Aspira Women's Health Inc. - Quarter Report: 2010 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2010.

OR

For the transition period from              to             .

Commission File Number: 001-34810

Vermillion, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (512) 519-0400

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this Chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

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

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨

As of June 30, 2010, the Registrant had 10,322,411 shares of common stock, par value $0.001 per share, outstanding.

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Vermillion, Inc.

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Vermillion, OVA1, and OvaCalc are trademarks of Vermillion, Inc. ProteinChip is a registered trademark of Bio-Rad Laboratories, Inc. BioSepra is a registered trademark of Pall Corporation.

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PART I—FINANCIAL INFORMATION

Vermillion, Inc.

Consolidated Balance Sheets

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

(Unaudited)

See accompanying notes to the consolidated financial statements.

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Vermillion, Inc.

Consolidated Statements of Operations

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

(Unaudited)

See accompanying notes to the consolidated financial statements.

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Vermillion, Inc.

Consolidated Statements of Cash Flows

(Amounts in Thousands)

(Unaudited)

See accompanying notes to the consolidated financial statements.

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Vermillion, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

1. ORGANIZATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

Organization

In this Quarterly Report on Form 10-Q, unless the context otherwise requires, Vermillion, Inc., a Delaware corporation, and its wholly-owned subsidiaries, are referred to as “we,” “the Company” or “Vermillion.”

We discover, develop and commercialize diagnostics tests in the fields of oncology, hematology, cardiology and women’s health. On March 9, 2010, the Company commercially launched its OVA1™ ovarian tumor triage test (the “OVA1 Test”).

We have incurred significant net losses and negative cash flows from operations since inception. We currently generate revenue solely through sales and collaborations associated with the OVA1 Test. Our ability to achieve our business objectives is dependent upon, among other things, generating sufficient revenue in excess of costs or raising additional capital. We may seek to raise additional funding from various possible sources, including the public equity market, private financings, sales of assets, collaborative arrangements and debt.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments necessary for the fair statement of results for the periods presented, have been included. The results of operations of any interim period are not necessarily indicative of the results of operations for the full year or any other interim period.

The unaudited consolidated financial statements and related disclosures have been prepared with the presumption that users of the interim unaudited consolidated financial statements have read or have access to the audited consolidated financial statements for the preceding fiscal year. The consolidated balance sheet at December 31, 2009, has been derived from the audited consolidated financial statements at that date but does not include all the information and footnotes required by GAAP. Accordingly, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2009, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on May 20, 2010.

The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC” or “Codification”) 852 “Reorganizations” applied to the Company’s financial statements while we operated under the provisions of Chapter 11. ASC 852 does not change the application of generally accepted accounting principles in the preparation of financial statements. However, for periods including and subsequent to the filing of the Chapter 11 petition ASC 852 does require that the financial statements distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, certain expenses that were realized or incurred during the Chapter 11 proceedings have been classified as “reorganization items” on the accompanying consolidated statements of operations. In addition, pre-petition obligations that were impacted by the Plan were classified as “liabilities subject to compromise” on the consolidated balance sheet as of December 31, 2009. Upon emergence from bankruptcy, we reclassified the pre-petition obligations back to accounts payable, accrued liabilities and convertible senior notes on the consolidated balance sheet as of June 30, 2010.

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.

Significant Accounting and Reporting Policies

The Company’s significant accounting policies are disclosed in its Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the SEC on May 20, 2010, and have not changed significantly since May 20, 2010 with exception to the following:

Revenue Recognition

        Product Revenue. The Company derives its revenues from product sales of the OVA1 Test. Our product revenues for tests performed are recognized when the following revenue recognition criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Prior to meeting all of these revenue recognition criteria for tests performed during the period, we recognize deferred revenue on the consolidated balance sheet.

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

License Revenue. Under the terms of the secured line of credit with Quest Diagnostics Incorporated (“Quest”), portions of the borrowed principal amounts may be forgiven upon the Company’s achievement of certain milestones relating to the development, regulatory approval and commercialization of certain diagnostic tests (see Note 5). We account for forgiveness of principal debt balances as license revenues over the term of the exclusive sales period that Quest receives upon commercialization of an approved diagnostic tests. We recognize license revenue straight-line over the 2.5 year period of Quest’s sales exclusivity since product sales cannot be reasonably estimated at this time.

2. CHAPTER 11 BANKRUPTCY

On March 30, 2009, we filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court. We operated our business and managed our properties as debtors in possession while under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. On January 22, 2010, we emerged out of bankruptcy.

Financial Statement Presentation

The accompanying consolidated financial statements have been prepared in accordance with ASC 852, and on a going-concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business.

Substantially all of our pre-petition debt was in default due to the Bankruptcy Filing. As described below, the accompanying consolidated financial statements present our pre-petition 4.50% Convertible Senior Notes due 2009 (the “4.50% Notes”) and 7.00% Convertible Senior Notes due 2011 (the “7.00% Notes”) totaling $7,365,000 as liabilities subject to compromise at December 31, 2009.

Liabilities Subject to Compromise

As required by ASC 852, we have recorded liability amounts for the claims that can be reasonably estimated and believe are probable of being allowed by the Bankruptcy Court. Such claims are subject to future adjustments that may result from, among other things, negotiations with creditors, and rejection of executory contracts and unexpired leases. Liabilities subject to compromise may change due to reclassifications, settlements or reorganization activities that give rise to new claims or increases in existing claims. Upon emergence from bankruptcy in January 2010, approved claims were either paid or assumed by the Company at an agreed upon rate. Certain matters are still subject to disputes as noted below under Plan of Reorganization.

Liabilities subject to compromise in the consolidated balance sheet consisted of the following at December 31, 2009 (in thousands):

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

Reorganization Items

Professional advisory fees and other costs directly associated with the Company’s reorganization are reported separately as reorganization items pursuant to ASC 852. Professional fees include legal fees undertaken as part of the reorganization process. The write-off of debt issuance costs and discounts related to debt generally represent one-time charges. Certain expenses incurred by non-debtors are paid by the Company and are also reported as reorganization items. The reorganization items in the consolidated statement of operations for the three and six months ended June 30, 2010 and 2009 consisted of the following items (in thousands):

Debtor-In-Possession Credit and Security Agreement with Quest

On October 16, 2009, the Bankruptcy Court gave final approval for us to enter into a Debtor-In-Possession Credit and Security Agreement (the “DIP Loan Agreement”) with Quest and to assume under the Bankruptcy Code the strategic alliance agreement with Quest (the “Strategic Alliance Agreement”), and its amendments thereto (the Strategic Alliance Agreement and the July 21, 2008, October 24, 2008 and October 7, 2009, amendments are collectively referred to as the “Amended Strategic Alliance Agreement”). In connection with the assumption of the Amended Strategic Alliance Agreement, we also assumed certain other agreements with Quest related to the Amended Strategic Alliance Agreement, including the pre-petition warrants for the purchase of our common stock. On October 27, 2009, we received $400,000 under this agreement. On January 22, 2010, we repaid the $400,000 and interest of $4,000, which terminated the DIP Loan Agreement. Professional service fees relating to the DIP Loan Agreement were expensed as incurred and classified as reorganization items in the accompanying consolidated statement of operations.

Plan of Reorganization

On January 7, 2010, the Bankruptcy Court issued a confirmation order approving our Plan of Reorganization. The Plan of Reorganization contemplated the reorganization of the Company and the discharge of all outstanding claims against and interests in the Company. Pursuant to the Plan of Reorganization, as confirmed, each holder of an allowed priority claim received cash in an amount equal to such allowed claim. The secured claim arising from the Quest Credit Agreement and the Patent Security Agreement (the “secured line of credit”) was reinstated and unimpaired. Holders of the outstanding 4.50% Notes received the payment of $2,195,000 of principle, $140,000 of unpaid interest and 9,044 shares of common stock in exchange of their claims. $5,000,000 in principal of the outstanding 7.00% Notes were reinstated. Holders of unpaid interest on previously converted 7.00% Notes received $362,000 in cash and 7,239 shares related to the unpaid interest of the 7.00% Notes. All holders of allowed general unsecured claims elected to receive cash and will be paid in full.

Subsequently on January 22, 2010, the confirmation order issued by the Bankruptcy Court for approving our Plan of Reorganization became final and all conditions precedent to January 22, 2010 were satisfied or waived. Accordingly, we emerged from bankruptcy under Chapter 11 and reinstated our common stock, par value $0.001. Although we have emerged out of bankruptcy, the bankruptcy case will remain open until the resolution of the following matters, which includes approval by the Bankruptcy Courts:

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

3. RECENT ACCOUNTING PRONOUNCEMENTS

In October 2009, the FASB issued Accounting Standards Update 2009-13, Revenue Recognition (Topic 605): “Multiple Deliverable Revenue Arrangements—A Consensus of the FASB Emerging Issues Task Force”. This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. The Company will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. We have not yet determined the impact that this update may have on our consolidated financial statements.

In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. The adoption of the updated guidance did not have a material impact on its consolidated results of operations or financial condition.

4. FAIR VALUE MEASUREMENT AND MARKETABLE SECURITIES

The Company invests in money market funds and auction rate securities. The following is a summary of available-for-sale securities at June 30, 2010 and December 31, 2009 (in thousands):

The scheduled contractual maturity dates for available-for-sale short-term investments at June 30, 2010, are as follows (in thousands):

As of June 30, 2010, financial assets measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above was as follows (in thousands):

The Company’s Level 1 financial assets are money market funds.

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

At June 30, 2010, long-term investments available-for-sale measured at fair value using Level 3 inputs consisted of $465,000 invested in auction rate securities. The continued failure of auctions and the lack of market activity and liquidity required that these securities be measured using Level 3 inputs. As of June 30, 2010 and December 31, 2009, the Company’s auction rate securities in credit linked notes were valued using a single factor Gaussian copula model and market bids received from Deutsche Bank. On July 26, 2010, we sold the auction rate securities investments for total proceeds of $465,000.

The Company’s financial assets measured at fair value on a recurring basis using significant Level 3 inputs as of June 30, 2010, consisted solely of auction rate securities. The reconciliation of financial assets measured at fair value using significant unobservable inputs (Level 3) for the six months ended June 30, 2010, was as follows (in thousands):

The Company measures certain common stock warrants at fair value on a recurring basis (see Note 9). We measure all other financial assets and liabilities at fair value on a nonrecurring basis. We recognize these financial assets and liabilities at fair value when they are deemed to be other-than-temporarily impaired.

5. SECURED LINE OF CREDIT WITH QUEST DIAGNOSTICS INCORPORATED

On July 22, 2005, in connection with the Strategic Alliance Agreement, Quest provided us with a $10,000,000 secured line of credit, which is collateralized by certain of our intellectual property and may only be used for payment of certain costs and expenses directly related to develop and commercialize up to three diagnostic tests from our product pipeline (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. Upon default on any principal or interest payment, the interest rate is increased to prime plus 2.0%. This secured line of credit also contains provisions for Quest to forgive portions of the amounts borrowed that corresponds to our achievement of certain milestones related to development, regulatory approval and commercialization of certain diagnostic tests. The amounts to be forgiven and the corresponding milestones we 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 earlier of the United States Food and Drug Administration (the “FDA”) clearance of the first diagnostic test kit or commercialization of the first diagnostic test kit; and

(iii) $2,000,000 upon each FDA clearance of up to two subsequent diagnostic test kits but no later than the first commercialization of each such diagnostic test kit, with a maximum forgiveness of $4,000,000 for two diagnostic test kits.

If not otherwise forgiven, the principal amount outstanding and any unpaid interest of this secured line of credit will become due and payable on October 7, 2012.

We achieved the milestone for FDA clearance of the first diagnostic test kit when the OVA1 Test was approved by the FDA in September 2009. While we were under Chapter 11 bankruptcy protection, we had not paid accrued interest on the secured line of credit and were therefore in default. In January 2010, we emerged from bankruptcy and cured the default upon payment of accrued interest, and as a result of the cure, the principal on the secured line of credit was reduced by $3,000,000 to $7,000,000. We are in discussions with Quest regarding the achievement of an additional $1,000,000 forgiveness milestone related to the OVA1 Test under the terms of the Strategic Alliance Agreement.

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

6. COMMITMENTS AND CONTINGENT LIABILITIES

Under the terms of a research collaboration agreement with The John Hopkins University School of Medicine (“JHU”), we were required to pay JHU $600,000, $618,000 and $637,000 for the years ending December 31, 2008, 2009 and 2010, respectively. In June 2010, the research collaboration agreement was amended by extending the term and reducing the payments to $300,000 for 2010, $400,000 for 2011, $400,000 for 2012 and $100,000 for 2013. In conjunction with the amendment, JHU forgave the previously outstanding amounts we owed of $623,000, which we recognize as a reduction to research and development expenses straight line over the term of the amended agreement. As of June 30, 2010, we owed $100,000 related to the research collaboration agreement. Collaboration costs under the JHU collaboration were $48,000 and $207,000 for the three and six months ended June 30, 2010, respectively, and $154,000 and $308,000 for the three and six months ended June 30, 2009, respectively. Collaboration costs under the JHU collaboration are included in research and development expenses. In addition, under the terms of the amended research collaboration agreement, we are required to pay the greater of 4% royalties on net sales of diagnostic tests using the assigned patents or annual minimum royalties of $50,000.

In June 2010, the Company entered into noncancelable facility leases for facilities located in Austin, Texas through May 2012 and Mountain View, California through August 2012. The combined annual base rent for these facilities is $129,000 per year, prorated for partial years.

Contingent Liabilities

Molecular Analytical Systems, Inc. Litigation

On July 9, 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 Laboratories, Inc. (“Bio-Rad”) as defendants (the “State Court lawsuit”). Under the State Court 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 the Company’s Surfaced Enhanced Laser Desorption/Ionization (“SELDI”) technology as a result of Vermillion’s entry into a sublicense agreement with Bio-Rad. Vermillion filed a petition to compel arbitration, which was denied in the trial court. Vermillion then filed its general denial and affirmative defenses on April 1, 2008. The Company and Bio-Rad thereafter appealed the denial of the motion to compel arbitration, which appeal had the effect of staying the State Court lawsuit, which stay was further extended in both the state trial and appellate courts when the Company filed on March 30, 2009, a Voluntary Petition for Relief under Chapter 11 in the Bankruptcy Court. MAS filed a proof of claim on June 30, 2009, in connection with the Company’s Chapter 11 bankruptcy proceedings. The proof of claim mirrored the MAS lawsuit and asserted that the Company breached the Exclusive License Agreement by transferring certain technologies to Bio-Rad without obtaining MAS’s consent. MAS listed the value of its claim as in excess of $5,000,000. On December 28, 2009, the Company objected to MAS’s Proof of Claim in the Bankruptcy Court. On January 7, 2010, the Bankruptcy Court confirmed the Company’s Plan of Reorganization. Per the Court’s order confirming the plan, the Company’s bankruptcy case will be closed after a final, non-appealable judgment is entered on MAS’s claims. After the plan was confirmed, MAS filed a motion with the Bankruptcy Court asking it to abstain from hearing its proof of claim and asked the Bankruptcy Court to grant relief from stay so that MAS could proceed with the State Court lawsuit in California. The Bankruptcy Court granted that motion on March 15, 2010. Thereafter, the California Court of Appeal set oral argument on the Company’s appeal of the trial court order denying the Company’s motion to compel arbitration for June 17, 2010. The California Court of Appeals overturned the Superior Court’s decision in an opinion dated July 9, 2010, and ordered that the dispute be arbitrated before the Judicial Arbitration and Mediation Service. MAS has not yet filed its arbitration demand. Management cannot predict the ultimate outcome of this matter at this time.

Bio-Rad Laboratories, Inc. Matters

On November 13, 2006, the Company completed the sale of assets and liabilities of its protein research products and collaborative services business (the “Instrument Business Sale”) to Bio-Rad. The Instrument Business Sale included the Company’s SELDI technology, ProteinChip arrays and accompanying software. Pursuant to the terms of the sales agreement, the total sales price was $20,000,000, of which $16,000,000 was paid by Bio-Rad to the Company at the closing of the transaction on November 13, 2006. A total of $4,000,000 was held back from the sales proceeds contingent upon the Company meeting certain obligations, which $2,000,000 was subsequently paid to the Company in fiscal 2007 upon the issuance by the United States Patent and Trademark Office a reexamination certificate for United States Patent No. 6,734,022. From the amounts held back, $2,000,000, subject to certain adjustments, is being held in escrow to serve as security for the Company to fulfill certain obligations.

        In connection with the Instrument Business Sale, the Company entered into a letter agreement with Bio-Rad pursuant to which the Company agreed to indemnify Bio-Rad and its subsidiaries with respect to certain payments made by Bio-Rad in connection with the termination of employees of its former subsidiary in the United Kingdom in the six-month period immediately following the Instrument Business Sale. On May 4, 2007, Bio-Rad delivered a claim for indemnification under the agreement for $307,000, which was paid out of $2,000,000 held in escrow. In August 2009, Bio-Rad also filed a proof of claim in the bankruptcy case for indemnification of the MAS lawsuit. Management is disputing the claim and cannot predict the ultimate outcome of this matter at this time.

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

In connection with the Instrument Business Sale, the Company also entered into a manufacture and supply agreement with Bio-Rad on November 13, 2006, whereby we agreed to purchase ProteinChip Systems and ProteinChip Arrays (collectively, the “Research Tools Products”) from Bio-Rad. Under the terms of the manufacture and supply agreement, we agreed to provide Bio-Rad quarterly, non-binding, twelve-month rolling forecasts setting forth our anticipated needs for Research Tools Products over the forecast period. We were permitted to provide revised forecasts as necessary to reflect changes in demand for the products, and Bio-Rad was required to use commercially reasonable efforts to supply amounts in excess of the applicable forecast. Either party was permitted to terminate the agreement for convenience upon 180 days’ prior written notice, or upon default if the other party failed to cure such default within 30 days after notice thereof. In a letter from the Company to Bio-Rad dated May 2, 2008, we exercised our 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. In October 2009, Bio-Rad filed a proof of claim in our bankruptcy case based on certain contract claims for approximately $1,000,000. We are attempting to resolve the contract claims and have accrued for this contingency within general and administrative expense at June 30, 2010 and December 31, 2009. 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 our operations. We establish reserves for specific liabilities in connection with legal actions that we deem to be probable and estimable. Other than as disclosed above, we are not currently a party to any proceeding, the adverse outcome of which would have a material adverse effect on our financial position or results of operations.

7. ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of accumulated other comprehensive loss as of June 30, 2010 and 2009 were as follows (in thousands):

8. EMPLOYEE BENEFITS PLANS

2010 Stock Option Plan

On February 8, 2010, our Board of Directors approved the Vermillion, Inc. 2010 Stock Incentive Plan (the “2010 Plan”). The 2010 Plan will be administered by the Compensation Committee of the Board. The Company’s employees, directors, and consultants are eligible to receive awards under the 2010 Plan. The 2010 Plan permits the granting of a variety of awards, including stock options, share appreciation rights, restricted shares, restricted share units, unrestricted shares, deferred share units, performance and cash-settled awards, and dividend equivalent rights. The 2010 Plan provides for issuance of up to 1,322,983 shares of common stock, par value $0.001 per share under the 2010 Plan, subject to adjustment as provided in the 2010 Plan.

Stock-Based Compensation

Employee Stock-based Compensation Expense

The Company granted options to purchase up to 40,000 and 146,000 shares of common stock with an average exercise price of $19.95 and $26.27 during the three and six months ended June 30, 2010, respectively. No options were granted during the three and six months ended June 30, 2009. The fair value of the stock options granted were valued on the date of grant using the Black-Scholes valuation model using the following average assumptions:

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

The allocation of employee stock-based compensation expense by functional area for the three and six months ended June 30, 2010 and 2009, was as follows (in thousands):

Non-employee Stock-based Compensation Expense

We recognize stock-based compensation expense related to stock options granted to non-employees as the stock options are earned. As part of the bankruptcy case, certain former employees were converted into consultants whereby their existing stock options continued to vest, under the original terms of their stock option grants, as they provided consulting services to the Company. We amortize the values attributable to these options over the service period. The unvested portion of these options was re-measured at each vesting date. We believe that the fair value of the stock options is more reliably measurable than the fair value of the services received. We revalued the fair value of the stock options granted at each reporting date using the Black-Scholes valuation model using the following average assumptions:

The stock-based compensation expense will fluctuate as the fair market value of the common stock fluctuates. In connection with stock options relating to non-employees, we recorded non-employee stock-based compensation allocated by functional area for the three and six months ended June 30, 2010, as follows (in thousands):

We incurred an insignificant amount of non-employee stock-based compensation expenses for the three and six months ended June 30, 2009.

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

9. COMMON STOCK

January 2010 Private Placement

On January 7, 2010, in connection with the Plan of Reorganization, we completed a private placement sale of 2,327,869 shares of our common stock at a price of $18.4932 per share to a group of new and existing investors for $43,050,000 in gross proceeds (net proceeds of $42,782,000, of which $42,780,000 was recorded as additional paid-in capital).

Common Stock Warrants

At June 30, 2010 and December 31, 2009, the Company had warrants outstanding to purchase 195,012 shares of common stock and 273,467 shares of common stock, respectively. The fair value of these common stock warrants on June 30, 2010 was determined using a Black Scholes valuation model with the following Level 3 inputs:

As a result of warrant exercises, we recognized total gains of $101,000 and $223,000 for the three and six months ended June 30, 2010, respectively. No warrants were exercised during the three or six months ended June 30, 2009. The following table is a reconciliation of the warrant liability measured at fair value using Level 3 inputs for the three and six months ended June 30, 2010 and 2009 (in thousands):

The following table sets forth the Company’s financial liabilities, related to common stock warrants issued in the August 29, 2007 private placement, subject to fair value measurements as of June 30, 2010:

10. LOSS PER SHARE

We calculate basic loss per share using the weighted average number of common shares outstanding during the period. Because we are 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 1,475,573 and 3,846,448 potential common shares as of June 30, 2010 and 2009, 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 common stock warrants.

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Vermillion, Inc.

Notes to Consolidated Financial Statements—(Continued)

(Unaudited)

11. RELATED PARTY TRANSACTIONS

Consulting Agreement

On March 26, 2009, the Company entered into a consulting agreement with its former Chief Executive Officer and current Director. For the three months ended June 30, 2010 and 2009, we incurred none and $55,000, respectively, in general and administrative expenses under the consultant arrangement. For the six months ended June 30, 2010 and 2009, we incurred $24,000 and $55,000 in general and administrative expenses under the consulting arrangement. On February 1, 2010, this consulting agreement was terminated when we re-hired our Chief Executive Officer.

Debtor’s Incentive Plan

In connection with the Bankruptcy Filing, on April 21, 2009, the Company filed the Debtor’s Motion for Entry of an Order Approving the Debtor’s Incentive Plan (the “Incentive Plan”) and Authorizing Payments thereunder pursuant to §§ 363(b) and 503(b) of the Bankruptcy Code (the “Incentive Plan Motion”) which sought to provide proper incentives to the Directors (Gail Page, John Hamilton and James Burns, collectively, the “Directors”) to help achieve a successful sale or restructuring of the Company. Under the final terms of the Incentive Plan, the Company was directed to distribute an aggregate of $5,000,000 in cash and 302,541 shares of restricted stock in Incentive Plan Payments to the Directors. All such restricted stock is to be distributed, with 1/24th of it to vest on each monthly anniversary of the vesting commencement date, June 22, 2009. The liability was accounted for upon the occurrence of the qualified transaction on January 7, 2010 when the Bankruptcy Courts issued a confirmation order approving the Company’s Reorganization Plan. Accordingly, the Company recorded a charge of $828,000 and $8,313,000 for the three and six months ended June 30, 2010, respectively, and will record additional charges totaling $3,313,000 through June 2011 as the underlying restricted stock vests. As of June 30, 2010, the Company incurred $8,313,000 under the terms of the Incentive Plan, of which $6,932,000 was recorded in Reorganization Items for the period prior to emerging out of bankruptcy and $1,381,000 was recorded in general and administrative expenses for the period subsequent to emerging out of bankruptcy. In April 2010, the Company distributed an aggregate of $5,000,000 in cash to the Directors.

12. SUBSEQUENT EVENTS

NASDAQ Stock Market

On July 6, 2010, The NASDAQ Stock Market LLC relisted the Company’s common stock on The NASDAQ Global Market.

Common Stock Warrants Fair Value

As of August 12, 2010, we estimated the fair value of the outstanding common stock warrants dated August 29, 2007, underlying the warrant liability was approximately $2.69 per share for a total fair value of $525,000, which is a decrease of $759,000 from the June 30, 2010, total fair value of $1,284,000.

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Forward Looking Statements

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:

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; our ability to manage the Company’s operating expenses and cash resources that is consistent with our plans; our ability to secure adequate funds on acceptable terms to execute our business plan; our ability to develop and commercialize diagnostic products using both Vermillion’s internal and external research and development resources; our ability to obtain market acceptance of Vermillion’s OVA1 Test or future diagnostic products, including the risk that our products will not be competitive with products offered by other companies, or that users will not be entitled to receive adequate reimbursement for our products from third party payers such as private insurance companies and government insurance plans; our ability to successfully license or otherwise successfully partner with third parties to commercialize our products; our ability to obtain any regulatory approval for Vermillion’s future diagnostic products; 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., the Company had its initial public offering on September 28, 2000. On November 13, 2006, the Company sold the assets and liabilities of its protein research products and collaborative services business to Bio-Rad, which allowed us to focus on the development of our diagnostics tests. On August 21, 2007, Ciphergen Biosystems, Inc. changed its corporate name to Vermillion, Inc.

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We are dedicated to the discovery, development and commercialization of novel high-value diagnostic tests that help physicians diagnose, treat and improve outcomes for patients. Our tests are intended to guide decisions regarding patient treatment, which may include decisions to refer patients to specialists, to perform additional testing, or to assist in the selection of therapy. A distinctive feature of our approach is to combine multiple markers into a single, reportable index score that has higher diagnostic accuracy than its constituents. We concentrate our development of novel diagnostic tests in the fields of oncology, hematology, cardiology and women’s health, with the initial focus on ovarian cancer. We also intend to address clinical questions related to early disease detection, treatment response, monitoring of disease progression, prognosis and others through collaborations with leading academic and research institutions.

Our lead product, the OVA1 Test, was cleared by the FDA on September 11, 2009. The OVA1 Test addresses a clear unmet clinical need, namely the presurgical identification of women who are at high risk of having a malignant ovarian tumor. Numerous studies have documented the benefit of referral of these women to gynecologic oncologists for their initial surgery. Prior to the clearance of the OVA1 Test, no blood test had been cleared by the FDA for physicians to use in the presurgical management of ovarian adnexal masses. The OVA1 Test is a qualitative serum test that utilizes five well-established biomarkers and proprietary FDA-cleared software to determine the likelihood of malignancy in women with a pelvic mass for whom surgery is planned. The OVA1 Test was developed through large pre-clinical studies in collaboration with numerous academic medical centers encompassing over 2,500 clinical samples. The OVA1 Test was fully validated in a prospective multi-center clinical trial encompassing 27 sites reflective of the diverse nature of the clinical centers at which ovarian adnexal masses are evaluated. The results of the clinical trial demonstrated that the OVA1 Test, in conjunction with clinical evaluation, was able to identify over 90% of the malignant ovarian tumors and to rule out malignancy (negative predictive value, or “NPV”) with over 90% certainty.

In addition to the OVA1 Test, we have development programs in other clinical aspects of ovarian cancer as well as in peripheral arterial disease. In the field of peripheral arterial disease, we have identified candidate biomarkers that may help to identify individuals at high risk for a decreased ankle-brachial index score, which is indicative of the likely presence of peripheral arterial disease (“PAD”).

Current and former academic and research institutions that we have or have had collaborations with include 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; Clinic of Gynecology and Clinic of Oncology, Rigshospitalet, Copenhagen University Hospital; The Ohio State University Research Foundation; Stanford University; and the University of Kentucky.

On July 22, 2005, we entered into the Strategic Alliance Agreement with Quest. The Strategic Alliance Agreement was set to expire 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 three diagnostic tests. On July 21, 2008, the Strategic Alliance Agreement was amended 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 three diagnostic tests. On October 24, 2008, the Strategic Alliance Agreement was amended 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. Subsequently on October 7, 2009, the Strategic Alliance Agreement was amended to extend the term of the agreement to end on the earlier of (i) October 7, 2012 and (ii) the date on which Quest makes its third development election. To date, Quest has selected only two diagnostic tests, which are the PAD blood test (“VASCLIR™”) and the OVA1 Test, to commercialize. We achieved the milestone provision in the secured line of credit agreement with Quest for FDA clearance of the first diagnostic test kit when the OVA1 Test was approved by the FDA in September 2009. While we were under Chapter 11 bankruptcy protection, we had not paid accrued interest on the secured line of credit and were therefore in default. In January 2010, we emerged from bankruptcy and cured the default upon payment of accrued interest, and as a result of the cure, the principal on the secured line of credit was reduced by $3,000,000 to $7,000,000. We are in discussions with Quest regarding the achievement of an additional $1,000,000 forgiveness milestone related to the OVA1 Test under the terms of the Strategic Alliance Agreement.

On March 30, 2009, we filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. Subsequently, on January 22, 2010, the confirmation order issued by the Bankruptcy Court approving our Second Amended Plan of Reorganization under Chapter 11 of the United States Bankruptcy Code dated January 5, 2010, became final and all conditions precedent to January 22, 2010, were satisfied or waived. Accordingly, we emerged from bankruptcy under Chapter 11 on January 22, 2010.

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The OVA1 Test was launched on March 9, 2010 by Quest under the terms of the Strategic Alliance Agreement at a list price of $650.00 for each OVA1 Test. On March 11, 2010, the Medicare contractor Highmark Medicare Services announced that it would cover the OVA1 Test in its reimbursement program. On May 10, 2010, Quest notified Vermillion that Highmark Medicare Services is adjudicating to Quest the OVA1 Test claims in the amount of $516.25 for each OVA1 Test. For the quarter ended June 30, 2010, the average payor reimbursement rate was approximately $571 for each OVA1 Test. We estimate 1,247 OVA1 Tests had been performed as of June 30, 2010. We recognized product revenue for 342 of these tests. It will not be easy for us to estimate revenues from Quest during the early period of the OVA1 Test’s commercial availability. As we enhance our ability to estimate reimbursements, we will be in a position to recognize revenues in better alignment with the actual performance of the test. Under the terms of the Strategic Alliance Agreement, we are entitled to a minimum of 25% of Quest’s gross margin for each OVA1 Test performed. The Strategic Alliance Agreement allows Vermillion additional revenue depending upon Vermillion’s gross margin from the sale of proprietary test kits and equipment, and we are in discussions with Quest regarding the amount and timing of this additional revenue.

On June 9, 2010, we announced that the European Patent Office had issued a Decision to Grant patent number 1,493,741 entitled “Use of biomarkers for detecting ovarian cancer.” On June 29, 2010, we announced that the United States Patent and Trademark Office had issued a notice of allowance of a patent entitled “Biomarkers for Alzheimer’s disease.” The issuance of these patents provides important validation of our biomarker patent strategy and the increasing breadth of our patent portfolio is an important corporate asset. Additionally, the issuance of the European patent will help support our commercialization efforts in Europe.

On July 6, 2010, we announced that The NASDAQ Stock Market LLC approved our application for the relisting of our common stock on The NASDAQ Global Market. The Company’s shares began trading on The NASDAQ Global Market upon market open on Tuesday, July 6, 2010 under the symbol “VRML.”

On July 23, 2010, we announced the relocation of our corporate headquarters from Fremont, California to Austin, Texas. We will continue to operate research and development, regulatory and quality operations in California. All other functions will be conducted at the Austin office.

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, 2009, except as disclosed below:

Revenue Recognition

Product Revenue. The Company derives its revenues from product sales of the OVA1 Test. Our product revenues for tests performed are recognized when the following revenue recognition criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Prior to meeting all of these revenue recognition criteria for tests performed during the period, we recognize deferred revenue on the consolidated balance sheet.

License Revenue. Under the terms of the secured line of credit with Quest, portions of the borrowed principal amounts may be forgiven upon the Company’s achievement of certain milestones relating to the development, regulatory approval and commercialization of certain diagnostic tests. The Company accounts for forgiveness of principal debt balances as license revenues over the term of the exclusive sales period that Quest receives upon commercialization of an approved diagnostic tests. We recognize license revenue straight-line over the 2.5 year period of Quest’s sales exclusivity since product sales cannot be reasonably estimated at this time.

Recent Accounting Pronouncements

In October 2009, the FASB issued Accounting Standards Update 2009-13, Revenue Recognition (Topic 605): “Multiple Deliverable Revenue Arrangements—A Consensus of the FASB Emerging Issues Task Force”. This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific or third-party evidence is available. The Company will be required to apply this guidance prospectively for revenue arrangements entered into or materially modified after January 1, 2011; however, earlier application is permitted. The Company has not determined the impact that this update may have on our consolidated financial statements.

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In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. The adoption of the updated guidance did not have a material impact on its consolidated results of operations or financial condition.

Results of Operations - Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009

The selected summary financial and operating data of Vermillion for the three months ended June 30, 2010 and 2009, were as follows (dollars in thousands):

Product Revenue. Product revenue was $45,000 for the three months ended June 30, 2010 compared to none for the same period in 2009. The Company recognized 342 OVA1 Tests as product revenue for the three months ended June 30, 2010. As we enhance our ability to estimate reimbursements, we will be in a position to recognize revenues in better alignment with the actual performance of the test.

License Revenue. License revenue was $299,000 for the three months ended June 30, 2010 compared to none for the same period in 2009. Under the terms of our secured line of credit with Quest, $3,000,000 principal was forgiven upon the achievement of FDA approval for the OVA1 Test. This amount is recognized as license revenue straight-lined over the 2.5 year period of sales exclusivity Quest received beginning on the OVA1 Test commercialization date of March 9, 2010.

Product Cost of Sales. Product cost of sales was $12,000 for the three months ended June 30, 2010 compared to none for the same period in 2009.

Research and Development Expenses. Research and development expenses represent costs incurred to develop our technology and carry out clinical studies, and include personnel-related expenses, regulatory costs, reagents and supplies used in research and development laboratory work, infrastructure expenses, including allocated facility occupancy and information technology costs, contract services and other outside costs. Research and development expenses also include costs related to activities performed under contracts with our collaborators and strategic partners. Research and development expenses increased by $343,000, or 58%, for the three months ended June 30, 2010 compared to the same period in 2009. This increase included a $195,000 increase in stock-based compensation, a $113,000 increase in personnel-related expenses and a $99,000 increase in consulting expenses, offset by a $44,000 decrease in depreciation expense and $52,000 waived under the amended JHU collaboration agreement. The increases were primarily due to an increase in personnel and their related stock options granted after our emergence from bankruptcy. We expect our research and development expenses to increase in future periods due to an increased investment in our ovarian cancer program and our peripheral arterial disease blood test.

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Sales and Marketing Expenses. Our sales and marketing expenses consist primarily of personnel-related expenses, education and promotional expenses, and infrastructure expenses, including allocated facility occupancy and information technology costs. These expenses include the costs of educating physicians, laboratory personnel and other healthcare professionals regarding our OVA1 Test. Sales and marketing expenses also include the costs of sponsoring continuing medical education, medical meeting participation and dissemination of scientific and health economic publications. Sales and marketing expenses increased by $532,000 for the three months ended June 30, 2010 compared to the same period in 2009. The increase was primarily due to a $389,000 increase in personnel and travel-related expenses, reflecting the addition of six domestic field sales representatives in the three months ended June 30, 2010, and a $129,000 increase in trade show, advertising and marketing expenses related to the commercialization launch of our OVA1 Test. We expect sales and marketing expenses to increase in future periods due to our continued efforts to establish adoption of, and reimbursement for, our OVA1 Test.

General and Administrative Expenses. General and administrative expenses consist primarily of personnel-related expenses, professional fees and other costs, including legal, finance and accounting expenses, bad debt expense and other infrastructure expenses, including allocated facility occupancy and information technology costs. The $2,157,000, or 483%, increase in general and administrative expenses for the three months ended June 30, 2010 was primarily due to a $580,000 increase in audit and tax related service fees, a $389,000 increase in personnel-related expenses, a $253,000 increase in legal expenses and a $164,000 increase in consulting and other outside service expenses. Personnel, consulting, legal, audit and tax related expenses increased due to significant efforts to bring current all periodic reports required by the Securities and Exchange Act of 1934. The Company also incurred $828,000 for the value of the vested portions of restricted stock under the Incentive Plan during the three months ended June 30, 2010. Stock-based compensation expense included in general and administrative expenses was $154,000 and $66,000 for the three months ended June 30, 2010 and 2009, respectively.

Interest Income. Interest income increased by $1,000, or 17%, for the three months ended June 30, 2010, compared to the same period in 2009.

Interest Expense. Interest expense decreased by $344,000, or 75%, for the three months ended June 30, 2010, compared to the same period in 2009. Interest expense in both periods consisted largely of interest related to our convertible senior notes and related party long-term debt; however, total debt outstanding at June 30, 2010 was $12,000,000 compared to $29,000,000 at June 30, 2009.

Change in fair value and gain from exercise of warrants. The increase in change in fair value and gain from exercise of warrants of $3,428,000 for the three months ended June 30, 2010 was primarily due to the change in the Company’s stock price from March 31, 2010 to June 30, 2010.

Reorganization items. Reorganization items for the three months ended June 30, 2010 amounted to $265,000 compared to $336,000 for the same period in 2009. Reorganization items include professional advisory fees and other costs directly associated with the Company’s Chapter 11 bankruptcy activities.

Other Income (Expense), Net. Net other expense was $35,000 for the three months ended June 30, 2010 compared to $14,000 of income for the same period in 2009.

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Results of Operations - Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009

The selected summary financial and operating data of Vermillion for the six months ended June 30, 2010 and 2009, were as follows (dollars in thousands):