and the Second Closing which is subject to stockholder approval.

     On March 4, 2005, we completed the First Closing and in connection therewith issued warrants to a placement agent for a total of 656,920 shares of common stock at an exercise price of $1.47 per share. Based on the conversion rate, the price we received equates to $ .88 per share of common stock. The conversion price and the exercise price of the warrants are subject to adjustment in the event of subsequent dilutive issuances. The holders of Series A Preferred Stock are entitled to a liquidation preference and have the benefit of covenants of the Company not to liquidate, merge, sell control or substantially all assets, issue debt or senior equity securities, or amend the charter in any way adverse to the holders. We are obligated not to issue other securities that would be senior to the Series A Preferred Stock, not to incur indebtedness in excess of $2,000,000 except in limited forms, and not to enter into or consummate a transaction which would result in the holders of all the voting power of our outstanding capital stock having less than a majority of voting power of a surviving entity after a merger, consolidation, share exchange or sale. We are further required to reserve sufficient shares of common stock for issuance upon conversion of the Series A Preferred Stock and exercise of the Warrants and to list the common shares into which the Series A Preferred Stock may be converted or which may result from exercise of the Warrants with the American Stock Exchange.

     We will seek stockholder approval of this transaction at our Annual Meeting of Stockholders to be held on May 25, 2005 or such other date to which such meeting may be adjourned. Under the Purchase Agreement and under American Stock

16

Exchange Rule 713, we need stockholder approval to sell additional shares of Series A Preferred Stock. Stockholder approval is also necessary to enable us issue more Conversion Shares at a conversion price below the current conversion floor of $ .70 per share or to issue shares of common stock upon exercise of the warrants at an exercise price below $1.34 per share if the anti-dilution provisions to which we have agreed are triggered.

     If stockholder approval is received, we intend to complete a second closing for the sale of an additional 755,852 shares of Series A Preferred Stock for an aggregate consideration of $6,651,498 (before cash commissions and expenses), and will issue additional five year placement agent warrants for a further 740,796 shares of common stock at an exercise price of $1.47 per share.

     The net cash proceeds of $5,325,000 from the First Closing, further reduced by the fair value of the placement agent warrants totaling $562,000, were allocated between the Series A Preferred Stock (approximately $869,000) and the 2005 Warrants (approximately $3,894,000). In this allocation, the 2005 Warrants are recorded as a liability at their fair value as set forth below and the Series A Preferred Stock is allocated the remaining balance of the net proceeds. The value of the 2005 Warrants was calculated using the Black-Scholes pricing model with the following assumptions: dividend yield of zero percent; expected volatility of 85%; risk free interest rate of approximately 4% and a term of five years.

     In connection with the issuance of the Series A Preferred Stock, we recorded a beneficial conversion feature of $1,627,000. A beneficial conversion feature is recorded when the consideration allocated to the convertible security, divided by the number of common shares into which the security converts, is below the fair value of the common stock into which the Series A Preferred Stock can convert at the date of issuance. The amount of the beneficial conversion feature has been immediately accreted as a deemed dividend because the preferred stock is immediately convertible. The value of the beneficial conversion feature has been reflected as an adjustment to the net loss attributable to common shareholders on our Consolidated Statement of Operations.

     As part of the Private Placement, we entered into a Registration Rights Agreement committing to timely file a registration statement covering the resale of the Conversion Shares and the shares for which the 2005 Warrants may be exercised. If we fail to timely file a registration statement, if the registration statement is not declared effective within certain time limits or if the registration statement does not remain effective, we are obligated to pay liquidated damages in an amount equal to 1.5% of the consideration paid for the Series A Preferred Stock for each thirty day period during which the failure persists. In accordance with Emerging Issues Task Force (“EITF”) 00-19, Accounting for Derivative Financial Instruments Indexed To, and Potentially Settled in a Company’s Own Stock, (“EITF 00-19”), a transaction which includes a potential for net-cash settlement, including liquidated damages, requires that derivative financial instruments, including warrants, be recorded at fair value as a liability and that subsequent changes in fair value be reflected in the statement of operations. We concluded that the Registration Rights Agreement liquidated damages provision applicable to the Warrant Shares meets the definition of net cash settlement under EITF 00-19. In accordance with EITF 00-19, the fair value of the warrants of $4,271,000 was accounted for as a liability at March 4, the date of the First Closing, and the subsequent changes in the fair value of the 2005 Warrants as of March 31 (approximately $1,091,000) are reflected on our Consolidated Statement of Operations as mark to market warrant adjustments. Transaction costs of $377,000 were allocated to the warrants and expensed upon closing of the transaction, offsetting subsequent mark to market warrant adjustments.

     On April 18, 2005, we amended the Registration Rights Agreement to eliminate any liquidated damage provision with respect to a failure to maintain the effectiveness of a registration statement covering resale of the Warrant Shares. On May 9, 2005 the registration statement covering resale of the Warrant Shares became effective and the 2005 Warrants were reclassified as equity because there is no future potential for a net-cash settlement with regard to the 2005 Warrants. The resulting mark to market adjustments and the reclassification of the 2005 Warrants will be presented in the Company’s financial statements for the quarter ending June 30, 2005.

     This sale has been deemed to be a dilutive issuance under the terms of our Convertible Debentures and our March 2003 Warrants. As a result, as of March 4, 2005, the Convertible Debentures are currently exercisable into 2,525,253 shares of our common stock at a price of $ .99 per share, representing a current increase of 869,623 shares from the conversion terms of the Debentures at December 31, 2004, and the March Warrants are exercisable to purchase shares of our common stock at a price of $ .88 per share. We have calculated an additional beneficial conversion charge totaling approximately $442,000 which will be recorded as a debt discount in the first quarter of 2005 and amortized over the remaining life of the Debentures.

     We have no material capital expenditure commitments.

17

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 2004 Annual Report on Form 10-K, filed on March 14, 2005 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 technologies. 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 $46.1 million for the period since our inception in October of 1987 through March 31, 2005. Research and development expenses include the salaries and related overhead of our research personnel, laboratory supplies, payments to third parties to help us execute clinical trials, depreciation of research related equipment, legal expenses related to filing and prosecuting patents, other direct expenses and an allocation of our occupancy and related expenses based on the square footage occupied by our research and development staff and their laboratories.

     Our research and development scientists typically are assigned to one project at a time but may also provide support for other projects. In addition, our various programs share a substantial amount of our common fixed costs such as facility depreciation, utilities and maintenance. All of our research and development programs are similar in nature as they are based on our common protein discovery technology and a significant finding in any one cancer type may provide a similar benefit across all programs. Accordingly, we do not track our research and development costs by individual research and development programs.

   Development Programs

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

18

     Spending on Research and Development Projects. Total research and development spending in the first quarter of 2005 was approximately $730,000. We expect research and development expenditures to be less than $3.2 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 2005 and 2006.

     NMP179 — Cervical. Discovery research on this product was completed prior to 2000 and our expenditures in 2004 and 2005 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. During Q1 2005 we purchased $60,000 of specimens for cervical cancer testing which we expect to sell to Sysmex, even though we do not have a signed contract for selling such specimens to Sysmex, as part of our collaboration with them. If we incur any additional costs in connection with this program, we expect such costs to be aimed at licensing this technology to a company with a slide-based cervical cancer detection system.

     Breast Cancer. Over the next two years, research and development funds will be spent principally to develop products and services for breast cancer, to improve our mass spectrometry technology and to further develop our ligand binding based technology for Lab Test Kits and/or Point Of Care Tests.

     Prostate Cancer. Over the next two years, we intend to devote more research and development resources to our prostate cancer program if the NMP66 program does not require all our research and development resources. Because of uncertainties of when we will more actively pursue our prostate cancer program, we cannot reasonably estimate the likelihood or timeframe for reaching commercialization goals set forth in the table above.

     Other existing programs. We will make decisions on how and when to proceed with our other existing programs based on our progress with the breast cancer and prostate cancer programs and the availability of appropriate resources for our remaining programs. We may consider options including, but not limited to, terminating certain activities, licensing the technology to third parties or selling the technology to third parties. The nature, timing and costs of the efforts to reach our commercialization goals, and the amount or timing of the net cash inflows of our individual programs, are not possible to predict.

19

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 until the end of the last fiscal year is $90,122,000. Our product sales and net losses for each of the past three fiscal years 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 fiscal quarter ended March 31, 2005, we had a net loss of $2.1 million, and as of March 31, 2005, we only had $7.8 million of cash and cash equivalents. As a result, we must rely on our ability to raise capital from outside sources in order to continue operations in the long-term. In March, 2003 we completed a sale of Convertible Debentures and accompanying warrants. In October and November 2003 we completed a sale of common stock and accompanying warrants. In March 2004 we completed a sale of common stock and accompanying warrants. In March 2005 we completed a sale of convertible preferred stock and accompanying warrants for common stock. We will, as we deem necessary or prudent, 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. 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.

     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 approximately $2.5 million as of March 31, 2005. The fair value of the Convertible Debentures at March 31, 2005 as estimated by management is approximately $2.3 million. The $1.2 million carrying value in the Company’s financial statements at March 31, 2005 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

20

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 62% of our product sales for the fiscal quarter ended March 31, 2005. Accounts of our European subsidiary are maintained in Euros and are translated into U.S. Dollars. To the extent that foreign currency exchange rates fluctuate in the future, we may be exposed to significant financial variability, both favorable and unfavorable. During the first quarter of 2005, exchange rate fluctuations were favorable as indicated in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” However, rate changes in the future may lead to unfavorable results.

     In addition, although we have integrated the operations of this subsidiary since its acquisition in June 2000, we still must coordinate geographically separate organizations, manage personnel with disparate business backgrounds and conduct business in a different regulatory and corporate culture. It remains to be seen whether the use of this subsidiary to spearhead the marketing effort of our products in Europe outside of Germany 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; and to finance the accounts receivable from physician practices that likely will be collected over a longer cycle.

     Since November 2003 we have had the responsibility for sales of NMP22 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 NMP22 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 may increase 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 do not expect our Days Sales Outstanding to remain at 39 days, the measurement calculated from our March 31, 2005 financial results.

21

     We rely primarily on distributors to market NMP22 BladderChek Tests in territories other than the United States and Germany, but our history with our distributors is limited and we do not know whether they will achieve substantial sales levels of our products.

     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, the latter of which has been approved for both monitoring and diagnosing bladder cancer and the former of which has 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 U.S. market that does not require FDA 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 U.S., 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 U.S. 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

22

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;
	•	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

23

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 and maintain profitability in the future will be affected by our progress in 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 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

24

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 may be unable to achieve profitability.

     We have been manufacturing and assembling our Lab Test Kits for commercial sales since 1995 but have not yet manufactured these products in large volumes. We may encounter difficulties in scaling up production of 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 commitments to customers.

     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

25

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 have been addressed by the manufacturer of the products and that the manufacturer has accepted 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 2004 compared to 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.

     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

26

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 lateral flow technology.

     Our BladderChek Test uses lateral flow technology consisting 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 lateral flow 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 investigate 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 accrue estimated royalties on sales of the BladderChek Test based on estimates of our obligations under existing licensing agreements and, when probable and estimable, based upon our appraisal of intellectual property claims to which we may be subject. If we are required to obtain additional licenses we can provide no assurances that additional royalties due when we complete those licensing agreements will not have an adverse effect on our results of operations.

     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 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 $0.87 and $1.58 in the fifty-two week period ended March 31, 2005. 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

27

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 first quarter of 2005, our shares had an average daily trading volume of only approximately 102,000 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. We filed a resale registration statement covering more than 14,000,000 additional shares for the benefit of our investors in connection with the sale in March 2005 of Series A Convertible Preferred Stock and accompanying warrants. 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 from 2002 through the first quarter of 2005 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.

     On March 4, 2005, we completed the sale of 670,272 shares of our Series A Convertible Preferred Stock and accompanying warrants to purchase 4,991,434 of our common stock at a price of $8.80 per share of Preferred Stock for an aggregate consideration of $5,898,394 (before cash expenses and commissions estimated to be approximately $573,000). Additional warrants were issued to a placement agent to purchase 656,920 shares of our common stock at $.147 per share. Each share of the Series A Convertible Preferred Stock is convertible into ten shares of our common stock, resulting in a price per share of common stock in this transaction of $.88. This sale was 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 2,525,253 shares of our common stock at a price of $.99 per share, representing an increase of 869,623 shares from the conversion terms of the Debenture immediately prior to the transaction. The exercise price of the March 2003 Warrants was also reduced to $.88 per share. If we do a future financing at a price less than $.88 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 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. The Series A Convertible Preferred Stock and the warrants issued in connection with the March 2005 transaction also have anti-dilution protection provisions which would result in the issuance of additional shares upon conversion of the Convertible Preferred Stock and in a reduction in the warrant price in the event of a subsequent dilutive financing.

28

     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, 2004 filed with the SEC (File No. 001-12128).

     We invest our cash in securities classified as cash and cash equivalents. At March 31, 2005, these securities totaled $7.8 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 $8,000 for the three months ended March 31, 2005.

     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 $997,000 and $1,334,000 for the three month periods ended March 31, 2004 and 2005, respectively.

Item 4. Controls and Procedures.

     Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable SEC rules and forms and were effective.

     Changes in Internal Control Over Financial Reporting. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly 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 1. Legal Proceedings

     On January 25, 2005, the court dismissed a lawsuit in which we were a third party defendant. The litigation, brought by a former employee of ours against our landlord, was pending under the caption Kira Shapiro et al v. Francis Biotti as Trustee of One Nevada Street Realty Trust, Civil Action No. 02-05439 in Middlesex County Superior Court, Massachusetts. On January 28, 2005, a stipulation of dismissal covering the third party claims against us was filed with the court. These dismissals conclude the case.

Item 6. Exhibits.

29

SIGNATURES

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

MATRITECH, INC.

Date: May 12, 2005	By:	/s/ Stephen D. Chubb
		Stephen D. Chubb
		Director, Chairman and Chief Executive Officer (principal executive officer)

Date: May 12, 2005	By:	/s/ Richard A. Sandberg
		Richard A. Sandberg
		Director, Vice President, Chief Financial Officer and Treasurer (principal accounting and financial officer)

30

EXHIBIT INDEX