PART I - FINANCIAL INFORMATION

Item 1

CHROMAVISION MEDICAL SYSTEMS, INC AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

	September 30, 2004			December 31, 2003
	(Unaudited)
Assets

Current assets:
Cash and cash equivalents	$	15,859		$	1,699
Accounts receivable, net	1,899			2,496
Other receivable	—			451
Other	426			287
Total current assets	18,184			4,933
Property and equipment, net	5,806			5,086
Patents, net of accumulated amortization	982			830
Other	365			202
Total assets	$	25,337		$	11,051

Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable	$	1,697		$	394
Accrued severance	—			254
Accrued payroll	1,725			684
Accrued liabilities	975			864
Current maturities of long-term debt, including capital lease obligation	1,612			1,028
Total current liabilities	6,009			3,224

Long-term debt, including capital lease obligation	2,042			1,808

Commitments and contingencies
Stockholders’ equity:
Series C convertible preferred stock, $.01 par value, authorized 8,000,000 shares, none issued and outstanding	—			—
Common stock $.01 par value, authorized 100,000,000 shares, issued and outstanding shares 51,428,084 in 2004 and 38,582,604 in 2003	514			386
Additional paid-in capital	117,257			92,445
Accumulated deficit	(99,718		)	(85,883		)
Deferred compensation	(722		)	(856		)
Accumulated other comprehensive loss	(45		)	(73		)
Total stockholders’ equity	17,286			6,019
Total liabilities and stockholders’ equity	$	25,337		$	11,051

See accompanying notes to condensed consolidated financial statements.

CHROMAVISION MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(in thousands, except share and per share amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Revenue:

Fee per use and other revenue	$	1,309		$	2,827		$	4,328		$	8,130

System sales	442			252			1,577			656

Lab services	812			—			981			—

Total revenue	2,563			3,079			6,886			8,786

Cost of revenue	2,167			970			4,224			2,687

Gross profit	396			2,109			2,662			6,099

Operating expenses:

Selling, general and administrative	3,467			3,115			10,302			8,981

General and administrative costs related to lab services	1,045			—			2,553			—

Research and development	1,241			1,171			3,570			3,636

Total operating expenses	5,753			4,286			16,425			12,617

Loss from operations	(5,357		)	(2,177		)	(13,763		)	(6,518		)

Total other income (expense)	5			(15		)	(72		)	(10		)

Loss before income taxes	(5,352		)	(2,192		)	(13,835		)	(6,528		)

Income taxes	—			—			—			—

Net loss	$	(5,352	)	$	(2,192	)	$	(13,835	)	$	(6,528	)

Basic and diluted net loss per common share	$	(0.10	)	$	(0.06	)	$	(0.29	)	$	(0.18	)
Weighted average number of common shares outstanding	51,428,084			37,820,840			48,123,157			37,094,625

See accompanying notes to condensed consolidated financial statements.

CHROMAVISION MEDICAL SYSTEMS, INC AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(in thousands, except share and per share amounts)

(Unaudited)

	Nine Months Ended September 30,
	2004			2003

Cash flows from operating activities:
Net loss	$	(13,835	)	$	(6,528	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	2,248			2,020
Non-cash compensation charges	586			136

Changes in operating assets and liabilities:
Accounts receivable, net	597			(255		)
Other assets	153			(325		)
Accounts payable	1,303			(361		)
Accrued payroll	787			(131		)
Accrued liabilities	111			15
Net cash used in operating activities	(8,050		)	(5,429		)

Cash flows from investing activities:
Additions to patents	(246		)	—
Purchase of property and equipment	(2,878		)	(2,845		)
Other	—			(19		)
Net cash used in investing activities	(3,124		)	(2,864		)

Cash flows from financing activities:
Proceeds from equipment lease financing	1,628			—
Borrowings on revolving credit facility & equipment financing	—			250
Repayments on long-term debt, including capital lease obligation	(810		)	3,000
Issuance of common stock	26,068			5,000
Offering Costs	(1,580		)	(31		)
Net cash used in financing activities	25,306			8,219

Effect of exchange rate changes on cash and cash equivalents	28			(39		)

Net increase (decrease) in cash and cash equivalents	14,160			(113		)

Cash and cash equivalents at beginning of period	1,699			2,810

Cash and cash equivalents at end of period	$	15,859		$	2,697

See accompanying notes to condensed consolidated financial statements.

CHROMAVISION MEDICAL SYSTEMS, INC AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(1) Interim Financial Statements

These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission.

The accompanying unaudited condensed consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and the results of operations for the interim periods presented. All such adjustments are of a normal, recurring nature. Certain amounts have been reclassified to conform to the current period presentation. The results of operations for any interim period are not necessarily indicative of the results to be obtained for a full fiscal year.

Stock Options

Pro forma information, which assumes the Company had accounted for stock options granted under the fair value method prescribed by Statement of Financial Accounting Standard No 123 (SFAS No. 123), “Accounting for Stock-based Compensation,” is presented below. The per share weighted-average fair value of stock options granted was $1.50 for the nine month period ended September 30, 2004, and $0.86 for the nine month period ended September 30, 2003, respectively, as estimated using the Black-Scholes option-pricing model.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting periods. The Company’s historical and pro forma net loss per share for the three and nine month periods ended September 30, 2004 and 2003 are as follows (in thousands, except per share data):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Consolidated net loss attributable to common stock:
As reported	$	(5,352	)	$	(2,192	)	$	(13,835	)	$	(6,528	)
Add: Stock-based employee compensation expense included in net loss	84			—			412			—
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards	(328		)	(342		)	(1,353		)	(1,120		)
Pro forma net loss	$	(5,596	)	$	(2,534	)	$	(14,776	)	$	(7,648	)

Net loss per share – Basic and diluted:
As reported	$	(0.10	)	$	(0.06	)	$	(0.29	)	$	(0.18	)
Pro forma	$	(0.11	)	$	(0.07	)	$	(0.31	)	$	(0.21	)

The following assumptions were used to determine the fair value of stock options granted using the Black-Scholes option-pricing model:

	2004		2003
Dividend yield	0.0	%	0.0	%
Volatility	108.44	%	97.47	%
Average expected option life	4 years		4 years
Risk-free interest rate	3.16	%	2.45	%

Restricted Stock

On September 1, 2003, the Company issued 816,950 shares of restricted stock to employees. The restricted stock vests over a two year period. Unearned compensation under the restricted stock plan as reflected on the balance sheet was recorded based on the fair market value of the shares issued. Under Accounting Principles Board (APB) No. 25 “Accounting for Stock Issued to Employees, compensation expense is reflected over the period in which services are performed (See Note 8 of Notes to the Consolidated Financial Statements).

(2) Net Loss Per Share

Basic and diluted loss per common share is calculated by dividing net loss by the weighted average common shares outstanding during the period. In-the-money stock options and warrants to purchase an aggregate of 1,192,402 and 4,407,162 shares of common stock were outstanding at September 30, 2004 and 2003, respectively. These stock options and warrants outstanding were not included in the computation of diluted earnings per share because the Company incurred a net loss in all periods presented and hence, the impact would be anti-dilutive.

(3) Patents

Patents with estimated useful lives are amortized over their respective estimated useful lives to their estimated residual values. The following table provides a summary of the Company’s patents with definite useful lives recorded as of September 30, 2004 (in thousands):

	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Amortization Period in Years
Technology related	$	1,175	$	(193	)	$	982	7 - 10

The following table summarizes the future estimated annual pretax amortization expense for these assets (in thousands):

Fiscal Year
2004	$	48
2005	192
2006	192
2007	192
2008 & thereafter	358
Total	$	982

(4) Currency Translation

The financial position and results of operations of our foreign subsidiaries are determined using the local currency as the functional currency. Assets and liabilities of these subsidiaries are translated at the exchange rate in effect at each quarter-end. Income statement accounts are translated at the average rate of exchange prevailing during the period. The effects of currency translations are included in comprehensive loss.

(5) Comprehensive Loss

The total comprehensive loss is summarized as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Net loss	$	(5,352	)	$	(2,192	)	$	(13,835	)	$	(6,528	)
Foreign currency translation adjustment	26			67			28			(39		)
Comprehensive loss	$	(5,326	)	$	(2,125	)	$	(13,807	)	$	(6,567	)

(6) Business Segments

The Company operates primarily in two business segments engaged in the development, manufacture and marketing of an automated cellular imaging system which is designed to assist physicians in making critical medical decisions and the offering of technical laboratory services. The segments are determined based on product and or services delivered to customer groups. The Company’s chief operating decision maker is the Chief Executive Officer and President. The chief operating decision maker allocates resources and assesses performance and other activities at the operating segment level.

Revenues, cost of revenue and operating loss for our operating segments are as follows (in thousands):

	Three Months Ended September 30,2004								Three Months Ended September 30,2003
	Lab			System Sales & Other		Total			Lab		System Sales & Other		Total
Revenue	$	812		$	1,751	$	2,563		$	—	$	3,079	$	3,079

Cost of revenue	1,301			866		2,167			—		970		970

Gross profit	$	(489	)	$	885	$	396		$	—	$	2,109	$	2,109
Selling, general and administrative (including lab administration)						4,512							3,115
Research & development						1,241							1,171
Operating loss						$	(5,357	)					$	(2,177	)

	Nine Months Ended September 30,2004								Nine Months Ended September 30,2003
	Lab			System Sales & Other		Total			Lab		System Sales & Other		Total
Revenue	$	981		$	5,905	$	6,886		$	—	$	8,786	$	8,786

Cost of revenue	1,471			2,753		4,224			—		2,687		2,687

Gross profit	$	(490	)	$	3,152	$	2,662		$	—	$	6,099	$	6,099
Selling, general and administrative (including lab administration)						12,855							8,981

Research & development						3,570							3,636
Operating loss						$	(13,763	)					$	(6,518	)

(7) Recent Accounting Developments

In October 2004, the FASB concluded that an exposure draft (Share-Based Payment) that will amend SFAS No 123, which would require all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. Adopting this new standard occurs in one of two ways — the modified prospective transition method or the modified retrospective transition method. The Company is currently evaluating the effect that the adoption would have on its financial position and results of operations.

(8) Stock Transactions

On February 26, 2003, the Company issued 4,646,408 shares of Common Stock for an aggregate cash purchase price of $5.0 million ($1.0761 per share) in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as amended to Safeguard Delaware, Inc., a wholly-owned subsidiary of Safeguard Scientifics, Inc. Safeguard Scientifics, Inc. and its wholly-owned subsidiaries will be referred to as “Safeguard”. As a result of the transaction, Safeguard’s percentage of beneficial ownership increased to approximately 62%. ChromaVision and Safeguard also entered into an agreement giving Safeguard certain rights to have the purchased shares registered under the Securities Act of 1933, as amended.

On September 1, 2003, the Company issued 816,950 shares of restricted stock to employees with a value on the date of grant of $1,021,188 ($1.25 per share), which was recorded as deferred compensation. This restricted stock vests over a two-year period. Compensation expense is recognized on a straight-line basis over the vesting period and is reduced to the extent that a participant forfeits shares of restricted stock received prior to vesting. The deferred compensation charge is unaffected by future changes in the price of the common stock. Safeguard did not exercise its anti-dilution rights in conjunction with the restricted stock grant. As a result, Safeguard’s beneficial ownership decreased from approximately 62% to approximately 60%. These shares were issued following our delisting from the Nasdaq National Market without first being qualified under California state securities laws. As a result, the Company may have potential liability under California state securities laws to the individuals to whom the shares of restricted stock were issued. The Company may elect to conduct a rescission offer to such individuals to give them the election to rescind their restricted stock grant. Management is currently analyzing this matter and cannot, at this time, ascertain the extent of its’ potential liability, if any, although it does not believe that it would be material to the Company’s financial statements.

On February 10, 2004, the Company completed a private placement exempt from registration under Section 4(2) of the Securities Act to issue 2,295,230 shares of common stock and a warrant to purchase shares of common stock to Safeguard for a purchase price of $5.0 million. The warrant issued to Safeguard is exercisable until March 1, 2008 and is currently exercisable to purchase 344,285 shares of common stock for an exercise price of $2.95 per share. As a result of this transaction, Safeguard’s percentage of beneficial ownership of the Company’s common stock increased from approximately 60% immediately preceding the transaction to approximately 63%. The Company also entered into a registration rights agreement giving Safeguard certain rights to have the purchased shares registered under the Securities Act of 1933, as amended.

On March 25, 2004, the Company entered into a securities purchase agreement with a limited number of accredited investors pursuant to which the Company agreed to issue and the investors agreed to purchase 10,500,000 shares of common stock, together with warrants to purchase an additional 1,575,000 shares of common stock at an exercise price of $2.75 per share for an aggregate purchase price of $21.0 million (this financing will be referred to as the “March 2004 financing”). The warrants issued in this transaction are exercisable for a period of four years after the date they were issued. This transaction was structured so that a portion of the common stock and warrants issued (4,200,000 shares of common stock and warrants to purchase 630,000 shares of common stock for aggregate gross proceeds of $8.4 million) were issued at an initial closing that occurred on March 31, 2004. The remaining shares and warrants to be issued in the transaction were issued at a subsequent closing which occurred on April 27, 2004. Safeguard was one of the purchasers in the March 2004 financing and acquired 3,750,000 shares (of which 1,500,000 shares were acquired at the initial closing) of common stock and warrants to purchase 562,500 shares of common stock (of which 225,000 were acquired at the initial closing) for an aggregate investment of $7.5 million. Following consummation of the subsequent closing of the financing Safeguard beneficially owned approximately 56.7% of the Company’s outstanding common stock.

Each of the purchasers in the March 2004 financing was granted a preemptive right to purchase its pro-rata share of 49.9% of any new equity securities that may be issued on or prior to March 31, 2005. Safeguard had previously been granted preemptive rights, which it waived in connection with the March 2004 financing (except to the extent that it purchased securities in the March 2004 transaction). In connection with the March 2004 financing, the Company entered into a registration rights agreement with the purchasers in that financing, and the Company has registered the resale of shares issued in the March 2004 financing with the Securities and Exchange Commission.

Due to its beneficial ownership of approximately 56.7% of the Company’s outstanding common stock, Safeguard has the power to elect all of the directors of the Company. The Company has given Safeguard contractual rights enabling it to exercise significant control over the Company.

(9) Line of Credit

In February 2003, the Company entered into a $3.0 million revolving credit agreement with Comerica Bank-California. This one year agreement was renewed for a second year to February 2005. The borrowings under the line of credit will be used for working capital purposes and will bear interest at Comerica’s prime rate plus one-half percent. The agreement also includes a one-time facility fee of $15,000, a fee of 0.25% on the unused balance of the line of credit, various restrictive covenants and requirements to maintain certain financial ratios. Borrowings under the line of credit are guaranteed by Safeguard in exchange for an annual fee of $15,000 and an amount equal to 4.5% per annum of the daily-weighted average principal balance

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

Forward-Looking Statements

Statements in this report describing our plans, goals, strategies, intentions, expectations and anticipated events are forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those described in this report. Factors that could cause or contribute to those differences include those described below under “Factors That May Affect Future Results of Operations,” “Risk Factors,” and elsewhere in this quarterly report, as well as: our ability to successfully implement and expand our cancer diagnostic laboratory service offerings, biopharma services and in-sourcing of our Access remote pathology program, the performance and acceptance of our system and service offerings in the marketplace; changes in rates of third-party payer reimbursement for tests performed using our system; uncertainty of success in developing any new software applications; our receipt of requisite federal and state licenses to provide a broad array of laboratory services; the outcome of any currently pending and any future litigation that involves us; any future success depends upon our ability to expand and maintain a successful sales and marketing organization; we may require additional financing for our business, and it is uncertain whether the financing will be available on favorable terms or at all; we may encounter unanticipated expenses, liabilities or other adverse events affecting cash flow; our ability to develop new tests and to distribute our systems and tests performed on the system depends on successful collaboration with third parties that we do not control; proper utilization of our system is dependent upon the quality of third party stains and reagents; we must successfully compete with other technologies and with emerging competitors in cell imaging many of which may have greater resources, market share, and brand recognition than us; an inadequate supply of biological samples could delay completion of clinical trials for new applications for our Automated Cellular Imaging System (“ACIS^®”); the clinical trials could fail to demonstrate the efficacy of the ACIS for new applications; new applications may not be successfully developed; the ability to commercialize new applications may be dependent on obtaining appropriate U.S. Food and Drug Administration (the “FDA”) and foreign regulatory approvals and clearances, which may not be obtained when anticipated or at all; our competitive position is dependent upon our ability to protect our patents and proprietary rights; manufacture of the ACIS is subject to FDA regulation and our ability to implement our strategy of providing decentralized ACIS analysis capabilities over the internet is dependent upon successful development of the related imaging technology and obtaining any required regulatory approvals. In addition, there is risk and uncertainty as to our expectation that our revenues may increase from the addition of new system placements, sales of systems to research accounts and the roll-out of the Access remote pathology program in our laboratory facilities. Recent experience with respect to ACIS placements, new contracts for placements, revenues and results of operations may not be indicative of future results for the reasons set forth above.

Overview and Outlook

ChromaVision is an advanced diagnostics and services company focused on improving the quality of patient care while reducing medical costs and speeding the discovery of new drugs to treat cancer. We develop, manufacture and market a versatile automated digital microscope system with the ability to detect, count and classify cells based on color, size and shape to assist pathologists in making critical medical decisions that can affect patient treatment. The ACIS combines an automated microscope with computer-based color imaging technology originally developed for the U.S. government’s “Star Wars” program.

The FDA-cleared ACIS device is currently being used by pathologists and researchers to analyze specimens placed on slides and stained with color-producing, commercially available reagents. The system’s ability to overcome the limitations of the human eye (even when aided by a microscope) dramatically improves the observer’s ability to analyze cells and tissue. Peer-reviewed clinical data and publications have demonstrated that the ACIS digital microscope and proprietary software can considerably improve accuracy and consistency over other methods of laboratory testing. ChromaVision brings standardization, accuracy and reproducibility to anatomic pathology, an area of the laboratory focused on esoteric tests, which have traditionally been analyzed manually.

Our focus historically has been on the development, manufacture and marketing of our ACIS device. Our primary customers for the placement of ACIS devices are large hospitals (with 500 beds or more) and academic research centers. These customers typically have laboratory facilities from which they can stain and image tissue samples for analysis using our ACIS device. However, many of our smaller customers, such as small community hospitals, do not have their own facilities to perform the laboratory services necessary to prepare tissues for viewing on our ACIS device. These customers can nevertheless utilize our advanced imaging technology by analyzing images and reports on remote viewing stations known as Access viewing stations. Historically, we have outsourced the staining and imaging of tissue samples from these customers to reference laboratory partners, which in turn distributed the images and reports back to these customers for viewing and analysis on the remote Access viewing stations.

Earlier this year, we made a decision to expand our service offerings into the complementary field of advanced cancer diagnostic services. At that time, we began several related steps to implement this strategic initiative by first raising new equity capital and then using these funds to make significant investments in the hiring of a number of individuals with significant

laboratory services experience, leasing a dedicated facility from which we can provide laboratory services directly to our Access customers and acquiring new laboratory equipment. Thus far, our laboratory services have been limited to providing Access technical services such as stain preparation and image scanning to our remote Access customers for analysis using the ACIS software. However, upon receipt of requisite state and federal licenses, we intend to broaden our laboratory service offerings ranging from in-house pathology testing using the ACIS device to other cutting-edge diagnostic technologies that assist physicians in managing cancer such as flow cytometry and molecular medicine. In the future, we expect that revenue from these laboratory services will comprise the greatest and fastest growing component of our total revenue.

In addition to our new diagnostic laboratory services, we also develop ACIS-based tools for academic and biopharmaceutical company researchers, allowing them to perform cellular-level analyses much faster and with improved accuracy. We believe that the combination of our proprietary image analysis technology and our ability to develop companion diagnostic tests with biopharma companies in their introduction of new cancer therapeutics (referred to as “BioAnalytical Services”) will position us to attract new customers and possibly more services from existing customers for our new laboratory service offerings.

Safeguard Scientifics, Inc., a Pennsylvania corporation whose shares are listed on the New York Stock Exchange, owns beneficially approximately 56.7% of the outstanding shares of our Common Stock. We refer to Safeguard Scientifics, Inc. and its wholly-owned subsidiaries as “Safeguard”. As a result of this stock ownership, Safeguard has the ability to elect all of our directors and it also has significant contractual rights to control our business. See Note 8 of Notes to Condensed Consolidated Financial Statements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the balance sheets and revenues and expenses for the periods presented. Therefore, on an ongoing basis, we evaluate our estimates, including those provisions for bad debts and reserves for ACIS in progress.

Allowance for Doubtful Accounts. For estimated bad debts, we review on an individual account basis the age of the receivable, all circumstances surrounding the transaction that gave rise to the receivable and whether the customer continues to have the financial resources to pay the receivable as of the balance sheet date and prior to the issuance of the financial statements for the respective period.

Impairment of Long-lived Assets. We review our long-lived assets, such as fixed asset and intangibles, for impairment whenever events or changes indicate the carrying value may not be recoverable or that the useful lives are no longer appropriate. If we determine that the carry value of the long-lived assets may not be recoverable, the asset is then written down to its estimated fair value based on a discounted cash flow basis. Assets included in long-lived assets are our ACIS and Access equipment in progress, which is recorded in property and equipment.

Revenue Recognition. We place most of our instruments with users on a “fee-per-use” basis. We obtain the billing information via modem, which accesses the ACIS database. Revenue is recognized based on the greater of actual usage fees or the minimum monthly rental fee. Under this pricing model, we own most of the ACIS instruments that are engaged in service and, accordingly, all related depreciation and maintenance and service costs are expensed as incurred. For those instruments that are sold, we recognize and defer revenue using the residual method pursuant to the requirements of Statement of Position No. 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by Statement of Position No. 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Arrangements.” At the outset of the arrangement with the customer, we defer revenue for the fair value of its undelivered elements (e.g., maintenance) and recognize revenue for the remainder of the arrangement fee attributable to the elements initially delivered in the arrangement (e.g., equipment and installation services) when the basic criteria in SOP 97-2 have been met. Maintenance revenue is recognized ratably over the term of the maintenance contract, typically twelve months. Revenue on product sales is recognized upon acceptance by the customer subsequent to a testing and evaluation period. Laboratory revenue is recognized at the time of completion of services at amounts equal to our anticipated collections of amounts to be billed to Medicare, third party insurance payors, and patients. Because of the requirements and nuances of billing for laboratory services, we may invoice these parties amounts that are greater than those allowable for payment, however, as noted, it is only the expected payment from these parties that is recorded as revenue.

Results of Operations

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

Revenue – Fee per use and other. Our sales focus has been on placing the ACIS with hospitals and academic research centers under a lease arrangement in which the customer is charged monthly based on the number of tests performed, subject to a minimum monthly payment. Fee per use revenue for the three months ended September 30, 2004 declined approximately $1.5 million or 54% over the comparable period in 2003 primarily due to pricing concessions we offered our customers in response to lower reimbursement levels from Medicare for our customers’ services (See discussion below under “Factors That May Affect our Future Results of Operations”). Further impacting the decline in revenue was the termination of our contract with our largest customer, US Labs on July 1, 2004. The termination of our relationship with US Labs enabled us to begin to directly provide our customers the technical scan and stain services that had previously been performed by US Labs (see discussion of “Revenue – Laboratory services” below). The average number of units and monthly revenue for ACIS placements was approximately 140 and $3,034, respectively, in the third quarter of 2004 as compared to 157 and $4,746 respectively for the comparable period in 2003. We anticipate that the average monthly ACIS system revenue will remain approximately at current levels and that most, if not all, of the negative impact from reimbursement changes has been reflected in the current revenue amounts.

Revenue - System sales. System sales revenue for the three months ended September 30, 2004 increased approximately $0.2 million or 75% over the comparable period in 2003 due primarily to an increase in the number of units sold. Three systems were sold during the third quarter of 2004 as compared to two during the comparable period in 2003. System sales contributed 17.2% of total revenue for the third quarter of 2004 as compared to 8.2% for the comparable period in 2003. Revenue from system sales can and will fluctuate significantly principally due to the infrequent and limited number of system sales.

Revenue – Lab services. In the second quarter, we began offering technical laboratory services which we believe will provide us a new and growing stream of complementary revenue. Our current line of services, which is confined to technical image scan and stain only services, is delivered through the remote Access viewing stations which pathologists use to interpret the image results using our ACIS software. Following the termination of our relationships with US Labs, we began to transition our Access customers who had been utilizing the US Lab facilities for staining and imaging of their tissue samples to our own laboratory operations. As of the end of the third quarter, approximately 75% of our Access customers had converted to our Access technical laboratory services offerings. We will continue to work with the remaining group of customers to convert them to our technical laboratory service offerings while also aggressively marketing our laboratory service capabilities to new customers. We expect that our laboratory services revenues will increase over the next several quarters. Lab services revenue for the three months ended September 30, 2004 was approximately $0.8 million. In this new arrangement, rather than directly billing pathologists and hospitals as we do with our ACIS system placements, we plan to submit claims for reimbursement for these technical services directly to Medicare and other third party payors. In the third quarter of 2004, we performed approximately 8,000 stain and scan slides for close to 100 different customers. Beginning in the fourth quarter of 2004, we plan to offer an internet-based service solution as an alternative to the Access remote viewing station that will ultimately eliminate the need to place physical assets in the field with these customers which will substantially reduce our costs of service to these customers.

Cost of revenue. Cost of revenue for the three months ended September 30, 2004 increased approximately $1.2 million, or 123% over the comparable period in 2003, due primarily to the introduction of the lab service direct costs and the increase in system sales placements. Also included in cost of revenue is cost for manufacturing the ACIS, which includes the cost for direct material, labor costs and manufacturing overhead, the cost of systems sold, direct costs of laboratory services, (i.e. lab technician salaries) and field customer service costs. For fee-per-use revenue the cost of the ACIS is depreciated over a three-year time period and for a system sale the entire cost of the ACIS system is recognized at the time of sale. The gross margin, as a percentage of total revenue for the three months ended September 30, 2004 was 15.5% as compared to 68.5% for the comparable period in 2003. The gross margin decline is primarily due to the lower revenue per unit for ACIS systems and the introduction of the lab service direct costs, offset by lower system sales costs due to the sale of refurbished units versus new units.

Selling, general and administrative expenses. Selling, general and administrative expenses for the three months ended September 30, 2004 increased approximately $0.4 million, or 11.3% over the comparable period in 2003 primarily due to non-cash compensation charges of $0.1 million, media costs of $0.1 million and legal costs of $0.3 million, offset by savings resulting from the third quarter 2003 reduction in force and lower depreciation and travel costs.

General and administrative costs related to lab services. During the first quarter of 2004, we began incurring costs directly related to the start-up and administration of the new laboratory services, which became operational during the latter portion of the second quarter of 2004. The start-up and administrative costs associated with these services are included in the caption in our condensed consolidated financial statements “General and administrative costs related to lab services.” Costs for the three months ended September 30, 2004 were approximately $1.0 million. The lab service costs, which support the

development of our in-house Access technical services capability, will continue to be an increasing component of total costs in future periods. The direct costs of providing laboratory services are included in “Cost of revenue.”

Research and development expenses. Research and development expenses for the three months ended September 30, 2004 were comparable to the same period in 2003. We believe that sufficient resources exist currently to support the development of new features for the clinical and research markets. These new development activities, which are intended to produce features that could expand the volume of clinical tests supported by ACIS and increase the attractiveness of the ACIS as a tool for researchers, are important to increasing clinical system test volume, expanding the count of clinical system placements, and increasing research system sales.

Other income (expense). Other income for the three months ended September 30, 2004 totaled $5,000, compared to $15,000 of other expense for the comparable period of 2003, and consisted of approximately $47,000 of interest expense offset by approximately $52,000 of interest income. The interest expense is due to the borrowings under our $3.0 million equipment financing agreement, which began in September 2003, and new borrowings of $1.6 million in the third quarter of 2004 related to our new leased laboratory equipment financing agreement. The $52,000 of interest income for the third quarter of 2004 compares to $3,000 of interest income for the comparable period of 2003. The increase in interest income is primarily the result of higher cash balances in the third quarter of 2004 compared to the third quarter of 2003.

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

Revenue – Fee per use and other. Our sales focus has been on placing the ACIS with hospitals and academic research centers under a lease arrangement in which the customer is charged monthly based on the number of tests performed, subject to a minimum monthly payment. Fee per use revenue for the nine months ended September 30, 2004 declined approximately $3.8 million or 46.8% over the comparable period in 2003 primarily due to pricing concessions we offered our customers in response to lower reimbursement levels from Medicare for our customers’ services (See discussion below under “Factors That May Affect our Future Results of Operations”). Further impacting the decline in revenue was the termination of our largest contract with our customer, US Labs on July 1, 2004. The termination of our relationship with US Labs enabled us to directly provide our customers the technical scan and stain services that had previously been performed by US Labs (see discussion of Revenue – Laboratory Services below). We anticipate that the average monthly ACIS system revenue will remain at approximately the current level of 2004 and that most, if not all, of the negative impact from reimbursement changes has been reflected in the current revenue amounts.

Revenue - System sales. System sales revenue for the nine months ended September 30, 2004 increased approximately $0.9 million or 140.4% over the comparable period in 2003 due primarily to an increase in the number of units sold. Eleven systems were sold during the first nine months of 2004 as compared to four during the comparable period in 2003. System sales contributed to 22.9% of total revenue for the first nine months of 2004 as compared to 7.5% for the comparable period in 2003. This revenue stream can and will fluctuate significantly principally due to the infrequent and limited number of system sales.

Revenue – Lab services. Lab services revenue for the nine months ended September 30, 2004 was approximately $1.0 million. During the second quarter we began offering technical laboratory services in our facilities which has provided a new and growing stream of complementary revenue. Our current line of services, which is confined to technical image scan and stain only service, is delivered through the remote Access viewing station which pathologists use to interpret the image results using our ACIS software. Following the termination of our relationships with US Labs, we began to transition our ACCESS customers who had been utilizing the US Lab facilities for staining and imaging of their tissue samples to our own laboratory operations. As of the end of the third quarter, approximately 75% of our ACCESS customers had converted to our ACCESS technical laboratory services offerings. We will continue to work with the remaining group of customers to convert them to our technical laboratory service offerings while also aggressively marketing our laboratory service capabilities to new customers. We expect that our laboratory services revenues will increase over the next several quarters. In this new arrangement, rather than directly billing pathologists and hospitals as we do with our ACIS system placements, we plan to submit claims for reimbursement for technical services directly to Medicare and other third party payors. Beginning in the fourth quarter of 2004, we plan to offer an internet-based service solution as an alternative to the Access remote viewing station that will ultimately eliminate the need to place physical assets in the field with these customers and will reduce our costs of service to these customers.

Cost of revenue. Cost of revenue for the nine months ended September 30, 2004 increased approximately $1.5 million, or 57.2% over the comparable period in 2003, due to the combination of direct laboratory costs and the increase in system placements. Cost of revenue primarily consists of the cost of manufacturing the ACIS, which includes the cost for direct material, labor costs and manufacturing overhead, the cost of systems sold, direct costs of laboratory services (i.e lab technician salaries), and field customer service costs. For fee-per-use revenue the cost of the ACIS is depreciated over a three-year time period and for a system sale the entire cost of the ACIS system is recognized at the time of sale. The gross margin, as a percentage of total revenue for the nine months ended September 30, 2004 was 38.6% as compared to 69.4% for the

comparable period in 2003. The gross margin decrease is primarily due to the lower revenue per unit for ACIS and the introduction of the lab service direct costs.

Selling, general and administrative expenses. Selling, general and administrative expenses for the nine months ended September 30, 2004 increased approximately $1.3 million, or 14.7% over the comparable period in 2003 primarily due to non-cash compensation charges of $0.6 million, lab branding expenses of $0.3 million, legal expenses of $1.0 million, Safeguard charges for interim CEO management of $0.2 million and outside consultants of $0.4 million, offset by savings due to the third quarter 2003 reduction in force and lower depreciation and travel costs. We anticipate that these costs will be somewhat lower going forward as the elimination of several “one-time” expenses is offset by higher spending for sales.

General and administrative costs related to lab services. During the first quarter of 2004, we began incurring costs directly related to the start-up and administration of the new laboratory services, which became operational during the latter portion of the second quarter of 2004. The start-up and administrative costs associated with this department are included in the caption in our condensed consolidated financial statements “General and administrative costs related to lab services.” Costs for the nine months ended September 30, 2004 were $2.6 million. The lab service costs, which support the development of our in-house Access technical services capability, will continue to be an increasing component of total costs in future periods. The direct costs of providing laboratory services are included in “Cost of revenue.”

Research and development expenses. Research and development expenses for the nine months ended September 30, 2004 decreased by approximately $0.1 million or 2.8% over the comparable period in 2003. The decrease for the nine month period is due to the reduction in personnel costs as a result of the third quarter 2003 workforce reduction. We believe that sufficient resources exist currently to support the development of new features for the clinical and research markets. These new development activities, which are intended to produce features that could expand the volume of clinical tests supported by ACIS and increase the attractiveness of the ACIS as a tool for researchers, are important to increasing clinical system test volume, expanding the count of clinical system placements, and increasing research system sales.

Other income (expense). Other expense for the nine months ended September 30, 2004 totaled $72,000, compared to $10,000 of other expense for the comparable period of 2003, and consisted of approximately $187,000 of interest expense offset by approximately $115,000 of interest income. The interest expense is due to the borrowings under our $3.0 million equipment financing agreement, which began in September 2003, and new borrowings of $1.6 million in the third quarter of 2004 related to our new leased laboratory equipment financing agreement. The $115,000 of interest income for the third quarter of 2004 compares to $24,000 of interest income for the comparable period of 2003. The increase in interest income is primarily the result of higher cash balances in the first nine months of 2004 compared to the same period of 2003.

Factors that May Affect Future Results of Operations

The year 2000 was our first full year of commercial activity during which we focused primarily on marketing and sales of the ACIS system to large hospitals, academic research centers and pathology groups as our menu of capabilities performed with the ACIS expanded and gained commercial acceptance. While we have made significant progress, we still face significant uncertainties, including those discussed below under “Risk Factors” and “Liquidity and Capital Resources,” which include our ability to achieve market acceptance of the ACIS, our ability to ensure satisfactory reimbursement by Medicare and other third party insurance carriers under new billing codes which have been established for image analysis-based testing effective as of January 1, 2004 and our ability to execute on our business plan to provide additional laboratory and bioanalytical services.

Laboratory services provided for patients with the assistance of ACIS technology are eligible for third party reimbursement using medical billing codes which apply to image analysis-based testing. These billing codes are known as Healthcare Common Procedure Coding System (HCPCS) codes, which include the Common Procedural Terminology, or CPT, codes as the means by which Medicare and private insurers identify medical services that are provided to patients in the United States. CPT codes are established by an independent editorial panel convened by the American Medical Association (AMA). The reimbursement amounts, or relative values, associated with the CPT codes are established by the Centers for Medicare and Medicaid Services (CMS), under a process that involves recommendations from an independent Relative Value Update Committee also convened by the AMA, with advice from professional societies representing the various medical specialties.

Effective April 1, 2003, the CMS instituted a National Correct Coding Initiative (NCCI) edit. The NCCI edit significantly reduced from April 1, 2003 to December 31, 2003 the amount of reimbursement previously paid by Medicare for services involving automated image analysis by limiting the codes that would be accepted for reimbursement for ACIS-based services. The CMS edit applied only to reimbursement for Medicare patients. We estimate that approximately 35% of ACIS-based services are performed for Medicare beneficiaries. We believe that, before the edit, the majority of our [hospital and pathologist] customers were being reimbursed approximately $200 per test. Under the NCCI interim edit (effective until December 31, 2003) customers were reimbursed about $85 per test for Medicare patients. During this time, the edit was adopted to a limited degree by other third-party payers.

A new CPT code for image analysis went into effect on January 1, 2004. Under the new code, the total Medicare reimbursement for ACIS-based procedures performed in physician offices or independent laboratories is approximately $140 per test, reflecting a technical component of approximately $85 and a professional component of approximately $55. The technical component involves preparation of the patient sample and running the test on the ACIS, while the professional component involves the physician’s reading and evaluation of the test results. The actual amount varies based upon a geographic factor index for each state and may be higher or lower than the amounts indicated above in particular cases based on one’s geographic location. In Southern California, for example, where ChromaVision’s Access technical services are currently performed, the reimbursement amount for technical services is approximately $99 per slide.

The adoption of a new CPT code appropriate for image analysis reflects the expanding role of image analysis in pathology and the need for appropriate reimbursement to enable use of this technology by healthcare providers to benefit patients. Potentially, the new CPT code could help to streamline reimbursement for ACIS users by allowing them to code more specifically for image analysis-based services in claims billed to third party payers. The 2004 valuations of the new code are considered interim valuations and are open for comment to influence further adjustments in 2005. ChromaVision will continue working with relevant medical societies and other appropriate constituents to obtain appropriate reimbursement amounts by all payers for providers of image analysis-based services. Our goal is to have the amount paid by Medicare and other payers for image analysis-based services accurately reflect the technology costs, the benefit that image analysis brings to patients, and its positive impact on healthcare economics.

The reduction of reimbursement resulting from the NCCI edit and the 2004 interim valuations for ACIS-based procedures not only reduced revenue for current ACIS customers, but also resulted in system returns or cancellations by current customers and may also negatively impact future placements of ACIS. In addition, because of the increase in the technical component to reimbursement, we may be required to enter into new contracts with the hospitals that often prepare the slides for analysis because these hospitals are the beneficiaries of the increase in the technical component of reimbursement. Hospitals typically have longer buying cycles and a more extensive contract evaluation process than the pathology practitioner which may delay the implementation of these contracts. At the same time, ChromaVision’s current pathologist customers, for whom professional service reimbursement was reduced from approximately $150 to $55 per test, required more significant rate reductions.

Due to the change in reimbursement effective January 1, 2004, our sales representatives focused considerable efforts during the first half of 2004 on renegotiating many of the fee-per-use contracts. The sales force also concentrated their efforts on converting Access customers to ChromaVision’s Access technical services laboratory operation. As a result, we have experienced a reduction in system placements and fee-per-use revenue during 2004, as compared with previous quarters in 2003. New sales efforts will now be substantially focused on system placement expansion and continued support of our existing base of installations.

We face risks that our ACIS and remote Access viewing systems may become obsolete or their market value may decline below their manufacturing cost. These risks have increased due to the recent slowdown in system placements and increase in system returns related to the aforementioned reimbursement reductions. Some of these risks are mitigated by the depreciation of these systems as they become engaged in service and our ability to upgrade these systems, at a relatively low cost, to meet new application demands.

We also face uncertainties with respect to our ability to complete development of additional tests for the ACIS. In order to mitigate the risk that any one test will not be successfully developed, we maintain a pipeline of tests in a prioritized queue so that if any one test is not successfully developed, or market feedback suggests that a test should be given a lower priority, we can align development efforts according to priority. In addition, the ACIS system is dependent upon the laboratory producing a quality stained slide for image analysis. Reagent and or stain quality issues by stain manufacturers may impact the rate at which the ACIS technology is adopted or new applications are added to existing placements.

Other uncertainties affecting our business include our ability to implement our new business initiatives, including transitioning from our primary imaging provider, US Labs, to providing our laboratory services in-house and to collaborate successfully with other companies, universities and research centers to develop, initiate and complete clinical trials of new applications for the ACIS and obtain governmental approvals for the applications. Although we have recently hired several individuals with experience in operating and building out laboratory services, we do not have historical or demonstrated competency in reference laboratory service provision and may, therefore, have a difficult time in transitioning new customers to our new laboratory services operation. Furthermore, there are several reference lab competitors in the advanced cancer diagnostics field with greater experience than we have. Lack of success in these efforts could have a material adverse effect on the future results of our operation and our ability to generate sufficient cash flow to fund operations. In addition, we are dependent on state and federal regulatory agencies to obtain necessary laboratory licenses. If our receipt of such licenses is delayed and/or postponed, our expansion of laboratory services could be compromised.

Liquidity and Capital Resources

At September 30, 2004, we had approximately $15.9 million of cash and cash equivalents. Cash used in operating activities was $8.1 million in the first nine months of 2004 due primarily to our net loss of $13.8 million offset by non-cash charges of $2.2 million for depreciation, $0.6 million for non-cash compensation, and an increase in our accrued and accounts payable of $2.2 million.

Cash used in investing activities of $3.1 million consisted of capital expenditures related primarily to the manufacture of the ACIS systems placed with customers and expenditures for new laboratory equipment in support of our expanded laboratory and bioanalytical services. The rate of capital expenditures, as it relates to ACIS equipment purchases for the remainder of 2004, is expected to be lower than in prior years, particularly in the last quarter of the year, due to the reduced backlog of contracts for new system placements at the end of the third quarter of 2004. The reduction in contract executions in the second half of 2003 and the first half of 2004 was due primarily to a focus on renegotiating current fee-per-use contracts and on converting Access customers to ChromaVision’s Access technical services laboratory operation. We expect placements of new Access systems and sales of systems to the research centers to increase in the coming quarters. We believe that contracts for new laboratory services, both those related to Access technical services as well as those for broader cancer diagnostic services, will also increase in the last quarter of 2004 as we begin to establish these service capabilities. In addition, management’s decision in the third quarter of 2003 to terminate agreements with low performing accounts coupled with a limited number of customer cancellations, has resulted in an increase in the supply of returned equipment that is available for placement with new accounts in the future. We believe that we will be able to place this supply of returned equipment with new customers over the next six months.

Our business plan also anticipates continuing to place ACIS and Access instruments with users and charging a fee-per-use for each time the instrument is used to perform a test or alternatively to sell these systems to research customers. The manufacturing of these instruments may require a significant outlay of cash, subject to the near term supply of returned equipment noted above. Revenues will be recognized over the lease term. In addition, expansion of our laboratory services initiative will continue to require a significant outlay of cash. We intend to fund these expenditures with our current cash resources, with the funds available under our $3.0 million revolving line of credit, and with new equipment financing specifically directed towards our new laboratory equipment acquisitions. While we believe that these resources will be adequate to support the entirety of our business expansion needs, both for new system placements as well as for the broader build-out of the laboratory facilities, we intend to increase our mix of system sales to per use contracts to generate more cash. The majority of these sales will be to research accounts. We expect the need for any new Access equipment placements to be significantly reduced as we implement our plan to offer an internet based service solution as an alternative to the Access remote viewing station in the fourth quarter of 2004. This move will ultimately eliminate the need to place physical assets in the field with remote Access customers which will substantially reduce our costs of service and equipment.

Net cash provided from financing activities during the first nine months of 2004 was $25.3 million primarily due to the completion of a $5.0 million private placement of our Common Stock with Safeguard in February 2004 and $21.0 million private placement of our Common Stock to a limited number of accredited investors including Safeguard in March and April 2004 net of $1.6 million of offering costs. Both of these financing transactions are described below. In addition, we paid down approximately $0.8 million of the outstanding GE equipment financing and received proceeds of $1.6 million related to our new lab equipment financing agreement.

In February 2003, we entered into a $3.0 million revolving credit agreement with Comerica Bank-California . This one-year agreement was renewed for a second year, or until February 2005. The borrowings under the line of credit will be used for working capital purposes and will bear interest at Comerica’s prime rate plus one-half percent. The agreement also includes a one-time facility fee of $15,000, a fee of 0.25% on the unused balance of the line of credit, various restrictive covenants and requirements to maintain certain financial ratios. Borrowings under the line of credit are guaranteed by Safeguard in exchange for an annual fee of $15,000 and an amount equal to 4.5% per annum of the daily-weighted average principal balance outstanding under the line of credit. We failed to satisfy certain financial covenants related to tangible net worth under the loan agreement as of the end of August 2003, and in October 2003 the lender waived these failures to satisfy the covenants and agreed to modify the covenants. The amended agreement which became effective in February 2004 now has only one financial covenant related to tangible net worth, which must be greater than $1 through September 30, 2004 and greater than $(2,000,000) thereafter. We were in compliance with the revised covenants at September 30, 2004 and believe that we will remain in compliance throughout the remaining term of the agreement. As of September 30, 2004, $3.0 million was available under the line of credit.

In August 2003, we entered into a $3.0 million equipment financing agreement with GE Capital. The loan principal amortizes ratably over a 33-month term. The borrowings under the equipment financing agreement are being used for working capital purposes and bear interest at 600 basis points over the three year treasury constant maturities rates (2.16% at 9/19/03). The agreement also provides for an incremental $2.0 million of financing availability upon reaching certain system placement objectives, various restrictive covenants, maintenance of certain financial ratios and a collateral monitoring fee of $5,000 per year. In September 2003, the entire $3.0 million available under the financing agreement was borrowed with an interest rate of

8.16%. As of September 30, 2004, $2.1 million of debt remains outstanding with approximately $1.1 million of the debt classified as current and $1.0 million as long-term.

Borrowings under the equipment financing agreement with GE Capital are secured by substantially all of our assets. The agreement with GE Capital incorporates some of the restrictive covenants and certain other requirements of the Comerica revolving credit agreement, including any subsequent amendments granted by Comerica with respect to the incorporated covenants. The agreement with GE Capital also includes a provision whereby a material adverse change to our financial condition could be considered an event of default. We believe, however, based on current operations, committed borrowings and the $24.0 million of proceeds, net of offering costs, received earlier this year from the private placements, that we will remain in compliance with our debt covenants over the next twelve months and that it is not probable that GE Capital will exercise the material adverse change clause as an event of default.

In June 2004, we entered into a new lease with GE Capital for the financing of up to $4.6 million in laboratory services related equipment. The lease financing has a term of 36 months for each financing executed under the line and provides for an early purchase option after 30 months at a predicted fair market value of the equipment. Any borrowings under the equipment lease financing agreement will bear interest based on a spread over the three year treasury constant maturities rate (3.24% at time of agreement). As of September 30, 2004, we had financed approximately $1.6 million of capital equipment.

On February 10, 2004, we completed a private placement of 2,295,230 shares of common stock and a warrant to purchase shares of common stock to Safeguard for a purchase price of $5.0 million. The warrant issued to Safeguard, which is exercisable until March 1, 2008, as amended, is currently exercisable to purchase 344,285 shares of common stock for an exercise price of $2.95 per share. In connection with this private placement transaction, we entered into a registration rights agreement giving Safeguard certain rights to have the purchased shares registered under the Securities Act of 1933, as amended.

On March 25, 2004, we entered into a securities purchase agreement with a limited number of accredited investors pursuant to which we agreed to issue and the investors agreed to purchase 10,500,000 shares of common stock for an aggregate purchase price of $21.0 million or $2.00 per share, together with warrants to purchase an additional 1,575,000 shares of common stock at an exercise price of $2.75 per share for an aggregate purchase price of $21.0 million (we refer to this financing as the “March 2004 financing”). The warrants issued in this transaction are exercisable for a period of four years after the date they are issued. Safeguard was one of the purchasers in the March 2004 financing and acquired 3,750,000 shares of common stock and warrants to purchase 562,500 shares of common stock for an aggregate investment of $7.5 million. Each of the purchasers in the March 2004 financing was granted a preemptive right to purchase its pro rata share of 49.9% of any new equity securities that we may issue on or prior to March 31, 2005. Safeguard had previously been granted preemptive rights, which it waived in connection with the March 2004 financing, except to the extent that it purchased securities in the March 2004 transaction. In connection with the March 2004 financing, we entered into a registration rights agreement giving the investors certain rights to have the purchased shares registered under the Securities Act of 1933, as amended.

We believe that our existing cash resources, the available $3.0 million revolving line of credit with Comerica bank, the $3.0 million equipment financing agreement and the $4.6 million equipment lease line with GE for financing of our lab expansion, will be sufficient to satisfy the cash needs of our existing operations during the next twelve months and will enable us to stay in compliance with our debt agreements. Over the longer term, we may need to seek additional debt or equity financing to fund our ongoing operations, development activities, clinical studies and/or regulatory activities. There can be no assurance that we will be able to obtain additional debt or equity financing when needed or on terms that are favorable to us and our stockholders. Furthermore, if additional funds are raised through an equity or convertible debt financing, our stockholders may experience significant dilution.

We currently lease our corporate headquarters and manufacturing facility and laboratory services facility under operating lease arrangements. The lease for the corporate headquarters and manufacturing facility expired in February 2004 and we exercised our option to extend the lease one-year. The lease for the laboratory services facility was entered into in May 2004 for a term of one year. Our purchase obligations represent commitments primarily for the purchase of materials for the manufacture of our ACIS units.

The following table summarizes our contractual and other commitments (in thousands):

Contractual Obligations	Less than 1 Year		1-3 Years
Operating leases	$	325	$	—
Capital lease financing	527		1,054
Long-term debt obligations	1,085		988
Total.	$	1,937	$	2,042

RISK FACTORS

Before deciding to invest in us or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and other reports we have filed with the Securities and Exchange Commission. The risks and uncertainties described below are not the only ones facing our Company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks are realized, our business, financial condition or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment.

RISKS RELATED TO OUR BUSINESS

Our existing business is highly dependent on increased market acceptance of the ACIS, and it is uncertain whether the ACIS will achieve that acceptance.

Increased market acceptance of the ACIS depends on a number of variables, including, but not limited to, the following:

• the ability of the ACIS to perform as expected;

• acceptance by patients, physicians, third party payors and laboratories of the ACIS to run the tests performed using it;

• our ability to develop a significant number of tests performed with the ACIS;

• our ability to implement our new diagnostic lab service initiative;

• the amount of reimbursement by third party payors for a test performed using the ACIS;

• the effectiveness of marketing, distribution and pricing strategy;

• availability of alternative and competing diagnostic products; and

• scientific studies and other publicity concerning ACIS or competitive products.

The future commercial success of our products will depend primarily on convincing research, reference and clinical laboratories to evaluate and offer these products as research tools for scientists and clinical investigators and as diagnostic products to physicians, laboratory professionals and other medical practitioner and convincing physicians, laboratory professionals and other medical practitioners to order tests for their patients involving our technologies. To accomplish this, we will need to convince oncologists, pathologists and other members of the medical and biotechnology communities of the benefits of our products. Additionally, if ongoing or future clinical trials result in unfavorable or inconsistent results, these products may not achieve market acceptance. Even if the efficacy of our future products and services are established, physicians may elect not to use them for a number of reasons. These reasons might include the training required for their use or unfavorable reimbursement from health care payors.

We have a history of operating losses, and our future profitability is uncertain.

We have incurred operating losses in every year since inception, and our accumulated deficit as of September 30, 2004 was $99.7 million. Those operating losses are principally associated with the research and development of our ACIS technology, the conducting of clinical trials, preparation of regulatory clearance filings and the development of our sales and marketing organization to commercialize the ACIS. Although leasing and sales of the ACIS have been encouraging since we began the commercial distribution of the ACIS in late 1999, we may not be able to achieve profitable operations at any time in the future.

Because our operating expenses are likely to increase significantly in the near term, we will need to generate significant additional revenue to achieve profitability. We expect our losses to continue to increase as a result of the expansion of the laboratory services, ongoing research and development and clinical trial expenses, as well as increased sales and marketing expenses. We are unable to predict when we will become profitable, and we may never become profitable. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to achieve and then maintain profitability, the market value of our common stock will decline.

We have limited experience in providing laboratory and other services, which may cause us to experience difficulties that could delay or prevent the development, introduction and marketing of these services.

We began providing the technical component of reference laboratory services in-house beginning in April 2004 and we intend to provide additional, oncology-focused laboratory services that complement our image analysis and certified ACCESS reference laboratory services. The success and viability of these initiatives is dependent on a number of factors including:

• our ability to develop and provide services that we have not previously provided;

• adequate reimbursement;

• medical efficacy as demonstrated by clinical studies and governmental clearances;

• governmental clearances, governmental regulations and expansion of the menu of tests performed by ACIS to bring greater economies of scale to our accounts operations; and

• our ability to obtain timely approval of requisite state and federal regulatory licenses.

We may not be successful in any of these areas, we may experience difficulties that could delay or prevent the successful development, introduction and marketing of these services, and we may not adequately meet the demands of the marketplace or achieve market acceptance. Our inability to accomplish any of these endeavors may have a material adverse effect on our business, operating results, cash flows and financial condition.

We may require additional financing to fund our new business initiatives, and it is uncertain whether such financing will be available on favorable terms, if at all.

We currently estimate that our existing capital resources will enable us to sustain operations for the foreseeable future. We have expended and will continue to expend substantial funds for research and development, clinical trials and manufacturing and marketing of our system. In addition we will expend substantial funds in implementing our new business initiatives, including our plans to provide reference laboratory services and other oncology-focused laboratory services. We will need capital sooner than currently expected if our new business initiatives are not successful or we fail to achieve the level of revenues from applications and our other services in the time frame contemplated by our business plan.

Our present and future funding requirements will also depend on certain external factors, including, among other things:

• the level of research and development investment required to maintain and improve our technology position;

• costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

• our need or decision to acquire or license complementary technologies or acquire complementary businesses;

• competing technological and market developments; and

• changes in regulatory policies or laws that affect our operations.

We do not know whether additional financing will be available on commercially acceptable terms when needed. In addition, our existing financing agreements contain covenants that prevent us from incurring additional debt (subject to limited exceptions) and prevent us from granting certain liens, claims or encumbrances on our assets. As a result, we may need the consent of our existing lenders to obtain additional debt financing. If adequate funds are not available or are not available on commercially acceptable terms, we might be required to delay, scale back or eliminate some or all of our development activities, new business initiatives, clinical studies or regulatory activities or to license to third parties the right to commercialize products or technologies that we would otherwise seek to commercialize ourselves.

Our ability to engage in certain business transactions may be limited by the restrictive covenants of our debt financing agreements.

Our existing financing agreements with Comerica Bank and GE Capital contain financial covenants requiring us to meet financial ratios and financial condition tests, as well as covenants restricting our ability to:

• incur additional debt;

• pay dividends or make other distributions or payments on capital stock;

• make investments;

• incur or permit to exist liens;

• enter into transactions with affiliates;

• change business, legal name or state of incorporation;

• guarantee the debt of other entities, including joint ventures;

• merge or consolidate or otherwise combine with another company; and

• transfer or sell our assets.

These covenants could adversely affect our ability to finance our future operations or capital needs and pursue available business opportunities, including acquisitions. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. We believe that we are currently in compliance with the covenants in our financing agreements.

We have recently terminated our relationships with reference laboratory partners, including our largest customer, which could have a negative impact on our revenue.

During the past several years, we have had reference laboratory partners service our remote pathology ACIS users by performing the technical and professional component of analysis such as staining and image scanning. US LABS, Inc. and Esoterix, Inc. are two national reference laboratory partners that have provided these services. In February 2004, we notified US LABS. Inc. and Esoterix, Inc. that we would end our relationship with them and begin to provide in-house laboratory services to our customers beginning in April 2004. For the year ended December 31, 2003, US Labs was our largest customer and accounted for approximately 7% of our revenues. Following the termination notice, we and US Labs were engaged in a dispute regarding the interpretation of a non-solicitation provision contained in the reference lab agreement between the parties. On March 19, 2004, we entered into a settlement agreement with US Labs pursuant to which we agreed that we would extend our contractual relationship with US Labs until July 1, 2004, when our contractual relationship would end. In return for this extension of time, US Labs agreed to pay us an increased compensation rate. US Labs also agreed that the termination of its contractual relationship on July 1, 2004 extinguished our remaining obligations under the non-solicitation provision of the laboratory reference agreement.

We have limited manufacturing experience and may encounter difficulties as we undertake to manufacture our system in increasing quantities.

We have limited commercial manufacturing experience and capabilities. We may encounter significant delays and incur significant unexpected costs in scaling-up our manufacturing operations. In addition, we may encounter delays and difficulties in hiring and training the workforce necessary to manufacture the ACIS in the increasing quantities required for us to achieve profitability. The failure to scale-up manufacturing operations successfully, in a timely and cost-effective manner, could have a material adverse effect on our revenues and income. We believe that we have adequate manufacturing capacity to meet anticipated demand for 2004. However, in order to meet demand thereafter, we will have to expand our manufacturing processes and facilities or rely on third-party manufacturers. We might encounter difficulties in expanding our manufacturing processes and facilities or in developing relationships with third-party manufacturers. If we are unable to overcome these difficulties our ability to meet product demand could be impaired or delayed.

We may not successfully manage our growth, which may result in delays or unanticipated difficulties in implementing our business plan.

Our success will depend upon the expansion of our operations and the effective management of our growth. We expect to experience growth in the scope of our operations and services and the number of our employees. If we grow significantly, such growth will place a significant strain on management and on administrative, operational and financial resources. To manage any growth, we would need to expand our facilities, augment our operational, financial and management systems, internal controls and infrastructure and hire and train additional qualified personnel. Our future success is heavily dependent upon growth and acceptance of our future products and services. If we are unable to scale our business appropriately or otherwise adapt to anticipated growth and new product introduction, our business, operating results, cash flows and financial condition may be harmed.

The medical imaging technology market is characterized by rapid technological change, frequent new product introductions and evolving industry standards, and we may encounter difficulties keeping pace with changes in this market.

The introduction of diagnostic tests embodying new technologies and the emergence of new industry standards can render existing tests obsolete and unmarketable in short periods of time. We expect competitors to introduce new products and services and enhancements to existing products and services. The life cycles of tests using the ACIS, and of the ACIS itself, are difficult to estimate. Our future success will depend upon our ability to enhance our current tests, to develop new tests, and to enhance and continue to develop the hardware and software included in the ACIS, in a manner that keeps pace with emerging industry standards and achieves market acceptance. Our inability to accomplish any of these endeavors will have a material adverse effect on our business, operating results, cash flows and financial condition.

We face substantial existing competition and potential new competition from others pursuing technologies for imaging systems.

We compete in a highly competitive industry. ACIS was first released in 1997 for use in research as an imaging system for the detection of rare cellular events. The primary application was for the detection of cells which contained a marker used to distinguish possible cancerous cells in bone marrow. At that time, the most significant competition to the ACIS for this application was use of manual microscopes and certain other cell-based techniques. These other techniques include PCR, a technique used in clinical labs to detect DNA sequences, and flow cytometry, a technique used to analyze biological material through the detection of the light-absorbing or fluorescing properties of cells. A natural progression for ChromaVision and the ACIS was to penetrate the manually intensive slide-based cancer testing market, with an initial focus on the breast cancer market. Companies such as DAKO, Ventana and BioGenex have greater cancer-testing market share and stronger medical laboratory relationships than we do. They also have two of the critical system components needed to drive standardization—reagents and staining automation. Other imaging companies such as TriPath and Applied Imaging are currently expanding into this market. Advancements in alternative cancer diagnostic tests and the development of new protein-based therapies will bring increased competition to this market segment, and such competition could adversely affect our operating results, cash flows and financial condition.

The clinical laboratory business is intensely competitive both in terms of price and service. This industry is dominated by several national independent laboratories, but includes many smaller niche and regional independent laboratories as well. Large commercial enterprises, including Quest and LabCorp, have substantially greater financial resources and may have larger research and development programs and more sales and marketing channels than we do, enabling them to potentially develop and market competing assays. These enterprises may also be able to achieve greater economies of scale or establish contracts with payor groups on more favorable terms. Smaller niche laboratories compete with us based on their reputation for offering a narrow test menu. Academic and regional institutions generally lack the advantages of the larger commercial laboratories but still compete with us on a limited basis. Pricing of laboratory testing services is one of the significant factors often used by health care providers in selecting a laboratory. As a result of the clinical laboratory industry undergoing significant consolidation, larger clinical laboratory providers are able to increase cost efficiencies afforded by large-scale automated testing. This consolidation results in greater price competition. Once we begin to provide laboratory services, we may be unable to increase cost efficiencies sufficiently, if at all, and as a result, our operating results, cash flows and our financial position could be negatively impacted by such price competition.

Competition in the pharmaceutical and biotechnology industries, and the medical devices and diagnostic products segments in particular, is intense and has been accentuated by the rapid pace of technological development. Our competitors in this area include large diagnostics and life sciences companies. Most of these entities have substantially greater research and development capabilities and financial, scientific, manufacturing, marketing, sales and service resources than we do. Some of them also have more experience than we do in research and development, clinical trials, regulatory matters, manufacturing, marketing and sales.

Because of their experience and greater research and development capabilities, our competitors might succeed in developing and commercializing technologies or products earlier and obtaining regulatory approvals and clearances from the FDA more rapidly than we. Our competitors also might develop more effective technologies or products that are more predictive, more highly automated or more cost-effective, and that may render our technologies or products obsolete or non-competitive.

We rely significantly on third-party manufacturers who may fail to supply us with components necessary to our products and services on a timely basis.

We rely currently and intend to continue to rely significantly in the future on third-party manufacturers to produce all of the components used in our ACIS device. We are dependent on these third-party manufacturers to perform their obligations in a timely and effective manner and in compliance with FDA and other regulatory requirements.

To date, we have generally not experienced difficulties in obtaining components from our manufacturers and, in cases where a particular manufacturer was unable to provide us with a necessary component, we have been able to locate suitable secondary sources. However, if the suppliers we rely on in the manufacturing of our products were unable to supply us with necessary components and we were unable to locate acceptable secondary sources, we might be unable to satisfy product demand, which would negatively impact our business. In addition, if any of these components are no longer available in the marketplace, we will be forced to further develop our technologies to incorporate alternate components. If we incorporate new components or raw materials into our products we might need to seek and obtain additional approvals or clearances from the FDA or foreign regulatory agencies, which could delay the commercialization of these products.

Our strategy for the development and commercialization of the ACIS platform contemplates collaborations with third parties, making us dependent on their success.

We have entered into and intend to continue to enter into corporate collaborations for the development of new applications, clinical collaborations with respect to tests using the ACIS and strategic alliances for the distribution of the ACIS and our other products. We, therefore, depend upon the success of third parties in performing their responsibilities. We cannot assure you that we will be able to enter into arrangements that may be necessary in order to develop and commercialize our products, or that we will realize any of the contemplated benefits from these arrangements. Furthermore, we cannot assure you that any revenues or profits will be derived from our collaborative and other arrangements.

We do not have the ability to independently conduct the clinical trials required to obtain regulatory clearances for our applications. We intend to rely on third-party expert clinical investigators and clinical research organizations to perform these functions. If we cannot locate and enter into favorable agreements with acceptable third parties, or if these third parties do not successfully carry out their contractual obligations, meet expected deadlines or follow regulatory requirements, including clinical laboratory, manufacturing and good clinical practice guidelines, then we may be the subject of an enforcement action by the FDA or some other regulatory body, and may be unable to obtain clearances for our products or to commercialize them on a timely basis, if at all.

Failure in our information technology systems could disrupt our operations.

Our success will depend, in part, on the continued and uninterrupted performance of our information technology systems. Information systems are used extensively in virtually all aspects of our business, including laboratory testing, billing, customer service, logistics and management of medical data. Our success depends, in part, on the continued and uninterrupted performance of our information technology, or IT, systems.

Our computer systems are vulnerable to damage from a variety of sources, including telecommunications failures, malicious human acts and natural disasters. Moreover, despite reasonable security measures we have implemented, some of our information technology systems are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems, in part because we conduct business on the Internet and because some of these systems are located at third party web hosting providers and we cannot control the maintenance and operation of the data centers. Despite the precautions we have taken, unanticipated problems affecting our systems could cause interruptions in our information technology systems, leading to lost revenue, deterioration of customer confidence, or significant business disruption. Our business, financial condition, results of operations, or cash flows could be materially and adversely affected by any problem that interrupts or delays our operations.

If a catastrophe were to strike our facility, we would be unable to operate our business competitively.

We currently assemble, test and release our ACIS device at our facility located in San Juan Capistrano, California which is where we house our corporate office. Our specimen processing facilities, our clinical laboratory are located in a separate facility located in Irvine, California. We do not have alternative production plans in place or alternative facilities available at this time. If there are unforeseen shutdowns to our facility, we will be unable to satisfy customer orders on a timely basis.

Our facilities may be affected by catastrophes such as fires, earthquakes or sustained interruptions in electrical service. Earthquakes are of particular significance to us because all of our clinical laboratory facilities are located in Southern, California, an earthquake-prone area. In the event our existing facilities or equipment are affected by man-made or natural disasters, we may be unable to process our customers’ samples in a timely manner and unable to operate our business in a commercially competitive manner.

Our ability to maintain our competitive position depends on our ability to attract and retain highly qualified managerial, technical and sales and marketing personnel.

We believe that our continued success depends to a significant extent upon the efforts and abilities of our executive officers and our scientific and technical personnel, including the following individuals:

• Michael Cola, our Chairman;

• Ronald A. Andrews, our President and Chief Executive Officer;

• Stephen T. D. Dixon, our Executive Vice President and Chief Financial Officer;

• Heather Creran, our Executive Vice President and Chief Operating Officer — Oncology Services;

• Ken Bloom, M.D., our Chief Medical Director;

• Kenneth Bauer, Ph.D., our Vice President and Chief Science Officer;

• Karen Garza, our Vice President of Marketing and Strategic Initiatives; and

• Jose de la Torre-Bueno, Ph.D., our Vice President and Chief Technology Officer.

We do not maintain key-person life insurance on any of our officers, scientific and technical personnel or other employees. The loss of any of our executive officers or senior managers could have a material adverse effect on our business, operating results, cash flows and financial condition.

Furthermore, our anticipated growth and expansion will require the addition of highly skilled technical, management, financial, sales and marketing personnel. In particular, we may encounter difficulties in attracting a sufficient number of qualified California licensed laboratory scientists. Competition for personnel is intense, and our failure to hire and retain talented personnel or the loss of one or more key employees could have a material adverse effect on our business. Many members of our current senior management group have been recruited and hired over the past 18 months. These individuals may not be able to fulfill their responsibilities adequately and may not remain with us.

The reimbursement rate for ACIS-based services has recently been significantly reduced, which may result in an adverse effect on our revenues and results of operations.

The majority of the sales of our products in the US and other markets will depend, in large part, on the availability of adequate reimbursement to users of these products from government insurance plans, including Medicare and Medicaid in the US, managed care organizations, private insurance plans and other third-party payors. The continued success of the ACIS depends upon its ability to replace or augment existing procedures that are covered and otherwise eligible for payments and covered by the medical insurance industry.

Prior to April 1, 2003, we had been successful in receiving widespread favorable reimbursement from the Medicare program and from other public and private payors. Effective April 1, 2003, the amount of reimbursement previously paid by Medicare for services involving automated image analysis was significantly reduced. The reduced reimbursement rate applied directly only to Medicare patients. We estimate that 25 to 35 percent of ACIS-based services are performed for Medicare beneficiaries. We believe that, before the reduction, the majority of our customers were being reimbursed approximately $200 per test. Under an interim reduced reimbursement rate (effective until December 31, 2003) customers were reimbursed about $85 per test for Medicare patients. During this time, other payers adopted the reduced reimbursement rate to a limited degree.

A new reduced reimbursement rate to be used for image analysis went into effect on January 1, 2004. Under the new rate, the total Medicare reimbursement for ACIS-based procedures performed in physician offices or independent laboratories is approximately $140 per test, reflecting a technical component of approximately $85 and a professional component of approximately $55. The actual amount will also vary based upon a geographic factor index.

The impact of the above-referenced reimbursement changes to us has been a reduction in our average revenue per system placement due to lower pricing that we began to offer to our customers in response to their reduced reimbursement rates. We began to experience the impact of the above-referenced reimbursement changes on our revenues in the third quarter of 2003. We estimate that the changed reimbursement rates resulted in a reduction of our revenue for the third quarter of 2003 of approximately $65,000 (due to a 2.2% reduction in average revenue per system) and a reduction in our revenue for the fourth quarter of 2003 of approximately $80,000 (due to an 8% reduction in average revenue per system). This impact was mitigated in part from an increase in the overall number of system placements.

The reduction of reimbursement for ACIS-based procedures has reduced revenue for current ACIS customers, may result in sales allowances or cancellations of contracts by current customers and may negatively impact future placements of ACIS. In addition, because of the increase in the technical component to reimbursement, we will be required to enter into new contracts with the hospitals that often prepare the slides for analysis. Hospitals have longer buying cycles and a more extensive contract

evaluation process that may delay the implementation of these contracts. At the same time, our current pathologist customers, for whom professional service reimbursement has been reduced, will require more significant rate reductions in their contract terms with us. The creation of these new agreements, where we will seek fees from both a hospital and pathology practitioner, have the potential to be difficult to implement and could cause delays in coming to agreement on contract rate terms.

We are not able to fully assess or predict the full impact of the changes in reimbursement levels on our business at this time, nor whether Medicare will review the medical necessity and appropriateness of amounts that have been paid in prior years, although it is likely that these reductions in reimbursement levels will impact our pricing, profitability and the demand for testing.

Our net revenue will be diminished if payors do not adequately cover or reimburse our services.

There has been and will continue to be significant efforts by both federal and state agencies to reduce costs in government healthcare programs and otherwise implement government control of healthcare costs. In addition, increasing emphasis on managed care in the U.S. may continue to put pressure on the pricing of healthcare services. Uncertainty exists as to the coverage and reimbursement status of new assays. Third party payors, including governmental payors such as Medicare and private payors, are scrutinizing new medical products and services and may not cover or may limit coverage and the level of reimbursement for our services. Third party insurance coverage may not be available to patients for any of our existing assays or assays we discover and develop. However, a substantial portion of the testing for which we bill our hospital and laboratory clients is ultimately paid by third party payors. Any pricing pressure exerted by these third party payors on our customers may, in turn, be exerted by our customers on us. If government and other third party payors do not provide adequate coverage and reimbursement for our assays, our operating results, cash flows or financial condition may decline.

Managed care organizations are using capitated payment contracts in an attempt to shift payment risks which may negatively impact our operating margins.

Managed care providers typically contract with a limited number of clinical laboratories and then designate the laboratory or laboratories to be used for tests ordered by participating physicians. The majority of managed care testing is negotiated on a fee-for-service basis at a discount. Such discounts have historically resulted in price erosion and we expect that they will negatively impact our operating margins once we commence offering laboratory services.

Third party billing is extremely complicated and will result in significant additional costs to us.

Billing for laboratory services is extremely complicated. We plan to provide testing services to a broad range of healthcare providers. We consider a “payor” as the party that pays for the test and a “customer” as the party who refers tests to us. Depending on the billing arrangement and applicable law, we will need to bill various payors, such as patients, insurance companies, Medicare, Medicaid, doctors and employer groups, all of which have different billing requirements. Additionally, our billing relationships require us to undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. Insurance companies also impose routine external audits to evaluate payments made. This adds further complexity to the billing process.

Among many other factors complicating billing are:

• pricing differences between our fee schedules and the reimbursement rates of the payors;

• disputes with payors as to which party is responsible for payment; and

• disparity in coverage and information requirements among various carriers.

We expect to incur significant additional costs as a result of our participation in the Medicare and Medicaid programs, as billing and reimbursement for clinical laboratory testing is subject to considerable and complex federal and state regulations. The additional costs we expect to incur include those related to: (1) complexity added to our billing processes; (2) training and education of our employees and customers; (3) implementing compliance procedures and oversight; (4) legal costs; and (5) costs associated with, among other factors, challenging coverage and payment denials and providing patients with information regarding claims processing and services, such as advanced beneficiary notices.

We may acquire other businesses, products or technologies in order to remain competitive in our market and our business could be adversely affected as a result of any of these future acquisitions.

We may make acquisitions of complementary businesses, products or technologies. If we identify any additional appropriate acquisition candidates, we may not be successful in negotiating acceptable terms of the acquisition, financing the acquisition, or integrating the acquired business, products or technologies into our existing business and operations. Further, completing an acquisition and integrating an acquired business will significantly divert management time and resources. The diversion of management attention and any difficulties encountered in the transition and integration process could harm our business. If we consummate any significant acquisitions using stock or other securities as consideration, our shareholders’ equity could be

significantly diluted. If we make any significant acquisitions using cash consideration, we may be required to use a substantial portion of our available cash. Acquisition financing may not be available on favorable terms, if at all. In addition, we may be required to amortize significant amounts of other intangible assets in connection with future acquisitions, which would harm our operating results, cash flows and financial condition.

RISKS RELATED TO LITIGATION AND INTELLECTUAL PROPERTY

Product liability claims could subject us to significant monetary damage.

The manufacture and sale of the ACIS entails an inherent risk of product liability arising from an inaccurate, or allegedly inaccurate, test or diagnosis. We currently maintain numerous insurance policies, including a $2,000,000 general liability policy, a $5,000,000 technology based errors and omissions policy and a $10,000,000 umbrella liability policy (which excludes technology based errors and omissions). These policies have deductible ranges from $5,000 to $25,000 and contain customary exclusions (including certain exclusions for medical malpractice and asbestos). Although we have not experienced any material losses to date, we cannot assure you that we will be able to maintain or acquire adequate product liability insurance in the future. Any product liability claim against us could have a material adverse effect on our reputation and operating results, cash flows and financial condition.

Clinicians or patients using our products or services may sue us and our insurance may not sufficiently cover all claims brought against us, which will increase our expenses.

The development, marketing, sale and performance of healthcare services expose us to the risk of litigation, including professional negligence. Damages assessed in connection with, and the costs of defending, any legal action could be substantial. We currently maintain numerous insurance policies, including a $3,000,000 professional liability insurance policy ($2,000,000 per incident). This policy has a deductible of $10,000 and contains customary exclusions (including exclusions relating to asbestos and biological contaminants). However, we may be faced with litigation claims which exceed our insurance coverage or are not covered under any of our insurance policies. In addition, litigation could have a material adverse effect on our business if it impacts our existing and potential customer relationships, creates adverse public relations, diverts management resources from the operation of the business or hampers our ability to perform assays or otherwise conduct our business.

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

Our research and development activities sometimes involve the controlled use of potentially harmful biological materials, hazardous materials, chemicals and various radioactive compounds. We cannot completely eliminate the risk of accidental contamination or injury to third parties from the use, storage, handling or disposal of these materials. We currently maintain numerous insurance policies, including a $2,000,000 general liability policy and a $10,000,000 umbrella liability policy (which excludes technology-based errors and omissions). These policies have deductible ranges from $5,000 to $25,000 and contain customary exclusions (including certain exclusions relating to asbestos and medical malpractice). However, in the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed our resources or any applicable insurance coverage we may have. Additionally, we are subject on an ongoing basis to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations is significant and could negatively affect our operations, cash flows and financial condition if these costs increase substantially.

Any breakdown in the protection of our proprietary technology, or any determination that our proprietary technology infringes on the rights of others, could materially affect our business.

Our commercial success will depend in part on our ability to protect and maintain our proprietary technology and to obtain and enforce patents on our technology. We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. However, obtaining, defending and enforcing our patents and other intellectual property rights involve complex legal and factual questions. We cannot assure you that we will be able to obtain, defend or enforce our patent rights covering our technologies in the US or in foreign countries, or be able to effectively maintain our technologies as unpatented trade secrets or otherwise obtain meaningful protection for our proprietary technology. Moreover, we cannot assure you that third parties will not infringe, design around, or improve upon our proprietary technology or rights.

The healthcare industry has been the subject of extensive litigation regarding patents and other proprietary rights and if we are unable to protect our patents and proprietary rights, through litigation or otherwise, our reputation and competitiveness in the marketplace could be materially damaged.

In February 2004, we filed suit against Applied Imaging Corporation alleging that Applied Imaging’s ARIOL SL-50 system infringes certain of our patents. Although we may initiate litigation to attempt to stop the infringement of our patent claims or to attempt to force an unauthorized user of our trade secrets to compensate us for the infringement or unauthorized use, patent and trade secret litigation is complex and often difficult and expensive, and would consume the time of our management and other significant resources. If the outcome of litigation is adverse to us, third parties may be able to use our technologies without payments to us. Moreover, some of our competitors may be better able to sustain the costs of litigation because they have substantially greater resources. Because of these factors relating to litigation, we may be unable to prevent misappropriation of our patent and other proprietary rights effectively.

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

Our competitors or others may have or acquire patent rights that they could enforce against us. If they do so, we may be required to alter our technologies, pay licensing fees or cease activities. If our technologies conflict with patent rights of others, third parties could bring legal action against us or our licensees, suppliers, customers or collaborators, claiming damages and seeking to enjoin manufacturing and marketing of the affected products. If these legal actions are successful, in addition to any potential liability for damages, we might have to obtain a royalty or licensing arrangement in order to continue to manufacture or market the affected products. A required license or royalty under the related patent or other intellectual property may not be available on acceptable terms, if at all.

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

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

• we may become involved in time-consuming and expensive litigation, even if the claim is without merit;

• we may become liable for substantial damages for past infringement, including possible treble damages for allegations of willful infringement, if a court decides that our technologies infringe upon a competitor’s patent;

• a court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be available on commercially acceptable terms, if at all, or which may require us to pay substantial royalties or grant cross licenses to our patents; and

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

If any of these events occurs, our business, results of operation, cash flows and financial condition will suffer and the market price of our common stock will likely decline.

In our lawsuit against Applied Imaging, Applied Imaging has filed a response and a countersuit in the United States District Court for the Southern District of California asserting that ChromaVision infringed upon its United States Patent No. 6,633,662 entitled, “Identification of Objects of Interest Using Multiple Illumination Schemes and Finding Overlay of Features In Corresponding Multiple Images.” Applied Imaging Corporation is seeking an injunction against ChromaVision’s continued manufacture, sale and use of the alleged infringing Automated Cellular Imaging System (ACIS®) in the United States and enhanced economic damages for ChromaVision’s alleged willful infringement. In addition to the patent infringement claim, Applied Image asserts ChromaVision intentionally interfered with Applied Imaging’s business relationships, misappropriation of valuable trade secrets, and unfair business practices and competition. Relief sought in this counter suit is estimated to exceed $20.0 million. ChromaVision believes that these allegations are without merit and intends to fully and vigorously defend and contest each of the allegations made by Applied Imaging Corporation. Currently, both parties are in discussions to determine whether a mutually agreed settlement can be reached.

RISKS RELATED TO REGULATION OF OUR INDUSTRY

FDA regulations and those of other regulatory agencies can cause significant uncertainty, delay and expense in introducing new applications for the ACIS and present a continuing risk to our ability to offer applications.

As a medical device, our ACIS product is subject to extensive and frequently changing federal, state and local governmental regulation in the United States and in other countries. The United States Food and Drug Administration (FDA) as well as various other federal and state statutes and regulations, govern the development, testing, manufacture, labeling, storage, record keeping, distribution, sale, marketing, advertising and promotion and importing and exporting of medical devices. Failure to comply with applicable governmental requirements can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution. In addition, changes in existing laws or regulations, or new laws or regulations, may delay or prevent us from marketing our products or cause us to reduce our pricing.

If we are not able to obtain all of the regulatory approvals and clearances required to commercialize our products, our business would be significantly harmed.

Regulatory clearance or approval of applications for the ACIS, including the related software, may be denied or may include significant limitations on the indicated uses for which it may be marketed. The FDA actively enforces the prohibition on marketing products that have not been approved or cleared and also imposes and enforces strict regulations regarding the validation and quality of manufacturing, which are enforced through periodic inspection of manufacturing facilities. Foreign countries have comparable regulations.

In most cases, the development and commercialization of additional diagnostic applications in the U.S. will require either pre-market notification, or 510(k) clearance, or pre-market approval (PMA) from the FDA prior to marketing. The 510(k) clearance pathway usually takes from two to twelve months from submission, but can take longer. The pre-market approval pathway is much more costly, lengthy, uncertain and generally takes from one to two years or longer from submission. We do not know whether we will be able to obtain the clearances or approvals required to commercialize these products.

Applications submitted for FDA clearance or approval will be subject to substantial restrictions, including, among other things, restrictions on the indications for which we may market these products, which could result in lower revenues. The marketing claims we will be permitted to make in labeling or advertising regarding our cancer diagnostic products, if cleared or approved by the FDA, will be limited to those specified in any clearance or approval. In addition, we are subject to inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements. If the FDA finds that we have failed to comply with these requirements, it can institute a wide variety of enforcement actions, ranging from a public warning letter to more severe sanctions, including:

• fines, injunctions and civil penalties;

• recall or seizure of our products;

• operating restrictions, partial suspension or total shutdown of production;

• denial of requests for 510(k) clearances or pre-market approvals of product candidates;

• withdrawal of 510(k) clearances or pre-market approvals already granted; and

• criminal prosecution.

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

We cannot predict the extent of future FDA regulation of our in-house diagnostic laboratory services.

Neither the FDA nor any other governmental agency currently fully regulates the new in-house diagnostic laboratory services that we may develop and market to physicians, laboratory professionals and other medical practitioners. These tests are commonly referred to as “home brews.” FDA maintains that it has the authority to regulate home brews under the Federal Food, Drug, and Cosmetic Act as medical devices, however, as a matter of enforcement discretion, has decided not to exercise its authority. FDA is currently assessing the feasibility of applying additional regulatory controls over in-house diagnostic laboratory testing. We cannot predict the extent of future FDA regulation and there can be no assurance that the FDA will not require in-house diagnostic laboratory testing to receive premarketing clearance, or premarket approval prior to marketing. Additional FDA regulatory controls over our in-house diagnostic laboratory services could add substantial additional costs to our operations, and may delay or prevent our ability to commercially distribute our products in the U.S.

Our medical devices, facilities and products are subject to significant quality control oversight and regulations, and our failure to comply with these could result in penalties or enforcement proceedings.

Manufacturers of medical devices are subject to federal and state regulation regarding validation and the quality of manufacturing facilities, including FDA’s Quality System Regulation, or QSR, which covers the design, testing production processes, controls, quality assurance, labeling, packaging, storing and shipping of medical devices. Our failure to comply with these quality system regulations could result in civil or criminal penalties or enforcement proceedings, including the recall of a product or a “cease distribution” order requiring us to stop placing our products in service or selling, any one of which could materially adversely affect our business, results of operations and financial condition. Similar results would occur if we were to violate foreign regulations.

Our operations are subject to strict laws prohibiting fraudulent billing and other abuse, and our failure to comply with such laws could result in substantial penalties.

Of particular importance to our operations are federal and state laws prohibiting fraudulent billing and providing for the recovery of non-fraudulent overpayments, as a large number of laboratories have been forced by the federal and state governments, as well as by private payors, to enter into substantial settlements under these laws. In particular, if an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $5,500 to $11,000 for each separate false claim. There are many potential bases for liability under the federal False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. Submitting a claim with reckless disregard or deliberate ignorance of its truth or falsity could result in substantial civil liability. A trend affecting the healthcare industry is the increased use of the federal False Claims Act and, in particular, actions under the False Claims Act’s “whistleblower” or “qui tam” provisions. Those provisions allow a private individual to bring actions on behalf of the government alleging that the defendant has submitted a fraudulent claim for payment to the federal government. The government must decide whether to intervene in the lawsuit and to become the primary prosecutor. If it declines to do so, the individual may choose to pursue the case alone, although the government must be kept apprised of the progress of the lawsuit. Whether or not the federal government intervenes in the case, it will receive the majority of any recovery. In recent years, the number of suits brought against healthcare providers by private individuals has increased dramatically. In addition, various states have enacted laws modeled after the federal False Claims Act.

Government investigations of clinical laboratories have been ongoing for a number of years and are expected to continue in the future. Written “corporate compliance” programs to actively monitor compliance with fraud laws and other regulatory requirements are recommended by the Department of Health and Human Services’ Office of the Inspector General and we have a program following the guidelines in place.

Our laboratory services will be subject to extensive federal and state regulation, and our failure to comply with such regulations could result in penalties or suspension of Medicare payments and/or loss of our licenses, certificates or accreditation.

The clinical laboratory testing industry is subject to extensive regulation, and many of these statutes and regulations have not been interpreted by the courts. The Clinical Laboratory Improvement Amendments of 1988 (“CLIA”) established quality standards for all laboratory testing to ensure the accuracy, reliability and timeliness of patient test results regardless of where the test was performed. Laboratories covered under CLIA are those which perform laboratory testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention, treatment of disease and other factors. The Centers for Medicare and Medicaid Services is charged with the implementation of CLIA, including registration, surveys, enforcement and approvals of the use of private accreditation agencies. For certification under CLIA, laboratories such as ours must meet various requirements, including requirements relating to quality assurance, quality control and personnel standards. Since we will be performing patient testing from all states, our laboratory will also be subject to strict regulation by California, New York and various other states. State laws may require that laboratory personnel meet certain qualifications, specify certain quality controls or require maintenance of certain records, and we will be required to obtain state regulatory licenses to offer the professional and technical components of laboratory services. If we are unable to secure our state regulatory license in a timely manner, our plans to expand into laboratory services could be compromised. We will also seek to be accredited by the College of American Pathologists, a private accrediting agency, and therefore will be subject to their requirements and evaluation. Our failure to comply with CLIA, state or other applicable requirements could result in various penalties, including restrictions on tests which the laboratory may perform, substantial civil monetary penalties, imposition of specific corrective action plans, suspension of Medicare payments and/or loss of licensure, certification or accreditation. Such penalties could result in our being unable to continue performing laboratory testing. Compliance with such standards is verified by periodic inspections and requires participation in proficiency testing programs.

We are subject to significant environmental, health and safety regulation.

We are subject to licensing and regulation under federal, state and local laws and regulations relating to the protection of the

environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials as well as to the safety and health of laboratory employees. In addition, the federal Occupational Safety and Health Administration has established extensive requirements relating to workplace safety for health care employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to, and transmission of, blood-borne pathogens. In addition, the federally-enacted Needlestick Safety and Prevention Act requires, among other things, that we include in our safety programs the evaluation and use of engineering controls such as safety needles if found to be effective at reducing the risk of needlestick injuries in the workplace.

We are subject to federal and state laws governing the financial relationship among healthcare providers, including Medicare and Medicaid laws, and our failure to comply with these laws could result in significant penalties and other adverse consequences.

Existing federal laws governing Medicare and Medicaid and other similar state laws impose a variety of broadly described restrictions on financial relationships among healthcare providers, including clinical laboratories. These laws include the federal anti-kickback law which prohibits individuals or entities, including clinical laboratories, from, among other things, making any payments or furnishing other benefits intended to induce or influence the referral of patients for tests billed to Medicare, Medicaid or certain other federally funded programs. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. Penalties for violations include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. In addition, some kickback allegations have been claimed to violate the Federal False Claims Act (discussed above). In addition, many states have adopted laws similar to the federal anti-kickback law. Some of these state prohibitions apply to referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs. Many of the federal and state anti-fraud statutes and regulations, including their application to joint ventures and collaborative agreements, are vague or indefinite and have not been interpreted by the courts.

In addition, these laws also include self-referral prohibitions which prevent us from accepting referrals from physicians who have non-exempt ownership or compensation relationships with us as well as anti-markup and direct billing rules that may apply to our relationships with our customers. Specifically, the federal anti-”self-referral” law, commonly known as the “Stark” law, prohibits, with certain exceptions, Medicare payments for laboratory tests referred by physicians who have, personally or through a family member, an investment interest in, or a compensation arrangement with, the testing laboratory. A person who engages in a scheme to circumvent the Stark Law’s prohibitions may be fined up to $100,000 for each such arrangement or scheme. In addition, anyone who presents or causes to be presented a claim to the Medicare program in violation of the Stark Law is subject to monetary penalties of up to $15,000 per claim submitted, an assessment of several times the amount claimed, and possible exclusion from participation in federal healthcare programs. In addition, claims submitted in violation of the Stark Law may be alleged to be subject to liability under the federal False Claims Act and its whistleblower provisions.

Several states in which we operate have enacted legislation that prohibits physician self-referral arrangements and/or requires physicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider. Some of these statutes cover all patients and are not limited to Medicare or Medicaid beneficiaries. Possible sanctions for violating state physician self-referral laws vary, but may include loss of license and civil and criminal sanctions. State laws vary from jurisdiction to jurisdiction and, in a few states, are more restrictive than the federal Stark Law. Some states have indicated they will interpret their own self-referral statutes the same way that the U.S. Centers for Medicare and Medicaid Services (“CMS”) interprets the Stark Law, but it is possible the states will interpret their own laws differently in the future. The laws of many states prohibit physicians from sharing professional fees with non-physicians and prohibit non-physician entities, such as us, from practicing medicine and from employing physicians to practice medicine.

If we do not comply with existing or additional regulations, or if we incur penalties, it could increase our expenses, prevent us from increasing net revenue, or hinder our ability to conduct our business. In addition, changes in existing regulations or new regulations may delay or prevent us from marketing our products or cause us to reduce our pricing.

Our business is subject to stringent laws and regulations governing the confidentiality of medical information, and our failure to comply could subject us to criminal penalties and civil sanctions.

The use and disclosure of patient medical information is subject to substantial regulation by federal, state, and foreign governments. For example, the Health Insurance Portability and Accountability Act of 1996, known as HIPAA, was enacted among other things, to establish uniform standards governing the conduct of certain electronic health care transactions and to protect the security and privacy of individually identifiable health information maintained or transmitted by health care providers, health plans and health care clearinghouses. We are currently required to comply with two standards under HIPAA. We must comply with the Standards for Electronic Transactions, which establish standards for common health care transactions, such as claims information, plan eligibility, payment information and the use of electronic signatures; unique identifiers for providers,

employers, health plans and individuals; security; privacy; and enforcement. We were required to comply with these Standards by October 16, 2003. We also must comply with the Standards for Privacy of Individually Identifiable Information, which restrict our use and disclosure of certain individually identifiable health information. We were required to comply with the Privacy Standards by April 14, 2003. Two other standards relevant to our use of medical information have been adopted under HIPAA, although our compliance with these standards is not yet required. The Security Standards will require us to implement certain security measures to safeguard certain electronic health information by April 21, 2005. In addition, CMS recently published a final rule, which will require us to adopt a Unique Health Identifier for use in filing and processing health care claims and other transactions by May 23, 2007. While the government intended this legislation to reduce administrative expenses and burdens for the health care industry, our compliance with this law may entail significant and costly changes for us. If we fail to comply with these standards, we could be subject to criminal penalties and civil sanctions.

The Standards for Privacy of Individually Identifiable Information establish a “floor” and do not supersede state laws that are more stringent. Therefore, we are required to comply with both federal privacy regulations and varying state privacy laws. In addition, for health care data transfers from other countries relating to citizens of those countries, we must comply with the laws of those other countries.

RISKS RELATED TO OUR COMMON STOCK

We have never paid cash dividends on our Common Stock and do not anticipate on paying dividends on our common stock, which may cause investors to rely on capital appreciation for a return on their investment.

We currently intend to retain future earnings for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will also depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of directors. Accordingly, you will have to rely on capital appreciation, if any, to earn a return on their investment in our common stock.

If we raise additional funds you may suffer dilution or subordination and we may grant rights in our technology or products to third parties.

If we raise additional funds by issuing equity securities, further dilution to our stockholders could result, and new investors could have rights superior to those of holders of the shares of our common stock. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. If we raise additional funds by issuing debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technologies or products, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we may have to delay or may be unable to continue to develop our products.

Our stock price is likely to continue to be volatile, which could result in substantial losses for investors.

The market price of our common stock has in the past been, and in the future is likely to be, highly volatile. These fluctuations could result in substantial losses for investors. Our stock price may fluctuate for a number of reasons including:

• media reports and publications and announcements about cancer or diagnostic products or treatments or new innovations;

• developments in or disputes regarding patent or other proprietary rights;

• announcements regarding clinical trials or other technological or competitive developments by us and our competitors

• loss of a significant customer or group purchasing organization contract;

• the hiring and retention of key personnel;

• announcements concerning our competitors or the biotechnology industry in general;

• regulatory developments regarding us or our competitors;

• changes in reimbursement policies concerning our products or competitors’ products;

• changes in the current structure of the healthcare financing and payment systems;

• stock market price and volume fluctuations, which have particularly affected the market prices for medical products and high technology companies and which are often been unrelated to the operating performance of such companies; and

• general economic, political and market conditions.

In addition, stock markets have from time to time experienced extreme price and volume fluctuations. The market prices for medical device and laboratory service affected by these market fluctuations and such effects have often been unrelated to the operating performance of such companies. These broad market fluctuations may cause a decline in the market price of our common stock.

Securities class action litigation is often brought against a company after a period of volatility in the market price of its stock. This type of litigation could be brought against us in the future, which could result in substantial expense and damage awards and divert management’s attention from running our business.

With the advent of the Internet, new avenues have been created for the dissemination of information. We do not have control over the information that is distributed and discussed on electronic bulletin boards and investment chat rooms. The motives of the people or organizations that distribute such information may not be in our best interest or in the interest of our shareholders. This, in addition to other forms of investment information, including newsletters and research publications, could result in a significant decline in the market price of our common stock.

Future sales of shares by existing stockholders could result in a decline in the market price of the stock.

Some of our current stockholders hold a substantial number of shares which they are currently able to sell in the public market, and our employees hold options to purchase a significant number of shares and/or have been issued shares of restricted stock that are covered by registration statements on Form S-8. If our common stockholders sell substantial amounts of common stock in the public market, or the market perceives that such sales may occur, the market price of our common stock could fall. Safeguard Scientifics, Inc., which owns a majority of our outstanding common stock, has rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. Furthermore, if we were to include in a Company-initiated registration statement shares held by those holders pursuant to the exercise of their registrations rights, the sale of those shares could impair our ability to raise needed capital by depressing the price at which we could sell our common stock.

We are controlled by a single existing stockholder, whose interests may differ from other stockholders’ interests and may adversely affect the trading price of our common stock.

Safeguard Scientifics, Inc. beneficially owns 56.7%, a majority, of the outstanding shares of our common stock. In the event Safeguard were to sell all of the shares covered by the registration statement of which this prospectus is a part, Safeguard’s beneficial ownership would be reduced to approximately 50%. As a result, Safeguard Scientifics, Inc. will have significant influence in determining the outcome of any corporate transaction or other matter submitted to the stockholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets. In addition, Safeguard Scientifics, Inc. will have the ability to elect all of our directors and they could, as a result, dictate the management of our business and affairs. The interests of this stockholder may differ from other stockholders’ interests. In addition, this concentration of ownership may delay, prevent, or deter a change in control and could deprive other stockholders of an opportunity to receive a premium for their common stock as part of a sale of our business. This significant concentration of share ownership may adversely affect the trading price of our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders.

We have adopted a stockholder rights plan and other arrangements which could inhibit a change in control and prevent a stockholder from receiving a favorable price for his or her shares.

Our board of directors has adopted a stockholders’ rights plan providing for discounted purchase rights to its stockholders upon specified acquisitions of our common stock. The exercise of these rights is intended to inhibit specific changes of control of our company.

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

In 2003 we were delisted from the NASDAQ National Market and transferred to the NASDAQ SmallCap Market which could result in a number of legal and other consequences that may negatively affect our business and the liquidity and price of our common stock.

Effective August 15, 2003, a Nasdaq Qualifications Panel terminated our Nasdaq National Market Listing and transferred our securities to the Nasdaq SmallCap Market. With our securities listed on the Nasdaq SmallCap Market, we face a variety of legal and other consequences that may negatively affect our business including, without limitation to, the following:

• future issuances of our securities may require time-consuming and costly registration statements and qualifications because state securities law exemptions available to us are more limited;

• securities analysts may decrease or cease coverage of ChromaVision; and

• we may lose current or potential investors.

In addition, we are required to satisfy various listing maintenance standards for our common stock to be quoted on the Nasdaq SmallCap Market. If we fail to meet such standards, our common stock would likely be delisted from the Nasdaq SmallCap Market and trade on the over-the-counter bulletin board, commonly referred to as the “pink sheets.” This alternative is generally considered to be a less efficient market and would seriously impair the liquidity of our common stock and limit our potential to raise future capital through the sale of our common stock, which could materially harm our business, results of operations, cash flows and financial position.

We may have issued stock options and shares of restricted stock to certain employees in violation of California state securities laws and may conduct a rescission offer with respect to such issuances.

Following our delisting from the Nasdaq National Market, we issued stock options and shares of restricted stock to certain employees in California without first qualifying such securities under California state securities laws, and such issuance may have been in violation of state securities laws. As a result, we may have potential liability under state securities laws to the individuals to whom the options and shares of restricted stock were granted. We may elect to conduct a rescission offer to such individuals to give them the election to rescind their option or restricted stock grant. Management does not believe that our potential liability would be material to our results of operations, cash flows and financial position.

We have received a notice from the Nasdaq SmallCap Market that we are not in compliance with the $1.00 per share bid price requirement and that our common stock is subject to delisting if we are unable to regain compliance with the listing criteria of the Nasdaq SmallCap Market

On October 27, 2004, we received a notice from the Nasdaq SmallCap Market that the our common stock is subject to delisting from the Nasdaq SmallCap Market as a result of failure to comply with the $1.00 per share bid price requirement for 30 consecutive days as required by Nasdaq Marketplace Rule 4310(c)(4). In the notice, Nasdaq informed us that we will be provided a grace period of 180 calendar days, or until April 25, 2005, to regain compliance. If at anytime before April 25, 2005, the bid price of our common stock closes at $1.00 per share for 10 consecutive days, Nasdaq may provide us written notification that we have regained compliance with its continued listing requirements. If we are not able to demonstrate compliance by April 25, 2005, we may qualify for an additional 180 day grace period if we are then in compliance with the other initial listing criteria of the Nasdaq SmallCap market. Thereafter, if we have not regained compliance within the second 180 day compliance period, but we satisfy the initial inclusion criteria, we may be afforded an additional compliance period, up to our next stockholders’ meeting, so long as we commit: (1) to seek stockholder approval for a reverse stock split at or before our next meeting and (2) to promptly thereafter effect the reverse stock split. The stockholders’ meeting to seek such approval must occur no later than two years from the date of the letter. If we do not regain compliance with the $1.00 minimum bid requirement and are not eligible for an additional grace period, Nasdaq will provide us a written notification that our shares will be delisted and, at that time, we may appeal the determination to delist to a Listing Qualifications Panel. We have determined not to take any specific action at this time with respect to the Nasdaq notice.

In order to maintain compliance with the Nasdaq SmallCap listing standards, we may consider several strategies, including without limitation a reverse stock split. We cannot predict what effect a reverse stock split would have on the market price of our common stock or our ability to maintain compliance with the listing standards of the Nasdaq SmallCap market. If a delisting of our common stock were to occur, our common stock would trade on the OTC Bulletin Board or in the “pink sheets” maintained by the National quotation Bureau, Inc. Such alternatives are generally considered to be less efficient markets, and our stock price, as well as the liquidity of our common stock, may be adversely impacted as a result.

Recently enacted and proposed changes in securities laws and regulations will increase our costs.

The Sarbanes-Oxley Act of 2002 along with other recent and proposed rules from the Securities and Exchange Commission and Nasdaq require changes in our corporate governance, public disclosure and compliance practices. Many of these new requirements will increase our legal and financial compliance costs, and make some corporate actions more difficult, such as proposing new or amendments to stock option plans, which now require shareholder approval. These developments could make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments also could make it more difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our audit committee.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Historically, we have invested excess cash in short-term debt securities that are intended to be held to maturity. These short-term investments typically have various maturity dates which do not exceed one year. We had no short-term investments as of September 30, 2004.

Two of the main risks associated with these investments are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of debt securities. Fluctuations in interest rates would not have a material effect on our financial statements because of the short-term nature of the securities in which we invest and our intention to hold the securities to maturity. Credit risk refers to the possibility that the issuer of the debt securities will not be able to make principal and interest payments. We have limited the investments to investment grade or comparable securities and have not experienced any losses on our investments to date due to credit risk.

Changes in foreign exchange rates, and in particular a strengthening of the U.S. dollar, may negatively affect our consolidated sales and gross margins as expressed in U.S. dollars. To date, we have not entered into any foreign exchange contracts to hedge our exposure to foreign exchange rate fluctuations. However, as our international operations grow, we may enter into such arrangements in the future. Effective January 1, 2002, our foreign sales were denominated in Euros. Foreign currency-denominated sales have not been significant.

Item 4. Controls and Procedures

Our Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed with the Securities and Exchange Commission (the “SEC”) pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Assessing the costs and benefits of such controls and procedures necessarily involves the exercise of judgment by management, and such controls and procedures, by their nature, can provide only reasonable assurance that management’s objectives in establishing them will be achieved.

As of September 30, 2004, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Company’s management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the foregoing, our Chief Executive Officer along with our Chief Financial Officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level in alerting them in a timely fashion to material information relating to our Company (including its consolidated subsidiaries) required to be included in our Exchange Act reports. There have been no significant changes in our Company’s internal controls or in other factors which could significantly affect, internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, subsequent to the date that our Company carried out its evaluation of the internal controls.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In February 2004, ChromaVision filed suit against Applied Imaging Corporation. The lawsuit, filed in the United States District Court for the Southern District of California, asserts the Applied Imaging’s ARIOL SL-50 system infringes upon three ChromaVision patents. ChromaVision has asked the court for damages and an injunction barring Applied Imaging from making, using, importing, selling, or offering for sale any device that infringes ChromaVision patented technology. In its complaint, ChromaVision has asserted Applied Imaging’s product infringes upon three ChromaVision patents relating to image analysis and automated microscopy. Those three patents are: United States Patent No. B1 6,215,892, entitled “Method and Apparatus for Automated Image Analysis of Biological Specimens;” United States Patent No. B1 6,404,916, entitled “Method and Apparatus for Applying Color Thresholds in Light Microscopy;” and United States Patent No. B1 6,418,236, entitled “Histological Reconstruction and Automated Image Analysis.”

In April 2004, ChromaVision amended its original claim against Applied Imaging Corporation to include infringement upon another ChromaVision patent as well as counts of copyright infringement, trade dress infringement, federal unfair competition/false designation of origin, common law unfair competition, and California unfair competition. The patent in question is United States Patent No. B1 6,718,053 entitled “Method and Apparatus for Automated Image Analysis of Biological Specimens.”

Applied Imaging Corporation filed a response and a countersuit in the United States District Court for the Southern District of California asserting that ChromaVision infringed upon its United States Patent No. 6,633,662 entitled, “Identification of Objects of Interest Using Multiple Illumination Schemes and Finding Overlay of Features In Corresponding Multiple Images.” Applied Imaging Corporation is seeking an injunction against ChromaVision’s continued manufacture, sale and use of the alleged infringing Automated Cellular Imaging System (ACIS®) in the United States and enhanced economic damages for ChromaVision’s alleged willful infringement. In addition to the patent infringement claim, Applied Image asserts ChromaVision intentionally interfered with Applied Image’s business relationships, misappropriation of valuable trade secrets, and unfair business practices and competition. Relief sought in this countersuit is estimated to exceed $20.0 million. ChromaVision believes that these allegations are without merit and intends to fully and vigorously defend and contest each of the allegations made by Applied Imaging Corporation. Currently, both parties are in discussions to determine whether a mutually agreed settlement can be reached. At this time, we are not able to determine the magnitude of any recovery to which we may be entitled with respect to our claims or the potential exposure, if any, that we may have with respect to Applied Imaging's counterclaims.

IMPATH, Inc, as a debtor-in-possession, commenced an adversary proceeding in Bankruptcy Court in the Southern District of New York against ChromaVision, Richard J. Cote, Heather Creran and Horacio Vall. Mr. Cote is a former director of IMPATH and Ms. Creran and Mr. Vall are each former employees of IMPATH. Mr. Cote, Ms. Creran and Mr. Vall are currently employed by ChromaVision. The complaint alleged that Mr. Cote, Ms. Creran and Mr. Vall have, among other things, misappropriated certain of IMPATH’s alleged trade secrets, breached fiduciary duties and unlawfully solicited former IMPATH employees to commence employment with ChromaVision. The lawsuit also alleged that ChromaVision aided and abetted these individuals in connection with these alleged actions and that ChromaVision breached a non-disclosure agreement with IMPATH. We recently entered into a settlement agreement with respect to this matter and expect the complaint to be dismissed in the near future.

The Company is not otherwise a party to any other legal proceedings, the adverse outcome of which, individually or in the aggregate, management believes would have a material adverse effect on the business, financial condition or results of operations of the business.

Item 4. Submission of Matters to a Vote of Security Holders

In September 2004, we obtained the written consent of holders of 29,159,279 shares of our common stock (or approximately 56.7% of the shares of common stock then outstanding) to amend our 1996 Equity Compensation Plan to increase the number of shares of our common stock that may be issued there under form 6,700,000 to 9,200,000. This amendment was also approved by our Board of Directors. Pursuant to Section 228 of the Delaware General Corporation Law and Section 14(c) of the Securities Exchange Act of 1934, we mailed an information statement to our stockholders for the purpose of informing them of this action before it took place.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

3.1	Certificate of Incorporation of the Company (as amended)(a)
3.2	Certificate of Designations of Series C Preferred Stock(b)
3.3	Certificate of Designations of the Powers and Preferences and Relative, Participating, Optional and Other Special Rights of Preferred Stock and Qualifications, Limitations and Restrictions Thereof of Series D 5% Cumulative Convertible Preferred Stock(c)
3.4	By-laws of the Company, as amended (a)
3.5	Amendment to Certificate of Incorporation (*)
10.11	Employment Agreement between the Company and Dr. Ken Bloom dated August 2, 2004 (*)
10.12	ChromaVision Medical Systems, Inc. 1996 Equity Compensation Plan (as amended) (*)
31.1	Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a) or Rule 15d-14(a). (*)
31.2	Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a) or Rule 15d-14(a). (*)
32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (*)

(*) Filed herewith.

(a) Filed on April 30, 1997 as an exhibit to the Company’s Registration Statement on Form S-1 (No. 333-26129) and incorporated by reference.

(b) Filed on March 12, 1999 as an exhibit to the Company’s Current Report on Form 8-K and incorporated by reference.

(b) Reports on Form 8-K

On July 23, 2004, the Company filed a report on Form 8-K with respect to its results of operations for the quarter and six months ended June 30, 2004 and announcing that Ronald A. Andrews had been named Chief Executive Officer, attaching a copy of a press release containing financial statements for such period.

On October 22, 2004 the Company filed a report on Form 8-K with respect to its results of operations for the quarter and nine months ended September 30, 2004, attaching a copy of a press release containing financial statements for such period.

On November 1, 2004 the Company filed a report on Form 8-K with respect to its a Notice of Delisting from Nasdaq.

Mark One

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

For The Quarterly Period Ended September 30, 2004

OR

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

For the Transition Period from to

COMMISSION FILE NUMBER 0-22677

DELAWARE		75-2649072
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)

33171 PASEO CERVEZA SAN JUAN CAPISTRANO, CA		92675
(Address of principal executive offices)		(Zip code)

(949) 443-3355
(Registrant’s telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)

	CHROMAVISION MEDICAL SYSTEMS, INC.

DATE: November 9, 2004	BY:	/s/ Ronald A. Andrews
		Ronald A. Andrews President and Chief Executive Officer

DATE: November 9, 2004	BY:	/s/ Stephen T. D. Dixon
		Stephen T.D. Dixon Executive Vice President and Chief Financial Officer

PART I		FINANCIAL INFORMATION

	Item 1	Financial Statements

		Condensed Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003

		Condensed Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2004 and 2003

		Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2004 and 2003

		Notes to Condensed Consolidated Financial Statements

	Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations

	Item 3	Quantitative and Qualitative Disclosures about Market Risk

	Item 4	Controls and Procedures

PART II		OTHER INFORMATION

	Item 1	Legal Proceedings

	Item 4	Submission of Matters to a Vote of Security Holders

	Item 6	Exhibits and Reports on Form 8-K

SIGNATURES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý

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

For The Quarterly Period Ended September 30, 2004

OR

o

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

For the Transition Period from to

COMMISSION FILE NUMBER 0-22677

CHROMAVISION MEDICAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE

75-2649072

(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification Number)

33171 PASEO CERVEZA SAN JUAN CAPISTRANO, CA

92675

(Address of principal executive offices)

(Zip code)

(949) 443-3355

(Registrant’s telephone number, including area code)

NOT APPLICABLE

(Former name, former address and former fiscal year, if changed since last report)

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, and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

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

Yes o No ý

As of November 1, 2004 there were 51,428,084 shares outstanding of the Issuer’s Common Stock, $0.01 par value.

SIGNATURES

PART I - FINANCIAL INFORMATION

Item 1

Condensed Consolidated Statements of Cash Flows

Stock Options

(7) Recent Accounting Developments

(8) Stock Transactions

Overview and Outlook

Critical Accounting Policies and Estimates

RISK FACTORS

SIGNATURES

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

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

(Exact name of registrant as specified in its
charter)

(State or other jurisdiction of incorporation or
organization)

33171 PASEO CERVEZA
SAN JUAN CAPISTRANO, CA