UNITED STATES
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 September 30, 2008.

OR

o		Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from                      to                     .

Commission File Number: 000-31617

Vermillion, Inc.

Delaware		33-0595156
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

47350 Fremont Blvd., Fremont, California		94538
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (510) 226-2800

Former name, former address and former fiscal year, if changed since last report: Not applicable

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of October 31, 2008, the Registrant had 6,382,166 shares of common stock, par value $0.001 per share, outstanding.

 

 

Vermillion, Inc. and Subsidiaries
Table of Contents

						Page
PART I
Item 1				Financial Statements
				Consolidated Balance Sheets as of September 30, 2008, and December 31, 2007			1
				Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007			2
				Consolidated Statements of Changes in Stockholders’ Equity (Deficit) and Comprehensive Loss for the nine months ended September 30, 2008 and 2007			3
				Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007			4
				Notes to Consolidated Financial Statements			5
Item 2				Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3				Quantitative and Qualitative Disclosures About Market Risk			34
Item 4T				Controls and Procedures			34
PART II
Item 1				Legal Proceedings			35
Item 1A				Risk Factors			36
Item 2				Unregistered Sales of Equity Securities and Use of Proceeds			46
Item 3				Defaults Upon Senior Securities			46
Item 4				Submission of Matters to a Vote of Security Holders			46
Item 5				Other Information			46
Item 6				Exhibits			47
SIGNATURES							54
EX-31.1
EX-31.2
EX-32.0

Vermillion is a trademark of Vermillion, Inc. ProteinChip is a registered trademark of Bio-Rad Laboratories, Inc. BioSepra is a registered trademark of Pall Corporation.

PART I — FINANCIAL INFORMATION

Vermillion, Inc. and Subsidiaries

(Amounts in Thousands, Except Share and Par Value Amounts)

(Unaudited)

		September 30,				December 31,
		2008				2007
Assets
Current assets:
Cash and cash equivalents		$	1,877			$	7,617
Short-term investments, at fair value			—				8,875
Accounts receivable			31				19
Prepaid expenses and other current assets			814				1,064
Total current assets			2,722				17,575
Property, plant and equipment, net			742				1,938
Long-term investments, at fair value			3,552				3,902
Other assets			134				638
Total assets		$	7,150			$	24,053
Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable		$	1,126			$	2,975
Accrued liabilities			2,056				3,595
Current portion of convertible senior notes, net of discount			2,500				2,471
Total current liabilities			5,682				9,041
Long-term debt owed to related party			10,000				10,000
Convertible senior notes, net of discount			16,333				16,196
Other liabilities			—				278
Total liabilities			32,015				35,515
Commitments and contingencies (Note 5)
Stockholders’ deficit:
Preferred stock, $0.001 par value, 5,000,000 shares authorized, none issued and outstanding at September 30, 2008 and December 31, 2007			—				—
Common stock, $0.001 par value, 150,000,000 shares authorized at September 30, 2008 and December 31, 2007; 6,382,166 and 6,380,197 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively			6				6
Additional paid-in capital			228,402				227,895
Accumulated deficit			(253,193	)			(239,142	)
Accumulated other comprehensive loss			(80	)			(221	)
Total stockholders’ deficit			(24,865	)			(11,462	)
Total liabilities and stockholders’ deficit		$	7,150			$	24,053

See accompanying notes to consolidated financial statements.

Vermillion, Inc. and Subsidiaries

(Amounts in Thousands, Except Share and Per Share Amounts)

(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Revenue:
Products		$	5			$	—			$	10			$	—
Services			66				—				114				21
Total revenue			71				—				124				21
Cost of revenue:
Products			2				—				4				—
Services			—				—				20				15
Total cost of revenue			2				—				24				15
Gross profit			69				—				100				6
Operating expenses:
Research and development			1,135				2,181				4,262				6,390
Sales and marketing			388				517				1,784				1,347
General and administrative			1,581				2,090				5,062				8,626
Total operating expenses			3,104				4,788				11,108				16,363
Loss on sale of instrument business			—				—				—				(382	)
Loss from operations			(3,035	)			(4,788	)			(11,008	)			(16,739	)
Interest income			79				169				360				458
Interest expense			(508	)			(596	)			(1,561	)			(1,727	)
Loss on investments in auction rate securities			(1,124	)			—				(1,748	)			—
Other income (expense), net			(142	)			95				(128	)			17
Loss before income taxes			(4,730	)			(5,120	)			(14,085	)			(17,991	)
Income tax benefit (expense)			(14	)			3				34				1
Net loss		$	(4,744	)		$	(5,117	)		$	(14,051	)		$	(17,990	)
Loss per share — basic and diluted		$	(0.74	)		$	(1.06	)		$	(2.20	)		$	(4.26	)
Shares used to compute basic and diluted loss per common share			6,382,166				4,805,658				6,381,290				4,221,424

See accompanying notes to consolidated financial statements.

Vermillion, Inc. and Subsidiaries

(Amounts in Thousands, Except Share Amounts)

(Unaudited)

																		Accumulated
										Additional								Other				Total
		Common Stock								Paid-In				Accumulated				Comprehensive				Stockholders’				Comprehensive
		Shares				Amount				Capital				Deficit				Loss				Equity (Deficit)				Loss
Balance at December 31, 2006			3,922,044			$	39			$	207,991			$	(217,860	)		$	(71	)		$	(9,901	)
Net loss			—				—				—				(17,990	)			—				(17,990	)		$	(17,990	)
Foreign currency translation adjustment			—				—				—				—				(31	)			(31	)			(31	)
Comprehensive loss																										$	(18,021	)
Common stock shares issued in connection with:
Exercise of stock options			2,031				—				24				—				—				24
Employee stock purchase plan			2,309				—				21				—				—				21
Private offering, net of issuance costs and registration fees			2,451,309				25				19,076												19,101
Stock compensation charge			—				—				684				—				—				684
Balance at September 30, 2007			6,377,693			$	64			$	227,796			$	(235,850	)		$	(102	)		$	(8,092	)
Balance at December 31, 2007			6,380,197			$	6			$	227,895			$	(239,142	)		$	(221	)		$	(11,462	)
Net loss			—				—				—				(14,051	)			—				(14,051	)		$	(14,051	)
Realized loss on available-for-sale securities			—				—				—				—				98				98				98
Foreign currency translation adjustment			—				—				—				—				43				43				43
Comprehensive loss																										$	(13,910	)
Registration costs adjustment related to private placement offering			—				—				26				—				—				26
Payment for fractional shares related to 1 for 10 reverse stock split			(31	)			—				—				—				—				—
Common stock shares issued in connection with employee stock purchase plan			2,000				—				2				—				—				2
Stock compensation charge			—				—				479				—				—				479
Balance at September 30, 2008			6,382,166			$	6			$	228,402			$	(253,193	)		$	(80	)		$	(24,865	)

See accompanying notes to consolidated financial statements.

Vermillion, Inc. and Subsidiaries

(Amounts in Thousands)

(Unaudited)

		Nine Months Ended
		September 30,
		2008				2007
Cash flows from operating activities:
Net loss		$	(14,051	)		$	(17,990	)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on sale of instrument business			—				382
Charge on impairment of investments			1,748				—
Loss on sale and disposal of property and equipment			343				—
Depreciation and amortization			796				882
Stock-based compensation expense			479				684
Amortization of debt discount associated with beneficial conversion feature of convertible senior notes			166				182
Amortization of debt issuance costs			49				54
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable			(12	)			29
Decrease in prepaid expenses and other current assets			250				848
Decrease in other assets			555				19
Decrease in accounts payable and accrued liabilities			(3,361	)			(1,004	)
Decrease in deferred revenue			(27	)			(14	)
Decrease in other liabilities			(278	)			(82	)
Net cash used in operating activities			(13,343	)			(16,010	)
Cash flows from investing activities:
Sales of investments			11,675				3,300
Purchases of investments			(4,100	)			(7,300	)
Purchase of certificate of deposit pledged as collateral on letter of credit			(100	)			—
Proceeds from sale of property and equipment			94				—
Purchase of property, plant and equipment			(37	)			(235	)
Net cash provided by (used in) investing activities			7,532				(4,235	)
Cash flows from financing activities:
Registration costs adjustment related to private placement offering of common stock and warrants			26				—
Proceeds from exercises of stock options			—				24
Proceeds from purchase of common stock by employee stock purchase plan			2				21
Proceeds from private offering of common stock and common stock warrants, net of issuance costs and registration fees			—				19,101
Proceeds of loan from Quest Diagnostics Incorporated			—				2,917
Net cash provided by financing activities			28				22,063
Effect of exchange rate changes on cash and cash equivalents			43				(31	)
Net increase (decrease) in cash and cash equivalents			(5,740	)			1,787
Cash and cash equivalents, beginning of period			7,617				17,711
Cash and cash equivalents, end of period		$	1,877			$	19,498
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	1,734			$	1,603
Income taxes			35				197

See accompanying notes to consolidated financial statements.

Vermillion, Inc. and Subsidiaries

(Unaudited)

1.		Organization, Basis of Presentation and Summary of Significant Accounting and Reporting Policies
		The Company
		Vermillion, Inc. (“Vermillion”; Vermillion and its wholly-owned subsidiaries are collectively referred to as the “Company”) is incorporated in the state of Delaware, and is engaged in the business of discovering, developing and commercializing diagnostics tests in the fields of oncology, hematology, cardiology and women’s health.
		Liquidity
		The accompanying consolidated financial statements of the Company were prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred significant net losses and negative cash flows from operations since inception. At September 30, 2008, the Company had an accumulated deficit of $253,193,000. On November 13, 2006, the Company completed the sale of assets and liabilities of the Company’s protein research products and collaborative services business (the “Instrument Business Sale”) to Bio-Rad Laboratories, Inc., and as a result the Company currently concentrates its resources on developing clinical protein biomarker diagnostic products and services, and it does not expect to generate substantial revenue until certain diagnostic tests are cleared by the United States Food and Drug Administration and commercialized. Management believes that current available resources will not be sufficient to fund the Company’s planned expenditures over the next twelve months. The Company’s ability to continue to meet its obligations and to achieve its business objectives is dependent upon, among other things, liquidating its investments in auction rate securities, raising additional capital or generating sufficient revenue in excess of costs. At such time as the Company requires additional funding, the Company will seek to raise such additional funding from various possible sources, including the public equity market, private financings, sales of assets, collaborative arrangements and debt. If Vermillion raises additional capital through the issuance of equity securities or securities convertible into equity, stockholders will experience dilution, and such securities may have rights, preferences or privileges senior to those of the holders of common stock or convertible senior notes. If the Company raises additional funds by issuing debt, the Company may be subject to limitations on its operations, through debt covenants or other restrictions. If the Company obtains additional funds through arrangements with collaborators or strategic partners, the Company may be required to relinquish its rights to certain technologies or products that it might otherwise seek to retain. In addition, auctions of the Company’s auction rate securities failed during the nine months ended September 30, 2008, due to a lack of buying demand. Consequently, the Company’s ability to liquidate and fully recover the carrying value of its auction rate securities in the near term is limited. There can be no assurance that the Company will be able to raise additional funds, or raise them on acceptable terms. If the Company is unable to obtain financing on acceptable terms, or to liquidate its investments in auction rate securities, it may be unable to execute its business plan, the Company could be required to delay or reduce the scope of its operations, and the Company may not be able to pay off the convertible senior notes if and when they come due. These consolidated financial statements do not include any adjustments relating to the recoverability or classification of recorded assets and liabilities or other adjustments that may be necessary should the Company not be able to continue as a going concern.
		The Company’s inability to operate profitably and to generate cash flows consistently from operations and its reliance on external funding either from loans or from equity, raise substantial doubt about the Company’s ability to continue as a going concern.
		Basis of Presentation
		The unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial statements and the instructions to Form 10-Q pursuant to Rule 10-01, Interim Financial Statements, of Regulation S-X promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, the unaudited consolidated financial statements do not include all of the disclosures required by GAAP for complete financial statements. The

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

December 31, 2007, consolidated balance sheet was derived from audited consolidated financial statements, but does not include all disclosures required by GAAP. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, filed with the SEC on March 31, 2008.

In the opinion of management, the unaudited consolidated financial statements contain all adjustments consisting only of a normal and recurring nature, which are considered necessary for a fair statement of the financial condition and results of operations for such periods. The accompanying unaudited consolidated financial statements include the accounts of the Company. All intercompany transactions have been eliminated in consolidation. The results of operations for the interim periods shown herein are not necessarily indicative of operating results for the entire year or any other future interim period.

At the February 14, 2008, Special Meeting of Stockholders, the stockholders of Vermillion approved the proposal to authorize the Board of Directors in its discretion, without further authorization of Vermillion’s stockholders, to amend Vermillion’s Certificate of Incorporation to effect a reverse split of Vermillion’s common stock by a ratio of between 1 for 6 to 1 for 10. On February 15, 2008, Vermillion’s Board of Directors approved a 1 for 10 reverse stock split (the “Reverse Stock Split”) of Vermillion’s common stock effective at the close of business on Monday, March 3, 2008. Accordingly, the basic and diluted loss per share on the consolidated statement of operations for the three and nine months ended September 30, 2007, was adjusted to reflect the impact of the Reverse Stock Split. The number of issued and outstanding shares of Vermillion’s common stock on the consolidated balance sheets at December 31, 2007, consolidated statement of changes in stockholders’ equity (deficit) and comprehensive loss at and for the nine months ended September 30, 2008 and 2007, was also adjusted to take into account the Reverse Stock Split. Additionally, all share and per share amounts were adjusted to take into account the Reverse Stock Split in the accompanying notes to the consolidated financial statements.

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimated results.

Reclassification

The Company made certain reclassifications to prior period consolidated financial statements to conform to the September 30, 2008, presentation.

Research and Development Costs

Research and development costs are expensed as incurred. Research and development costs consist primarily of payroll and related costs, materials and supplies used in the development of new products, and fees paid to third parties that conduct certain research and development activities on behalf of the Company. Software development costs incurred in the research and development of new products are expensed as incurred until technological feasibility is established.

On January 1, 2008, the Company adopted Emerging Issues Task Force (the “EITF”) Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities. EITF Issue No. 07-3 requires companies to defer and capitalize prepaid, nonrefundable research and development payments to third parties over the period that the research and development activities are performed or the services are provided, subject to an assessment of recoverability. The Company’s adoption of EITF Issue No. 07-3 had no impact on its consolidated financial statements.

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

Fair Value

Financial instruments include cash and cash equivalents, marketable securities, accounts receivables, accounts payable, accrued liabilities, convertible senior notes and the amount owed on a secured line of credit with Quest Diagnostics Incorporated (“Quest”). The estimated fair value of financial instruments has been determined using available market information or other appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value; therefore, the estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. The effect of using different market assumptions and/or estimation methodologies may be material to the estimated fair value amounts. The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities are at cost, which approximates fair value due to the short maturity of those instruments. The carrying value of marketable securities is at fair value, which is generally based on quoted market price of the marketable security, and if the quoted market price is not available, the fair value is extrapolated from the quoted market prices of similar marketable securities or by discounting the future cash flows taking into consideration the interest rate probabilities that reflect the risk associated with that marketable security. Historically, the carrying value of auction rate securities was at cost, which approximates fair value due to the frequent resetting of the interest rates. Upon auction failure, the fair value of each auction rate security is computed by discounting the future cash flows taking into consideration the interest rate probabilities that reflect the risk associated with that auction rate security. The future liquidation value is derived from the trend of indicative bid prices on the secondary market. The estimated fair value of the convertible senior notes is based on quoted market prices. The carrying value of the amount owed on a secured line of credit with Quest approximates fair value, which is based on discounting the future cash flows using applicable spreads to approximate current interest rates available to the Company.

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, on a prospective basis for its financial assets and liabilities as well as for nonfinancial assets and liabilities that are recognized or disclosed at fair value on a recurring basis in the consolidated financial statements. The adoption of SFAS No. 157 for its financial assets and liabilities as well as for nonfinancial assets and liabilities that are recognized or disclosed at fair value on a recurring basis in the consolidated financial statements had no impact on the consolidated financial statements. In February 2008, the Financial Accounting Standards Board (the “FASB”) issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis, until fiscal years beginning after November 15, 2008. The Company’s adoption of SFAS No. 157 for nonfinancial assets and liabilities measured at fair value on a nonrecurring basis is not expected to have a material impact on its consolidated financial statements.

SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. As defined in SFAS No.157, fair value is the price that would be received for an asset when sold or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The Company primarily applies the market approach for recurring fair value measurements and endeavors to utilize the best information available to it. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, and considers the security issuers’ and the third party insurers’ credit risk in its assessment of fair value. The Company classifies the determined fair value based on the observability of those inputs. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). SFAS No. 157 describes three levels of inputs that may be used to measure fair value, as follows:

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

	•		Level 1 inputs are quoted prices in active markets for identical assets or liabilities;
	•		Level 2 inputs are observable inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs derived from observable market data; and
	•		Level 3 inputs are unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities, and include assets and liabilities whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation (see additional information regarding the Company’s implementation of SFAS No. 157 in Note 10, “Fair Value”).

		On January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115. SFAS No. 159 provides entities with an option to report selected financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The Company has elected not to report selected financial assets and liabilities at fair value, and accordingly, there was no impact upon adoption of SFAS No. 159 to its consolidated financial statements.
2.		Recent Accounting Pronouncements
		Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active
		On October 10, 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active. FSP No. FAS 157-3 clarifies the application of SFAS No. 157 in an inactive market and provides an example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP No. FAS 157-3 was effective upon issuance, including periods for which financial statements had not been issued. The adoption of FSP No. 157-3 had no impact on the Company’s consolidated results of operation, financial position or cash flows as of and for the nine months ended September 30, 2008.
		Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock
		In June 2008, the EITF reached a consensus on EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock. EITF Issue No. 07-5 applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative instrument under paragraphs 6 to 9 of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. EITF Issue No. 07-5 provides a two-step approach to determine whether an entity’s equity-linked financial instrument or embedded feature is indexed to its own stock by evaluating the instrument’s contingent exercise provisions and settlement provisions. Equity-linked financial instruments or embedded features that are indexed to an issuer’s own stock and classified in stockholders’ equity in its statement of financial position are not considered derivative instruments under paragraph 11(a) of SFAS No. 133. EITF Issue No. 07-5 also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. EITF No. 07-5 is effective for financial statements issued for the fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Earlier application by an entity that has previously adopted an alternative accounting policy is not permitted. At September 30, 2008, the Company had warrants outstanding to purchase 2,293,147 shares of common stock with exercise prices between $9.25 and $25.00 per share. The Company is currently evaluating the impact of adopting EITF Issue No. 07-5 will have on its consolidated financial statements.
		Transition Guidance for Conforming Changes to Issue No. 98-5
		In June 2008, FASB issued EITF Issue No. 08-4, Transition Guidance for Conforming Changes to Issue No. 98-5. EITF Issue No. 08-4 provides transition guidance for conforming changes made to EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

result from EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, and SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. EITF Issue No. 08-4 is effective for financial statements issued for fiscal years ending after December 15, 2008. Earlier application is permitted. The effect, if any, of applying the conforming changes shall be presented retrospectively with the cumulative effect of the change being reported in retained earnings in the statement of financial position as of the beginning of the first period presented. The Company is currently evaluating the impact of adopting EITF No. 08-4 will have on its consolidated financial statements.

Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities

In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP No. EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method described in SFAS No. 128, Earnings Per Share. FSP No. EITF 03-6-1 requires that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. FSP No. EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings and selected financial data) to conform with the provisions of FSP No. EITF 03-6-1. Early application is not permitted. The Company does not expect the adoption of FSP No. EITF 03-6-1 to have an impact on its earnings per share.

The Hierarchy of Generally Accepted Accounting Principles

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not expect the adoption of SFAS No. 162 to have an impact on its consolidated financial statements.

Accounting for Convertible Debt Instruments That May Be Settled In Cash upon Conversion (Including Partial Cash Settlement)

In May 2008, the FASB issued FSP No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled In Cash upon Conversion (Including Partial Cash Settlement). FSP No. APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP No. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. FSP No. APB 14-1 shall be applied retrospectively to all periods presented unless instruments were not outstanding during any period included in the financial statements. The Company is currently evaluating the impact of adopting FSP No. APB 14-1 will have on its consolidated financial statements.

Determination of the Useful Life of Intangible Assets

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets. FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. FSP No. FAS 142-3 amends paragraph 11(d) of SFAS No. 142 to require an entity to use its own assumptions about renewal or extension of an arrangement, adjusted for the entity-specific factors in paragraph 11 of

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

		SFAS No. 142, even when there is likely to be substantial cost or material modifications. FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, with early adoption prohibited. The provisions of FSP No. FAS 142-3 are to be applied prospectively to intangible assets acquired after January 1, 2009, for the Company, although the disclosure provisions are required for all intangible assets recognized as of or subsequent to January 1, 2009. The Company does not expect the adoption of FSP No. FAS 142-3 to have an impact on its consolidated financial statements.
		Disclosures about Derivative Instruments and Hedging Activities
		In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133. SFAS No. 161 amends and expands the disclosure requirements with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact of adopting SFAS No. 161 will have on its consolidated financial statements.
		Accounting for Business Combinations
		In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) retains the fundamental requirements that the acquisition method of accounting, which was called the purchase method under SFAS No. 141, be used for all business combinations and for an acquirer to be identified for each business combination. SFAS No. 141(R) requires an acquirer to measure the assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values at the acquisition date, with limited exceptions. This replaces the cost-allocation process under SFAS No. 141, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. SFAS No. 141(R) also requires the acquirer in a business combination achieved in stages, which is sometimes referred to as a step acquisition, to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their fair values or other amounts determined in accordance with SFAS No. 141(R). SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The Company is currently evaluating the impact of adopting SFAS No. 141(R) will have on its consolidated financial statements.
		Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property
		In November 2007, the EITF reached a consensus on EITF Issue No. 07-01, Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property, which is focused on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties, how sharing payments pursuant to a collaboration agreement should be presented in the income statement and certain related disclosure questions. EITF Issue No. 07-01 is to be applied retrospectively for collaboration arrangements in fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting EITF Issue No. 07-01 will have on its consolidated financial statements.
3.		Short-Term and Long-Term Investments
		At September 30, 2008, the Company’s investments consisted of $3,552,000 invested in auction rate securities, which were classified as available-for-sale long-term investments due to failed auctions related to these investments through September 30, 2008. The underlying assets of these auction rate securities include student loans guaranteed by the United States Government under the Federal Family Education Loan Program, closed-end funds

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

and private placements. The maturity dates of these auction rate securities range from July 1, 2024, to November 1, 2047. These auction rate securities are intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined calendar intervals, which is generally every 28 days. Upon an auction failure, the interest rates do not reset at a market rate but instead reset based on a formula contained in the security, which is generally higher than the current market rate. The failure of the auctions means the Company may be unable to liquidate its auction rate securities into cash at par value until a future auction of these investments is successful or the auction rate security is refinanced by the issuer into another type of instrument. The Company used a weighted discounted cash flow (“DCF”) model to determine the estimated fair value as of September 30, 2008 (see assumptions used in preparing the DCF model in Note 10, “Fair Value”).

The Company reviews its impairment in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and FSP Nos. FASB 115-1 and FASB 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, in order to determine the classification of the impairment as “temporary” or “other-than-temporary”. A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income (loss) component of stockholders’ equity. Such an unrealized loss does not affect net income (loss) for the applicable accounting period. An other-than-temporary impairment charge is recorded as a realized loss in the consolidated statement of operations and increases net loss for the applicable accounting period. In evaluating the impairment of any individual auction rate securities, the Company classifies such impairment as temporary or other-than-temporary. The differentiating factors between temporary and other-than-temporary impairment are primarily the length of the time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer, and the Company’s intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.

The Company recognized an other-than-temporary impairment expense of $1,124,000 for the three months ended September 30, 2008, to reduce the carrying amount of six auction rate securities from $4,676,000 to $3,552,000, and an other-than-temporary impairment expense of $1,748,000 for the nine months ended September 30, 2008, to reduce the carrying amount of six auction rate securities from $5,300,000 to $3,552,000. The other-than-temporary impairment was a result of multiple auction failures for these auction rate securities and the Company’s inability to hold these auction rate securities until the recovery of the par amount due to operating cash requirements within the next twelve months. The other-than-temporary impairment is included in loss on investments in auction rate securities in the consolidated statement of operations. The Company had no net unrealized loss on marketable securities available-for-sale at September 30, 2008. The Company’s available-for-sale long-term investments consist of the following at September 30, 2008 (in thousands):

						Gross				Gross				Other-Than-
		Amortized				Unrealized				Unrealized				Temporary				Market
		Cost				Gain				Loss				Impairment				Value
Long-term investments:
Auction rate securities		$	5,300			$	—			$	—			$	(1,748	)		$	3,552

The Company’s available-for-sale short-term and long-term investments consist of the following at December 31, 2007 (in thousands):

						Gross				Gross
		Amortized				Unrealized				Unrealized				Market
		Cost				Gain				Loss				Value
Short-term investments:
Auction rate securities		$	8,875			$	—			$	—			$	8,875
Long-term investments:
Auction rate securities		$	4,000			$	—			$	(98	)		$	3,902

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

The unrealized loss positions of the Company’s available-for-sale short-term and long-term investments at December 31, 2007 were as follows (in thousands):

		Less Than 12 Months								12 Months or More								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
Short-term investments:
Auction rate securities		$	—			$	—			$	—			$	—			$	—			$	—
Long-term investments:
Auction rate securities		$	902			$	(98	)		$	—			$	—			$	902			$	(98	)

The scheduled contractual maturity dates for available-for-sale long-term investments at September 30, 2008, are as follows (in thousands):

						After 1 Year				After 5 Year
		Within				Through				Through				After
		1 Year				5 Years				10 Years				10 Years				Total
Long-term investments:
Auction rate securities		$	—			$	—			$	—			$	5,300			$	5,300

4.		Long-Term Debt
		4.50% Convertible Senior Notes Due September 1, 2008
		As a result of negotiations between the holders of the 4.50% convertible senior notes due September 1, 2008 (The “4.50% Notes”), and Vermillion, the $2,500,000 outstanding principal balance related to the 4.50% Notes, which matured on September 1, 2008, was not redeemed by Vermillion. Interest of $56,000 related to the 4.50% Notes was paid on the maturity date, September 1, 2008. Pursuant to the 4.50% Notes indenture agreement, late payment may result in payment of interest on the outstanding principal balance and overdue interest.
5.		Commitments and Contingent Liabilities
		ThinkPanmure LLC Agreement
		On July 2, 2008, Vermillion engaged ThinkPanmure LLC (“ThinkPanmure”), a global growth company investment bank, to assist Vermillion with identifying and evaluating strategic alternatives intended to enhance the potential of its peripheral artery disease (“PAD”) blood test (“VASCLIR™”) and ovarian tumor triage test (“OVA1™”), and its pipeline of proprietary biomarkers to maximize stockholder value. Under this agreement, Vermillion will pay ThinkPanmure a non-refundable retainer fee of $150,000, which will be credited against any transaction fees payable under this agreement. Pursuant to the agreement, Vermillion made a $50,000 payment on August 8, 2008, and $50,000 payment on September 26, 2008, towards the non-refundable retainer fee to ThinkPanmure. The remaining $50,000 payment towards the non-refundable retainer fee is due October 15, 2008. As of September 30, 2008, the non-refundable retainer fee of $100,000 is included in prepaid expenses and other current assets of the consolidated balance sheet. Upon closing of any strategic transaction, ThinkPanmure will be paid the greater of (1) $425,000 or (2) 1.5% of the aggregate consideration if it is with a company specified in the agreement; or will be paid the greater of (1) $425,000 or (2) 3.0% of the aggregate consideration received up to $50,000,000, 1.5% of the aggregate consideration received between $50,000,000 and $100,000,000, and 1.0% of the aggregate consideration received above $100,000,000 if it is with a company unspecified in the agreement. Vermillion also will reimburse ThinkPanmure for reasonable out-of-pocket expenses not to exceed $75,000. Additionally, if Vermillion receives any payment, including any payment for reimbursement of expenses, from another company in connection with the termination, abandonment or failure to complete a proposed strategic transaction, ThinkPanmure will be paid 25.0% of the breakup fee up to a maximum of $425,000.

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

Operating Lease

On June 3, 2008, the Company entered into a noncancelable operating lease for a new principal facility located in Fremont, California. Under the lease agreement, the term is from July 1, 2008, through June 30, 2010, with an annual base rent of $87,000 and $92,000 for the first year and second year, respectively. The Company will also pay common area charges, taxes and insurance with an annual estimated cost of $21,000. Additionally, under the lease agreement, the Company has pledged a $100,000 certificate of deposit as collateral on a letter of credit serving as a security deposit for the first year. For the second year, the certificate of deposit pledged as collateral on a letter of credit serving as a security deposit will be reduced to $60,000. The $100,000 certificate of deposit is restricted cash and is included in other assets of the consolidated balance sheet.

The lease to the Company’s former principal facility, located in Fremont, California, expired on July 31, 2008. On September 22, 2008, the Company was refunded its $553,000 security deposit related to the former principal facility.

Noncancelable Collaboration Obligations and Other Commitments

On January 30, 2008, Vermillion renewed its research collaboration agreement with The Johns Hopkins University School of Medicine (“JHU”) which was directed at the discovery and validation of biomarkers in human subjects, including but not limited to clinical application of biomarkers in the understanding, diagnosis and management of human diseases. The agreement has an effective period from January 1, 2008, through December 31, 2010, with automatic one-year extensions for up to three additional years unless terminated by Vermillion or JHU. Under the terms of the research collaboration agreement, Vermillion is required to pay noncancelable contributions of $600,000, $618,000 and $637,000 for the years ending December 31, 2008, 2009 and 2010, respectively. As of September 30, 2008, Vermillion owed $150,000 related to the renewed research collaboration agreement with JHU. Collaboration costs, which are included in research and development expenses, were $150,000 and $450,000 for the three and nine months ended September 30, 2008, respectively. Under the previous agreement with JHU, collaboration costs were $150,000 for the three months ended September 30, 2007, and $218,000 for the nine months ended September 30, 2007, which is net of a credit of $232,000 related to a reduction in the collaboration obligation as of December 31, 2006.

On September 22, 2005, Vermillion entered into a two year collaborative research agreement with University College London and UCL Biomedica Plc (collectively referred to as “UCL”), which expired on September 30, 2007. The collaborative research agreement was directed at the utilization of Vermillion’s former suite of proteomic solutions to further both parties’ ongoing research in ovarian cancer and breast cancer. Under the terms of the agreement, Vermillion had exclusive rights to license intellectual property resulting from discoveries made during the course of this collaboration for use in developing, manufacturing and commercializing products and services utilizing the intellectual property. Under the terms of the collaborative research agreement, Vermillion had a noncancelable obligation to contribute £604,000 in the first year of the agreement. In the second year of the agreement, which was cancelable with three months advance notice, Vermillion had an obligation to contribute cash of £605,000. On April 8, 2008, Vermillion made a final contribution of £112,000 or $223,000 to UCL to complete Vermillion’s obligation related to this collaborative research agreement. As of April 8, 2008, Vermillion has paid a total of £1,209,000 or $2,388,000 related to this agreement. Additionally, under the terms of the collaborative research agreement, Vermillion had a noncancelable obligation to provide equipment, software, arrays and consumable supplies with an estimated value at Vermillion’s list selling price of £370,000 to cover part of the costs incurred by UCL specifically for this research program. As of September 30, 2007, Vermillion had completed its obligation to provided equipment, software, arrays and consumable supplies to UCL at Vermillion’s cost of $112,000, or $546,000 valued at its list selling price. There were no further collaboration costs related to this agreement subsequent to December 31, 2007. Collaboration costs related to this agreement were $285,000 and $832,000 for the three and nine months ended September 30, 2007, respectively.

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

On October 4, 2006, Vermillion entered into a one-year research and development agreement, which has automatic renewals for two additional one-year terms, with Katholieke Universiteit Leuven, Belgium, directed at discovery, validation and characterization of novel biomarkers related to gynecologic disease. Under the terms of the agreement, Vermillion has exclusive rights to license discoveries made during the course of this collaboration. Under the terms of the research and development agreement, Vermillion had a noncancelable obligation of €45,000 in the first year of the agreement to fund sample collection at the Katholieke Universiteit Leuven from patients undergoing evaluation of a persistent mass who will undergo surgical intervention. On May 10, 2007, Vermillion paid €45,000 or $61,000 to complete its obligation related to this agreement. There were no collaboration costs related to this agreement for the three and nine months ended September 30, 2008. Collaboration costs related to this agreement were $15,000 and $61,000 for the three and nine months ended September 30, 2007, respectively.

On October 13, 2006, the Company entered into a two year research and collaboration agreement, which has automatic renewals of additional one-year terms, with The Ohio State University Research Foundation (“OSU”) directed at discovery, purification, identification and/or validation of biomarkers related to thrombotic thrombocytopenic purpura (“TTP”) and production of associated technology. Under the terms of the agreement, Vermillion has an option to take an exclusive license to discoveries made during the course of this collaboration. During the first fifteen months of the agreement, Vermillion had a total noncancelable obligation of $150,000 to OSU in consideration for costs incurred specifically for this research program. On January 2, 2008, Vermillion made a final payment of $30,000 to OSU to complete Vermillion’s obligation related to this agreement. As of January 2, 2008, Vermillion has paid a total of $150,000 related to this agreement. There were no collaboration costs related to this agreement for the three and nine months ended September 30, 2008. Collaboration costs related to this agreement were $90,000 for the nine months ended September 30, 2007. There were no collaboration costs related to this agreement for the three months ended September 30, 2007.

On December 11, 2006, Vermillion entered into a consulting agreement with PrecisionMed International (“PrecisionMed”), which was subsequently amended on April 5, 2007. Under the terms of the first amendment to the consulting agreement, PrecisionMed collected whole blood specimens from up to 1,000 research subjects for the purposes of Vermillion’s whole blood collection protocol for its ovarian tumor triage test clinical trial. The first amendment to the consulting agreement provided for a maximum payment of $1,335,000 for 500 research subjects and a maximum payment of $1,788,000 for 1,000 research subjects. On August 22, 2008, Vermillion entered into a second amendment to the consulting agreement with PrecisionMed. Under the terms of the second amendment to the consulting agreement, PrecisionMed would collect whole blood specimens and process serum from up to 300 research subjects in connection with Vermillion’s OVA1 test submission to the FDA. The second amendment to the consulting agreement provided for a maximum payment of $241,000. As of September 30, 2008, Vermillion has paid a total of $1,695,000, including travel expenses of $50,000, related to this agreement and amendments, and owed $58,000 related to the second amendment to the consulting agreement. These costs, which are included in research and development expenses, related to this agreement were $58,000 and $319,000 for the three and nine months ended September 30, 2008, respectively, and $488,000 and $1,288,000 for the three and nine months ended September 30, 2007, respectively.

On June 1, 2007, Vermillion entered into a nonexclusive license agreement with the National Cardiovascular Center (“NCVC”), an entity organized and existing under the laws of Japan. Under this agreement, Vermillion obtained a ten year worldwide nonexclusive license with the right to extend the term for the life of the licensed patent, which includes a United States Patent Application, a Japan Patent and a Patent Cooperation Treaty (“PCT”) Application, for technology used in Vermillion’s TTP diagnostic test kit that is under development. Under this agreement, Vermillion will pay NCVC a non-refundable license fee of $50,000. The payment terms are $20,000 upon execution of this agreement, $10,000 upon submission of an in vitro diagnostic test to the FDA for clearance, $10,000 upon the first commercial sale of such in vitro diagnostic test kit and $10,000 upon achievement of

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

		$500,000 in net sales of such in vitro diagnostic test kits. Additionally, Vermillion will pay royalties to NCVC for net sales to customers located in the United Sates, Japan, Europe and China. On July 18, 2007, Vermillion made a payment of $20,000 related to the execution of this agreement. There have been no subsequent payments made through September 30, 2008.
		In connection with the Instrument Business Sale, Vermillion entered into a manufacture and supply agreement with Bio-Rad, whereby Vermillion agreed to purchase ProteinChip Systems and ProteinChip Arrays (collectively referred to as “Research Tools Products”) from Bio-Rad. In a letter from Vermillion to Bio-Rad dated May 2, 2008, Vermillion exercised its right to terminate the November 13, 2006, manufacture and supply agreement for convenience upon 180 days’ written notice. Consequently, termination of the agreement became effective on October 29, 2008. Under the terms of the manufacture and supply agreement, Vermillion had a commitment to purchase 10 systems and 30,000 arrays in the first year, 13 systems and 30,000 arrays in the second year and 20 systems and 30,000 arrays for the third year. Vermillion had estimated the cost to be $70,000 per system and $40 per array for a total estimated obligation of $6,610,000. Vermillion made total purchases of $2,000 and $119,000 under this agreement for the three and nine months ended September 30, 2008, respectively, and total purchases of $11,000 and $174,000 under this agreement for the three and nine months ended September 30, 2007, respectively. As of September 30, 2008, Vermillion had a total remaining first year obligation to purchase 4 systems and 9,876 arrays, or a total estimated value of $675,000 based the on estimated costs of $70,000 per system and $40 per array. Additionally, Vermillion made no purchases towards the second year commitment of 13 systems and 30,000 arrays, on a total estimated value of $2,110,000 based on the estimated costs of $70,000 per system and $40 per array. As of September 30, 2008, Vermillion owed Bio-Rad $122,000 for Research Tools Products.
		Contingent Liabilities
		On September 17, 2007, Molecular Analytical Systems (“MAS”) filed a lawsuit in the Superior Court of California for the County of Santa Clara naming Vermillion and Bio-Rad as defendants. Under the lawsuit, MAS seeks an unspecified amount of damages and alleges, among other things, that Vermillion is in breach of its license agreement with MAS relating to Surface Enhanced Laser Desorption/Ionization (“SELDI”) technology as a result of Vermillion’s entry into a sublicense agreement with Bio-Rad. Vermillion filed its general denial and affirmative defense on April 1, 2008, and is seeking to have the matter sent to arbitration. Vermillion intends to vigorously defend this action. Given the early stage of this action, management cannot predict the ultimate outcome of this matter at this time.
		In addition, from time to time, the Company is involved in legal proceedings and regulatory proceedings arising out of its operations. The Company establishes reserves for specific liabilities in connection with legal actions that it deems to be probable and estimable. No amounts have been accrued in the consolidated financial statements with respect to any pending litigation. The Company is not able to make a reasonable estimate of any liability due to the uncertainties related to the outcome and the amount or range of loss. Other than as disclosed above, the Company is not currently a party to any proceeding, the adverse outcome of which would have a material adverse effect on the Company’s financial position or results of operations.
6.		Accumulated Other Comprehensive Loss
		The components of accumulated other comprehensive loss as of September 30, 2008 and 2007, were as follows (in thousands):

		2008				2007
Cumulative translation adjustment		$	(80	)		$	(102	)
Accumulated other comprehensive loss		$	(80	)		$	(102	)

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

7.		Stock-Based Compensation
		Options for 259,000 shares were granted with an average exercise price of $2.30 during the three months ended September 30, 2008, and 395,250 shares were granted with a weighted average exercise price of $2.21 during the nine months ended September 30, 2008. The allocation of stock-based compensation expense by functional area for the three and nine months ended September 30, 2008 and 2007, was as follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Cost of products revenue		$	—			$	—			$	—			$	1
Research and development			31				52				92				129
Sales and marketing			18				20				78				66
General and administrative			113				166				309				488
Total		$	162			$	238			$	479			$	684

8.		Loss Per Share
		Basic loss per share is calculated using the weighted average number of common shares outstanding during the period. Because the Company is in a net loss position, diluted loss per share is calculated using the weighted average number of common shares outstanding and excludes the effects of 3,875,535 and 3,744,000 potential common shares as of September 30, 2008 and 2007, respectively, that are antidilutive. Potential common shares include common shares issuable upon conversion of all convertible senior notes, common stock issuable under the Company’s 2000 Employee Stock Purchase Plan, and incremental shares of common stock issuable upon the exercise of outstanding stock options and warrants.
9.		Related Party Transactions
		In connection with the Instrument Business Sale, Bio-Rad became a significant stockholder of Vermillion, and entered into a transition services agreement with Vermillion. Under this agreement, Bio-Rad and the Company agreed to provide each other with certain administrative and operational support and related services and share the use of certain equipment. The term of the agreement was generally six months from the closing of the asset sale but could be extended or shortened with respect to certain items upon mutual agreement by the parties. The agreement was amended in May and June 2007 to extend the term during which the parties would provide certain consulting services to each other until December 31, 2007. Although the agreement expired on December 31, 2007, both the Company and Bio-Rad continued to provide each other with certain administrative and operational support and related services. The parties pay each other a fee for the provision of the consulting services based on an hourly rate tied to the salary of the employee or consultant who is providing such services. Transitional services provided by the Company to Bio-Rad amounted to $26,000 for the nine months ended September 30, 2008, and $17,000 and $107,000 for the three and nine months ended September 30, 2007, respectively. The Company provided no transitional services to Bio-Rad for the three months ended September 30, 2008. Transitional services provided by Bio-Rad to the Company amounted to $16,000 for the nine months ended September 30, 2008, and $16,000 and $55,000 for the three and nine months ended September 30, 2007, respectively. Bio-Rad provided no transitional services to the Company for the three months ended September 30, 2008.
		In connection with the Instrument Business Sale, Vermillion entered into a sublease agreement with Bio-Rad, pursuant to which Vermillion subleased approximately 29,000 square feet of its Fremont, California facility. Bio-Rad was permitted to use the sublet premises only for general office, laboratory, research and development, and other uses necessary to conduct their business, and was not permitted to sublet the premises without Vermillion’s consent. The sublease expired on July 31, 2008. Rent under the sublease was payable monthly and consisted of base rent plus a proportionate share of certain other expenses including property taxes, management fees, insurance, maintenance and utilities. Rent and certain other facility related expenses were paid directly to Vermillion, and in

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

accordance with the terms of the master lease, all payments received by Vermillion from Bio-Rad under the sublease were paid to the landlord. Under the sublease agreement, Vermillion recognized base rent of $132,000 and $925,000 for the three and nine months ended September 30, 2008, respectively, and $386,000 and $1,153,000 for the three and nine months ended September 30, 2007, respectively. Under the sublease agreement, Vermillion recognized other rental income of $24,000 for the nine months ended September 30, 2008, and $12,000 and $41,000 for the three and nine months ended September 30, 2007, respectively. The Company assessed no charges for other expenses to Bio-Rad for the three months ended September 30, 2008.

Subsequent to the Instrument Business Sale, both the Company and Bio-Rad recognized business activities with each other. As of September 30, 2008, the Company owed Bio-Rad $30,000, which consisted of $22,000 for accounts receivable the Company collected on behalf of Bio-Rad and $8,000 for invoices paid by the Company that were reimbursed twice by Bio-Rad. Similarly, Bio-Rad owed the Company $31,000, which consisted of $15,000 of invoices paid by the Company on behalf of Bio-Rad and $16,000 for Bio-Rad’s portion of expenses related to facilities shared with the Company. As of December 31, 2007, the Company owed Bio-Rad $50,000, which consisted of $42,000 for accounts receivable the Company collected on behalf of Bio-Rad and $8,000 for invoices paid by the Company that were reimbursed twice by Bio-Rad. Similarly, Bio-Rad owed the Company $33,000, which consisted of $15,000 of invoices paid by the Company on behalf of Bio-Rad and $18,000 for Bio-Rad’s portion of expenses related to facilities shared with the Company.

In connection with a strategic alliance agreement dated July 22, 2005, Quest became a significant stockholder of Vermillion. Pursuant to the strategic alliance agreement, Quest agreed to provide Vermillion with a $10,000,000 secured line of credit, which is collateralized by certain intellectual property of Vermillion, that may be used only for payment of certain costs and expenses directly related to the strategic alliance. Under the terms of this secured line of credit, the interest rate is at the prime rate plus 0.5% and is payable monthly. Additionally, this secured line of credit contains provisions for Quest to forgive portions of the amounts borrowed that correspond to Vermillion’s achievement of certain milestones related to development, regulatory approval and commercialization of certain diagnostic tests. The amounts to be forgiven and the corresponding milestones that Vermillion must achieve are (i) $1,000,000 for each application that allows a licensed laboratory test to be commercialized with a maximum of three applications for $3,000,000; (ii) $3,000,000 for the commercialization of the first diagnostic test kit; and (iii) $2,000,000 for each subsequent commercialization of diagnostic test kits with a maximum of two subsequent commercialized diagnostic test kits for $4,000,000. Should Vermillion fail to achieve these milestones, it would be responsible for the repayment of the outstanding principal amount and any unpaid interest on the secured line of credit on or before July 22, 2010. Vermillion has drawn on this secured line of credit in monthly increments of $417,000 on the last day of each month during the first two years of the strategic alliance. The outstanding principal balance of this secured line of credit was $10,000,000 at September 30, 2008, and December 31, 2007. Accrued interest payable related this secured line of credit was $45,000 and $67,000 as of September 30, 2008, and December 31, 2007, respectively. Interest expense related to this secured line of credit was $139,000 and $445,000 for the three and nine months ended September 30, 2008, respectively, and $218,000 and $589,000 for the three and nine months ended September 30,2007, respectively.

In connection with the August 29, 2007, private placement sale of Vermillion’s common stock and warrants to purchase additional shares of its common stock, Highbridge International LLC (“Highbridge”) became a significant stockholder of Vermillion. At September 30, 2008, and December 31, 2007, Highbridge held $11,100,000 in principal of the 7.00% senior convertible notes due September 1, 2011 (the “Highbridge 7.00% Notes”). Accrued interest related to the Highbridge 7.00% Notes was $65,000 and $259,000 as of September 30, 2008, and December 31, 2007, respectively. Interest expense related to the Highbridge 7.00% Notes was $225,000 and $675,000 for the three and nine months ended September 30, 2008, respectively, and $227,000 and $685,000 for the three and nine months ended September 30, 2007, respectively.

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

10.		Fair Value
		As of September 30, 2008, the Company had no financial liabilities that were measured at fair value on a recurring basis. The financial assets measured at fair value on a recurring basis at September 30, 2008, were as follows (in thousands):

						Fair Value Measurements at Reporting Date Using
						Quoted Prices				Significant
						in Active				Other				Significant
						Markets for				Observable				Unobservable
		Total Fair				Identical Assets				Inputs				Inputs
		Value				(Level 1)				(Level 2)				(Level 3)
Assets:
Cash and cash equivalents:
Money market funds		$	694			$	694			$	—			$	—
Foreign denominated cash			463				463				—				—
Long-term investments available-for-sale:
Auction rate securities			3,552				—				—				3,552
Total		$	4,709			$	1,157			$	—			$	3,552

The Company’s financial assets measured at fair value on a recurring basis using significant Level 3 inputs as of September 30, 2008, consisted solely of auction rate securities. The reconciliation of financial assets measured at fair value using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2008, was as follows (in thousands):

		Long-Term Investments
		Available- for-Sale (Level 3)
		Auction Rate Securities
		Three Months				Nine Months
		Ended				Ended
		September 30,				September 30,
		2008				2008
Balance at beginning of period		$	4,626			$	—
Total realized losses included in earnings			(1,124	)			(1,748	)
Change in unrealized gains included in other comprehensive loss			100				98
Sales			(50	)			(1,250	)
Transfers into Level 3			—				6,452
Balance at end of period		$	3,552			$	3,552
Total losses included in earnings attributable to the change in unrealized losses relating to assets still held at the reporting date		$	—			$	—

At September 30, 2008, long-term investments available-for-sale measured at fair value using Level 3 inputs consisted of $3,552,000 invested in auction rate securities. The recent failure of auctions and the lack of market activity and liquidity required that these securities be measured using Level 3 inputs. The fair value of our auction rate securities was determined using a probability weighted discounted cash flow analysis that is consistent with the market approach, income approach and cost approach of a valuation technique. Assumptions used by the Company included estimates of (i) when a successful auction would occur or the securities would be redeemed, based on current market development on redemption for each type of auction rate securities and also the development of the secondary market; (ii) a discount rate commensurate with the implied risk associated with holding the auction rate securities, which is based on prime rate plus spreads for liquidity premiums and risk-free premiums; and (iii) cash flow stream using indicative bids in the current secondary market for liquidation value. The valuation of the Company’s investment in auction rate securities is subject to uncertainties that are difficult to predict. Factors that may impact

Vermillion, Inc. and Subsidiaries
Notes to Consolidated Financial Statements — Continued
(Unaudited)

		its valuation include changes to credit ratings of the securities as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates, liquidity and ongoing strength, and quality of credit markets. If the current market conditions deteriorate further, or the anticipated recovery in market values does not occur, we may be required to record additional impairment charges in future quarters. The Company will continue to monitor the value of its auction rate securities and consider the impact, if any, on the fair value of its investment in auction rate securities.
		The underlying assets of the auction rate securities were measured using Level 3 inputs due to the failure of the auction market, based on the Company’s assessment of the underlying collateral, the creditworthiness of the issuers of the securities, and the Company’s ability to hold these securities until anticipated recovery, which could be at final maturity. Based on such assessment, the Company recognized an other-than-temporary impairment of $1,124,000 and $1,748,000 for the three and nine months ended September 30, 2008, respectively. The other-than-temporary impairment is included in loss on investments in auction rate securities of the consolidated statement of operations.
11.		Subsequent Events
		On October 7, 2008, the Company sold for $1,183,000, two auction rate securities with an aggregate par value of $1,300,000. During the three and nine months ended September 30, 2008, an other-than-temporary impairment of $119,000 was recorded for these two auction rate securities.
		On October 9, 2008, Vermillion entered into a third amendment to the consulting agreement with PrecisionMed. Under the terms of the third amendment to the consulting agreement, PrecisionMed would collect whole blood specimens and process serum from a minimum of 10 research subjects and up to a maximum of 45 research subjects in connection with Vermillion’s OVA1 test submission to the FDA. The third amendment to the consulting agreement provided for a maximum payment of $35,000.
		On November 13, 2008, the holders of the $2,500,000 outstanding principal balance related to the 4.50% Notes have agreed to extend the maturity date of the 4.50% Notes to September 1, 2009, and to waive any past default by Vermillion of its obligation to make payment on the principal of and interest on the 4.50% Notes. Vermillion has agreed to extend each holder’s rights to require Vermillion to repurchase the 4.50% Notes at 105.00% of such holder’s outstanding principal amount upon a change in control, as defined in the indenture governing the 4.50% Notes, and to convert the 4.50% Notes into common stock accordingly. In addition, the holders of the 4.50% Notes have agreed to permit the full redemption of the outstanding principal related to the 4.50% Notes at a redemption price of 100.00% on or before August 31, 2009, and Vermillion has agreed to adjust the conversion rate for the 4.50% Notes to 20 shares per $1,000 principal amount of the 4.50% Notes, which is equal to a conversion price of $50.00 per share.

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

FORWARD LOOKING STATEMENTS

Vermillion, Inc. (“Vermillion”) and its wholly owned subsidiaries (collectively the “Company”) has made statements in this Quarterly Report on Form 10-Q that are deemed forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. The Company claims the protection of such safe harbor, and disclaims any intent or obligation to update any forward-looking statement. You can identify these statements by forward-looking words such as “may”, “will”, “expect”, “intend”, “anticipate”, “believe”, “estimate”, “plan”, “could”, “should” and “continue” or similar words. These forward-looking statements may also use different phrases. The Company has based these forward-looking statements on management’s (“we”, “us” or “our”) current expectations and projections about future events. Examples of forward-looking statements include the following statements:

•

projections of the Company’s future revenue, results of operations and financial condition;

•

anticipated deployment, capabilities and uses of Vermillion’s products and Vermillion’s product development activities and product innovations;

•

the importance of proteomics as a major focus of biology research;

•

competition and consolidation in the markets in which the Company competes;

•

existing and future collaborations and partnerships;

•

the utility of biomarker discoveries;

•

our belief that biomarker discoveries may have diagnostic and/or therapeutic utility;

•

our plans to develop and commercialize diagnostic tests through Vermillion’s strategic alliance with Quest Diagnostics Incorporated (“Quest”);

•

our ability to comply with applicable government regulations;

•

our ability to expand and protect Vermillion’s intellectual property portfolio;

•

our ability to decrease general and administrative costs;

•

our ability to decrease sales and marketing costs;

•

our ability to decrease research and development costs;

•

anticipated future losses;

•

expected levels of capital expenditures;

•

forgiveness of the outstanding principal amounts of the secured line of credit by Quest;

•

the period of time for which the Company’s existing financial resources, debt facilities and interest income will be sufficient to enable the Company to maintain current and planned operations; and

•

the market risk of the Company’s investments.

These statements are subject to significant risks and uncertainties, including those identified in Part II Item 1A, “Risk Factors”, that could cause actual results to differ materially from those projected in such forward-looking statements due to various factors, including our ability to generate sales after completing development of new diagnostic products; managing the Company’s operating expenses and cash resources that is consistent with our plans; our ability to conduct new diagnostic product development using both Vermillion’s internal research and development resources, and collaboration partners within the budgets and time frames we have established; the ability of the ProteinChip technology to discover protein biomarkers that have diagnostic, theranostic and/or drug development utility; the continued emergence of proteomics as a major focus of biological research and drug discovery; and our ability to protect and promote Vermillion’s proprietary technologies. We believe it is important to communicate our expectations to Vermillion’s investors. However, there may be events in the future that we are not able to accurately predict or that we do not fully control that could cause actual results to differ materially from those expressed or implied in the Company’s forward-looking statements.

Overview

Vermillion was originally incorporated in California on December 9, 1993, under the name Abiotic Systems. In March 1995, Abiotic Systems changed its corporate name to Ciphergen Biosystems, Inc., and subsequently on June 21, 2000, it reincorporated in Delaware. Under the name Ciphergen Biosystems, Inc., Vermillion had its initial public offering on September 28, 2000. On November 13, 2006, the Company sold assets and liabilities of its protein research products and collaborative services business (the “Instrument Business Sale”) to Bio-Rad Laboratories, Inc. (“Bio-Rad”) in order to concentrate the Company’s resources on developing clinical protein biomarker diagnostic products and services. On August 21, 2007, Ciphergen Biosystems, Inc. changed its corporate name to Vermillion, Inc. In conjunction with the name change, Vermillion changed its common stock ticker symbol on the NASDAQ Capital Market from “CIPH” to “VRML”. Effective at the close of business on March 3, 2008, Vermillion had a 1 for 10 reverse stock split of Vermillion’s common stock. Accordingly, all share and per share amounts were adjusted to reflect the impact of the 1 for 10 reverse stock split in this Quarterly Report on Form 10-Q. On September 25, 2008, Vermillion’s common stock was delisted from and suspended from trading on the NASDAQ Stock Market as a result of Vermillion’s noncompliance with the listing criteria under Marketplace Rule 4310(c)(3). Upon delisting from the NASDAQ Stock Market, Vermillion’s common stock became immediately eligible for quotation and began trading in the Pink Sheets on September 25, 2008, under the ticker symbol “VRML.PK”. After a market maker’s application to trade Vermillion’s common stock on the over-the-counter (the “OTC”) Bulletin Board was approved by the Financial Industry Regulatory Authority (“FINRA”), Vermillion’s common stock began trading on the OTC Bulletin Board under the ticker symbol “VRML.OB” on October 10, 2008.

The Company is dedicated to the discovery, development and commercialization of novel diagnostic tests that help physicians diagnose, treat and improve outcomes for patients. Vermillion utilizes advanced protein separation methods to identify and resolve variants of specific biomarkers (known as “translational proteomics”) for developing a procedure to measure a property or concentration of an analyte (known as an “assay”) and commercializing novel diagnostic tests. The Company’s expenses consist primarily of research and development costs related to its diagnostics efforts; sales and marketing expenses; and general and administrative costs, which include accounting and auditing expenses.

Through collaborations with leading academic and research institutions, including The Johns Hopkins University School of Medicine, The University of Texas M.D. Anderson Cancer Center, University College London, The University of Texas Medical Branch, The Katholieke Universiteit Leuven, The Ohio State University Research Foundation and Stanford University, we have developed and plan to develop diagnostic tests in the fields of oncology, hematology, cardiology and women’s health. Vermillion will also address clinical questions related to early stage disease detection, treatment response, monitoring of disease progression, prognosis and others. These research collaborations have provided Vermillion with the clinical data and intellectual property portfolio that form the basis of Vermillion’s product pipeline. Vermillion is now engaged in product development and commercialization of discoveries made under these collaborations.

On July 22, 2005, Vermillion entered into a strategic alliance agreement with Quest pursuant to which the parties have agreed to develop and commercialize up to three diagnostic tests. The term of the agreement was set to end on the earlier of (i) the three-year anniversary of the agreement, which was July 22, 2008, and (ii) the date on which Quest commercializes the three diagnostic tests. On July 21, 2008, Vermillion and Quest amended the strategic alliance agreement to extend the term of the agreement to end on the earlier of (i) September 1, 2008 and (ii) the date on which Quest commercializes the three diagnostic tests. Subsequently on October 24, 2008, Vermillion and Quest amended the strategic alliance agreement to extend the term of the agreement to end on the earlier of (i) September 1, 2009 and (ii) the date on which Quest makes its third development election. To date, Quest has selected only two diagnostic tests, which are peripheral artery disease (“PAD”) blood test (“VASCLIR™”) and ovarian tumor triage test (“OVA1™”), to commercialize. Vermillion’s major initiatives are currently aimed at commercializing these diagnostic tests, both within the context of its strategic alliance agreement with Quest as well as markets in which Quest does not participate, to the extent permitted under the strategic alliance agreement.

We expect to incur losses for at least the next year. Due to the Instrument Business Sale, the Company will have limited revenues until its diagnostic tests are developed and successfully commercialized. To become profitable, the Company will need to complete development of key diagnostic tests, obtain United States Food and Drug Administration (the “FDA”) approval and successfully commercialize its products. The Company has a limited history of operations in developing diagnostic tests, and we anticipate that the Company’s quarterly results of

operations will fluctuate for the foreseeable future due to several factors, including market acceptance of current and new products, the timing and results of the Company’s research and development efforts, the introduction of new products by the Company’s competitors and possible patent or license issues. The Company’s limited operating history as a diagnostics business makes accurate prediction of future results of operations difficult.

Recent Developments

On November 13, 2008, the holders of the $2,500,000 outstanding principal balance related to the 4.50% convertible senior notes due September 1, 2008 (The “4.50% Notes”), have agreed to extend the maturity date of the 4.50% Notes to September 1, 2009, and to waive any past default by Vermillion of its obligation to make payment on the principal of and interest on the 4.50% Notes. Vermillion has agreed to extend each holder’s rights to require Vermillion to repurchase the 4.50% Notes at 105.00% of such holder’s outstanding principal amount upon a change in control, as defined in the indenture governing the 4.50% Notes, and to convert the 4.50% Notes into common stock accordingly. In addition, the holders of the 4.50% Notes have agreed to permit the full redemption of the outstanding principal related to the 4.50% Notes at a redemption price of 100.00% on or before August 31, 2009, and Vermillion has agreed to adjust the conversion rate for the 4.50% Notes to 20 shares per $1,000 principal amount of the 4.50% Notes, which is equal to a conversion price of $50.00 per share.

On August 26, 2008, Vermillion entered into separate key employee severance agreements with Eric Fung, Vermillion’s Vice President and Chief Scientific Officer; Simon Shorter, Vermillion’s Vice President of Corporate Business Development; and Qun Zhou, Vermillion’s Corporate Controller. Each severance agreement provides certain severance benefits to the employee in the event that Vermillion terminates the employee’s employment without cause or the employee resigns his or her employment for good reason. The severance benefits provided for in the agreements with Dr. Fung and Dr. Shorter include (i) continued payment of the employee’s base salary, as then in effect, payable over a period of nine months following the date of termination, (ii) immediate, accelerated vesting of 24 months of any options previously granted by Vermillion to the employee and (iii) continuation of health and dental benefits through COBRA premiums paid by Vermillion directly to the COBRA administrator for a period of nine months following the date of termination. The severance benefits provided for in the agreement with Ms. Zhou include (i) continued payment of the employee’s base salary, as then in effect, payable over a period of six months following the date of termination, (ii) immediate, accelerated vesting of 24 months of any options previously granted by Vermillion to the employee and (iii) continuation of health and dental benefits through COBRA premiums paid by Vermillion directly to the COBRA administrator for a period of six months following the date of termination. Each severance agreement also provides that, in the event the employee’s employment is terminated by Vermillion for reasons other than cause or by the employee for good reason within the 12-month period following a change in control, then, in addition to the severance benefits described above, any then-unvested shares under Vermillion’s stock option plans then held by the employee will fully vest immediately upon the date of such termination. Payment of the severance benefits under these agreements will be conditioned on the employee’s continued compliance with the provisions of each employee’s proprietary information and inventions agreement will be delayed as required by Section 409A of the Internal Revenue Code of 1986, as amended.

On August 26, 2008, Vermillion appointed Richard G. Taylor as Senior Finance Consultant and Interim Chief Financial Officer, effective immediately. Mr. Taylor assumed the position of Interim Chief Financial Officer from Ms. Qun Zhou, who held the position beginning November 1, 2007. Under Vermillion’s consulting agreement with Mr. Taylor, he will serve as an independent contractor and will provide finance, accounting and financial oversight services to Vermillion. Mr. Taylor will be compensated at a rate of $1,000 per day for work in excess of five hours per day, $125 per hour for work less than five hours per day and $62.50 per hour for travel time. The consulting agreement has an initial term of 90 days, which may be extended upon mutual agreement. Mr. Taylor, age 54, served as Vice President, Finance and Administration at Cellgate, Inc., a privately held oncology company, from May 2001 until February 2008, where he was the senior finance officer responsible for all financial matters related to the company. From February 2008 until August 2008, following the acquisition of Cellgate, Inc. by Progen Pharmaceuticals, Inc., a molecule-based cancer therapeutics company, Mr. Taylor worked for Progen Pharmaceuticals, Inc. as Head of United States Finance Operations under a post-merger short-term contract. Mr. Taylor earned a B.A. in Biological Sciences from the University of California, Berkeley, an M.S. in Biological Sciences from Stanford University and an M.B.A. from the University of Chicago.

On July 2, 2008, Vermillion engaged ThinkPanmure LLC, a global growth company investment bank, to assist Vermillion with identifying and evaluating strategic alternatives intended to enhance the potential of its VASCLIR and OVA1 tests, and its pipeline of proprietary biomarkers to maximize stockholder value.

On March 20, 2008, Vermillion announced its preliminary results from a clinical trial evaluating OVA1. The study met its primary endpoints in that the ovarian tumor triage test successfully stratified women with pelvic masses into high-risk and low-risk categories, thereby enabling a more informed determination of which patients should be referred to a specialist prior to surgery. These results indicate that the use of the ovarian tumor triage test could significantly increase the percentage of high-risk cases referred to the appropriate specialist for treatment, ultimately improving survival rates. Vermillion’s novel ovarian biomarker panel ruled out malignancy with approximately 95% certainty or negative predictive value. Negative predictive value is the probability that the patient is free of disease based on diagnostic evaluation. The novel ovarian biomarker panel also showed approximately 90%

sensitivity for detecting malignant ovarian tumors. The prospective clinical trial was one of the largest ever conducted and assessed more than 550 patients with a confirmed adnexal mass at 27 clinical trial sites in the United States. On June 19, 2008, Vermillion submitted a 510(k) pre-market notification application to the FDA requesting regulatory clearance of its OVA1. Vermillion’s 510(k) pre-market notification submission is currently pending before the FDA. To date, Vermillion and the FDA have had several substantive discussions regarding the submission. Vermillion is working diligently to provide information and data in response to the FDA’s inquiries related to the Vermillion’s 510(k) pre-market notification submission.

On February 22, 2008, the staff of the NASDAQ Listing Qualifications Department (the “Staff”) notified Vermillion that it did not comply with Marketplace Rule 4310(c)(3) for continued inclusion on the NASDAQ Capital Market due to its noncompliance with the $35,000,000 market value of listed securities requirement for the previous 10 consecutive business days. Pursuant to Marketplace Rule 4310(c)(8)(C), Vermillion was granted 30 days, or until March 24, 2008, to regain compliance with the market value of listed securities requirement. Vermillion did not regain compliance by March 24, 2008, and on March 25, 2008, Vermillion received written notification from the Staff (the “Staff Determination Notice”) that Vermillion’s securities were subject to delisting unless Vermillion requested a hearing before a NASDAQ Listing Qualifications Panel (the “Panel”). Vermillion subsequently requested a hearing before the Panel, which stayed the delisting action by the Staff. On May 1, 2008, Vermillion attended a hearing before the Panel to appeal the Staff Determination Notice, present a plan to evidence compliance and request continued listing on the NASDAQ Capital Market pending completion of its compliance plan. Subsequently, on June 25, 2008, the Panel granted Vermillion’s request for continued listing of its securities on the NASDAQ Capital Market, subject to Vermillion having stockholders’ equity of at least $2,500,000 on or before September  22, 2008, or demonstrating compliance with one of the other listing criteria under Marketplace Rule 4310(c)(3). Vermillion failed to achieve either requirement by September 22, 2008, and accordingly, the NASDAQ Stock Market delisted Vermillion’s common stock from trading on the NASDAQ Capital Market on September 25, 2008. Upon delisting from the NASDAQ Stock Market, Vermillion’s common stock became immediately eligible for quotation and began trading in the Pink Sheets on September 25, 2008, under the ticker symbol “VRML.PK”. After a market maker’s application to trade Vermillion’s common stock on the OTC Bulletin Board was approved by FINRA, Vermillion’s common stock began trading on the OTC Bulletin Board under the ticker symbol “VRML.OB” on October 10, 2008.

Critical Accounting Policies and Significant Estimates

The Company has made no significant changes in its critical accounting policies and significant estimates from those disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

Recently Adopted Accounting Pronouncements

Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active

On October 10, 2008, the Financial Accounting Standards Board (the “FASB”) issued FASB Staff Position (“FSP”) No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active. FSP No. FAS 157-3 clarifies the application of SFAS No. 157 in an inactive market and provides an example to demonstrate how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP No. FAS 157-3 was effective upon issuance, including periods for which financial statements had not been issued. The adoption of FSP No. 157-3 had no impact on the Company’s consolidated results of operation, financial position or cash flows as of and for the nine months ended September 30, 2008.

Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities

On January 1, 2008, the Company adopted Emerging Issues Task Force (the “EITF”) Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities. EITF Issue No. 07-3 requires companies to defer and capitalize prepaid, nonrefundable research and development payments to third parties over the period that the research and development activities are performed or the services are provided, subject to an assessment of recoverability. The Company’s adoption of EITF Issue No. 07-3 had no impact on its consolidated financial statements.

Fair Value Option for Financial Assets and Financial Liabilities

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115. SFAS No. 159 provides entities with an option to report selected financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The Company has elected not to report selected financial assets and liabilities at fair value, and accordingly, there was no impact upon adoption of SFAS No. 159 to its consolidated financial statements.

Fair Value Measurements

On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements, on a prospective basis for its financial assets and liabilities as well as for nonfinancial assets and liabilities that are recognized or disclosed at fair value on a recurring basis in the consolidated financial statements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. As defined in SFAS No.157, fair value is the price that would be received for an asset when sold or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The adoption of SFAS No. 157 for its financial assets and liabilities as well as for nonfinancial assets and liabilities that are recognized or disclosed at fair value on a recurring basis in the consolidated financial statements had no impact on the consolidated financial statements. In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis, until fiscal years beginning after November 15, 2008. The Company’s adoption of SFAS No. 157 for nonfinancial assets and liabilities measured at fair value on a nonrecurring basis is not expected to have a material impact on its consolidated financial statements.

Recent Accounting Pronouncements to be Adopted

Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock

In June 2008, the EITF reached a consensus on EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock. EITF Issue No. 07-5 applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative instrument under paragraphs 6 to 9 of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. EITF Issue No. 07-5 provides a two-step approach to determine whether an entity’s equity-linked financial instrument or embedded feature is indexed to its own stock by evaluating the instrument’s contingent exercise provisions and settlement provisions. Equity-linked financial instruments or embedded features that are indexed to an issuer’s own stock and classified in stockholders’ equity in its statement of financial position, are not considered derivative instruments under paragraph 11(a) of SFAS No. 133. EITF Issue No. 07-5 also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. EITF No. 07-5 is effective for financial statements issued for the fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Earlier application by an entity that has previously adopted an alternative accounting policy is not permitted. At September 30, 2008, the Company had warrants outstanding to purchase 2,293,147 shares of common stock with exercise prices between $9.25 and $25.00 per share. The Company is currently evaluating the impact of adopting EITF Issue No. 07-5 will have on its consolidated financial statements.

Transition Guidance for Conforming Changes to Issue No. 98-5

In June 2008, FASB issued EITF Issue No. 08-4, Transition Guidance for Conforming Changes to Issue No. 98-5. EITF Issue No. 08-4 provides transition guidance for conforming changes made to EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that result from EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, and SFAS

No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. EITF Issue No. 08-4 is effective for financial statements issued for fiscal years ending after December 15, 2008. Earlier application is permitted. The effect, if any, of applying the conforming changes shall be presented retrospectively with the cumulative effect of the change being reported in retained earnings in the statement of financial position as of the beginning of the first period presented. The Company is currently evaluating the impact of adopting EITF No. 08-4 will have on its consolidated financial statements.

Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities

In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP No. EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method described in SFAS No. 128, Earnings Per Share. FSP No. EITF 03-6-1 requires that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. FSP No. EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings and selected financial data) to conform with the provisions of FSP No. EITF 03-6-1. Early application is not permitted. The Company does not expect the adoption of FSP No. EITF 03-6-1 to have an impact on its earnings per share.

The Hierarchy of Generally Accepted Accounting Principles

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS No. 162 is effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not expect the adoption of SFAS No. 162 to have an impact on its consolidated financial statements.

Accounting for Convertible Debt Instruments That May Be Settled In Cash upon Conversion (Including Partial Cash Settlement)

In May 2008, the FASB issued FSP No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled In Cash upon Conversion (Including Partial Cash Settlement). FSP No. APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP No. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. FSP No. APB 14-1 shall be applied retrospectively to all periods presented unless instruments were not outstanding during any period included in the financial statements. The Company is currently evaluating the impact of adopting FSP No. APB 14-1 will have on its consolidated financial statements.

Determination of the Useful Life of Intangible Assets

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets. FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. FSP No. FAS 142-3 amends paragraph 11(d) of SFAS No. 142 to require an entity to use its own assumptions about renewal or extension of an arrangement, adjusted for the entity-specific factors in paragraph 11 of SFAS No. 142, even when there is likely to be substantial cost or material modifications. FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, with early adoption prohibited. The provisions of FSP No. FAS 142-3 are to be applied prospectively to intangible assets acquired after January 1, 2009, for the Company, although the disclosure provisions are required for all intangible assets recognized as of or subsequent to January 1, 2009. The Company does not expect the adoption of FSP No. FAS 142-3 to have an impact on its consolidated financial statements.

Disclosures about Derivative Instruments and Hedging Activities

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133. SFAS No. 161 amends and expands the disclosure requirements with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact of adopting SFAS No. 161 will have on its consolidated financial statements.

Accounting for Business Combinations

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) retains the fundamental requirements that the acquisition method of accounting, which was called the purchase method under SFAS No. 141, be used for all business combinations and for an acquirer to be identified for each business combination. SFAS No. 141(R) requires an acquirer to measure the assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values at the acquisition date, with limited exceptions. This replaces the cost-allocation process under SFAS No. 141, which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. SFAS No. 141(R) also requires the acquirer in a business combination achieved in stages, which is sometimes referred to as a step acquisition, to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their fair values or other amounts determined in accordance with SFAS No. 141(R). SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The Company is currently evaluating the impact of adopting SFAS No. 141(R) will have on its consolidated financial statements.

Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property

In November 2007, the EITF reached a consensus on EITF Issue No. 07-01, Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property, which is focused on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties, how sharing payments pursuant to a collaboration agreement should be presented in the income statement and certain related disclosure questions. EITF Issue No. 07-01 is to be applied retrospectively for collaboration arrangements in fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting EITF Issue No. 07-01 will have on its consolidated financial statements.

Results of Operations

Three Months Ended September 30, 2008, Compared to Three Months Ended September 30, 2007

The selected summary financial and operating data of Vermillion for the three months ended September 30, 2008 and 2007, were as follows (dollars in thousands):

		Three Months Ended
		September 30,								Increase (Decrease)
		2008				2007				Amount				%
Revenue:
Products		$	5			$	—			$	5				—
Services			66				—				66				—
Total revenue			71				—				71				—
Cost of revenue:
Products			2				—				2				—
Services			—				—				—				—
Total cost of revenue			2				—				2				—
Gross profit			69				—				69				—
Operating expenses:
Research and development			1,135				2,181				(1,046	)			(47.96	)
Sales and marketing			388				517				(129	)			(24.95	)
General and administrative			1,581				2,090				(509	)			(24.35	)
Total operating expenses			3,104				4,788				(1,684	)			(35.17	)
Loss from operations			(3,035	)			(4,788	)			(1,753	)			(36.61	)
Interest income			79				169				(90	)			(53.25	)
Interest expense			(508	)			(596	)			(88	)			(14.77	)
Loss on investment in auction rate securities			(1,124	)			—				1,124				—
Other income (expense), net			(142	)			95				(237	)			(249.47	)
Loss before income taxes			(4,730	)			(5,120	)			(390	)			(7.62	)
Income tax benefit (expense)			(14	)			3				(17	)			(566.67	)
Net loss		$	(4,744	)		$	(5,117	)		$	(373	)			(7.29	)

Products Revenue. Products revenue of $5,000 was generated from the sales of thrombotic thrombocytopenic purpura (“TTP”) test component material to The Ohio State University Research Foundation (“OSU”) for the three months ended September 30, 2008. There was no products revenue for the three months ended September 30, 2007.

Services Revenue. Services revenue of $66,000 was received from a consortium supported by the European Union for advanced molecular diagnostics research performed. There was no services revenue for the three months ended September 30, 2007.

Cost of Products Revenue. Cost of products revenue related to sales of TTP test component material to OSU was $2,000 for the three months ended September 30, 2008. There was no cost of products revenue for the three months ended September 30, 2007.

Cost of Services Revenue. There was no cost of services revenue for the three months ended September 30, 2008 and 2007.

Research and Development Expenses. Research and development expenses decreased by $1,046,000, or 48.0%, to $1,135,000 for the three months ended September 30, 2008, from $2,181,000 for the same period in 2007. This decrease was primarily due to the reduction in employee headcount to four at September 30, 2008, from twelve at

September 30, 2007, and, correspondingly, salaries, payroll taxes, employee benefits and stock-based compensation decreased by $284,000. Additionally, collaboration costs decreased by $751,000 due to the completion of Vermillion’s collaboration obligations to University College London and UCL Biomedica Plc, and the completion of the whole blood specimen collection for the OVA1 510(k) pre-market notification application by PrecisionMed International; materials and supplies used in the development of new products decreased by $120,0000 due to the completion of the OVA1 clinical trials; and occupancy costs decreased by $152,000 due to the reduction of rent expense related to the Company’s move into a smaller principal facility on July 1, 2008. These decreases were offset by an increase in equipment costs of $274,000, which reflects the disposal of research equipment resulting from the Company’s move into a smaller principal facility. Stock-based compensation expense included in research and development expenses was $31,000 and $52,000 for the three months ended September 30, 2008 and 2007, respectively.

Sales and Marketing Expenses. Sales and marketing expenses decreased by $129,000, or 25.0%, to $388,000 for the three months ended September 30, 2008, from $517,000 for the same period in 2007. The decrease was primarily due to the reduction in employee headcount to four at September 30, 2008, from five at September 30, 2007, offset by the higher number of senior level positions at September 30, 2008, compared to September 30, 2007. As a result salaries, payroll taxes, employee benefits and stock-based compensation decreased by $78,000. Stock-based compensation expense included in sales and marketing expenses was $18,000 and $20,000 for the three months ended September 30, 2008 and 2007, respectively.

General and Administrative Expenses. General and administrative expenses decreased by $509,000, or 24.4%, to $1,581,000 for the three months ended September 30, 2008, from $2,090,000 for the same period in 2007. The decrease was primarily due to the reduction in employee headcount to six at September 30, 2008, from thirteen at September 30, 2007, and, correspondingly, salaries, payroll taxes, employee benefits and stock-based compensation decreased by $363,000. Additionally, other professional fees decreased by $64,000 due the reduction of costs to support the finance area; equipment costs decreased by $78,000 primarily due to the final amortization of leasehold improvements and furniture related to the old principal facility during July 2008; and occupancy costs decreased by $54,000 due to the reduction of rent expense related to the Company’s move into a smaller principal facility on July 1, 2008. These decreases were offset by an increase in legal fees of $150,000, which reflects legal work related to the filing of new patent applications and the maintenance of existing patents. Stock-based compensation expense included in general and administrative expenses was $113,000 and $166,000 for the three months ended September 30, 2008 and 2007, respectively.

Interest Income. Interest income was $79,000 for the three months ended September 30, 2008, compared to $169,000 for the same period in 2007. Interest income decreased primarily due to lower interest yields and the reduction of investments available-for-sale and money market funds.

Interest Expense. Interest expense was $508,000 for the three months ended September 30, 2008, compared to $596,000 for the same period in 2007. Interest expense in both periods consisted largely of interest related to our convertible senior notes and borrowings from Quest. Interest expense included the amortization of the beneficial conversion feature associated with the convertible senior notes amounting to $52,000 and $57,000 for the three months ended September 30, 2008 and 2007, respectively.

Loss on investment in auction rate securities. Loss on investment in auction rate securities was due to an other-than-temporary charge on investments available-for-sale of $1,124,000 for the three months ended September 30, 2008. There were no losses related to investments available-for-sale for the three months ended September 30, 2007.

Other Income (Expense), Net. Net other expense was $142,000 for the three months ended September 30, 2008, compared to net other income of $95,000 for the same period in 2007. Net other expense for three months ended September 30, 2008, included a net realized foreign currency exchange loss of $111,000 due to a decrease in foreign currency exchange rates from June 30, 2008, and offering costs amortization related to the convertible senior notes of $14,000. Net other income for the three months ended September 30, 2007, included a net realized foreign currency exchange gain of $110,000 due to an increase in foreign currency exchange rates from June 30, 2007, offset by offering costs amortization related to the convertible senior notes of $17,000.

Income Tax Benefit (Expense). Income taxes were an expense of $14,000 for the three months ended September 30, 2008, compared to a benefit of $3,000 for the same period in 2007. The income tax expense was due to foreign income taxes.

Nine Months Ended September 30, 2008, Compared to Nine Months Ended September 30, 2007

The selected summary financial and operating data of Vermillion for the nine months ended September 30, 2008 and 2007, were as follows (dollars in thousands):

		Nine Months Ended
		September 30,								Increase (Decrease)
		2008				2007				Amount				%
Revenue:
Products		$	10			$	—			$	10				—
Services			114				21				93				442.86
Total revenue			124				21				103				490.48
Cost of revenue:
Products			4				—				4				—
Services			20				15				5				33.33
Total cost of revenue			24				15				9				60.00
Gross profit			100				6				94				1,566.67
Operating expenses:
Research and development			4,262				6,390				(2,128	)			(33.30	)
Sales and marketing			1,784				1,347				437				32.44
General and administrative			5,062				8,626				(3,564	)			(41.32	)
Total operating expenses			11,108				16,363				(5,255	)			(32.12	)
Loss on sale of instrument business			—				(382	)			(382	)			(100.00	)
Loss from operations			(11,008	)			(16,739	)			(5,731	)			(34.24	)
Interest income			360				458				(98	)			(21.40	)
Interest expense			(1,561	)			(1,727	)			(166	)			(9.61	)
Loss on investment in auction rate securities			(1,748	)			—				1,748				—
Other income (expense), net			(128	)			17				(145	)			(852.94	)
Loss before income taxes			(14,085	)			(17,991	)			(3,906	)			(21.71	)
Income tax benefit			34				1				33				3,300.00
Net loss		$	(14,051	)		$	(17,990	)		$	(3,939	)			(21.90	)