SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
   
þ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended JuneSeptember 30, 2005
   
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the transition period from            to            .
Commission file number: 000 — 20703
 
Adeza Biomedical Corporation
(Exact name of Registrant as specified in its charter)
   
Delaware77-0054952

(State or Other Jurisdiction of
(I.R.S. Employer

Incorporation or Organization)
 77-0054952
(I.R.S. Employer
Identification Number)
1240 Elko Drive, Sunnyvale, California 94089
(Address of principal executive offices and zip code)
(408) 745-0975
(Registrant’s telephone number, including area code)
   
Securities registered pursuant to Section 12(b) of the Act:
 None
   
Securities registered pursuant to Section 12(g) of the Act:
 Common Stock, $0.001 Par Value
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. Yesþ Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ
As of August 5,November 4, 2005, 16,853,92617,153,232 shares of the registrant’s common stock were outstanding.
 
 

 


TABLE OF CONTENTS
     
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 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2
Adeza Biomedical Corporation Trademarks and Registered Trademarks are trademarks of Adeza. Our trademarks and trade names include the stylized A, Adeza®, E-tegrity® Test, SalEst®, FullTerm™FullTerm® and TLiIQ® System. Other service marks, trademarks and trade names referred to in this Form 10-Q are the property of their respective owners.

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PART I— FINANCIAL INFORMATION
Item I.1. Condensed Financial Statements (Unaudited)
Adeza Biomedical Corporation
 
CONDENSED BALANCE SHEETS

(in thousands, except share and per share information)
                
 June 30, December 31, September 30, December 31, 
 2005 2004 2005 2004 
 (unaudited) (note 2) (unaudited) (note 2) 
Assets
  
Current assets:  
Cash and cash equivalents $82,959 $80,118  $86,849 $80,118 
Accounts receivable, net 8,091 6,628  7,765 6,628 
Inventories 848 667  739 667 
Prepaid and other current assets 301 271  261 271 
          
Total current assets 92,199 87,684  95,614 87,684 
Property and equipment, net 315 268  354 268 
Intangible assets, net 152 176  140 176 
          
Total assets $92,666 $88,128  $96,108 $88,128 
          
Liabilities and stockholders’ equity
  
Current liabilities:  
Accounts payable $2,375 $2,750  $2,491 $2,196 
Accrued compensation 1,547 1,863  1,515 1,863 
Accrued royalties 1,207 1,007  699 1,007 
Other accrued liabilities 1,653 752  2,201 1,306 
Deferred revenue 49 45  59 45 
          
Total current liabilities 6,831 6,417  6,965 6,417 
Commitments Stockholders’ equity: 
Common stock, $0.001 par value; 100,000,000 shares authorized; 16,853,926 and 16,461,390 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively 17 16 
Commitments 
Stockholders’ equity: 
Common stock, $0.001 par value; 100,000,000 shares authorized; 17,117,167 and 16,461,390 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively 17 16 
Additional paid-in capital 130,085 129,695  131,022 129,695 
Deferred compensation  (2,784)  (3,232)  (2,563)  (3,232)
Accumulated deficit  (41,483)  (44,768)  (39,333)  (44,768)
          
Total stockholders’ equity 85,835 81,711  89,143 81,711 
          
Total liabilities and stockholders’ equity $92,666 $88,128  $96,108 $88,128 
          
See accompanying notes to condensed financial statements.

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Adeza Biomedical Corporation
 
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except share and per share information)
                                
 Three months ended Six months ended Three months ended Nine months ended 
 June 30, June 30, September 30, September 30, 
 2005 2004 2005 2004 2005 2004 2005 2004 
Product sales $10,634 $8,396 $20,244 $15,638  $11,419 $8,767 $31,663 $24,405 
Cost of product sales 1,429 1,716 2,856 3,343  1,703  (2,448) 4,559 895 
                  
Gross profit 9,205 6,680 17,388 12,295  9,716 11,215 27,104 23,510 
 
Operating costs and expenses:  
Selling and marketing 4,787 3,812 9,512 7,485  4,566 4,153 14,078 11,638 
General and administrative 1,867 926 3,404 1,552  1,959 1,079 5,363 2,631 
Research and development 1,213 681 2,077 1,197  1,634 559 3,711 1,755 
                  
Total operating costs and expenses 7,867 5,419 14,993 10,234  8,159 5,791 23,152 16,024 
                  
Income from operations 1,338 1,261 2,395 2,064  1,557 5,424 3,952 7,486 
Interest income 593 31 1,073 57  729 48 1,802 104 
                  
Income before provision for (benefit from) income taxes 1,931 1,292 3,468 2,118 
Provision for (benefit from) income taxes 102  (19) 183 81 
Income before provision for income taxes 2,286 5,472 5,754 7,590 
Provision for income taxes 136 226 319 307 
                  
Net income $1,829 $1,311 $3,285 $2,037  $2,150 $5,246 $5,435 $7,283 
                  
Basic net income per share $0.11 $7.20 $0.20 $11.18  $0.13 $28.77 $0.32 $39.97 
                  
Diluted net income per share $0.10 $0.10 $0.19 $0.15  $0.12 $0.39 $0.31 $0.54 
                  
Shares used to compute basic net income per share 16,754,828 182,160 16,707,081 182,160  16,990,858 182,344 16,802,712 182,222 
                  
Shares used to compute diluted net income per share 17,696,949 13,394,126 17,762,420 13,330,430  17,931,154 13,454,649 17,797,756 13,383,760 
                  
See accompanying notes to condensed financial statements.

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Adeza Biomedical Corporation
 
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) (in thousands)
                
 Six months ended Nine months ended 
 June 30, September 30, 
 2005 2004 2005 2004 
Operating activities
  
Net income $3,285 $2,037  $5,435 $7,283 
Adjustments to reconcile net income to net cash provided by operating activities:  
Depreciation and amortization 94 44  143 88 
Stock based compensation expense 483 22  740 455 
Tax benefits from stock option exercises 135  
Changes in operating assets and liabilities:  
Accounts receivable  (1,463)  (384)  (1,137)  (1,247)
Inventories  (181)  (91)  (72)  (7)
Prepaid and other assets  (30) 25  10  (1,284)
Accounts payable  (375)  (86)  (259) 859 
Accrued compensation  (316) 69   (348)  (447)
Accrued royalties 200 1,202   (308)  (2,902)
Other accrued liabilities 901  (25) 1,449 206 
Deferred revenue 4  (370) 14  (357)
      ��   
Net cash provided by operating activities 2,602 2,443  5,802 2,647 
          
Investing activities
  
Purchases of property and equipment  (117)  (40)  (193)  (101)
          
Net cash used in investing activities  (117)  (40)  (193)  (101)
          
Financing activities
  
Net proceeds from issuances of common stock 356   1,122  
          
Net cash provided by financing activities 356   1,122  
          
Net increase in cash and cash equivalents 2,841 2,403  6,731 2,546 
Cash and cash equivalents at beginning of period 80,118 12,092  80,118 12,092 
          
Cash and cash equivalents at end of period $82,959 $14,495  $86,849 $14,638 
          
Supplemental cash flow information
  
Cash paid for income taxes $252 $13  $597 $196 
          
See accompanying notes to condensed financial statements.

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Adeza Biomedical Corporation
 
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. Organization and business
Adeza Biomedical Corporation (“Adeza” or the “Company”) is a Delaware corporation which was originally incorporated in the state of California on January 3, 1985 and reincorporated in Delaware in 1996. Adeza is engaged in the design, development, manufacturing, sales, and marketing of products for women’s health markets worldwide. The Company designs, develops, manufactures and markets innovative products for women’s health. The Company’s initial focus is on reproductive healthcare, using its proprietary technologies to predict preterm birth and assess infertility. The Company’s products consist of:
 The TLiIQ System and FullTerm, The Fetal Fibronectin Test, which are used to assess the risk of preterm birth in pregnant women.
 
 The E-tegrity Test, which is used to determine the feasibility of embryo implantation in patients with infertility who are candidates for in vitro fertilization (“IVF”).
During the three and sixnine months ended JuneSeptember 30, 2005 approximately 97% and 98%, respectively, of the Company’s product sales were derived from customers located in the United States as compared to 97% for both the three and sixnine month periods ended JuneSeptember 30, 2004. Sales were predominately derived from the sale of FullTerm, The Fetal Fibronectin Test.
2. Summary of significant accounting policies
Basis of presentation
The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles and applicable Securities and Exchange Commission regulations for interim financial information. These financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The condensed balance sheet at December 31, 2004 has been derived from the audited financial statements at that date, but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements.date. The accompanying unaudited condensed financial statements reflect all adjustments (consisting of normal, recurring adjustments) that, in our opinion, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future periods. The accompanying condensed financial statements and related notes should be read in conjunction with ourthe Company’s audited financial statements and notes included in ourits Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission.
On December 6, 2004, the Company effected a three-for-four reverse split of the Company’s common stock. All common share and per share amounts contained in these financial statements were retroactively adjusted accordingly.
In the quarter ended JuneSeptember 30, 2005, certain amounts previously included under Accounts Payable in the balance sheet as of December 31, 2004 were reclassified to Other Accrued Liabilities reflecting the appropriate account description for the liability.
Stock-based compensation
As permitted by Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation(SFAS 123)123”) as amended by Statement of Financial Accounting Standards No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure(SFAS 148), the Company has elected to account for stock options granted to employees and directors using the intrinsic value method and, accordingly, does not recognize compensation expense for stock options granted to employees and directors with exercise prices equal to the fair value of the underlying common shares. Options granted to nonemployees have been accounted for in accordance with SFAS 123 and Emerging Issues Task Force Consensus No. 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,and are periodically remeasured with the resulting value charged to expense over the period of the related services being rendered.

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For purposes of pro forma disclosures as required under SFAS 123, the estimated fair value of the stock options is amortized to expense over the options’ vesting period. The pro forma information and related assumptions are as follows (in thousands):

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 Three Months Ended Six Months Ended Three Months Ended Nine Months Ended 
 June 30, June 30, September 30, September 30, 
 2005 2004 2005 2004 2005 2004 2005 2004 
Net income:  
As reported $1,829 $1,311 $3,285 $2,037  $2,150 $5,246 $5,435 $7,283 
Add: Total stock based employee and director compensation expense determined under the intrinsic value method for all awards 222  448   221 154 669 166 
Less: Total stock based employee and director compensation expense determined under the fair value method for all awards  (688)  (105)  (1,276)  (210)  (611)  (400)  (1,887)  (1,309)
                  
Pro forma $1,363 $1,206 $2,457 $1,827  $1,760 $5,000 $4,217 $6,140 
                  
Reported basic net income per share $0.11 $7.20 $0.20 $11.18  $0.13 $28.77 $0.32 $39.97 
                  
Reported diluted net income per share $0.10 $0.10 $0.19 $0.15  $0.12 $0.39 $0.31 $0.54 
                  
Pro forma basic net income per share $0.08 $6.62 $0.15 $10.03  $0.10 $27.42 $0.25 $33.70 
                  
Pro forma diluted net income per share $0.08 $0.09 $0.14 $0.14  $0.10 $0.37 $0.23 $0.46 
                  
  
Risk-free interest rate  3.72%  3.63%  4.01%  3.63%  4.07%  3.63%  4.03%  3.63%
                  
Expected life (in years) 4 4 4 4  4 4 4 4 
                  
Expected dividends ��         
                  
Expected volatility  75%  85%  75%  85%  75%  85%  75%  85%
                  
Recent accounting pronouncements
In December 2004, the Financial Accounting Standards Board (FASB), issued a revision of SFAS 123,Share-Based Payment(SFAS 123R), which requires all share-based payments to employees and directors, including grants of employee and director stock options, to be recognized in the statement of operations based on their fair values. The Company plans to adopt SFAS 123R on January 1, 2006. The Company expects the adoption of SFAS 123R to have a material impact on its financial statements in that quarter and thereafter, but cannot reasonably estimate the impact of adoption because it will depend upon the levels of share-baseshare-based payments granted in the future. However, had the Company adopted SFAS 123R in prior periods using the Black-Scholes valuation model, the impact of the standard we believe would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and net income per share in the stock-based compensation section above.
3. Inventories
Inventories are stated at the lower of standard cost (which approximates actual cost) or market and consists of the following (in thousands):
                
 June 30, December 31, September 30, December 31, 
 2005 2004 2004 2004 
Raw materials $343 $297  $288 $297 
Work in process 182 119  184 119 
Finished goods 323 251  267 251 
          
 $848 $667  $739 $667 
          
4. Intangible assets
Intangible assets consist of purchased patents. Accumulated amortization at JuneSeptember 30, 2005 and December 31, 2004 was $88,000$100,000 and $64,000, respectively. Intangible assets are amortized on a straight line basis over their estimated useful lives of five years. Amortization expense is expected to be $48,000 per year in 2005 through 2007 and $32,000 for the year ending December 31, 2008.

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5. Net income per share
Basic net income per share is calculated by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per share is computed by dividing net income by the weighted-average number of common shares and dilutive potential common shares outstanding for the period. For purposes of this calculation, common stock subject to repurchase by the Company, preferred stock, options, and warrants are considered to be potential common shares and are only included in the calculation of diluted net income per share when their effect is dilutive. The calculation of net income per share is as follows (in thousands, except share and per share information):
                                
 Three Months Ended Six Months Ended Three Months Ended Nine Months Ended 
 June 30, June 30, September 30, September 30, 
 2005 2004 2005 2004 2005 2004 2005 2004 
Numerator:  
Net income $1,829 $1,311 $3,285 $2,037  $2,150 $5.246 $5,435 $7,283 
                  
Denominator:  
Denominator for basic earnings per share-weighted-average common shares outstanding 16,754,828 182,160 16,707,081 182,160  16,990,858 182,344 16,802,712 182,222 
Effect of dilutive securities:  
Stock options 862,744 1,100,237 974,153 1,045,576  856,189 1,152,611 912,755 1,091,580 
Warrants 79,377 154,407 81,186 145,372  84,107 162,372 82,289 152,636 
Convertible preferred stock  11,957,322  11,957,322   11,957,322  11,957,322 
                  
Dilutive potential common shares 942,121 13,211,966 1,055,339 13,148,270  940,295 13,272,305 995,044 13,201,538 
                  
Denominator for diluted earnings per share-weighted-average common shares and dilutive potential common shares 17,696,949 13,394,126 17,762,420 13,330,430  17,931,154 13,454,649 17,797,756 13,383,760 
                  
Basic net income per share $0.11 $7.20 $0.20 $11.18  $0.13 $28.77 $0.32 $39.97 
                  
Diluted net income per share $0.10 $0.10 $0.19 $0.15  $0.12 $0.39 $0.31 $0.54 
                  
6. Comprehensive income
Comprehensive income for the three and sixnine months ended JuneSeptember 30, 2005 and 2004 equaled the net income in each period.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with the condensed financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q. Statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this quarterly report on Form 10-Q which express that we “believe,” “anticipate,” “expect” or “plan to” as well as other statements which are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.Examples of forward-looking statements include, without limitation, statements regarding the expansion of products, markets and offerings and additional product indications.Actual events or results may differ materially as a result of the risks and uncertainties described herein and elsewhere including, but not limited to, those factors described under “Business” and “Factors That May Affect Future Results” below and those described under “Business” set forth in Part I of our Annual Report on Form 10-K for the year-ended December 31, 2004.
OVERVIEW
We design, develop, manufacture and market innovative products for women’s health. Our initial focus is on reproductive healthcare, using our proprietary technologies to predict preterm birth and assess infertility. Our principal product is a patented diagnostic test FullTerm, The Fetal Fibronectin Test, that utilizes a single-use, disposable cassette and is analyzed on our patented instrument, the TLiIQ System. This FDA-approved product is designed to objectively determine a woman’s risk of preterm birth by detecting the presence of a specific protein, fetal fibronectin, in vaginal secretions during pregnancy. We began selling our single-use, disposable FullTerm, The Fetal Fibronectin Test in 1999 and launched our second-generation system, the TLiIQTLiIQ System, in 2001. Sales of TLiIQTLiIQ Systems to hospital and clinical laboratories allow healthcare providers access to our FullTerm, The Fetal Fibronectin Test, resulting in the potential for better patient care and for significant cost savings by avoiding unnecessary medical treatment.
We believe the key factors underlying our growth since 1999 include greater healthcare provider acceptance, demonstrated cost savings from the use of our tests, expanded reimbursement coverage by insurance companies, expansion of our sales force and increased marketing efforts. Continued growth in test volume and revenue will depend on the above and a number of factors, including placing additional TLiIQ Systems in hospitals and clinical laboratories, increasing utilization of existing TLiIQ Systems, increasing healthcare provider acceptance for other FDA-approved uses of the product and developing additional applications or products.

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Product sales
Our product sales are derived primarily from the sale of our disposable FullTerm, The Fetal Fibronectin Test. In addition, we derive a small portion of our revenues from the sale of our Etegrity test, TLiIQ Systems and other consumables. Sales in the United States accounted for approximately 97% of our product sales in the three-month period and 98% in both three and six-month periodsthe nine-month period ended JuneSeptember 30, 2005 and 97% for both the three and six-monthnine-month periods ended JuneSeptember 30, 2004, respectively.2004. International sales accounted for approximately 3% of our product sales in the three-month period and 2% in both three and six-month periodsthe nine-month period ended JuneSeptember 30, 2005 and 3% for both the three and six-monthnine-month periods ended JuneSeptember 30, 2004. We currently use distributors for sales outside of the United States and Canada. Our business has been and may continue to be seasonal and is affected by customer ordering patterns, which may involve quarterly or semi-annual orders, as well as other factors which may cause quarterly variances in our revenue. As such, revenue may not increase in sequential quarters and our net income may fluctuate significantly.
Cost of product sales
Our cost of product sales represents the cost of materials, direct labor and overhead associated with the manufacture of our products, direct labor,and delivery charges, lab services and royalties.
Royalty costs for the three months ended September 30, 2005 were $0.6$0.7 million or 6.1% of product sales, an increase of $3.9 million from the ($3.2) million for the three months ended September 30, 2004. The increase in cost of product sales for the three months ended JuneSeptember 30, 2005 as compared to $1.0 million or 12.2%was primarily the result of product sales for the three months ended June 30, 2004. Thea one-time reduction in accrued royalties and reduced royalty costs was primarily relatedtotaling $3.7 million attributable to changesroyalties accrued under a license agreement.agreement that we determined in the third quarter of 2004 were in excess of amounts actually due. Although royalty costs as a percentage of product sales is expected to fluctuate as it is dependent on several factors, including the level and type of sales and the level of allowed deductions, we believe royalty costs as a percentage of revenue will remain below 7.5% for the year ended December 31, 2005, assuming no new licenses involving royalties are required.
Selling and marketing expenses
Selling and marketing expenses consist primarily of sales and marketing personnel compensation, sales force incentive compensation, travel, tradeshows, promotional materials and programs, advertising and healthcare provider education materials and events.
General and administrative expenses
Our general and administrative expenses consist primarily of personnel expenses for accounting, human resources, information technology and corporate administration functions. Other costs include facility costs, and professional fees for legal and accounting services.services including patent expenses.
Research and development expenses
Our research and development expenses consist of costs incurred for company-sponsored and collaborative research and development activities. These expenses consist primarily of direct and research-related allocated overhead expenses such as facilities costs, salaries and benefits, and material and supply costs and include costs associated with clinical trials.
Recent accounting pronouncements
In December 2004, the Financial Accounting Standards Board (FASB), issued a revision of Statement of Financial Accounting Standards No. 123,Share-Based Payment(SFAS 123R), which requires all share-based payments to employees and directors, including grants of employee and director stock options, to be recognized in the statement of operations based on their fair values. We plan to adopt SFAS 123R on January 1, 2006. We expect that the adoption of SFAS 123R will have a material impact on our financial statements but cannot reasonably estimate the impact of adoption because it will depend upon the levels of share-based payments granted in the future and other factors. However, we expect our selling and marketing, general and administrative and research and development expenses to increase in conjunction with the adoption of SFAS 123R in 2006.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our financial statements in accordance with U.S. generally accepted accounting policies.principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the

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circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates have not changed significantly from the critical accounting policies and estimates discussed in our Annual Report on Form 10-K for the year ended December 31, 2004.

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RESULTS OF OPERATIONS
Comparison of three and sixnine months ended JuneSeptember 30, 2005 compared to three and sixnine months ended JuneSeptember 30, 2004
Product sales
Product sales increased 26.7%30% to $10.6$11.4 million in the secondthird quarter of 2005 from $8.4$8.8 million in the comparable quarter in 2004. The growth in sales of $2.2$2.7 million was primarily due to an increase in the sales volume of our FullTerm, The Fetal Fibronectin Test.
Product sales increased 29.5%30% to $20.2$31.7 million for the sixnine months ended JuneSeptember 30, 2005 from $15.6$24.4 million in the comparable period in 2004. The growth in sales of $4.6$7.3 million was primarily due to an increase in the sales volume of our FullTerm, The Fetal Fibronectin Test.
Cost of product sales
Cost of product sales for the quarter ended JuneSeptember 30, 2005 was $1.4$1.7 million, a decreasean increase of approximately 16.8%$4.1 million from $1.7($2.4) million for the secondthird quarter of 2004. The decreaseincrease in cost of product sales was primarily the result of changes under a license agreement. We incurredone-time reduction in accrued royalties and reduced royalty costs totaling $3.7 million that we determined were in excess of approximately $0.6 millionamounts actually due in the second quarter of 2005, compared to approximately $1.0 million in the secondthird quarter of 2004. The decreaseincrease in cost of product sales from decreased royalty expense was partially offset byalso due to increases in standard product costs from increased unit sales. As a percent of revenue, cost of product sales was 13.4%14.9% of revenue for the quarter ended JuneSeptember 30, 2005 as compared to 20.4%14.8% , excluding the one-time reduction in accrued royalties and reduced royalty costs of $3.7 million, for the same period in the prior year.third quarter of 2004.
Cost of product sales was $2.9$4.6 million or 14.1% of product sales, for the sixnine months ended JuneSeptember 30, 2005, as compared to $3.3$0.9 million or 21.4% of product sales for the same period in 2004. CostThe increase in cost of product sales for the sixnine months ended JuneSeptember 30, 2005 decreased as awas primarily the result of changesa one-time reduction in accrued royalties of $2.7 million attributable to royalties accrued under a license agreement. We incurred royaltyagreement through December 31, 2003 that we determined in the third quarter of 2004 were in excess of amounts actually due. As a percentage of revenue, costs of approximately $1.2 millionproduct sales was 14.4% for the sixnine months ended JuneSeptember 30, 2005 as compared to approximately $1.9 million14.9% which excludes the effect of the one-time reduction in accrued royalties for the same period in the prior year. The decrease in cost of product sales from decrease royalty expense was partially offset by increases in standard product costs from increased unit sales.
Gross profit
Our gross profit for the quarter ended JuneSeptember 30, 2005 was $9.2$9.7 million, an increasea decrease of approximately 37.8%$1.5 million from $6.7$11.2 million for the secondthird quarter of 2004. The gross profit increasedecrease was primarily due to increased sales adding $2.2 millionthe effects of the one-time reduction in accrued royalties and reduced royalty costs totaling $3.7 million in the third quarter of 2004. Net of the one-time reduction of $3.7 million in 2004, gross profit increased by $2.2 million primarily due to an increase in sales of $2.6 million partially offset by increaseda $0.2 million increase in standard product costs from increased unit sales.sales and an increase of $0.2 million in other royalty expenses. Gross margin was 86.6%85.1% in the quarter ended JuneSeptember 30, 2005, as compared to 79.6%85.7%, excluding the one-time reduction in accrued royalties and reduced royalty costs for the secondthird quarter of 2004.
Gross profit for the sixnine months ended JuneSeptember 30, 2005 was $17.4$27.1 million, an increase of approximately 41.4%15.3% from $12.3$23.5 million for the same period in the prior year. The gross profit increase was primarily due to increased sales adding $4.6 million and reduced royalty costs, partially offset by the one-time reduction in accrued royalties as of December 31, 2003 of $2.7 million and increased standard product costs from increased unit sales. Gross margin was 85.9%85.6% in the sixnine months ended JuneSeptember 30, 2005 as compared to 78.6%85.2%, excluding the one-time reduction in accrued royalties of $2.7 million, for the same period in the prior year.
Selling and marketing expenses
Selling and marketing expenses were $4.8$4.6 million, or 45.0%40% of product sales, for the quarter ended JuneSeptember 30, 2005, compared to $3.8$4.2 million, or 45.4%47.4% of product sales, for the secondthird quarter of 2004. The dollar increase was largelyprimarily attributable to $0.7increased salary and associated personnel costs of $0.3 million relateddue to expansiona higher average number of our direct sales force personnel and associated costs for travel and personnel costs, $0.2$0.3 million related to new marketing programs, and $0.1partially offset by a decrease of $0.2 million in stock-based compensation expense.expense, which was higher in the third quarter of 2004 due to the expense for a non-employee option grant. We expect our selling and marketing expenditures to

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continue to increase in 2005 as we continue our efforts to expand our markets.
Selling and marketing expenses were $9.5$14.1 million, or 47.0%44.5% of product sales for the sixnine months ended JuneSeptember 30, 2005, compared to $7.5$11.6 million, or 47.9%47.7% of product sales for the same period in 2004. The dollar increase was primarily due to $1.2increased salary and associated personnel costs of $1.5 million due to a higher average number of direct sales force personnel and $0.9 million related to expansion of our direct sales force and associated costs for travel and personnel costs, $0.6 million related to new marketing programs and $0.2 million in stock-based compensation expense.programs.

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General and administrative expenses
General and administrative expenses were $1.9$2.0 million, or 17.6%17.2% of product sales, for the quarter ended JuneSeptember 30, 2005, compared to $0.9$1.1 million, or 11.0%12.3% of product sales, for the secondthird quarter of 2004. The increase in expenses is primarily due to various costs associated with being a public company, such as increased accounting fees associated with public reporting, costs associated with compliance with section 404 of the Sarbanes-Oxley Act, implementation of FAS123R and increases in headcount and associated personnel costs. We expect our general and administrative expenses to continue to increase in 2005 primarily relatedconjunction and due to costs associated with compliance with Section 404 of the Sarbanes-Oxley Act and other costs associated with being a public company.
General and administrative expenses were $3.4$5.4 million, or 16.8%16.9% of product sales, for the sixnine months ended JuneSeptember 30, 2005, compared to $1.6$2.6 million, or 9.9%10.8% of product sales, for the same period in 2004. The increase in expenses is primarily due to costs associated with being a public company of $1.5$2.5 million, in additionwhich includes fees related to increasedaccounting and tax services, Sarbanes-Oxley Act implementation consulting, investor relations services, insurance and legal expense, for patents of $0.1 million and stock basedstock-based compensation expense of $0.1$0.2 million.
Research and development expenses
Research and development expenses were $1.2$1.6 million, or 11.4%14.3% of product sales, for the quarter ended JuneSeptember 30, 2005, compared to $0.7$0.6 million, or 8.1%6.4% of product sales, for the secondthird quarter of 2004. The increase is primarily due to costs associated with our continued product development efforts of $0.4$0.9 million in addition to increases associated with headcount and associated personnel costs or $0.1of $0.2 million. We expect that our research and development costs will continue to increase in 2005 as comparedconjunction with costs related to 2004 as the result of additional clinical trials and product development.
Research and development expenses were $2.1$3.7 million, or 10.3%11.7% of product sales, for the sixnine months ended JuneSeptember 30, 2005, compared to $1.2$1.8 million, or 7.6%7.2% of product sales, for the same period in 2004. The increase is primarily due to costs associated with our continued product development efforts of $0.6 million, including clinical trial costs and costs associated with the induction of labor indication for the Fetal Fibronectin Test of $0.1$1.5 million expenses related to personnel and associated costs of $0.2$0.4 million, and stock-based compensation expense of $0.1 million.
Interest income
We recognized interest income of $593,000$0.7 million for the quarter ended JuneSeptember 30, 2005, an increase of $562,000$0.7 million from the same period in 2004, primarily due to higher cash balances earning interest largely as a result of our recently completedDecember 2004 initial public offering.offering that was completed in December 2004. We expect interest income to remain consistent with the interest income earned in the secondthird quarter of 2005.
We recognized interest income of $1.1$1.8 million for the sixnine months ended JuneSeptember 30, 2005, an increase of $1.0$1.7 million from the same period in 2004, primarily due to higher cash balances earning interest due to the proceeds from our recently completedDecember 2004 initial public offering. We expect future interest income to fluctuate based on prevailing interest rates and changes in our cash balances.
Provision for income taxes
We recorded a provision for income taxes of $102,000$136,000 for the quarter ended JuneSeptember 30, 2005, related to federal alternative minimum taxes and state taxes compared to a benefitprovision of approximately $19,000$226,000 for the same period in 2004. Our effective tax rate for the quarter ended JuneSeptember 30, 2005 was 5.28%. The effective tax rate is lower than the statutory rate due primarily to tax benefits arising from the utilization of net operating losses to the extent allowable under current law. The effective tax rate decreased period-over-period due to changes in a variety of estimates of inputs required to calculate the estimated tax rate for the year. The benefit recorded in the quarter ended June 30,and 2004 was the result of an accrual adjustment.
6.0% and 4.0%, respectively. We recorded a provision for income taxes of $183,000$319,000 for an effective tax rate of 5.28%5.5% for the sixnine months ended JuneSeptember 30, 2005 compared to a provision of $81,000$307,000 for an effective tax rate of 8.5%4.0% for the same period in 2004. The effective tax rate for bothall periods is lower than the statutory rate due primarily to tax benefits arising from the utilization of net operating losses to the extent allowable under current law.
A valuation allowance is recorded to reduce any deferred tax asset that is more likely than not to be not realized. We perform

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assessments of the realization of our deferred tax assets considering all available evidence, both positive and negative. These assessments require that management make significant judgments about many factors, including the amount and likelihood of future taxable income. As a result of this assessment, we have concluded that it was more likely than not that our deferred tax assets would not be realized and have recorded a full valuation allowance against our deferred tax assets. We will continue to evaluate the need for a valuation allowance. We may determine that some, or all, of our deferred tax assets will be realized, in which case we will reduce

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ourreduceour valuation allowance in the quarter in which such determination is made. If the valuation allowance is reduced, we may recognize a benefit from income taxes on our income statement in that period. If such a benefit is recognized, then subsequent periods mayare likely to have significantly higher tax provision expenses.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, our operations have been primarily financed through privatepublic and publicprivate equity investments, working capital provided by our product sales, capital leases, and research and development contracts. As of JuneSeptember 30, 2005 our cash and cash equivalents were $83.0$86.8 million. All of our cash equivalents have original maturities of three months or less. During the sixnine months ended JuneSeptember 30, 2005, our operating activities provided cash of approximately $2,602,000,$5.8 million, compared to approximately $2,443,000$2.6 million during the same period of 2004. The increase period-over-period is due primarily related to anthe increase in net income, partially offset bynet of the $2.7 million one-time reduction in accrued royalties in 2004, plus changes in working capital, including an increase in accounts receivable.capital.
Our investing activities used cash of approximately $117,000$0.2 million during the sixnine months ended JuneSeptember 30, 2005, compared to $40,000$0.1 million for the same period of 2004. Investing activities in for both periods were related to purchases of equipment.
Net cash provided by financing activities of approximately $356,000$1.1 million during the sixnine months ended JuneSeptember 30, 2005, compared to none during the same period of 2004, were related to cash generated from stock option exercises.
As of JuneSeptember 30, 2005, we had no long-term debt, capital lease obligations or long-term purchase agreements or commitments other than atwo facility lease which we have for a one-year term with two one-year renewal options and an operating lease for a new telephone system.
In addition to cash generated from product sales, we believe our existing cash and cash equivalents will be sufficient to meet our anticipated cash requirements for at least the next two years. However, future research and development, clinical trials and sales and marketing expenses, as well as administration support, or licensing or acquisition of other products may require additional capital resources. We may raise additional funds through public or private equity offerings, debt financings, capital lease transactions, corporate collaborations or other means. Due to the uncertainty of financial markets, financing may not be available to us on acceptable terms or at all. Therefore, we may raise additional capital from time to time due to favorable market conditions or strategic considerations even if we have sufficient funds for planned operations.
Our future capital requirements are difficult to forecast and will depend on many factors, including:
 success of our product sales and related collections;
 
 future expenses to expand and support our sales and marketing activities;
 
 costs relating to changes in regulatory policies or laws that affect our operations;
 
 maintaining and expanding our manufacturing capacity;
 
 the level of investment in research and development and clinical trials required to maintain and improve our technology position;
 
 costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; and
 
 our need or decision to acquire or license complementary businesses, products or technologies.
If at any time sufficient capital is not available, either through existing capital resources or through raising additional funds, we may be required to delay, reduce the scope of, eliminate or divest one or more of our research, clinical or sales and marketing programs or our entire business.

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FACTORS THAT MAY AFFECT FUTURE RESULTS
RISKS RELATING TO OUR BUSINESS
Because our revenues and financial results depend significantly on a limited product line, if we are unable to manufacture or sell our products in sufficient quantities and in a timely manner, our business will suffer.
To date, substantially all of our revenue has resulted from sales of our principal product line, our FullTerm, The Fetal Fibronectin Test, the TLiIQ System (and its predecessor, the TLi System) and related consumables. Although we intend to introduce additional products, we expect sales of the Fetal Fibronectin Test to account for substantially all of our near-term revenue. Because our business is highly dependent on our Fetal Fibronectin Tests, the TLiIQ System and the related consumables, factors adversely affecting the pricing of or demand for these products could have a material and adverse effect on our business and cause the value of our securities to decline substantially. We will lose revenue if alternative diagnostic products or technologies gain commercial acceptance or if reimbursement is limited. We cannot assure you that we will be able to continue to manufacture these products in commercial quantities at acceptable costs. Our inability to do so would adversely affect our operating results and cause our business to suffer.
If our products do not achieve and sustain market acceptance, we may fail to generate sufficient revenue to maintain our business.
Our commercial success depends in large part on our ability to achieve and sustain market acceptance of our principal product line, FullTerm, The Fetal Fibronectin Test and the TLiIQ System. A key element of our business plan calls for us to expand sales of our TLiIQ System in hospitals and clinical laboratories and increase the related sales of the Fetal Fibronectin Test and other consumables used in conjunction with the TLiIQ System. To accomplish this, we will need to convince healthcare providers of the benefits of our products through various means, including through published papers, presentations at scientific conferences and additional clinical trials. If existing users of our products determine that these products do not satisfy their requirements, or if our competitors develop a product perceived to better satisfy their requirements, our sales of Fetal Fibronectin Tests and other consumables may decline, and our revenues may correspondingly decline.
In addition, our commercial success may depend on our ability to gain market acceptance for our other products and product candidates. Market acceptance of our product portfolio will depend on our ability to develop additional applications of our existing products and to introduce new products to additional markets, including the oncology diagnostic market, the reproductive endocrinology and infertility markets and other women’s health markets.

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Other factors that might influence market acceptance of our products and product candidates include the following:
 evidence of clinical utility;
 
 convenience and ease of use;
 
 availability of alternative and competing diagnostic products;
 
 cost-effectiveness;
 
 effectiveness of marketing, distribution and pricing strategy;
 
 publicity concerning these products or competitive products, and
 
 reimbursement.
In addition, our marketing and development efforts could require us to expend significant time and resources, and we may not succeed in these efforts. If our products are unable to achieve or maintain broad market acceptance, our revenues and operating results may be negatively impacted and our business would suffer.
Our quarterly revenues and operating results are subject to significant fluctuations, and our stock price may decline if we do not meet the expectations of investors and analysts.

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As of JuneSeptember 30, 2005, we had an accumulated deficit of $41.5$39.3 million. For the three and sixnine month periods ended JuneSeptember 30, 2005, we had net income of $1.8$2.2 million and $3.3$5.4 million, respectively. However, we may not sustain profitability and cannot guarantee losses will not occur in the future. Our quarterly revenues and operating results are difficult to predict and have in the past and may in the future fluctuate significantly from quarter to quarter due to a number of factors, many of which are outside our control. These factors include, but are not limited to:
 our ability to increase market acceptance of women’s health diagnostics generally and of our products in particular, as discussed under “Factors that may affect future results— if our products do not achieve and sustain market acceptance, we may fail to generate sufficient revenue to maintain our business”;
 
 our need and ability to generate and manage growth as discussed under “Factors that may affect future results — if we fail to properly manage our anticipated growth in the United States or abroad, we may incur significant additional costs and expenses and our operating results may suffer”;
 
 delays in, or failure of, delivery of components by our suppliers as more fully described in “Factors that may affect future results— we rely on a limited number of suppliers, and if these suppliers fail or are unable to perform in a timely and satisfactory manner, we may be unable to manufacture our products or satisfy product demand in a timely manner, which could delay the production or sale of these products”;
 
 the seasonal nature of our business and quarterly variations in demand for our products based on procurement cycles of our customers;
 
 changes in the manner in which our operations are regulated;
 
 increases in the length of our sales cycle;
 
 fluctuations in gross margins; and
 
 difficult political and economic conditions.
These and other factors make it difficult for us to predict sales for subsequent periods and future performance. If our quarterly operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and

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significantly. We believe quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.
In addition, we expect to incur additional expenses to execute our business plan, and these expenses will increase as we expand our marketing efforts, research and development activities, clinical testing and manufacturing capacity. These expenses, among other things, may cause our net income and working capital to decrease or result in a net loss. If sales do not continue to grow, we may not be able to maintain profitability. Our expansion efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues sufficiently to offset these higher expenses. If we fail to do so, the market price for our common stock will likely decline.
If third-party payors do not adequately reimburse our customers, market acceptance of our products may be impaired, which may adversely affect our revenues and our operating results.
Market acceptance of our products and the majority of our sales depend, in large part, on the availability of adequate reimbursement for the use of our products from government insurance plans, including Medicare and Medicaid, managed care organizations, private insurance plans and other third-party payors primarily in the United States and, to a lesser extent abroad. Third-party payors are often reluctant to reimburse healthcare providers for the use of medical diagnostic products incorporating new technology.
Because each third-party payor individually approves reimbursement, obtaining these approvals can be a time-consuming and costly process that requires us to provide scientific and clinical support for the use of each of these products to each third-party payor separately with no assurance that approval will be obtained. For example, while the policies of some third-party payors limit reimbursement for the use of our Fetal Fibronectin Test to women with signs and symptoms of preterm labor, other third-party payors provide reimbursement for broader use of our Fetal Fibronectin Test.labor. This individualized process can delay the market acceptance of new products and may have a negative effect on our revenues and operating results.

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Market acceptance of our products internationally may depend in part upon the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country and include both government sponsored healthcare and private insurance. We may not obtain international reimbursement approvals in a timely manner, if at all. Our failure to receive international reimbursement approvals may negatively impact market acceptance of our products in the international markets in which those approvals are sought.
We believe third-party payors are increasingly limiting coverage for medical diagnostic products in the United States and internationally, and in many instances are exerting pressure on medical products suppliers to reduce their prices. Consequently, third-party reimbursement may not be consistently available or adequate to cover the cost of our products. Additionally, third-party payors who have previously approved a specific level of reimbursement may reduce that level. Under prospective payment systems, in which healthcare providers may be reimbursed a set amount based on the type of diagnostic procedure performed, such as those utilized by Medicare and in many privately managed care systems, the cost of our products may not be justified and reimbursed. This could limit our ability to commercialize and sell new products and continue to sell our existing products, or may cause the prices of our existing products to be reduced, which may adversely affect our revenues and operating results.
If we fail to properly manage our anticipated growth in the US or abroad, we may incur significant additional costs and expenses and our operating results may suffer.
Anticipated rapid growth of our business is likely to place a significant strain on our managerial, operational and financial resources and systems. In the United States, while we anticipate hiring additional personnel to assist in the planned expansion of sales efforts for our current products and the development of future products, we may not be able to successfully increase sales of current products or introduce new products and meet our growth goals. To manage our anticipated growth, we must attract and retain qualified personnel and manage and train them effectively. We will depend on our personnel and third parties to effectively market our products to an increasing number of hospitals, physicians and other healthcare providers. We will also depend on our personnel to develop next generation technologies. Further, our anticipated growth will place additional strain on our suppliers and manufacturers, as well as our own internal manufacturing processes, resulting in an increased need for us to carefully monitor for quality assurance. In addition, we may choose or be required to relocate or expand our manufacturing facility to accommodate potential growth in our business. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our revenue and profitability goals.

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Our plans to significantly expand our presence in international markets will cause us to incur various costs and expenses and may strain our operating and financial systems and resources in a manner that could materially and adversely affect our operating results. We will be subject to the regulatory oversight of additional authorities as we expand internationally. These authorities may impose regulations and restrictions on the sales and marketing of our products that are different and potentially more restrictive than those placed on us by regulators in the US. We may be required to expend considerable resources to comply with these requirements. Ultimately, we may not be able to comply with such regulations in a timely manner, if at all. If we are unable to satisfy these requirements on commercially reasonable terms, our ability to commercialize our products would be hampered and our revenues may be adversely affected.
We will need to devote considerable resources to comply with federal, state and foreign regulations and, if we are unable to fully comply, we could face substantial penalties.
We are directly or indirectly through our customers subject to extensive regulation by both the federal government and the states and foreign countries where we conduct our business. Companies such as ours are required to expend considerable resources complying, in particular, with laws such as the following:
 the Federal Food, Drug and Cosmetic Act, which regulates the design, testing, manufacture, labeling, marketing, distribution and sale of medical devices;
 
 the Federal Anti-Kickback Law, which prohibits the illegal inducement of referrals for which payment may be made under federal healthcare programs such as the Medicare and Medicaid Programs;
 
 Medicare laws and regulations that prescribe the requirements for coverage and payment, including the amount of such payment, and laws prohibiting false claims for reimbursement under Medicare and Medicaid;
 
 CE mark which could limit our ability to sell in Europe, and
ISO 13485 which could limit our ability to sell in Canada.

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ISO 13485 which could limit our ability to sell in Canada.
Companies such as ours are also required to comply with laws and regulations regarding the practice of medicine by non-physicians, consumer protection and Medicare and Medicaid payments. If our past or present operations are found to be in violation of any of the laws described above or the other governmental regulations to which we or our customers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations. If we are required to obtain permits or licenses under these laws that we do not already possess, we may become subject to substantial additional regulation or incur significant expense. Any penalties, damages, fines, curtailment or restructuring of our operations may adversely affect our ability to operate our business and our financial results. Because many of these laws have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations and additional legal or regulatory change, we may be at a heightened risk of being found to be in violation of these laws. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from the operation of our business and damage our reputation.
If we are unable to maintain our existing regulatory approvals and clearances for our existing products, or obtain new regulatory approvals and clearances for our product candidates, our ability to commercially distribute our products and our business may be significantly harmed.
The US Food and Drug Administration, or FDA, and comparable agencies of other countries generally regulate our products as medical devices. In the United States, FDA regulations govern, among other things, the activities that we perform, including product development, product testing, product labeling, product storage, manufacturing, advertising, promotion, product sales, reporting of certain product failures and distribution. Most of the new products that we plan to develop and commercialize in the United States will require either pre-market notification, also known as 510(k) clearance, or pre-market approval, from the FDA prior to marketing. The 510(k) clearance process requires us to notify the FDA of our intent to market a medical device. The overall 510(k) clearance process usually takes from three to twelve months from the time of submission to being ablethe time that you can begin to sell a product in the market, but can take significantly longer. The pre-market approval process, often referred to as the PMA process, is much more costly, lengthy and uncertain and generally takes between one and three years from submission to PMA approval, but may take significantly longer and such clearance or approval may never be obtained.

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All of the products that we have submitted and may submit in the future for FDA clearance or approval are or will be subject to substantial restrictions, including, among other things, restrictions on the indications for which we may market our products, which could result in reductions in or an inability to grow our revenues. Even if regulatory approval of a product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or certain requirements for costly post-marketing testing and surveillance to monitor the performance and clinical utility of the product. For example, any of our products that have received FDA approval, such as our FullTerm, The Fetal Fibronectin Test or TLiIQ System, remain subject to ongoing post-marketing regulation and oversight by the FDA. The marketing claims that we are permitted to make in labeling our diagnostic products, if cleared or approved by the FDA, are limited to those specified in any clearance or approval. Our intention to expand the use of our products into new areas such as the prediction of successful induction of labor and oncology will require us to make new submissions to the FDA.
In addition, we are subject to review, periodic inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements for any product for which we obtain marketing approval. Following approval, our manufacturing processes, subsequent clinical data and promotional activities are subject to ongoing regulatory obligations. If the FDA finds that we have failed to comply with these requirements or later discovers previously unknown problems with our products, including unanticipated adverse events of unanticipated severity or frequency, manufacture or manufacturing processes or failure to comply with regulatory requirements, it can institute a wide variety of enforcement actions, ranging from a public warning letter to more severe sanctions, including:
 fines, injunctions and civil penalties;
 
 recall or seizure of our products;
 
 restrictions on our products or manufacturing processes, including operating restrictions, partial suspension or total shutdown of production;

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 denial of requests for 510(k) clearances or PMAs of product candidates;
 
 withdrawal of 510(k) clearances or PMAs already granted;
 
 disgorgement of profits; and
 
 criminal prosecution.
Any of these enforcement actions could affect our ability to commercially distribute our products in the United States and may also harm our ability to conduct the clinical trials necessary to support the marketing, clearance or approval of these products and could materially and adversely affect our business.
Our PMA supplement seeking approval for use of our FullTerm, The Fetal Fibronectin Test in predicting successful induction of labor has been submitted to the FDA. The FDA has placed its review of the application on hold while a third party we have engaged conducts an audit of all of the clinical study sites because of the number of protocol deviations, in order to confirm the accuracy of the data. Upon completion of the third-partyThe audit has been completed and we will need to submit new analyses of the data and a corrective action plan to the FDA before it will resume its review of the application. The new analyses of the data or the corrective action plan may not be acceptable to us or to the FDA and we may not continue to pursue or obtain FDA approval for this application.
We rely on our CLIA-certified laboratory located at our facility in Sunnyvale, California to process E-tegrity Tests. The Centers for Medicare and Medicaid Services, or the CMS, requires that operators of CLIA-certified laboratories submit to surveillance and follow-up inspections. If we are unable to meet the CMS’s requirements for continued operation pursuant to CLIA, our laboratory may lose its CLIA certification, and we may be unable to continue to process E-tegrity Tests. As a result, our business may be harmed.
If we modify our marketed products, we may be required to obtain new 510(k) clearances or PMAs, or we may be required to cease marketing or recall the modified products until clearances are obtained.
Any modification to a 510(k)-cleared or pre-market approved diagnostic device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance or PMA, such as the

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development of our FullTerm, The Fetal Fibronectin Test as a diagnostic test for the induction of labor. The FDA requires every manufacturer to make the determination of whether new clearance or approval is required for 510(k)-cleared devices. The FDA may review any manufacturer’s decision. The FDA may not agree with our decisions regarding whether new clearances or approvals are necessary. If the FDA requires us to seek 510(k) clearance or PMA for any modification to a previously cleared or approved product, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties. Any recall or FDA requirement that we seek additional approvals or clearances could result in delays, fines, costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA.
If we or any of our third-party manufacturers do not operate in accordance with Quality System Regulations, we could be subject to FDA enforcement actions, including the seizure of our products and the halt of our production.
We and any third-party manufacturers that we currently rely on or will rely on in the future, including those we rely on to produce components of our products, must continuously adhere to the current good manufacturing practices, or cGMP, set forth in the FDA’s Quality System Regulations, or QSR, and enforced by the FDA through its facilities inspection program. In complying with QSR, we and our third-party manufacturers must expend significant time, money and effort in design and development, testing, production, record keeping and quality control to assure that our products meet applicable specifications and other regulatory requirements. The failure to comply with these specifications and other requirements could result in an FDA enforcement action, including the seizure of products and shutting down of production. We or any of these third-party manufacturers may also be subject to comparable or more stringent regulations of foreign regulatory authorities. In any of these circumstances, our ability to develop, produce and sell our products could be impaired.
We have received regulatory approvals for some of the operations located at our Sunnyvale, California headquarters, including our CLIA-certified laboratory. Should we choose to relocate, or if for some reason we are required to relocate some or all of our facilities from this location, we may be required to apply for regulatory approvals for the new location. It may be difficult or impossible for us to obtain the necessary approvals to continue our business in its present form at any such new location, and our business may be

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harmed as a result.
If we experience delays in the development of new products or delays in planned improvements to our products, our commercial opportunities will be reduced and our future competitive position may be adversely affected.
To improve our competitive position, we believe that we will need to develop new products as well as improve our existing instruments, reagents and ancillary products. Improvements in automation and the number of tests that can be performed in a specified period of time will be important to the competitive position of our products as we market to a broader, perhaps less technically proficient, group of customers. Our ability to develop new products and make improvements in our products may face difficult technological challenges leading to delays in development. If we are unable to successfully complete development of new products or if we are unable to successfully complete the planned enhancements to our products, in each case without significant delays, our future
competitive position may be adversely affected.
If other companies develop and market technologies or diagnostic products faster than we do, or if those products are more cost effective or useful than our products, our commercial opportunities will be reduced or eliminated.
The extent to which any of our technologies and products achieve and sustain market acceptance will depend on numerous competitive factors, many of which are beyond our control. Competition in the medical devices and diagnostic products industries is intense and has been accentuated by the rapid pace of technological development. While no company directly competes with us in our core markets, there are other diagnostic techniques currently in use to diagnose the likelihood of preterm birth, such as ultrasound. In addition, other companies may develop new diagnostic products or technologies that could compete with or entirely displace our products and technologies. For example, other biomarkers, including cytokines and other proteins indicative of infection, and proteomics are the subject of research that may yield new products or technologies. The effectiveness of these alternative techniques may improve with time and additional research by clinicians or manufacturers. The medical devices and diagnostic products industries include large diagnostics and life sciences companies. Most of these entities have substantially greater research and development capabilities and financial, scientific, manufacturing, marketing, sales and service resources than we do. Some of them also have more experience than we do in research and development, clinical trials, regulatory matters, manufacturing, marketing and sales. These organizations also compete with us to:
pursue acquisitions, joint ventures or other collaborations;

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pursue acquisitions, joint ventures or other collaborations;
 license proprietary technologies that are competitive with our technologies;
 
 attract funding; and
 
 attract and hire scientific and other talent.
If we cannot successfully compete with new products or technologies, sales of our products and our competitive position will suffer, and our stock price might be adversely affected. Because of their greater experience with commercializing technologies and larger research and development capabilities, other companies might succeed in developing and commercializing technologies or products earlier and obtaining regulatory approvals and clearances from the FDA more rapidly than we do. Other companies also might develop more effective technologies or products that are more predictive, more highly automated or more cost-effective, which may render our technologies or products obsolete or non-competitive.
We rely on a limited number of suppliers, and if these suppliers fail or are unable to perform in a timely and satisfactory manner, we may be unable to manufacture our products or satisfy product demand in a timely manner, which could delay the production or sale of these products.
We rely on a limited number of suppliers for both raw materials and components necessary for the manufacture of our products, including our FullTerm, The Fetal Fibronectin Test and TLiIQ System. We acquire all of these components, assemblies and raw materials on a purchase-order basis, which means that the supplier is not required to supply us with specified quantities over a certain period of time or to set aside part of its inventory for our forecasted requirements. If we need alternative sources for key components, assemblies or raw materials for any reason, such components, assemblies or raw materials may not be immediately available. If alternative suppliers are not immediately available, we will have to identify and qualify alternative suppliers, and delivery of such components, assemblies or raw materials may be delayed. Consequently, if we do not forecast properly, or if our suppliers are unable or unwilling to supply us in sufficient quantities or on commercially acceptable terms, we may not have access to sufficient quantities of these components, assemblies and raw materials on a timely basis and may not be able to satisfy product demand. We also rely upon a fulfillment provider to process orders for our products, coordinate invoicing and collections, as well as ship our products to customers in the United States. We may not be able to find an adequate alternative supplier or fulfillment provider if required, in a reasonable time period, or on commercially acceptable terms, if at all. Our inability to obtain a supplier for the manufacture of our products may force us to curtail or cease operations, which would have a material adverse effect on our product sales and profitability. During 2005, we plan to transfer this fulfillment operation back to Adeza. Any problems with this transition may have a material adverse effect on our product sales and profitability.
In addition, if any of these components, assemblies or raw materials are no longer available in the marketplace, we will be forced to further develop our technologies to incorporate alternate components, assemblies and raw materials and to do so in compliance with QSR. If we incorporate new components, assemblies or raw materials into our products, we may need to seek and obtain additional approvals or clearances from the FDA or foreign regulatory agencies, which could delay the commercialization of these products.
We depend on distributors to market and sell our products in overseas markets, and if our foreign distributors fail in their efforts or are unwilling or unable to devote sufficient resources to market and sell our products, our ability to effectively market our products and our business will be harmed.
If we cannot successfully compete with new products or technologies, sales of our products and our competitive position will suffer, and our stock price might be adversely affected. Because of their greater experience with commercializing technologies and larger research and development capabilities, other companies might succeed in developing and commercializing technologies or products earlier and obtaining regulatory approvals and clearances from the FDA more rapidly than we do. Other companies also might develop more effective technologies or products that are more predictive, more highly automated or more cost-effective, which may render our technologies or products obsolete or non-competitive.
We rely on a limited number of suppliers, and if these suppliers fail or are unable to perform in a timely and satisfactory manner, we may be unable to manufacture our products or satisfy product demand in a timely manner, which could delay the production or sale of our products.
We rely on a limited number of suppliers for both raw materials and components necessary for the manufacture of our products, including our FullTerm, The Fetal Fibronectin Test and TLiIQ System. We acquire all of these components, assemblies and raw materials on a purchase-order basis, which means that the supplier is not required to supply us with specified quantities over a certain period of time or to set aside part of its inventory for our forecasted requirements. If we need alternative sources for key components, assemblies or raw materials for any reason, such components, assemblies or raw materials may not be immediately available. If alternative suppliers are not immediately available, we will have to identify and qualify alternative suppliers, and delivery of such components, assemblies or raw materials may be delayed. Consequently, if we do not forecast properly, or if our suppliers are unable or unwilling to supply us in sufficient quantities or on commercially acceptable terms, we may not have access to sufficient quantities

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of these components, assemblies and raw materials on a timely basis and may not be able to satisfy product demand. We also relied upon a fulfillment provider to process orders for our products, coordinate invoicing and collections, as well as ship our products to customers in the United States through September 30, 2005. We may not be able to find an adequate alternative supplier if required, in a reasonable time period, or on commercially acceptable terms, if at all. Our inability to obtain a supplier for the manufacture of our products may force us to curtail or cease operations, which would have a material adverse effect on our product sales and profitability. During 2005, we transferred the fulfillment operation back to Adeza. Any problems with this transition may have a material adverse effect on our product sales and profitability.
In addition, if any of these components, assemblies or raw materials are no longer available in the marketplace, we will be forced to further develop our technologies to incorporate alternate components, assemblies and raw materials and to do so in compliance with QSR. If we incorporate new components, assemblies or raw materials into our products, we may need to seek and obtain additional approvals or clearances from the FDA or foreign regulatory agencies, which could delay the commercialization of these products.
We depend on distributors to market and sell our products in overseas markets, and if our foreign distributors fail in their efforts or are unwilling or unable to devote sufficient resources to market and sell our products, our ability to effectively market our products and our business will be harmed.
Our international sales currently depend upon the marketing efforts of and sales by certain distributors in Europe, Australia, the Pacific Rim region and South America. In most instances, our distribution arrangements are governed by short-term purchase orders. We also rely upon certain of these distributors to assist in obtaining product registration and reimbursement approvals in certain international markets, and we may not be able to engage qualified distributors in our targeted markets. The distributors that we are able to obtain may not perform their obligations. If a distributor fails to invest adequate resources and support in promoting our products and training physicians, hospitals and other healthcare providers in the proper techniques for using our products or in awareness of our products, or if a distributor ceases operations, we would likely be unable to achieve significant sales in the territory represented by the distributor. If we decide to market new products abroad, we will likely need to educate our existing or new distributors about these new products and convince them to distribute the new products. If these distributors are unwilling or unable to market and sell our products, we may experience delayed or reduced market acceptance and sales of our products outside the United States. Our failure to engage adequate distributors, or the failure of the distributors to perform their obligations as expected, may harm our ability to effectively market our products and our business.

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The regulatory approval process outside the United States varies depending on foreign regulatory requirements and may limit our ability to develop, manufacture and sell our products internationally.
To market any of our products outside of the United States, we and our collaborative partners, including certain of our distributors, are subject to numerous and varying foreign regulatory requirements, implemented by foreign health authorities, governing the design and conduct of human clinical trials and marketing approval for diagnostic products. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process includes all of the risks associated with obtaining FDA approval set forth above, and approval by the FDA does not ensure approval by the health authorities of any other country, nor does the approval by foreign health authorities ensure approval by the FDA.
If our products do not perform as expected, we may experience reduced revenue, delayed or reduced market acceptance of our products, increased costs and damage to our reputation.
Our success depends on the market’s confidence that we can provide reliable, high quality medical diagnostic devices. Our customers are particularly sensitive to product defects and errors because of the use of our products in medical practice. Our reputation and the public image of our products may be impaired for any of the following reasons:
 failure of our products to perform as expected;
 
 a perception that our products are difficult to use; and
 
 litigation concerning the performance of our products.
Even after any underlying problems are resolved, any manufacturing defects or performance errors in our products could result in lost revenue, delay in market acceptance, damage to our reputation, increased service and warranty costs and claims against us.

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If product liability suits or other claims and product field actions are initiated against us, we may be required to engage in expensive and time-consuming litigation, pay substantial damages, face increased insurance rates and sustain damage to our reputation, which would significantly impair our financial condition.
Our business exposes us to potential product liability claims and field action risks that are inherent in the testing, manufacturing, marketing and sale of diagnostic products. We may be unable to avoid product liability claims or field actions, including those based on claims that the use or failure of our products resulted in a misdiagnosis or harm to a patient. Although we believe that our liability coverage is adequate for our current needs, and while we intend to expand our product liability insurance coverage to any products for which we obtain marketing approval, insurance may be unavailable, prohibitively expensive or may not fully cover our potential liabilities. If we are unable to maintain sufficient insurance coverage on reasonable terms or to otherwise protect against potential product liability claims or field actions, we may be unable to continue to market our products and develop new markets. Defending a lawsuit could be costly and significantly divert management’s attention from conducting our business. A successful product liability claim brought against us in excess of any insurance coverage we have at that time could cause us to incur substantial liabilities, potentially in excess of our total assets, and our business to fail. In addition, we are a specialty company focused on women’s health. We have a narrow customer base that is subject to significant malpractice litigation that may place us at risk of the same. In addition, product liability claims or product field action or other regulatory proceedings may damage our reputation by raising questions about our products’ safety and efficacy, could significantly harm our reputation, interfere with our efforts to market our products and make it more difficult to obtain the funding and commercial relationships necessary to maintain our business.
We depend on the services of key personnel to implement our strategy, and if we lose key management or scientific personnel, scientific collaborators or other advisors or are unable to attract and retain other qualified personnel, we may be unable to execute our business plan and our operations and business would suffer.
Our success depends, in large part, on the efforts and abilities of Emory Anderson, who is our President and Chief Executive Officer, Dr. Durlin Hickok, who is our Vice President, Medical Affairs, Dr. Robert Hussa, our Vice President, Research and Development, Mark Fischer-Colbrie, who is our Vice President of Finance and Administration and Chief Financial Officer, and Marian Sacco, our Vice President, Sales and Marketing, as well as the other members of our senior management and our scientific and technical personnel. While we have executed management continuity agreements, we do not currently have employment agreements with any of these individuals. We do not currently carry key person insurance on the lives of any of these executives. Many of these people have

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been members of our executive team for several years, and their knowledge of our business would be difficult or time-consuming to replace. We also depend on our scientific collaborators and other advisors, particularly with respect to our research and development efforts. If we lose the services of one or more of our key officers, employees or consultants, or are unable to retain or attract the services of existing or new scientific collaborators and other advisors, our research and development and product development efforts could be delayed or curtailed, our ability to execute our business strategy would be impaired, and our stock price might be adversely affected.
Most of our operations are currently conducted at a single location that may be at risk from earthquakes and other natural or unforeseen disasters.
We currently conduct all of our manufacturing, development and management activities at a single location in Sunnyvale, California near known fault zones. In addition, our E-tegrity Tests are currently processed solely through our CLIA-certified laboratory located at our Sunnyvale facility. Despite precautions taken by us, any future natural or man-made disaster, such as a fire, earthquake or terrorist activity, could cause substantial delays in our operations, damage or destroy our equipment or inventory, and reduce our sales or cause us to incur additional expenses. In addition, the facility and some pieces of manufacturing equipment would be difficult to replace and could require substantial replacement lead-time. A disaster could seriously harm our business and results of operations. While we carry insurance for certain business interruptions, some natural and man-made disasters are excluded from our insurance policies, including those caused by terrorist acts or earthquakes. We believe that our insurance coverage is generally adequate for our current needs in the event of losses not caused by excluded events, but we may be subject to interruptions caused by excluded events or extraordinary events resulting in losses in excess of our insurance coverage or for which we have no coverage. This could impair our operating results and financial condition.
If we use biological and hazardous materials in a manner that causes injury, we could be liable for damages.
Our research and development activities sometimes involve the controlled use of potentially harmful biological materials, hazardous materials and chemicals that are dangerous to human health and safety or the environment. We are subject on an ongoing basis to

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federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations might be significant and could negatively affect our profitability. We believe our safety procedures for handling and disposing of these materials comply in all material aspects with federal, state and local laws and regulations and to date, we have not been required to take any action to correct any noncompliance. However, we cannot completely eliminate the risk of accidental contamination or injury to third parties from the use, storage, handling or disposal of these materials. Although we believe our insurance coverage is adequate for our current needs, in the event of contamination or injury, we could be held liable for any resulting damages, and any liability could exceed our resources or any applicable insurance coverage we may have.
Potential business combinations could require significant management attention and prove difficult to integrate with our business, which could distract our management, disrupt our business, dilute stockholder value and adversely affect our operating results.
If we become aware of potential business combination candidates that are complementary to our business, which could include license, co-promote, joint venture, and other types of arrangements, we may decide to combine with such businesses or acquire their assets in the future. We have acquired businesses or product lines in the past. For example, we acquired exclusive rights to the SalEst Test in 2003. While we have not encountered such difficulties following our prior acquisitions, business combinations generally involve a number of additional difficulties and risks to our business, including:
 failure to integrate management information systems, personnel, research and development and marketing, operations, sales and support;
 
 potential loss of key current employees or employees of the other company;
 
 disruption of our ongoing business and diversion of management’s attention from other business concerns;
 
 potential loss of the other company’s customers;
 
 failure to develop further the other company’s technology successfully;
 
 unanticipated costs and liabilities; and
other accounting consequences.

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other accounting consequences.
In addition, we may not realize benefits from any business combination we may undertake in the future. If we fail to successfully integrate such businesses, or the technologies associated with such business combinations into our company, the revenue and operating results of the combined company could be adversely affected. Any integration process would require significant time and resources, and we may not be able to manage the process successfully. If our customers are uncertain about our ability to operate on a combined basis, they could delay or cancel orders for our products. We may not successfully evaluate or utilize the acquired technology or accurately forecast the financial impact of a combination, including accounting charges or volatility in the stock price of the combined entity. If we fail to successfully integrate other companies with which we may combine in the future, our business could be harmed.
If we fail to obtain necessary funds for our operations, we will be unable to continue to develop and commercialize new products and technologies and we may need to downsize or halt our operations.
We expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure, commercialization, manufacturing, clinical trials and research and development activities. We believe that our cash and cash equivalents, will be sufficient to meet our operating and capital requirements for at least the next two years. However, our present and future funding requirements will depend on many factors, including, among other things:
 the level of research and development investment required to maintain and improve our technology position;
 
 costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;
 
 the success of our product sales and related collections;

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 our need or decision to acquire or license businesses, products or technologies;
 
 maintaining or expanding our manufacturing or commercialization capacity;
 
 competing technological and market developments; and
 
 costs relating to changes in regulatory policies or laws that affect our operations.
As a result of these factors, we may need to raise additional funds, and we cannot be certain that such funds will be available to us on acceptable terms when needed, if at all. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish potentially valuable rights to our future products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to expand our operations, develop new products, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements and may be required to delay, reduce the scope of, eliminate or divest one or more of our research, clinical or sales and marketing programs or our entire business.
RISKS RELATING TO OUR INTELLECTUAL PROPERTY
If we are unable to protect our proprietary rights, we may not be able to compete effectively.
Our success depends significantly on our ability to protect our proprietary rights to the technologies used in our products. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions, to protect our proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example, our pending US and foreign patent applications may not issue as patents at all, or if they do, they may not issue as patents in a form that will be advantageous to us or may issue and be subsequently successfully challenged by others and invalidated. Additionally, our family of issued patents and patent applications, if and when issued, relating to our FullTerm, The Fetal Fibronectin Test and TLiIQ System, have a range of expiration dates from 2007 to 2025. Upon the expiration of one or more patents relating to our FullTerm, The Fetal Fibronectin Test and TLiIQ System, we may not be able to protect our proprietary rights relating to the technologies used in these products. In addition, our pending patent applications include claims to material aspects of our products and procedures that are not currently protected by

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issued patents. Both the patent application process and the process of managing patent disputes can be time-consuming and expensive. Competitors may be able to design around our patents or develop products that provide outcomes comparable to ours. Although we have taken steps to protect our intellectual property and proprietary technology, including entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants and advisors, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States.
If any of these events occur, our business will suffer and the market price of our common stock may decline.
Although we may initiate litigation to stop the infringement of our patent claims or to attempt to force an unauthorized user of our patented inventions or trade secrets to compensate us for the infringement or unauthorized use, patent and trade secret litigation is complex and often difficult and expensive, and would consume the time of our management and other significant resources. If the outcome of litigation is adverse to us, third parties may be able to use our technologies without payments to us. Moreover, other companies against whom we might initiate litigation may be better able to sustain the costs of litigation because they have substantially greater resources. Because of these factors relating to litigation, we may be effectively unable to prevent misappropriation of our patent and other proprietary rights.
Our rights to use technologies and patents licensed to us by third parties are not within our control, and we may not be able to commercialize our products without these technologies.
We have licensed a number of patents, including patents related to our FullTerm, The Fetal Fibronectin Test and our E-tegrity Test from third parties, including the Fred Hutchinson Cancer Research Center, Inverness Medical and the University of Pennsylvania. Our business may significantly suffer if one or more of these licenses terminate, if we or our licensors fail to abide by the terms of the licenses or fail to prevent infringement by third parties or if the licensed patents are found to be invalid.

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If we violate the terms of our licenses, or otherwise lose our rights to these patents, we may be unable to continue developing and selling our products. Our licensors or others may dispute the scope of our rights under any of these licenses. The licensors under these licenses may breach the terms of their respective agreements or fail to prevent infringement of the licensed patents by third parties. Loss of any of these licenses for any reason could materially harm our financial condition and operating results.
In addition, if we determine that our products do not incorporate the patented technology that we have licensed from third parties, or that one or more of the patents that we have licensed is not valid, we may dispute our obligation to pay royalties to our licensors.
Any dispute with a licensor could be complex, expensive and time-consuming and an outcome adverse to us could materially harm our business and impair our ability to commercialize our products, including our FullTerm, The Fetal Fibronectin Test. As a result, our stock price might be adversely affected.
If the use of our technologies conflicts with the intellectual property rights of third parties, we may incur substantial liabilities, and we may be unable to commercialize products based on these technologies in a profitable manner, if at all.
Other companies may have or acquire patent rights that they could enforce against us. If they do so, we may be required to alter our technologies, pay licensing fees or cease activities. If our technologies conflict with patent rights of others, third parties could bring legal action against us or our licensees, suppliers, customers or collaborators, claiming damages and seeking to enjoin manufacturing and marketing of the affected products. If these legal actions are successful, in addition to any potential liability for damages, we might have to obtain a license in order to continue to manufacture or market the affected products. A required license under the related patent may not be available on acceptable terms, if at all.
Because patent applications can take many years to issue, there may be currently pending applications unknown to us or reissuance applications that may later result in issued patents upon which our technologies may infringe. There could also be existing patents of which we are unaware that our technologies may infringe. In addition, if third parties file patent applications or obtain patents claiming technology also claimed by us in pending applications, we may have to participate in interference proceedings in the US Patent and Trademark Office to determine priority of invention. If third parties file oppositions in foreign countries, we may also have to participate in opposition proceedings in foreign tribunals to defend the patentability of the filed foreign patent applications. We may have to participate in interference proceedings involving our issued patents or our pending applications.
If a third party claims that we infringe upon its proprietary rights, it could cause our business to suffer in a number of ways, including:

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 we may become involved in time-consuming and expensive litigation, even if the claim is without merit;
 
 we may become liable for substantial damages for past infringement if a court decides that our technologies infringe upon a competitor’s patent;
 
 a court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be available on commercially acceptable terms, if at all, or which may require us to pay substantial royalties or grant cross-licenses to our patents; and
 
 we may have to redesign our product so that it does not infringe upon others’ patent rights, which may not be possible or could require substantial funds or time.
If any of these events occur, our business will suffer and the market price of our common stock may decline.
If we are involved in intellectual property claims and litigation, the proceedings may divert our resources and subject us to significant liability for damages, substantial litigation expense and the loss of our proprietary rights.
In order to protect or enforce our patent rights, we may initiate patent litigation. In addition, others may initiate patent litigation against us. We may become subject to interference proceedings conducted in patent and trademark offices to determine the priority of inventions. There are numerous issued and pending patents in the medical device field. The validity and breadth of medical technology patents may involve complex legal and factual questions for which important legal principles may remain unresolved.
Litigation may be necessary to assert or defend against infringement claims, enforce our issued and licensed patents, protect our trade

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secrets or know-how or determine the enforceability, scope and validity of the proprietary rights of others. Our involvement in intellectual property claims and litigation could:
 divert existing management, scientific and financial resources;
 
 subject us to significant liabilities;
 
 allow our competitors to market competitive products without obtaining a license from us;
 
 cause product shipment delays and lost sales;
 
 require us to enter into royalty or licensing agreements, which may not be available on terms acceptable to us, if at all; or
 
 force us to discontinue selling or modify our products, or to develop new products.
We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.
Many of our employees were previously employed at universities or other diagnostic companies, including our potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to market existing or new products, which could severely harm our business.
If we cannot obtain additional licenses to intellectual property owned by third parties that we desire to incorporate into new products we plan to develop, we may not be able to develop or commercialize these future products.
We are developing diagnostic products designed to expand the utility of fetal fibronectin in multiple applications. The technology that we ultimately may use in the development and commercialization of these future products may be protected by patent and other intellectual property rights owned by third parties. If we are unable to obtain rights to use necessary third-party intellectual property under commercially reasonable terms, or at all, we may be unable to develop these products, and this could harm our ability to expand our commercial product offerings and to generate additional revenue from these products.

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RISKS RELATING TO OUR COMMON STOCK
If we are unable to timely satisfy new regulatory requirements relating to internal controls, our stock price could suffer.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies do a comprehensive evaluation of their internal control over financial reporting. Beginning on December 31, 2005, we must perform an annual evaluation of our internal control over financial reporting, include in our annual report the results of the evaluation, and have our external auditors publicly attest to such evaluation. We have been working on our evaluation pursuant to an internal plan of action that calls for completion before the end of our fiscal year, but it is difficult for us to predict how long it will actually take to complete the evaluation, including the final assessment of the significance of any control deficiencies that may be found. If we fail to complete the evaluation on time, or if our external auditors cannot attest to our evaluation, we could fail to meet our regulatory reporting requirements and be subject to regulatory scrutiny and a loss of public confidence in our internal controls, which could have an adverse effect on our stock price.
If our principal stockholders, executive officers and directors choose to act together, they may be able to control our management and operations, which may prevent us from taking actions that may be favorable to our stockholders.
Our executive officers, directors and principal stockholders, and entities affiliated with them, beneficially own in the aggregate approximately 41.40% of our common stock as of March 31, 2005. This significant concentration of share ownership may adversely affect the trading price of our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. These stockholders, acting together, have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of

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ownership could have the effect of delaying, deferring or preventing a change in control of us or impeding a merger or consolidation, takeover or other business combination that could be favorable to our stockholders.
The future sale of our securities could dilute our common stockholders’ investments and negatively affect our stock price.
If our common stockholders sell substantial amounts of common stock in the public market, or the market perceives that such sales may occur, the market price of our common stock could fall. The holders of a substantial number of shares of our common stock, subject to some conditions, tocould require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. Furthermore, if we were to include in a company-initiated registration statement shares held by those holders pursuant to the exercise of their registration rights, the sale of those shares could impair our ability to raise needed capital by depressing the price at which we could sell our common stock.
If we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. Furthermore, we may enter into financing transactions at prices that represent a substantial discount to market price. Raising funds through the issuance of equity securities will dilute the ownership of our existing stockholders. A negative reaction by investors and securities analysts to any sale of debt or our equity securities could result in a decline in the trading price of our common stock.
The price and volume of our common stock experience fluctuations, which could lead to costly litigation for us.
Our stock price has been volatile fromvolatile. From December 10, 2004, the date of our initial public offering, through JuneSeptember 30, 2005, our stock has traded as high as $20.90 and as low as $10.97. The market price of our common stock may fluctuate substantially due to a variety of factors, including:
 media reports and publications and announcements about women’s health and cancer diagnostic products or new cancer treatments or innovations that could compete with our products;
 
 new regulatory pronouncements, changes in regulatory guidelines, such as adverse changes in reimbursement for women’s health and cancer diagnostic products, and the timing of regulatory approvals concerning the products in our pipeline;
 
 market conditions or trends related to the medical devices and diagnostic products industries or the market in general;
 
 changes in financial estimates or recommendations by securities analysts;
 
 the seasonal nature of our revenues and expenses;

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 variations in our quarterly operating results; and
 
 changes in accounting principles.
The market prices of the securities of medical devices and diagnostic products companies, particularly companies like ours without consistenta long history of product sales and earnings, have been highly volatile and are likely to remain highly volatile in the future. This volatility has often been unrelated to the operating performance of particular companies. Moreover, market prices for stocks of biotechnology and medical diagnostic related companies, particularly following an initial public offering, frequently reach levels that bear no relationship to the operating performance of these companies. These market prices may not be sustainable and are highly volatile. In the past, companies that experience volatility in the market price of their securities have often faced securities class action litigation. Whether or not meritorious, litigation brought against us could result in substantial costs, divert our management’s attention and resources and harm our ability to grow our business.
Anti-takeover provisions in our certificate of incorporation and bylaws and under Delaware law may inhibit a change in control or a change in management that our stockholders consider favorable.
Provisions in our certificate of incorporation and bylaws could delay or prevent a change of control or change in management that would provide our stockholders with a premium to the market price of our common stock. These provisions include those:
authorizing the issuance without further approval of “blank check” preferred stock that could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt;

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authorizing the issuance without further approval of “blank check” preferred stock that could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt;
 prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
 
 limiting the ability to remove directors;
 
 limiting the ability of stockholders to call special meetings of stockholders;
 
 prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of stockholders; and
 
 establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
In addition, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by our board of directors. These provisions and others could make it difficult for a third party to acquire us, or for members of our board of directors to be replaced, even if doing so would be beneficial to our stockholders. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt to replace the current management team. If a change of control or change in management is delayed or prevented, our stockholders may lose an opportunity to realize a premium on their shares of common stock or the market price of our common stock could decline.
We do not expect to pay dividends in the foreseeable future. As a result, our stockholders must rely on stock appreciation for any return on their investment in our common stock
We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of directors. Accordingly, our stockholders will have to rely on capital appreciation, if any, to earn a return on their investment in our common stock. Furthermore, we may, in the future, become subject to contractual restrictions on, or prohibitions against, the payment of dividends.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no significant changes in our market risk compared to the disclosures in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2004.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(c). Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer, concluded that our disclosure controls and procedures are effective at the reasonable assurance level.
Changes in internal controls.There were no changes in our internal controls over financial reporting during the quarter ended JuneSeptember 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Disclosure Controls.We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to correct any material deficiencies that we may discover. Our goal is to ensure that our senior management has timely access to material information that could affect our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may cause us to modify our disclosure controls and procedures. The effectiveness of controls cannot be absolute because the cost to design and implement a control to identify errors or mitigate the risk of errors occurring should not outweigh the potential loss caused by errors that would likely be detected by the control. Moverover, we believe that disclosure controls and procedures cannot be guaranteed to be 100% effective all of the time. Accordingly, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.

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PART II— OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On December 10, 2004, we completed an initial public offering of 3,750,000 shares of our common stock. The common stock sold in the offering was registered under the Securities Act of 1933, as amended, on the Registration Statement on Form S-1 (Reg. No. 333-118012) that was declared effective by the SEC on December 9, 2004. The offering commenced on December 10, 2004. On December 21, 2004, the underwriters in the offering exercised their over-allotment option to purchase an additional 562,500 shares of our common stock to cover over-allotments. All 4,312,500 of the shares sold in the offering were sold at the initial public offering price of $16.00 per share. After deducting underwriting discounts and commissions and offering expenses, we received net proceeds form the offering of approximately $61.9 million.
During the sixnine months ended JuneSeptember 30, 2005, we spent (i) approximately $9.3$14.1 million of the proceeds from the offering on sales and marketing efforts, (ii) approximately $2.0$3.7 million on research and development activities related to product development, clinical trials and regulatory approvals for additional indications for our Fetal Fibronectin Test, and (iii) approximately $3.4$5.4 million on working capital and other general corporate purposes. The remaining proceeds from the offering have been placed in temporary investments of marketable securities for future use as needed.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
(a)The Company held its annual meeting of stockholders on June 9, 2005.
(b)Votes regarding the election of our directors for terms expiring at our 2005 annual meeting of stockholders:
         
Term expiring in 2005 For Withheld
Nancy D. Burrus  11,306,551   22,761 
Craig C. Taylor  11,318,049   11,263 
The above directors constitute our Class I directors.

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Our board is composed of the elected Class I directors and the following continuing directors:
Andrew E. Senyei, MD
Emory V. Anderson
Michael P. Downey
Kathleen D. LaPorte
(c)Votes on the proposal to ratify the appointment of Ernst & Young LLP as the Company’s Registered Public Accounting firm for the 2005 fiscal year were as follows:
         
      Abstentions and broker
For Against non-votes
11,328,857  455    
None.
Item 5. Other Information
None.(a) In August 2005, Emory Anderson, our President and Chief Executive Officer, entered into a trading plan pursuant to Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, pursuant to which Mr. Anderson may sell up to approximately 25,000 shares of our common stock beginning on or after February 23, 2006.
In August 2005, Robert Hussa, our Vice President, Research and Development, entered into a trading plan pursuant to Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, pursuant to which Dr. Hussa may sell up to approximately 34,000 shares of our common stock beginning in November 2005.
Item 6. Exhibits
     
Exhibit  
number Description
 31.1  Certificate pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Emory V. Anderson.
     
 31.2  Certificate pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Mark D. Fischer-ColbrieFischer-Colbrie.
     
 32.1  Certificate pursuant to 18 U.S.C. Section 1350 of Emory V. AndersonAnderson.
     
 32.2  Certificate pursuant to 18 U.S.C. Section 1350 of Mark D. Fischer-Colbrie.

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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 12th14th day of AugustNovember 2005.
     
 ADEZA BIOMEDICAL CORPORATION
 By:  /s/ Emory V. Anderson  
  By/s/ Emory V. Anderson
President and Chief Executive Officer
     
   Emory V. Anderson
 By: /s/ Mark D. Fischer-ColbriePresident and Chief Executive Officer
  
  By:/s/ Mark D. Fischer-Colbrie
  
Mark D. Fischer-Colbrie
  Vice President, Finance and Administration and Chief Financial Officer

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    Chief Financial Officer

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EXHIBIT INDEX
     
Exhibit  
number Description
 31.1  Certificate pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Emory V. Anderson.
     
 31.2  Certificate pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of Mark D. Fischer-ColbrieFischer-Colbrie.
     
 32.1  Certificate pursuant to 18 U.S.C. Section 1350 of Emory V. Anderson.
     
 32.2  Certificate pursuant to 18 U.S.C. Section 1350 Mark D. Fischer-Colbrie.

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