CIPHERGEN BIOSYSTEMS INC - 10-Q Quarterly Report

UNITED STATES
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 MARCH 31, 2005

		OR

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

		Commission file number: 000-31617

CIPHERGEN BIOSYSTEMS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		33-0595156
(State or other jurisdiction of incorporation of organization)		(I.R.S. Employer Identification Number)

6611 DUMBARTON CIRCLE, FREMONT, CALIFORNIA		94555
(Address of principal executive offices)		(ZIP Code)

Registrant’s telephone number, including area code: 510-505-2100

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

Yes 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 ý No o

Number of shares of common stock, $0.001 par value, outstanding as of April 30, 2005: 29,475,663

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CIPHERGEN BIOSYSTEMS, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

	March 31, 2005			December 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	30,058		$	35,392
Short-term investments	2,190			2,175
Accounts receivable, net of allowance for doubtful accounts of $229 and $247, respectively	4,746			10,811
Notes receivable from related parties	12			126
Prepaid expenses and other current assets	1,626			1,847
Inventories	7,028			6,919

Total current assets	45,660			57,270

Property, plant and equipment, net	9,044			9,315
Goodwill	2,529			2,529
Other intangible assets, net	2,911			3,040
Other long-term assets	2,167			2,223

Total assets	$	62,311		$	74,377

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,536		$	3,369
Accrued liabilities	6,791			7,499
Deferred revenue	4,732			5,529
Current portion of capital lease obligations	15			16
Current portion of long-term debt	811			925

Total current liabilities	14,885			17,338

Deferred revenue	695			855
Capital lease obligations, net of current portion	23			28
Long-term debt, net of current portion	191			377
Convertible senior notes, net of discount	28,183			28,051
Other long-term liabilities	882			1,013

Total liabilities	44,859			47,662

Stockholders’ equity:
Common stock	29			29
Additional paid-in capital	187,136			187,133
Notes receivable from stockholders	(39		)	(349		)
Accumulated other comprehensive income	19			263
Accumulated deficit	(169,693		)	(160,361		)

Total stockholders’ equity	17,452			26,715

Total liabilities and stockholders’ equity	$	62,311		$	74,377

See notes to unaudited condensed consolidated financial statements.

CIPHERGEN BIOSYSTEMS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

	Three Months Ended March 31,
	2005			2004
Revenue:
Products	$	4,481		$	10,890
Services	2,167			2,362

Total revenue	6,648			13,252

Cost of revenue:
Products	2,112			3068
Services	1,023			902

Total cost of revenue	3,135			3,970

Gross profit	3,513			9,282

Operating expenses:
Research and development	3,507			5,757
Sales and marketing	5,273			6,021
General and administrative	3,504			3,675

Total operating expenses	12,284			15,453

Loss from operations	(8,771		)	(6,171		)

Interest and other income (expense), net	(411		)	(527		)

Loss from continuing operations before income taxes	(9,182		)	(6,698		)

Income tax provision from continuing operations	150			52

Net loss from continuing operations	(9,332		)	(6,750		)

Net loss from discontinued operations	—			(731		)

Net loss	$	(9,332	)	$	(7,481	)

Net loss per share, basic and diluted:
Net loss per share from continuing operations	$	(0.32	)	$	(0.23	)
Net loss per share from discontinued operations	—			(0.03		)

Net loss per share	$	(0.32	)	$	(0.26	)

Shares used in computing basic and diluted net loss per share	29,472			29,039

See notes to unaudited condensed consolidated financial statements.

CIPHERGEN BIOSYSTEMS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

	Three Months Ended March 31,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(9,332	)	$	(7,481	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	1,527			1,859
Stock-based compensation expense	—			205
Amortization of debt discount associated with beneficial conversion feature of convertible senior notes	132			133
Accrued investment income	(15		)	(16		)
Interest accrued on notes receivable from related parties	(6		)	(21		)
Changes in operating assets and liabilities:
Accounts receivable, net	5,947			1,513
Prepaid expenses and other current assets	334			(95		)
Inventories	(91		)	(741		)
Other long-term assets	(53		)	(2		)
Accounts payable and accrued liabilities	(1,519		)	(224		)
Deferred revenue	(942		)	113
Other long-term liabilities	24			266

Net cash used in operating activities	(3,994		)	(4,491		)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment, net	(944		)	(1,303		)
Maturities of marketable securities	—			4,030
Cash paid for license related to litigation settlement	(174		)	(232		)
Purchase of Ciphergen Biosystems KK common stock	—			(1,000		)

Net cash provided by (used in) investing activities	(1,118		)	1,495

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net	3			147
Repayments of notes receivable from stockholders	310			105
Principal payments on capital lease obligations	(3		)	(85		)
Repayments of long-term debt	(300		)	(159		)

Net cash provided by financing activities	10			8

Effect of exchange rate changes	(232		)	(556		)

Net decrease in cash and cash equivalents	(5,334		)	(3,544		)
Cash and cash equivalents, beginning of period	35,392			32,853

Cash and cash equivalents, end of period	$	30,058		$	29,309

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Reductions in deferred stock-based compensation	$	—		$	(34	)
Transfer of fixed assets to inventory	52			102
Acquisition of property and equipment under capital leases	—			21
Increase to goodwill from BioSepra acquisition due to income tax settlement accrued	—			203

See notes to unaudited condensed consolidated financial statements.

CIPHERGEN BIOSYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2005

1. ORGANIZATION AND BASIS OF PRESENTATION

The Company

Ciphergen Biosystems, Inc. (the “Company” or “Ciphergen”) develops, manufactures and sells ProteinChipâ Systems for life science researchers. The core technology, which is patented, is Surface Enhanced Laser Desorption/Ionization (“SELDI”). The systems consist of ProteinChip Readers, ProteinChip Software and related accessories, which are used in conjunction with consumable ProteinChip Arrays. These products are sold primarily to biologists at pharmaceutical and biotechnology companies, and academic and government research laboratories. The Company also provides research services primarily through its Biomarker Discovery Center® laboratories.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement have been included. Certain financial statement items have been reclassified to conform to the current year’s format. The results of operations for the interim periods shown herein are not necessarily indicative of operating results for the entire year or any other future interim period.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions have been eliminated in consolidation. BioSepra S.A. was a wholly-owned subsidiary and was consolidated through November 30, 2004, at which time the Company sold BioSepra S.A., along with other assets related to its process chromatography business. All comparative periods shown in the statements of operations have been restated to reflect the BioSepra business as a discontinued operation.

This unaudited financial data should be read in conjunction with the audited consolidated financial statements and footnotes contained in the Company’s 2004 Form 10-K.

Liquidity

From its inception through March 31, 2005, the Company has financed its operations principally with $190.4 million from the sales of products and services to customers and net proceeds from equity financings totaling approximately $145.8 million. Ciphergen received $28.1 million of net proceeds from the sale of 4.5% convertible senior notes on August 22, 2003. These notes are due September 1, 2008. The Company also received $27.0 million from the sale of its BioSepra business in November 2004. The Company has incurred significant net losses and negative cash flows from operations since inception. At March 31, 2005, the Company had an accumulated deficit of $169.7 million.

Management believes that currently available resources will provide sufficient funds to enable the Company to meet its obligations at least through the end of the first quarter of 2006. Ciphergen currently expects to fund expenditures for capital requirements as well as liquidity needs from a combination of available cash, sales of assets, and long-term debt. If anticipated operating results are not achieved, however, management believes that planned expenditures may need to be reduced, extending the time period over which the currently available resources will be adequate to fund the Company’s operations. At such time as the Company requires additional funding, the Company will seek to raise such additional funding from various possible sources, including the public equity market, private financings, sales of assets, collaborative arrangements and debt. If additional capital is raised through the issuance of equity or securities convertible into equity, stockholders may experience dilution, and such securities may have rights, preferences or privileges senior to those of the holders of its common stock or convertible senior notes. If the Company obtains funds through arrangements with collaborators or strategic partners, it may be required to relinquish its rights to certain technologies or products that it might otherwise seek to retain. There can be no assurance that the Company will be able to obtain such financing, or obtain it on acceptable terms. If Ciphergen is unable to obtain financing on acceptable terms, it may be unable to execute its business plan and it could be required to delay or reduce the scope of its operations, and it may not be able to pay off the notes if and when they come due.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs, an amendment of ARB 43, Chapter 4”. SFAS 151 requires certain inventory costs to be recognized as current period expenses. This standard also provides guidance for the allocation of fixed production overhead costs. This standard is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company will adopt this standard in fiscal 2006. The Company has not yet determined the impact, if any, this standard will have on its financial statements and related disclosures, but does not expect it to have a material impact.

In December 2004, the FASB issued SFAS No. 123 (Revised), “Share-Based Payment.” This standard revises SFAS 123, APB 25 and related accounting interpretations, and eliminates the use of the intrinsic value method. As noted previously, the Company currently uses the intrinsic value method of APB 25 to value stock options and, accordingly, no compensation expense has been recognized for stock options. This standard requires the expensing of all stock-based compensation, including stock options, using the fair value method. The FASB’s transition provisions require implementation of SFAS 123 (R) for quarters beginning after June 15, 2005. However, in April 2005, the Securities and Exchange Commission announced a deferral of the required implementation date to fiscal years beginning after June 15, 2005 or, in Ciphergen’s case, its 2006 fiscal year. SFAS 123 (R) will apply to all awards granted after the implementation date and to previously-granted awards unvested as of the implementation date. The Company will continue to evaluate the effect of SFAS 123 (R) on its financial statements and related disclosures. The Company’s actual share-based compensation expense in 2006 will be dependent on a number of factors, including the amount of awards granted and the fair value of those awards at the time of grant.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”. SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for fiscal periods beginning after June 15, 2005 and is required to be adopted by Ciphergen in the third quarter of 2005. The Company has not yet determined the impact, if any, this standard will have on its financial statements and related disclosures, but does not expect it to have a material impact.

In March 2005, the FASB issued Interpretation No. 47 (“FIN 47”) to clarify the guidance included in SFAS No. 143, “Accounting for Asset Retirement Obligations”. FIN 47 requires companies to recognize a liability for the fair value of a legal obligation to perform asset retirement activities that are conditional on a future event if the amount can be reasonably estimated. If amounts cannot be reasonably estimated, certain disclosures will be required about the unrecognized asset retirement obligations. The interpretation is required to be adopted in the first quarter of 2006. The Company has not yet determined the impact, if any, this standard will have on its financial statements and related disclosures, but does not expect it to have a material impact.

3. INVENTORIES

Inventories consisted of the following (in thousands):

	March 31, 2005		December 31, 2004
Raw materials	$	2,278	$	2,822
Work in process	1,738		1,400
Finished goods	3,012		2,697
	$	7,028	$	6,919

4. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets consisted of the following (in thousands):

	March 31, 2005						December 31, 2004
	Gross Carrying Amount		Accumulated Amortization		Total		Gross Carrying Amount		Accumulated Amortization		Total
Non-amortizing:
Goodwill	$	2,529	$	—	$	2,529	$	2,529	$	—	$	2,529
Amortizing:
Acquired license related to litigation settlement	5,330		2,419		2,911		5,156		2,116		3,040
	$	7,859	$	2,419	$	5,440	$	7,685	$	2,116	$	5,569

During the first three months of 2005, the acquired license related to the Company’s litigation settlement increased $174,000 as a result of cash payments made by the Company for license fees.

Amortization expense for these intangible assets was (in thousands):

	Three Months Ended March 31,
	2005		2004

Acquired completed technology	$	—	$	192
Patents	—		14
Acquired license related to litigation settlement	303		303
	$	303	$	509

Annual amortization expense for these intangible assets is expected to be approximately $1,209,000 in both 2005 and 2006, $493,000 in 2007 and zero thereafter.

5. WARRANTIES AND MAINTENANCE CONTRACTS

Ciphergen has a direct field service organization that provides service for its products. The Company generally includes a standard 12 month warranty on its ProteinChip Systems, ProteinChip Tandem MS Interfaces and accessories in the form of a maintenance contract upon initial sale, after which maintenance and support may be provided under a separately priced contract or on an individual call basis. Ciphergen makes no distinction between a standard warranty and a maintenance (extended warranty) contract. The Company substitutes a maintenance contract in place of a standard 12-month warranty on its instruments and accessories upon initial sale. Ciphergen also sells separately priced maintenance (extended warranty) contracts, which are generally for 12 or 24 months, upon expiration of the initial warranty. Coverage under both the standard and extended warranty maintenance contracts is identical. Because the Company does not offer traditional warranties but enhances them such that they are identical to its separately priced maintenance contracts, management believes it is appropriate to account for them in the same way. Revenue for both the standard and extended warranty maintenance contracts is deferred and recognized on a straight line basis over the period of the applicable maintenance contract. Related costs are recognized as incurred.

Changes in product warranty obligations, including separately priced maintenance obligations, were as follows (in thousands):

		Three Months Ended March 31,
		2005			2004
Balance at the beginning of period		$	3,778		$	3,442
Add:	Costs incurred for maintenance contracts	706			489
	Revenue deferred for separately priced maintenance contracts	979			1,340
Less:	Settlements made under maintenance contracts	(706		)	(489		)
	Revenue recognized for separately priced maintenance contracts	(1,318		)	(1,189		)
Balance at end of period		$	3,439		$	3,593

6. NON-MONETARY TRANSACTION

In March 2005, the Company entered into a transaction with a customer whereby the Company exchanged one of its ProteinChip Systems held in inventory with a net book value of $57,000 for a QStar XL hybrid mass spectrometer which it intends to use as a fixed asset. The Company measured the exchange based on fair value and recognized revenue of $300,000 on the transaction.

7. FOREIGN CURRENCY TRANSACTIONS

During the quarter ended March 31, 2005, there were no transactions related to forward contracts. Net realized foreign currency gains and losses related to foreign currency forward contracts and a related intercompany loan were not material for the three month period ended March 31, 2004.

8. STOCK-BASED COMPENSATION

The Company accounts for its stock-based employee compensation arrangements using the intrinsic value method of accounting. Unearned compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price. Unearned compensation is amortized and expensed using an accelerated method. The Company accounts for stock issued to non-employees using the fair value method of accounting.

Had compensation expense for options granted to employees, officers and directors been determined based on fair value at the grant date, the Company’s net loss per share would have increased to the pro forma amounts indicated below (in thousands, except per share amounts):

		Three Months Ended March 31,
		2005			2004
Net loss as reported		$	(9,332	)	$	(7,481	)
Add:	Employee stock-based compensation expense in reported net income, net of tax	—			216
Less:	Employee stock-based compensation expense determined under the fair value method, net of tax	(1,063		)	(1,027		)
Pro forma net loss		$	(10,395	)	$	(8,292	)

Basic and diluted net loss per share:
As reported		$	(0.32	)	$	(0.26	)
Pro forma		$	(0.35	)	$	(0.29	)

9. INCOME TAXES

Based on the available objective evidence, management believes it is more likely than not that the net deferred tax assets related to the Company’s operations will not be fully realizable. Accordingly, the Company has provided a full valuation allowance against the net deferred tax assets related to its operations at March 31, 2005. The Company incurs income tax liabilities primarily in Japan, as well as in most of the other countries outside the U.S. in which it operates.

10. COMPREHENSIVE LOSS

Comprehensive loss consisted of the following (in thousands):

	Three Months Ended March 31,
	2005			2004
Net loss	$	(9,332	)	$	(7,481	)
Other comprehensive income (loss):
Net change in unrealized gains/losses on investments	—			7
Currency translation losses	(244		)	(600		)
Other comprehensive loss	(244		)	(593		)
Total comprehensive loss	$	(9,576	)	$	(8,074	)

11. NET LOSS PER SHARE

Basic net loss per share is calculated using the weighted average number of common shares outstanding during the period. Because the Company is in a net loss position, diluted earnings per share is calculated using the weighted average number of common shares outstanding and excludes the effects of 8.8 million and 8.2 million potential common shares as of March 31, 2005 and 2004, respectively, that are antidilutive. Potential common shares include shares that could be issued if all convertible senior notes were converted into common stock, common stock subject to repurchase, common stock issuable under the Company’s 2000 Employee Stock Purchase Plan, and incremental shares of common stock issuable upon the exercise of outstanding stock options. The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except per share amounts):

	Three Months Ended March 31,
	2005			2004
Numerator:
Net loss	$	(9,332	)	$	(7,481	)
Denominator:
Weighted average common shares outstanding	29,474			29,091
Weighted average unvested common shares subject to repurchase	(2		)	(52		)
Denominator for basic and diluted calculations	29,472			29,039
Basic and diluted net loss per share	$	(0.32	)	$	(0.26	)

12. SEGMENT INFORMATION AND GEOGRAPHIC DATA

Ciphergen’s revenue is derived from the sales of related products and services on a worldwide basis. Although discrete components that earn revenues and incur expenses exist, significant expenses such as sales and marketing and corporate administration are not incurred by nor allocated to these operating units but rather are employed by the entire enterprise. Additionally, the chief operating decision maker evaluates resource allocation not on a product or geographic basis, but rather on an enterprise-wide basis. Therefore, management has determined that Ciphergen operates in only one reportable segment, which is the protein research tools and collaborative services business.

The Company sells most of its products and services directly to customers in North America, Western Europe, Japan and China, and through distributors in other parts of Asia and in Eastern Europe. Revenue for geographic regions reported below is based upon the customers’ locations and excludes revenue from discontinued operations. Long-lived assets, predominantly machinery and equipment, are reported based on the location of the assets. Following is a summary of the geographic information related to revenue from continuing operations for the three month periods ended March 31, 2005 and 2004 (in thousands):

	Three Months Ended March 31,
	2005		2004
Revenue
U.S.	$	3,330	$	5,301
Canada	333		307
Europe	1,517		3,389
Asia	1,468		4,255
Total	$	6,648	$	13,252

During the three month periods ended March 31, 2005 and 2004, sales to customers in Japan represented 21% and 28%, respectively, of revenue from continuing operations. No other country outside the U.S. accounted for 10% or more of total revenue from continuing operations during these periods.

Long-lived assets, primarily machinery and equipment, are reported based on the location of the assets. Long-lived asset information by geographic area as of March 31, 2005 and December 31, 2004 is presented in the following table (in thousands):

	March 31, 2005		December 31, 2004
Long - lived assets
United States	$	7,171	$	7,308
Canada	81		111
Europe	916		958
Asia	876		938
Total	$	9,044	$	9,315

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We have made statements under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Factors That May Affect Our Results” and in other sections of this Form 10-Q that are forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. We claim the protection of such safe harbor, and disclaim any intent or obligation to update any forward-looking statement. You can identify these statements by forward-looking words such as “may”, “will”, “expect”, “intend”, “anticipate”, “believe”, “estimate”, “plan”, “could”, “should” and “continue” or similar words. These forward-looking statements may also use different phrases. We have based these forward-looking statements on our current expectations and projections about future events. Examples of forward-looking statements include statements about projections of our future revenue, gross margin, results of operations and financial condition; anticipated deployment, capabilities and uses of our products and our product development activities and product innovations; the importance of proteomics as a major focus of biology research; the ability of our products to enable proteomics research; competition and consolidation in the markets in which we compete; existing and future collaborations and partnerships; our ability to operate and expand our Biomarker Discovery Center® laboratories and secure the commercial rights to biomarkers discovered at our Biomarker Discovery Center laboratories; the utility of biomarker discoveries and the effectiveness of our Biomarker Discovery Center laboratories; our ability to comply with applicable government regulations; our ability to expand and protect our intellectual property portfolio; increasing the future sales volumes of consumables; increasing general and administrative costs; decreasing sales and marketing and research and development costs; anticipated future losses; expected levels of capital expenditures; increased manufacturing efficiencies and a corresponding decline in cost of revenue as a percentage of revenue; the rating of our convertible notes and the value of the related put options; the period of time for which our existing financial resources and interest income will be sufficient to enable us to maintain current and planned operations; foreign currency exchange rate fluctuations and our plans for mitigating foreign currency exchange risks; and the market risk of our investments. These statements are subject to risks and uncertainties that could cause actual results to differ materially, including the risks set forth under the caption “Factors That May Affect Our Results” in this Form 10-Q and the similar factors and risks outlined in our other filings with the Securities and Exchange Commission (“SEC”).

OVERVIEW

We develop, manufacture and sell our ProteinChipâ Systems, which use patented Surface Enhanced Laser Desorption/Ionization (“SELDI”) technology. These systems consist of a ProteinChip Reader, ProteinChip Software and related accessories which are used in conjunction with our consumable ProteinChip Arrays. We market and sell our products primarily to research biologists in pharmaceutical and biotechnology companies, and academic and government research laboratories. In 1997, we acquired IllumeSys Pacific, Inc., which holds specific rights to the SELDI technology for the life science research market. Our first designed and manufactured system, the ProteinChip System, Series PBS I, was available for shipment in the third quarter of 1997. In 1997, we also established a subsidiary in the U.K. and began direct selling in Europe. During 1999, we initiated an expanded marketing program and in May began shipping the ProteinChip System, Series PBS II, which is now referred to as the ProteinChip Biology System. In 1999, we also established a joint venture with Sumitomo Corporation to distribute our products in Japan. During 2000, we began offering research services and established Biomarker Discovery Center laboratories in Fremont, California; Copenhagen, Denmark; and Malvern, Pennsylvania.

In 2001, we introduced the ProteinChip Biomarker System, which utilizes sophisticated third-party software to automate pattern recognition-based statistical analysis methods and correlate protein expression patterns from clinical samples with disease phenotypes. We also began selling the Biomek® 2000 Workstation, later superceded by the Biomek 3000 workstation, a robotic accessory which is manufactured by Beckman Coulter and which has been optimized for use with our ProteinChip Biomarker System to increase sample throughput and reproducibility. In addition, we expanded our product offering with a SELDI ProteinChip interface

to high-end tandem mass spectrometers, which we developed and which is manufactured for us by a third party manufacturing company. On July 31, 2001, Ciphergen acquired the BioSepraâ process chromatography business from Invitrogen Corporation; this business was subsequently sold to Pall Corporation on November 30, 2004.

In 2002, we opened an office in Beijing, China, hired local staff and began direct selling in China. On August 31, 2002, we increased our ownership interest in Ciphergen Biosystems KK, the Japanese joint venture we formed with Sumitomo Corporation in 1999, from 30% to 70%. Shortly thereafter, we opened a Biomarker Discovery Center laboratory at the Yokohama facility of Ciphergen Biosystems KK. In October 2002, we launched the ProteinChip AutoBiomarker System, an automated version of our ProteinChip Biomarker System, which incorporates an autoloader and a Biomek robot to increase sample throughput and automate the reading of ProteinChip Arrays. On March 23, 2004, we purchased the remaining 30% ownership interest in Ciphergen Biosystems KK. In July 2004, we launched the ProteinChip System, Series 4000, our next generation ProteinChip System.

We have used our resources primarily to develop and expand our proprietary ProteinChip Systems and related consumables and to establish a marketing and sales organization for commercialization of our products. We also used our funds to establish a joint venture to distribute our products in Japan and to increase our ownership in the joint venture to 100%. In addition, we acquired the BioSepra process chromatography business in 2001, which we sold for a gain in 2004. We have also used our resources to establish Biomarker Discovery Center laboratories to provide research services to our clients, to foster further adoption of our products and technology, and to discover biomarkers that we seek to patent for diagnostic and other purposes. In early 2004, we formed a Diagnostics Division and increased our efforts to discover protein biomarkers and panels of biomarkers that can be developed into protein molecular diagnostic tests that improve patient care. To date, the Diagnostics Division has not generated any revenue from diagnostic tests. Since our inception we have incurred significant losses and as of March 31, 2005, we had an accumulated deficit of $169.7 million.

Our sales are currently driven by the need for new and better tools to perform protein discovery, characterization, purification, identification and assay development. In addition, many of our customers later enhance their ProteinChip Systems to add automation accessories and advanced software. Most of the ProteinChip Systems sold to our customers also generate a recurring revenue stream from the sale of consumables and maintenance contracts.

Our expenses have consisted primarily of materials, contracted manufacturing services, labor and overhead costs to manufacture our ProteinChip Systems and ProteinChip Arrays and to provide customer services; marketing and sales activities; research and development programs; litigation; and general and administrative costs associated with our operations. We expect our cost of revenue to increase in the second quarter of 2005 relative to the first quarter of 2005 due to an expected increase in unit sales of our ProteinChip Systems and arrays. However, we expect cost of revenue to decrease as a percent of total revenue because we have provided for substantial inventory reserves for the older model ProteinChip Systems that were superceded by the Series 4000 and for certain obsolete arrays, and should not have to make such provisions again for the foreseeable future. We expect our research and development expenses to decrease in 2005 relative to 2004 due to the transition of the ProteinChip System, Series 4000 into manufacturing and scaling back selected other projects, which has led to reduced research and development headcount as well as reduced use of outside contractors and services. We anticipate that these decreases will be partly offset by increased efforts at our Biomarker Discovery Center laboratories to discover, validate and patent biomarkers that may have diagnostic and/or therapeutic utility. We expect our selling expenses to decrease in 2005 relative to 2004 as a result of a smaller sales force and reduced marketing programs. We expect our general and administrative expenses to increase slightly in 2005 relative to 2004 due to normal salary increases, largely offset by a decline in stock-based compensation expense associated with our initial public offering. As a result, we expect to incur losses for at least the next year. Our current level of revenue is insufficient for us to become profitable. To become profitable, we will need to increase unit sales of our ProteinChip Systems and Arrays as well as begin achieving revenue from diagnostic tests from our Diagnostics Division.

We have a limited history of operations and we anticipate that our quarterly results of operations will fluctuate for the foreseeable future due to several factors, including market acceptance of current and new products, the length of the sales cycle and timing of significant orders, the timing and results of our research and development efforts, the introduction of new products by our competitors and possible patent or license issues. Our limited operating history makes accurate prediction of future results of operations difficult or impossible.

RECENT DEVELOPMENTS

On November 30, 2004, we completed the sale of our process chromatography business, consisting of our wholly-owned French subsidiary, BioSepra S.A., along with certain other related assets (together, the “BioSepra business”), to Pall Corporation for net proceeds of approximately $27.0 million, and an additional $1.0 million was deposited in an escrow account. We recorded a gain of $18.5 million on the sale, net of tax and approximately $321,000 of transaction costs, in net income from discontinued operations. The BioSepra business operating results have been removed from our results of continuing operations for all periods presented.

In January 2005, we took actions, consisting primarily of headcount reductions, to reduce our operating expenses. These cost

control measures generally involved the Biosystems Division, leaving our Diagnostics Division largely unaffected, and did not constitute an exit or disposal activity as defined by Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” Operating expenses in the first quarter of 2005 were $1.2 million less than in the fourth quarter of 2004, largely as a result of these actions. At March 31, 2005, we had 215 employees, consisting of 36 in manufacturing, 52 in research and development, 92 in sales and marketing, and 35 in administration.

RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTH PERIODS ENDED MARCH 31, 2005 AND MARCH 31, 2004

PRODUCT REVENUE. Product revenue decreased to $4.5 million in the first three months of 2005 from $10.9 million in the same period of 2004, a decrease of $6.4 million or 59%. The decrease was primarily the result of a 75% decrease in revenue from sales of our ProteinChip Systems, accessories and software. This was largely due to a 59% decline in unit sales of ProteinChip Systems, reflecting a more competitive selling environment, reductions in our sales force, and more limited funding available to our academic prospects. In addition, we experienced a 40% decrease in average revenue per system sold due to lower list prices for the Series 4000 as well as increased discounting as a result of pricing pressure caused by generally lower funding currently available to academia, incentives we’ve offered to expedite orders, lower prices offered when customers trade in their older ProteinChip Systems for a new Series 4000, and the competitive environment.

SERVICE REVENUE. Service revenue decreased to $2.2 million in the first three months of 2005 from $2.4 million in the same period of 2004, a decrease of $195,000 or 8%. This decrease was primarily due to a decline of $524,000 in revenue from services provided by our Biomarker Discovery Center laboratories, partially offset by increases in revenue from training and consulting services of approximately $200,000, and from maintenance contracts of approximately $129,000, driven by growth in our installed base. We redirected much of our selling effort towards ProteinChip System sales and away from service projects during the latter half of 2004 and first quarter of 2005, in part due to our desire to focus more of our Biomarker Discovery Center resources on research for our own account.

We expect revenue in the second quarter of 2005 to be approximately $7.5 to $8.5 million.

COST OF PRODUCT REVENUE. Cost of product revenue decreased to $2.1 million in the first three months of 2005 from $3.1 million in the same period of 2004, a decrease of $1.0 million or 31%. The decrease resulted primarily from a decrease in unit sales of our ProteinChip Systems. The gross margin for product revenue decreased to 53% in the first three months of 2005, compared to 72% in the same period of 2004. This decline was partly due to the decrease in the average selling price of our new systems. In the nine months since launching the ProteinChip System, Series 4000, this new product accounted for 81% of our unit sales, with older model ProteinChip Systems and Tandem MS Interfaces accounting for 15% and 4%, respectively. We have also been discounting our remaining stock of older models of our ProteinChip System. In addition, increases to inventory reserves for obsolete arrays and components for older model ProteinChip Systems amounted to approximately 8% of product revenue in the first quarter of 2005, but there was no comparable increase in inventory reserves in the first quarter of 2004.

COST OF SERVICE REVENUE. Cost of service revenue increased to $1.0 million in the first three months of 2005 from $902,000 of the same period of 2004, an increase of $121,000 or 13%. This increase was primarily the result of increased field service costs to provide service for a greater number of maintenance contracts as our installed base continued to increase. The gross margin for service revenue decreased to 53% in the first three months of 2005, compared to 62% in the same period of 2004. This decrease was mainly due to lower margins in field service which resulted primarily from higher net usage of parts for repairing older model customer instruments.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses decreased to $3.5 million in the first three months of 2005 from $5.8 million in the same period of 2004, a decrease of $2.3 million or 39%. The decrease was largely due to completing the development of the ProteinChip System, Series 4000 in July 2004 and scaling back or canceling other research and development projects in our Biosystems Division. This resulted in a decrease of $1.1 million for materials and supplies used in the development of new products and a decrease of $243,000 in consultant fees in the Biosystems Division. In addition, payroll and related expenses for our Biosystems Division decreased approximately $358,000 as a result of a 36% reduction in research and development headcount comparing March 31, 2005 to March 31, 2004.

We expect research and development expenses to decline in 2005 relative to 2004 due to having fewer research and development employees in 2005 as well as slowing or canceling selected early-stage research and development programs in our Biosystems Division as part of our efforts to control expenses, partially offset by an increase in our research and development activities associated with our Diagnostics Division.

SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased to $5.3 million in the first three months of 2005 from $6.0 million in the same period of 2004, a decrease of $748,000 or 12%. The decrease was largely due to a 26% decrease in headcount comparing March 31, 2005 to March 31, 2004, resulting in a decrease in payroll and related costs of approximately $433,000. Also as a result of the decrease in staffing, travel expenses in sales and marketing declined approximately $233,000 and internal

consumption of ProteinChip Arrays and other consumables for customer demonstrations and support decreased approximately $116,000. However, depreciation expense increased approximately $140,000 largely related to the addition of demonstration instruments following the introduction of the ProteinChip System, Series 4000.

We expect sales and marketing expenses to decrease in 2005 relative to 2004 as a result of a smaller sales force and reduced associated selling expenses.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses decreased to $3.5 million in the first three months of 2005 from $3.7 million of the same period of 2004, a decrease of $171,000 or 5%. The decrease was largely driven by decreases of approximately $209,000 in legal fees primarily due to being more selective in patent activities, $169,000 in consulting and outside service fees following reductions in outside assistance with investor relations and recruiting, $126,000 in stock-based compensation expense, and $113,000 in the provision for bad debts. These were partially offset by a $261,000 increase in payroll and related costs and an increase of $202,000 in accounting fees. Administrative headcount increased approximately 3% comparing March 31, 2005 to March 31, 2004, as we added senior-level resources for our Diagnostics Division and for business development related to pharmaceutical customers. Accrued audit fees related to compliance with Section 404 of the Sarbanes-Oxley Act of 2002 added approximately $118,000 of the increase in accounting fees in the first quarter of 2005.

We expect general and administrative expenses to increase slightly in 2005 relative to 2004 due to normal salary increases, offset largely by a decline in stock-based compensation associated with our initial public offering.

INTEREST AND OTHER INCOME (EXPENSE), NET. Interest income in the first three months of 2005 was $182,000 compared to $116,000 in the same period of 2004. The increase was primarily due to an increase in average interest rates, partially offset by lower average investment balances during the first three months of 2005 compared to the same period of 2004. Interest expense in the first three months of 2005 was $492,000 compared to $503,000 in the same period of 2004. Interest expense in both periods consisted largely of interest accrued on our convertible senior notes, equipment-financing loan and capital leases. Approximately $132,000 and $133,000 of the interest expense in the first quarter of 2005 and the first quarter of 2004, respectively, was non-cash, attributable to amortization of the beneficial conversion feature associated with the notes. Other income (expense) in the first three months of 2005 was a net expense of $101,000 compared to a net expense of $191,000 in the same period of 2004. The net expense in the first quarter of 2005 resulted primarily from $93,000 for the amortization of the offering costs related to the convertible senior notes, realized foreign exchange losses of $56,000, and losses on disposals of fixed assets of $53,000, partially offset by a recovery of approximately $119,000 related to a tax dispute concerning our foreign operations. The net expense in the first quarter of 2004 resulted primarily from the amortization of the offering costs related to the convertible senior notes.

PROVISION FOR INCOME TAXES. The provision for income taxes from continuing operations in the first three months of 2005 was $150,000, compared to $52,000 in the same period of 2004. The increase was primarily related to our Japanese subsidiary, Ciphergen Biosystems KK. In 2004, we fully utilized the previous Japanese accumulated net operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

From our inception through March 31, 2005, we have financed our operations principally with $190.4 million from the sales of products and services to customers and net proceeds from equity financings totaling approximately $145.8 million. This includes net proceeds of $92.4 million from our initial public offering in September 2000 and net proceeds of $26.9 million from our Series E Preferred Stock financing in March 2000. We received $28.1 million of net proceeds from the sale of 4.5% convertible senior notes on August 22, 2003. These notes are due September 1, 2008. We also received net proceeds of $27.0 million from the sale of our BioSepra business in November 2004. Cash, cash equivalents and short-term investments at March 31, 2005 were $32.2 million, compared to $37.6 million at December 31, 2004. Working capital at March 31, 2005 was $30.8 million, compared to $39.9 million at December 31, 2004. The decrease in working capital was principally due to a $5.3 million decrease in cash and investments to fund our operating losses, and a $6.1 million decrease in accounts receivable, reflecting the decline in revenue during the first quarter of 2005. Long-term debt and capital lease balances at March 31, 2005 totaled $29.2 million compared to $29.4 million at December 31, 2004.

Net cash used in operating activities was $4.0 million in the first three months of 2005 compared to $4.5 million in the first three months of 2004. Collections from customers in the first three months of 2005 were approximately $3.0 million less than in the comparable period of 2004. This was more than offset by reductions in payroll expense of $914,000, other operating and manufacturing overhead expenditures of $2.3 million and inventory purchases of $340,000, comparing the first quarter of 2005 to the same period of 2004. Interest expense and interest income did not significantly change comparing the first three months of 2005 to the first three months of 2004. Interest expense in both periods consisted largely of interest accrued on our convertible senior notes, equipment-financing loan and capital leases.

Net cash used in investing activities was $1.1 million in the first three months of 2005 compared to net cash provided by investing activities of $1.5 million in the first three months of 2004. Net cash used in investing activities in the first three months of 2005 consisted primarily of net purchases of property and equipment of approximately $944,000 and payments totaling $174,000 for a technology license related to our litigation which was settled in 2003. Net cash provided by investing activities in the first three months of 2004 consisted largely of maturities of investment securities of $4.0 million, offset by net property and equipment purchases of $1.3 million, the acquisition of the remaining 30% ownership in Ciphergen Biosystems KK for $1.0 million, and payments totaling $232,000 for a technology license related to our litigation which was settled in 2003. We anticipate capital expenditures of approximately $3 to $4 million in 2005.

Net cash provided by financing activities was $10,000 in the first three months of 2005 compared to $8,000 in the first three months of 2004. Net cash provided by financing activities in the first three months of 2005 was derived primarily from the repayment of stockholder loans in the aggregate principal amount of $310,000. These were largely offset by $300,000 of debt repayments. Net cash provided by financing activities in the first three months of 2004 consisted of the issuance of common stock under our stock option plans of $147,000 and repayment of stockholder loans in the aggregate principal amount of $105,000, offset by repayments of capital lease obligations of $85,000 and repayments of an equipment financing loan of $159,000.

We believe that current cash resources will be sufficient to maintain current and planned operations at least through the end of the first quarter of 2006. We currently expect to fund expenditures for capital requirements as well as liquidity needs from a combination of available cash, sales of assets, and long-term debt. We will be required to raise additional capital at some point in the future, which might be achieved through a variety of sources, including securities issuances and collaborative arrangements. If additional capital is raised through the issuance of equity or securities convertible into equity, our stockholders may experience dilution, and such securities may have rights, preferences or privileges senior to those of the holders of our common stock or the notes. If we obtain funds through arrangements with collaborators or strategic partners, we may be required to relinquish our rights to certain technologies or products that we might otherwise seek to retain. Additional financing may not be available to us on favorable terms, if at all. If we are unable to obtain financing on acceptable terms, we may be unable to execute our business plan and we could be required to delay, reduce the scope of, or eliminate our operations and we may not be able to pay off the senior notes or the capital equipment loan if and when they come due.

The following summarizes Ciphergen’s contractual cash obligations at March 31, 2005 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

	Total		Less than 1 Year		1-3 Years		4-5 Years		Beyond 5 Years
Contractual cash obligations:
Capital lease obligations(1)	$	38	$	15	$	20	$	3	$	—
Equipment financing loan(1)	1,002		811		191		—		—
Convertible senior notes(2)	30,000		—		—		30,000		—
Interest payable on convertible senior notes	4,725		1,350		2,700		675		—
Non-cancelable collaboration obligation(3)	228		228		—		—		—
Non-cancelable operating lease obligations	13,700		4,225		7,537		1,938		—
Purchase obligations(4)	355		355		—		—		—

Total contractual cash obligations	$	50,048	$	6,984	$	10,448	$	32,616	$	—

(1) Principal amounts, not including interest.

(2) Excludes the beneficial conversion feature amounting to $2,677, less related amortization of $860.

(3) We have made a commitment to fund a Biomarker Discovery Center laboratory at The Johns Hopkins University School of Medicine which totals $914,000 for the period December 2004 to November 2005, of which $228,000 was non-cancelable at March 31, 2005.

(4) Purchase obligations include agreements to purchase inventory that are enforceable and legally binding on Ciphergen and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.

Ciphergen has complied with all requirements set forth in its credit agreements.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2 of the Unaudited Condensed Consolidated Financial Statements for a description of recent accounting pronouncements, including the respective dates of adoption and effects on results of operations and financial condition.

FACTORS THAT MAY AFFECT OUR RESULTS

We expect to continue to incur net losses in 2005 and 2006. If we are unable to significantly increase our revenues or significantly decrease our expenses, we may never achieve profitability.

From our inception in December 1993 through March 31, 2005, we have generated cumulative revenue from continuing operations of approximately $154.5 million and have incurred net losses of approximately $169.7 million. We have experienced significant operating losses each year since our inception and expect these losses to continue for at least the next several quarters. For example, we experienced net losses of approximately $25.8 million in 2001, $29.1 million in 2002, $36.7 million in 2003, $19.8 million in 2004, and $9.3 million in the first quarter of 2005. Our losses have resulted principally from costs incurred in research and development, sales and marketing, litigation, and general and administrative costs associated with our operations. These costs have exceeded our gross profit which, to date, has been generated principally from product sales. We expect to incur additional operating losses and these losses may be substantial. We may never achieve profitability. 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 further establish the utility of our products, our products and services may not achieve market acceptance.

The commercial success of our ProteinChip Systems and Arrays depends upon validating their utility for important biological applications and increasing their market acceptance by researchers in pharmaceutical and biotechnology companies, academic and government research centers and clinical reference laboratories. If our products are not demonstrated to be more effective in providing commercially useful protein information than other existing technologies, it could seriously undermine market acceptance of our products and reduce the likelihood that we will ever achieve profitability.

If we fail to successfully expand sales of our ProteinChip Systems, including the successful commercialization of the Series 4000, and develop new versions of proteomic systems to expand sales of other products, our revenue will not increase and we will not achieve profitability.

Our success depends on our ability to continue to expand commercial sales of our ProteinChip Systems and Arrays, and develop new, higher performance, easier to use versions of proteomic systems. In particular, our success will depend on our success in marketing our next generation ProteinChip System, the Series 4000. If this new system does not perform in accordance with market expectations, it is unlikely that we will be able to expand our sales. We may encounter difficulties in developing new, higher performance products or producing our current proteomic systems on a timely basis, we may not be able to produce them economically, we may fail to achieve expected performance levels, or we may fail to gain industry acceptance of such products.

We may experience increased manufacturing costs or failure rates for our ProteinChip Systems and Arrays that are higher than we anticipated, particularly for newer products being introduced, such as the ProteinChip System, Series 4000.

Our products and the components used in our products are based on complex technologies and we are currently in the process of developing new versions of certain products. We may not be able to cost effectively manufacture such new products. In addition, it is difficult to predict the failure rate of new products, such as the ProteinChip System, Series 4000. If our manufacturing costs are higher than anticipated or if the failure rates for our products are higher than anticipated, resulting in increased warranty claims and increased costs associated with servicing those claims, our gross profit will decrease.

We may not succeed in developing diagnostic products and even if we do succeed in developing diagnostic products, they may never achieve significant commercial market acceptance.

There is considerable risk in developing diagnostic products based on our biomarker discovery efforts; potential tests may fail to validate results in larger clinical studies and may not achieve acceptable levels of clinical sensitivity and specificity. If we do succeed in developing diagnostic tests with acceptable performance characteristics, we may not succeed in achieving significant commercial market acceptance for those tests. Our ability to successfully commercialize diagnostic products that we may develop will depend on several factors, including:

• our ability to convince the medical community of the safety and clinical efficacy of our products and their potential advantages over existing diagnostic products;

• our ability to establish business relationships with other diagnostic companies that can assist in the commercialization of these products; and

• the agreement by Medicare and third-party payers to provide full or partial reimbursement coverage for our products, the scope and extent of which will affect patients’ willingness to pay for our products and will likely heavily influence physicians’ decisions to recommend our products.

These factors present obstacles to significant commercial acceptance of our potential diagnostic products, which we will have to spend substantial time and money to overcome, if we can do so at all. Our inability to successfully do so will harm our business.

If we are unable to attract additional clients for our Biomarker Discovery Center services and satisfy these clients, we may not be successful in furthering adoption of our products and technology or generating additional revenue through commercial rights related to biomarker discoveries.

One element of our business strategy is to operate Biomarker Discovery Center laboratories in part through partnerships with academic and government research centers as well as pharmaceutical and biotechnology companies in order to increase adoption of our products and technology. Although we are currently in negotiation with additional potential partners and clients, to date we have entered into only a few such arrangements. Failure to enter into additional arrangements or expand existing relationships could limit adoption of our products and prevent us from generating additional revenue through commercialization of biomarker discoveries.

New product introductions, in particular the ProteinChip System, Series 4000, can result in disruptions to our revenue patterns and increased sales and marketing costs, and may involve manufacturing challenges that can negatively impact our gross margin.

We have introduced, and we plan to introduce in the future, new versions of our ProteinChip Systems, Arrays and Software, including our ProteinChip System, Series 4000. New product introductions entail training and educating our customers and prospective customers about the new features, protocols and technology encompassed by the new products. This could disrupt our revenue patterns or temporarily lengthen our sales cycles to a greater extent than it would at larger companies with broader product offerings. New product introductions may temporarily increase our sales and marketing costs. Manufacturing new products inherently runs the risk that initial costs may be high as new production processes are introduced, and it is possible that new products may involve quality issues that negatively impact our gross margins. In addition, the introduction of new products makes the continuing sales of previous product versions difficult and may require significant price discounts on such products.

If we fail to continue to develop the technologies we base our products on, we may not be able to successfully foster further adoption of our products and services as an industry standard or develop new product offerings.

The technologies we use for our ProteinChip Systems and related product offerings are new and complex technologies, which are subject to change as new discoveries are made. New discoveries and further progress in our field are essential if we are to maintain and expand the adoption of our product offerings. Development of these technologies remains a substantial risk to us due to various factors including the scientific challenges involved, our ability to find and collaborate with others working in our field, and competing technologies, which may prove more successful than ours. In addition, we have recently reduced our research and development headcount and expenditures, which may adversely affect our ability to further develop our technology.

If we are unable to provide our customers with software that enables the integration and analysis of large volumes of data, the acceptance and use of our products may be limited.

The successful commercial research application of our products requires that they enable researchers to process and analyze large volumes of data and to integrate the results into other phases of their research. The nature of our software enables a level of integration and analysis that is adequate for many projects. However, if we do not continue to develop and improve the capabilities of our ProteinChip Software to perform more complex analyses of customer samples and to meet increasing customer expectations, market acceptance of our products may not increase and we could lose our current customers, which might adversely impact our revenues and we could be unable to develop a profitable business.

Our quarterly operating results may fluctuate significantly due to a number of causes outside our control.

Because the timing of our product orders can vary, we may not be able to reliably predict quarterly revenue and profitability. Our operating results can also vary substantially in any period depending on the mix of products sold. Our quarterly sales and operating results are highly dependent on the volume and timing of orders received during the quarter, as well as the seasonal and cyclical nature of our markets. Historically, a relatively large percentage of our sales have arrived in the last month of each quarter, and often towards the end of such month. Accordingly, a short delay in receiving an order, shipping product, or recognizing revenue from such order may result in substantial quarterly fluctuations in revenue and earnings.

A significant portion of our operating expenses is relatively fixed in nature due to our significant sales, research and development, administration and manufacturing costs. If we cannot adjust spending quickly enough to compensate for a revenue shortfall, this may magnify the adverse impact of such revenue shortfall on our results of operations. As a result, our quarterly

operating results could fluctuate, and such fluctuation could cause the market price of our common stock and convertible senior notes to decline. Results from one quarter should not be used as an indication of future performance.

If we are unable to reduce our lengthy sales cycle, our ability to become profitable will be harmed.

Our ability to obtain customers for our products depends in significant part upon the perception that our products and services can help enable protein biomarker discovery, characterization and assay development. From the time we make initial contact with a potential customer until we receive a binding purchase order typically takes between a few weeks to a year or more. Our sales effort requires the effective demonstration of the benefits of our products and may require significant training, sometimes of many different departments within a potential customer. These departments might include research and development personnel and key management. In addition, we may be required to negotiate agreements containing terms unique to each customer. We may expend substantial funds and management effort and may not be able to successfully sell our products or services in a short enough time to achieve profitability.

We will need to raise additional capital in the future, and if we are unable to secure adequate funds on terms acceptable to us, we may be unable to execute our business plan.

We currently believe that current cash resources will be sufficient to meet our anticipated financial needs at least through the end of the first quarter of 2006. However, we may need to raise additional capital sooner in order to develop new or enhanced products or services, increase our Biomarker Discovery Center laboratory activities undertaken for our Diagnostics Division, or acquire complementary products, businesses or technologies. If we are unable to obtain financing, or to obtain it on acceptable terms, we may be unable to successfully execute our business plan.

Legislative actions resulting in higher compliance costs are likely to adversely impact our future financial position and results of operations.

Compliance with changing regulation of corporate governance and public disclosure will result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market listing requirements, are resulting in increased compliance costs. Specifically, we are undertaking significant efforts and numerous significant expenses to continue to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Compliance with these evolving standards will result in increased general and administrative expenses and may cause a diversion of management time and attention from revenue-generating activities to compliance activities.

Future changes in financial accounting standards or practices may cause adverse unexpected fluctuations and affect our reported results of operations.

Future changes in financial accounting standards, including those currently proposed, will likely affect our reported results of operations. For example, the mandated change effective for us on January 1, 2006 requiring that we record compensation expense in the statement of operations for employee stock options using the fair value method or changes in existing taxation rules related to stock options will have a negative effect on our reported results. The Financial Accounting Standards Board (“FASB”) has proposed a choice of valuation models to estimate the fair value of employee stock options. These models, including the Black-Scholes option-pricing model, use varying methods and inputs and may yield significantly different results. If another party asserts that the fair values of our employee stock options are misstated, securities class action litigation could be brought against us and/or the market price of our common stock could decline.

Because our business is highly dependent on key executives, scientists, engineers and sales people, our inability to recruit and retain these people could hinder our business expansion plans.

We are highly dependent on our executive officers, senior scientists, engineers and sales people. In certain countries, a few key individuals are important to our local success. Our product development and marketing efforts could be delayed or curtailed if we lose the services of any of these people. To expand our research, product development and sales efforts, we need people skilled in areas such as bioinformatics, biochemistry, information services, manufacturing, sales, marketing and technical support. Competition for qualified employees is intense. We will not be able to expand our business if we are unable to hire, train and retain a sufficient number of qualified employees. During 2004 and early 2005, we took steps to reduce our headcount and our voluntary employee turnover has increased from historic levels. In addition, the FASB has announced changes to generally accepted accounting principles in the U.S. that may require us to change the manner in which we compensate our employees, which could considerably impact our ability to recruit and retain qualified employees.

If we are unable to successfully expand our limited manufacturing capacity for ProteinChip readers and arrays, we may encounter manufacturing and quality control problems as we increase our efforts to meet demand.

We currently have only one manufacturing facility at which we produce limited quantities of our ProteinChip Arrays and ProteinChip Readers. Some aspects of our manufacturing processes may not be easily scalable to allow for production in larger volumes, resulting in higher than anticipated material, labor and overhead costs per unit. As a result, manufacturing and quality

control problems may arise as we increase our level of production. We may not be able to increase our manufacturing capacity in a timely and cost-effective manner and we may experience delays in manufacturing new products. If we are unable to consistently manufacture our products on a timely basis because of these or other factors, we will not be able to meet anticipated demand. As a result, we may lose sales and fail to generate increased revenue and become profitable.

We face intense competition in our current and potential markets and if our competitors develop new technologies or products, our products may not achieve market acceptance and may fail to capture market share.

Competition in our existing and potential markets is intense and we expect it to increase. Currently, our principal competition comes from other technologies that are used to perform many of the same functions for which we market our ProteinChip System. The major technologies that compete with our ProteinChip System are liquid chromatography-mass spectrometry and 2D-gel electrophoresis-mass spectrometry. In the life science research market, competitive protein research tools and services are currently provided by a number of companies, including several which are larger than Ciphergen. In the diagnostics market, there are several larger direct competitors. In many instances, our competitors may have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations. Additionally, our potential customers may internally develop competing technologies. If we fail to compete effectively with these technologies and products, or if competitors develop significant improvements in protein detection systems, develop systems that are easier to use, or introduce comparable products that are less expensive, our products may not achieve market acceptance and our sales may decrease.

If we are unable to maintain our licensed rights to the SELDI technology, we may lose the right to produce ProteinChip Systems and products based on the SELDI technology and the right to provide services and information related thereto.

Our commercial success depends on our ability to maintain our sublicenses to the SELDI technology. In 2002, 2003, 2004 and the first three months of 2005, all of our revenue from continuing operations was derived from SELDI-based products within the scope of the Baylor SELDI patents. Pursuant to the settlement of the litigation between Ciphergen, Molecular Analytical Systems (“MAS”), LumiCyte and T. William Hutchens, MAS cannot terminate Ciphergen’s rights under the sublicenses. However, Baylor College of Medicine has the right to terminate its license with MAS in case of material breach by MAS. If the agreements between Baylor College of Medicine and MAS were terminated and we were unable to obtain a license to these rights from Baylor College of Medicine, we would be precluded from selling any SELDI-based products within the scope of the Baylor SELDI patents, we would no longer generate revenue from the sale of these products and we would have to revise our business direction and strategy.

If the government grants a license to the SELDI technology to others, it may harm our business.

Some of the inventions covered by our sublicense agreements with MAS were developed under a grant from an agency of the U.S. government and therefore, pursuant to the Bayh-Dole Act and regulations promulgated thereunder, the government has a paid-up, nonexclusive nontransferable license to those inventions and will be able in limited circumstances to grant a license to others on reasonable terms. We are not aware of any basis for the government to exercise such rights, but if circumstances change and the government exercises such rights, our business could be harmed.

If we fail to maintain our rights to utilize intellectual property directed to diagnostic biomarkers, we may not be able to offer diagnostic tests using those biomarkers.

Our Diagnostics Division is developing diagnostic tests based on certain biomarkers which we have the right to utilize through licenses with our academic collaborators, such as The Johns Hopkins School of Medicine and Eastern Virginia Medical School. In some cases, our collaborators own the entire right to the biomarkers. In other cases we co-own the biomarkers with our collaborator. If, for some reason, we lose our license to biomarkers owned entirely by our collaborators, we may not be able to use these biomarkers in diagnostic tests. If we lose our exclusive license to biomarkers co-owned by us and our collaborators, our collaborators may license their share of the intellectual property to a third party that may compete with us in offering the diagnostic test.

If a competitor infringes our proprietary rights, we may lose any competitive advantage we may have as a result of diversion of management time, enforcement costs and the loss of the exclusivity of our proprietary rights.

Our commercial success depends in part on our ability to maintain and enforce our proprietary rights. We rely on a combination of patents, trademarks, copyrights and trade secrets to protect our technology and brand. In addition to our licensed SELDI technology, we also have submitted patent applications directed to subsequent technological improvements and application of the SELDI technology, including patent applications covering biomarkers that may have diagnostic or therapeutic utility. Our patent applications may not result in additional patents being issued.

If competitors engage in activities that infringe our proprietary rights, our management’s focus will be diverted and we may incur significant costs in asserting our rights. We may not be successful in asserting our proprietary rights, which could result in our patents being held invalid or a court holding that the competitor is not infringing, either of which would harm our competitive position. We cannot be sure that competitors will not design around our patented technology.

We also rely upon the skills, knowledge and experience of our technical personnel. To help protect our rights, we require all employees and consultants to enter into confidentiality agreements that prohibit the disclosure of confidential information. These agreements may not provide adequate protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure.

If others successfully assert their proprietary rights against us, we may be precluded from making and selling our products or we may be required to obtain licenses to use their technology.

Our success also depends on avoiding infringing on the proprietary technologies of others. We are aware of third parties whose business involves the use of mass spectrometry for the analysis of proteins and DNA, and third parties whose business involves providing diagnostic tests. Certain of these parties have brought their patents to our attention. If these parties assert claims that we are violating their patents, we may incur substantial costs defending ourselves in lawsuits against charges of patent infringement or other unlawful use of another’s proprietary technology. Any such lawsuit may not be decided in our favor, and if we are found liable, we may be subject to monetary damages or injunction against using their technology. We may also be required to obtain licenses under their patents and such licenses may not be available on commercially reasonable terms, if at all.

We rely on single-source suppliers for many components of our ProteinChip Systems as well as processing services for our ProteinChip Arrays, and if we are unable to obtain these components and processing services, we would be harmed and our operating results would suffer.

We depend on many single-source suppliers for the necessary raw materials and components required to manufacture our products. We also rely on some single-source subcontractors for certain outsourced manufacturing services. Some of these suppliers are small companies without extensive financial resources. Because of the limited quantities of products we currently manufacture, it is not economically feasible to qualify and maintain alternate vendors for most components of our ProteinChip Readers and processing services for our ProteinChip Arrays. We have occasionally experienced delays in receiving raw materials, components and services, resulting in manufacturing delays. If we are unable to procure the necessary raw materials, components or services from our current vendors, we will have to arrange new sources of supply and our raw materials and components shipments could be delayed, harming our ability to manufacture our products, and our ability to sustain or increase revenue could be harmed. As a result, our costs could increase and our profitability could be harmed.

If we fail to maintain certain distribution and patent license agreements, we may have to stop selling certain products and this may harm our revenue.

We sell certain products under either OEM or distribution or patent license agreements. These include arrangements with Beckman Coulter with respect to selling a customized version of the Biomek 3000 Workstation, with Salford Systems with respect to selling Biomarker Patterns software, and with Applied Biosystems / MDS Sciex with respect to selling our ProteinChip Tandem MS Interfaces. If we fail to maintain or extend after their expiration the underlying agreements with these companies, we would have to stop selling these particular products and may have to seek alternate products to sell, as a result of which our sales may be harmed.

If there are reductions in research funding, the ability of our existing and prospective customers to purchase our products could be seriously harmed.

A significant portion of our products are sold to universities, government research laboratories, private foundations and other institutions where funding is dependent upon grants from government agencies, such as the National Institutes of Health. Government funding for research and development has fluctuated significantly in the past due to changes in congressional appropriations. Research funding by the U.S. government or the governments of other countries may be significantly reduced in the future. Any such reductions may seriously harm the ability of our existing and prospective research customers to purchase our products or may reduce the number of ProteinChip Arrays used. Limitations in funding for commercial, biotechnology and pharmaceutical companies and academic institutions that are the potential customers for our ProteinChip Systems and Arrays, and general cost containment pressures for biomedical research may limit our ability to sell our products and services.

If we or our future potential partners fail to comply with Food and Drug Administration (“FDA”) requirements, we may not be able to market our products and services and may be subject to stringent penalties; further improvements to our manufacturing operations will be required which may not be accomplished and will entail additional cost.

Currently, the FDA does not actively regulate clinical laboratory tests, or “home brews”, that have been developed and used by the laboratory to conduct in-house testing. The FDA does regulate as medical devices the “active ingredients” (known as “analyte specific reagents” or “ASRs”) of certain tests developed in-house by clinical laboratories. The FDA’s regulations provide that most ASRs are exempt from the FDA’s pre-market review requirements. We believe that ASRs that we may provide will fall within those exemptions. However, the FDA has publicly stated it is reevaluating its ASR policy and regulations, and we expect that revisions to these regulations may be implemented in the future that may have the effect of increasing the regulatory burden on manufacturers of these devices. The commercialization of our products and services could be impacted by being delayed, halted or prevented. If the FDA were to view any of our actions as non-compliant, it could initiate enforcement action such as a regulatory warning letter and

possible imposition of penalties. Finally, ASRs that we may provide will be subject to a number of FDA requirements, including compliance with the FDA’s Quality System Regulations (“QSRs”), which establish extensive regulations for quality assurance and control as well as manufacturing procedures. Failure to comply with these regulations could result in enforcement action for us or our potential partners. Adverse FDA action in any of these areas could significantly increase our expenses and limit our revenue and profitability. Although we are ISO 9001:2000 certified in our ProteinChip manufacturing processes, we will need to undertake additional steps to bring our operations in line with FDA QSR requirements. Significant additional resources may be required to achieve this quality level. If we are successful in entering the diagnostics market, our manufacturing facilities will be subject to periodic regulatory inspections by the FDA and other federal and state regulatory agencies. We have not yet been subject to an FDA inspection. We may not satisfy such regulatory requirements, and any such failure to do so would have an adverse effect on our diagnostics efforts.

Our diagnostic efforts may cause us to have significant product liability exposure.

The testing, manufacturing and marketing of medical diagnostics entails an inherent risk of product liability claims. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. Our existing insurance will have to be increased in the future if we are successful at introducing diagnostic products and this will increase our costs. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the limits of our insurance coverage, our liabilities could exceed our total assets.

Business interruptions could limit our ability to operate our business.

Our operations as well as those of the collaborators on which we depend are vulnerable to damage or interruption from computer viruses, human error, natural disasters, power shortages, telecommunication failures, international acts of terror and similar events. Although we have certain business continuity plans in place, we have not established a formal comprehensive disaster recovery plan, and our back-up operations and our business interruption insurance may not be adequate to compensate us for losses we may suffer. A significant business interruption could result in losses or damages incurred by us and require us to cease or curtail our operations.

Our business is subject to risks from international operations.

We conduct business globally. Accordingly, our future results could be materially adversely affected by a variety of uncontrollable and changing factors including, among others, foreign currency exchange rates; regulatory, political, or economic conditions in a specific country or region; trade protection measures and other regulatory requirements; and natural disasters. Any or all of these factors could have a material adverse impact on our future international business. In certain countries, a few key individuals are important to our local success. In particular, we have operations in China. Given the distance from our headquarters in California and the cultural, language, and time zone differences, we have been heavily dependent on a single general manager and a small number of other local employees in China to manage such operations. We have recently experienced significant turnover and job-related issues with such employees, including the recent departure of our general manager. While we are in the process of recruiting new senior management and employees in China, it will be difficult for us to replace such employees in a timely fashion and our operations in China will be adversely affected. In addition, China does not currently have a comprehensive and highly developed legal system, particularly with respect to the protection of intellectual property rights. As a result, enforcement of existing and future laws and contracts is uncertain, and the implementation and interpretation of such laws may be inconsistent. Such inconsistency could lead to piracy and degradation of our intellectual property protection.

We are exposed to fluctuations in the exchange rates of foreign currency.

As a global concern, we face exposure to adverse movements in foreign currency exchange rates. With our ownership of Ciphergen Biosystems KK, a significant percentage of our net sales are exposed to foreign currency risk. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.

Consolidation in the pharmaceutical and biotechnology industries may reduce the size of our target market and cause a decrease in our revenue.

Consolidation in the pharmaceutical and biotechnology industries is generally expected to occur. Planned or future consolidation among our current and potential customers could decrease or slow sales of our technology and reduce the markets our products target. Any such consolidation could limit the market for our products and seriously harm our ability to achieve or sustain profitability.

We may not successfully resolve problems encountered in connection with any future acquisitions or strategic investments.

In July 2001, we acquired the BioSepra process chromatography business from Invitrogen Corporation, which we subsequently sold in November 2004. In August 2002, we increased our ownership interest in Ciphergen Biosystems KK, the Japanese joint venture we formed with Sumitomo Corporation in 1999, from 30% to 70%, and in March 2004, we further increased our ownership to 100%. In the event of any future acquisitions, joint ventures and other strategic investments, we could:

• issue stock that would dilute ownership of our then-existing stockholders;

• incur charges for the impairment of the value of investments or acquired assets; or

• incur amortization expense related to intangible assets.

If we fail to achieve the financial and strategic benefits of past and future acquisitions or strategic investments, our operating results will suffer. Acquisitions and strategic investments involve numerous other risks, including:

• difficulties integrating the acquired operations, technologies or products with ours;

• failure to achieve targeted synergies;

• unanticipated costs and liabilities;

• diversion of management’s attention from our core business;

• adverse effects on our existing business relationships with suppliers and customers or those of the acquired organization; and

• potential loss of key employees, particularly those of the acquired organization.

We are subject to environmental laws and potential exposure to environmental liabilities.

We are subject to various federal, state and local environmental laws and regulations that govern our operations, including the handling and disposal of nonhazardous and hazardous wastes, and emissions and discharges into the environment. Failure to comply with such laws and regulations could result in costs for corrective action, penalties or the imposition of other liabilities. We also are subject to laws and regulations that impose liability and clean-up responsibility for releases of hazardous substances into the environment. Under certain of these laws and regulations, a current or previous owner or operator of property may be liable for the costs of remediating hazardous substances or petroleum products on or from its property, without regard to whether the owner or operator knew of, or caused, the contamination, as well as incur liability to third parties impacted by such contamination. The presence of, or failure to remediate properly, such substances could adversely affect the value and the ability to transfer or encumber such property. Based on currently available information, although there can be no assurance, we believe that such costs and liabilities have not had and will not have a material adverse impact on our financial results.

Anti-takeover provisions in our charter, bylaws and Stockholder Rights Plan and under Delaware law could make a third party acquisition of us difficult.

Our certificate of incorporation, bylaws and Stockholder Rights Plan contain provisions that could make it more difficult for a third party to acquire us, even if doing so might be deemed beneficial by our stockholders. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. We are also subject to certain provisions of Delaware law that could delay, deter or prevent a change in control of us.

The rights issued pursuant to our Stockholder Rights Plan will become exercisable the tenth day after a person or group announces acquisition of 15% or more of our common stock or announces commencement of a tender or exchange offer the consummation of which would result in ownership by the person or group of 15% or more of our common stock. If the rights become exercisable, the holders of the rights (other than the person acquiring 15% or more of our common stock) will be entitled to acquire, in exchange for the rights’ exercise price, shares of our common stock or shares of any company in which we are merged, with a value equal to twice the rights’ exercise price.

Risks Related to Our Convertible Senior Notes and Common Stock

Substantial leverage and debt service obligations may adversely affect our cash flows.

In connection with the sale of the convertible senior notes (the “notes”), we incurred $30 million of indebtedness. As a result of this indebtedness, our principal and interest payment obligations increased substantially. The degree to which we are leveraged could, among other things:

• make it difficult for us to make payments on the notes;

• make it difficult for us to obtain financing for working capital, acquisitions or other purposes on favorable terms, if at all;

• make us more vulnerable to industry downturns and competitive pressures; and

• limit our flexibility in planning for, or reacting to changes in, our business.

Our ability to meet our debt service obligations will depend upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.

The notes are unsecured, and future indebtedness could effectively rank senior to the notes.

The notes are unsecured and will rank equal in right of payment with our existing and future unsecured and unsubordinated indebtedness. The notes will be effectively subordinated to any secured debt to the extent of the value of the assets that secure the indebtedness. The notes will also be “structurally subordinated” to all indebtedness and other liabilities, including trade payables and lease obligations, of our existing and future subsidiaries. In the event of our bankruptcy, liquidation or reorganization or upon acceleration of the notes, payment on the notes could be less, ratably, than on any secured indebtedness. We may not have sufficient assets remaining to pay amounts due on any or all of the notes then outstanding.

The indenture governing the notes does not prohibit or limit us or our subsidiaries from incurring additional indebtedness and other liabilities, or from pledging assets to secure such indebtedness and liabilities. The incurrence of additional indebtedness and, in particular, the granting of a security interest to secure the indebtedness, could adversely affect our ability to pay our obligations on the notes. We anticipate that we may incur additional indebtedness from time to time in the future.

The notes are not protected by restrictive covenants, including financial covenants.

Neither we nor our subsidiaries are restricted from incurring additional debt, including senior debt, or liabilities under the indenture. In addition, the indenture does not restrict us or any of our subsidiaries from paying dividends or issuing or repurchasing securities. If we or our subsidiaries were to incur additional debt or liabilities, our ability to pay our obligations on the notes could be adversely affected.

We may be unable to repay, repurchase or redeem the notes.

At maturity, the entire outstanding principal amount of the notes will become due and payable by us. Upon a change in control, as defined in the indenture, note holders may require us to repurchase all or a portion of their notes. We may not have enough funds or be able to arrange for additional financing to pay the principal at maturity or to repurchase the notes on a change in control. Future credit agreements or other agreements relating to our indebtedness may restrict the redemption or repurchase of the notes and provide that a change in control constitutes an event of default. If the maturity date or a change in control occurs at a time when we are prohibited from repaying or repurchasing the notes, we could seek the consent of our lenders to purchase the notes or we could attempt to refinance this debt. If we do not obtain the necessary consents or cannot refinance the debt on favorable terms, or at all, we will be unable to repay or repurchase the notes. Our failure to repay the notes at maturity or repurchase tendered notes would constitute an event of default under the indenture, which might constitute a default under the terms of our other debt. Our obligation to offer to purchase the notes upon a change in control would not necessarily afford note holders protection in the event of a highly leveraged transaction, reorganization, merger or similar transaction involving us.

There may not be an active, liquid market for our common stock or the notes.

There is no guarantee that an active trading market for our common stock will be maintained on the Nasdaq Stock Market’s National Market. Investors may not be able to sell their shares quickly or at the latest market price if trading in our stock is not active. An active trading market for the notes may not be maintained. If an active market for the notes is not sustained, the trading price of the notes could decline significantly. The notes are eligible for trading on the PORTAL^sm Market. We do not intend to apply for listing of the notes on any securities exchange.

The notes and the common stock issuable upon conversion of the notes may be subject to restrictions on resale.

We entered into a registration rights agreement with the initial purchasers of the notes, pursuant to which we filed a shelf registration statement covering the resale of the notes and the common stock issuable upon conversion of the notes. If the effectiveness of the registration statement is not maintained, the liquidity and price of the notes and common stock issuable upon conversion of the notes would be adversely affected and note holders could lose all or part of their investment.

At various times during 2003, 2004 and 2005, the price at which our common stock could be purchased on the Nasdaq National Market was lower than the conversion price of the notes, and our stock price may be lower than the conversion price in the future.

Prior to electing to convert notes, the note holder should compare the price at which our common stock is trading in the market to the conversion price of the notes. Our common stock trades on the Nasdaq National Market under the symbol CIPH. The initial conversion price of the notes is approximately $9.19 per share. The market prices of our securities are subject to significant fluctuations. Such fluctuations, as well as economic conditions generally, may adversely affect the market price of our securities, including our common stock and the notes.

The notes may not be rated or may receive a lower rating than anticipated.

We believe it is unlikely that the notes will be rated. However, if one or more rating agencies rates the notes and assigns the notes a rating lower than the rating expected by investors, reduces their rating in the future or indicates that it will have their ratings on

the notes under surveillance or review with possible negative implications, the market price of the notes and our common stock would be harmed. In addition, a ratings downgrade could adversely affect our ability to access capital.

Our stock price has been highly volatile, and an investment in our stock could suffer a decline in value, adversely affecting the value of the notes or the shares into which those notes may be converted.

The trading price of our common stock has been highly volatile and could continue to be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

• actual or anticipated period-to-period fluctuations in financial results;

• failure to achieve, or changes in, financial estimates by securities analysts;

• announcements of new products or services or technological innovations by us or our competitors;

• developments regarding actual or potential discoveries of biomarkers by us or others;

• comments or opinions by securities analysts or major stockholders;

• conditions or trends in the pharmaceutical, biotechnology and life science industries;

• announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

• developments regarding our patents or other intellectual property or that of our competitors;

• litigation or threat of litigation;

• additions or departures of key personnel;

• sales of our common stock;

• limited daily trading volume; and

• economic and other external factors or disasters or crises.

In addition, the stock market in general, and the Nasdaq National Market and the market for technology companies in particular, have experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, there has been significant volatility in the market prices of securities of life science companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in substantial costs, potential liabilities and the diversion of management’s attention and resources.

Future sales of our common stock in the public market could adversely affect the trading price of our common stock, the value of the notes and our ability to raise funds in new stock offerings.

Future sales of substantial amounts of our common stock in the public market, or the perception that such sales are likely to occur, could affect prevailing trading prices of our common stock and the value of the notes. As of March 31, 2005, we had:

• 29,475,663 shares of common stock outstanding;

• 5,335,520 shares of common stock reserved for issuance upon exercise of options outstanding under our stock option plans with a weighted average exercise price of $5.68 per share;

• in addition to the shares reserved for issuance upon the exercise of options referred to in the preceding bullet point, 1,791,682 shares reserved for future issuance under our stock option and employee stock purchase plans; and

• 96,750 shares of common stock potentially issuable to Stanford Research Systems, Inc. under a development contract if certain milestones are met.

Because the notes are convertible into common stock only at a specific conversion price, a decline in our common stock price may cause the value of the notes to decline.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have classified our short-term investments as available-for-sale, and have accordingly recorded them on the balance sheet at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss). These investments are not leveraged and are held for purposes other than trading.

The following discussion about our market risk involves forward-looking statements. We are exposed to market risk related mainly to changes in interest rates. We do not invest in derivative financial instruments.

INTEREST RATE SENSITIVITY

As of March 31, 2005, our only investment was a fixed rate annuity with a fair value of $2.2 million due to mature on February 28, 2006, with an option to renew for one year at an estimated interest rate of 3.0% per annum. With the exception of the

investment in this annuity, we believe that, in the near-term, we will maintain our available funds in short-term, highly liquid securities with original maturities of 90 days or less, and money market accounts.

The primary objective of our investment activities is to preserve principal, maintain proper liquidity to meet operating needs and maximize yields. Our investment policy, which has been approved by our Board of Directors, specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer or type of investment. We may maintain our portfolio of cash equivalents, short-term investments and long-term investments in a variety of securities, including commercial paper, money market funds, and government and non-government debt securities, subject to our investment policy.

Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our available funds for investment. Our long-term debt and capital lease agreements are at fixed interest rates. We do not plan to use derivative financial instruments in our investment portfolio.

FOREIGN CURRENCY EXCHANGE RISK

Most of our revenue is realized in U.S. dollars. However, all our revenue in Japan is realized in Japanese yen. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Because most of our revenue is currently denominated in U.S. dollars, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in foreign markets.

The functional currency of Ciphergen Biosystems KK is the yen. Accordingly, the accounts of this operation were translated from yen to the U.S. dollar using the current exchange rate in effect at the balance sheet date for the balance sheet accounts, and using the average exchange rate during the period for revenue and expense accounts. The effects of translation are recorded as a separate component of stockholders’ equity.

The accounts of all other non-U.S. operations are remeasured to the U.S. dollar, which is the functional currency. Accordingly, all monetary assets and liabilities of these foreign operations are translated into U.S. dollars at current period-end exchange rates, and non-monetary assets and related elements of expense are translated using historical rates of exchange. Income and expense elements are translated to U.S. dollars using average exchange rates in effect during the period. Gains and losses from the foreign currency transactions of these subsidiaries are recorded as other income or loss in the statement of operations.

The net tangible assets of our non-U.S. operations, excluding intercompany debt, were $6.4 million at March 31, 2005.

In 2004 we entered into foreign currency contracts to manage the volatility of currency fluctuations as a result of an intercompany loan of approximately $1.0 million, denominated in yen, to our subsidiary in Japan. The effect of exchange rate changes on the forward exchange contracts largely offset the effect of exchange rate changes on the intercompany loan. Net realized foreign currency gains and losses related to foreign currency forward contracts were not material for the quarter ended March 31, 2004. As of January 1, 2005, there were no forward contracts outstanding and during the quarter ended March 31, 2005, there were no transactions related to forward contracts. Although we will continue to monitor our exposure to currency fluctuations, we cannot provide assurance that exchange rate fluctuations will not harm our business in the future.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of March 31, 2005, an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, Ciphergen’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that Ciphergen’s disclosure controls and procedures (as defined in Rules 13(a) — 15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) were effective in ensuring that information required to be disclosed by Ciphergen in this report and in other reports it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes In Internal Control Over Financial Reporting

There have been no changes in Ciphergen’s internal control over financial reporting or in other factors during the most recent fiscal quarter that have materially affected, or could be reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The following exhibits have been filed with this report:

3.2 *		Amended and Restated Certificate of Incorporation of Registrant
3.4 *		Amended and Restated Bylaws of Registrant
3.5 **		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Ciphergen Biosystems, Inc.
4.1*		Form of Registrant’s Common Stock Certificate
4.2 **		Preferred Shares Rights Agreement dated March 20, 2002 between Ciphergen Biosystems, Inc. and Continental Stock Transfer & Trust Company
31.1		Certification of the Chief Executive Officer Pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002
31.2		Certification of the Chief Financial Officer Pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002
32		Certification of the 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

* Incorporated by reference to exhibits (with same exhibit number) to Ciphergen Biosystems’ Registration Statement on Form S-1 (File No. 333-32812) declared effective on September 28, 2000.

** Incorporated by reference to our Registration Statement on Form 8-A, filed with the Securities and Exchange Commission on March 21, 2002.

PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Unaudited Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004

	Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and March 31, 2004

	Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and March 31, 2004

	Notes to Condensed Consolidated Financial Statements (Unaudited)

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 2.	Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

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

Item 5.	Other Information

Item 6.	Exhibits

SIGNATURES

EXHIBIT INDEX

May 10, 2005

CIPHERGEN BIOSYSTEMS, INC.

(Registrant)

/s/ William E. Rich
William E. Rich
President, Chief Executive Officer and Director

/s/ Matthew J. Hogan
Matthew J. Hogan
Senior Vice President and Chief Financial Officer

Exhibit No.		Exhibit Title
3.2 *		Amended and Restated Certificate of Incorporation of Registrant
3.4 *		Amended and Restated Bylaws of Registrant
3.5 **		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Ciphergen Biosystems, Inc.
4.1 *		Form of Registrant’s Common Stock Certificate
4.2 **		Preferred Shares Rights Agreement dated March 20, 2002 between Ciphergen Biosystems, Inc. and Continental Stock Transfer & Trust Company
31.1		Certification of the Chief Executive Officer Pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002
31.2		Certification of the Chief Financial Officer Pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002
32		Certification of the 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