SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common stock, par value $0.001

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes   o    No  ý

The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant on June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter was $49,126,257 based on the average of the reported high and low sales price of the registrant’s common stock on June 30, 2004 as reported on the Frankfurt Stock Exchange, of 3.4 Euros, or $4.17 per share, based on the exchange rate in effect as of such date.

As of January 31, 2005, there were 13,954,684 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for the 2005 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of the year ended December 31, 2004, are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

TABLE OF CONTENTS

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PART I.

Item 1.  Business

General

MacroPore Biosurgery specializes in the discovery and development of regenerative medicine therapies.  We have two principal technology platforms, adipose-derived regenerative cells and bioresorbable implants.

The regenerative cell technology program is developing treatments for cardiovascular disease, spine and orthopedic conditions, gastrointestinal disorders and new approaches for aesthetic and reconstructive surgery using regenerative cells from adipose tissue (fat).  This tissue is the richest and most accessible known source for regenerative cells, a population of cells that includes adult stem cells, angiogenic cells (blood vessel forming) and other regeneration-promoting cells.  Our lead regenerative cell research program, currently in preclinical testing, targets myocardial infarction (heart attack). 

To facilitate the processing and delivery of adipose-derived regenerative cells, we are designing a proprietary point-of-care system, Celution™, to isolate and concentrate a patient’s own regenerative cells in real-time.  Our goal is to commercialize a system that may be used universally across multiple therapeutic applications.  The commercialization model will be based on the sale of a device and related consumables.

Strategically, we are pursuing partnering and licensing agreements with medical device, biotechnology and pharmaceutical companies, as well as universities and private research organizations, to fund the development of applications for adipose-derived regenerative cells outside of cardiovascular disease.

Additionally, we manufacture the HYDROSORB™ family of FDA-cleared bioresorbable spine and orthopedic implants, which are distributed exclusively through Medtronic, Inc (“Medtronic”).  As of December 31, 2004, Medtronic owned 7.2% of our outstanding common stock and is considered a related party.  Our strategy contemplates that we will use cash flows from HYDROSORB™ revenues, licensing agreements, product line divestitures and milestone payments under development arrangements are used to fund our adipose-derived regenerative cell research and development.

MacroPore Biosurgery, Inc. (MacroPore) was initially formed as a California general partnership in July 1996, and incorporated in the State of Delaware in May 1997.

Regenerative Medicine

Regenerative medicine harnesses the body’s own healing mechanisms to repair organs and tissues damaged from disease, trauma, congenital abnormalities and the effects of aging.  Regenerative therapies, technologies and devices are being developed at corporations, universities, and public and private research organizations around the world to augment the body’s own healing mechanisms as an alternative to traditional pharmaceuticals or surgical procedures.

Stem cells are master cells that have the ability to differentiate into multiple cell and tissue types, including bone, muscle (including cardiac muscle), cartilage, fat, and nerve.  They reside naturally in several sources, including but not limited to adipose tissue, bone marrow, embryonic and fetal tissue, peripheral and umbilical cord blood.  These cells are commonly classified into two types: those which reside in embryonic tissue, known as embryonic stem cells, and all others, known collectively as adult stem cells.

Our investigational therapies use exclusively human adult regenerative cells from adipose tissue. 

Regenerative Cell Technology

Regenerative cells from adipose tissue have been shown to differentiate into multiple cell types in vitro, including cells of the heart muscle, bone, fat, cartilage, skeletal muscle, smooth muscle and nerve.  The major advantages of adipose tissue as a source of regenerative cells, which separate it from alternative sources, are that:

•                    Real-time therapy is possible because a therapeutic dose can be isolated in approximately one hour;

•                    The cells do not need to leave the clinic and are not extensively manipulated since no cell culture is required;

•                    Patients receive their own cells (autologous-use) so there is no risk of immune rejection and/or disease transmission; and

•                    Adipose tissue is an easily accessible source of regenerative cells requiring only a minimally invasive procedure.

With our proprietary process and methods, a high yield and high quality of stem and other regenerative cells can be quickly obtained from adipose tissue.  Alternative cell sources are difficult to harvest and most do not yield a sufficient number of regenerative-capable cells without extensive cell culture.  Cell culture, also known as ex-vivo expansion, is a process whereby cells are

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grown for a period of at least two days to three weeks in a laboratory to obtain therapeutic quantities.   For example, it has been reported that 10,000 stem cells exist within 100 milliliters of bone marrow.  In 100 milliliters of adipose tissue, there is an average of 750,000 stem cells in addition to the presence of hundreds of thousands of angiogenic and growth factor producing cells. 

Another significant benefit of adipose-derived regenerative cells is that they are well suited to autologous use (using the patient’s own cells).  This avoids the problems of disease transmission and rejection associated with donor tissue. 

Bioresorbable Technology

To date, we have introduced three bioresorbable product lines that are marketed in the United States, Canada, Europe and other countries.  These product lines include:

1.               HYDROSORB™ bioresorbable spine and orthopedic surgical implants, which are marketed by Medtronic;

2.               Thin Film bioresorbable surgical implants (includes SurgiWrap™ bioresorbable products), which are used for soft tissue indications; and

3.               Craniomaxillofacial (“CMF”) bioresorbable surgical implants, which consists of bioresorbable bone fixation implants for the face and skull, and associated instruments and accessories.

As discussed below, we have sold most of the assets of the second product line and all of the assets of the third product line.  

All three bioresorbable product lines are made from a polylactide copolymer composed of lactic acid similar to that which occurs naturally in the human body.  The polymer implant maintains its strength during the healing process, while slowly breaking down in the body through hydrolysis.  The polymer fragments into single lactic acid molecules and the lactic acid molecules are then metabolized by the liver into carbon dioxide and water, and released from the body through the lungs.  By polymerizing lactic acid and taking advantage of thermoplastic properties, we can create bioresorbable products that can be easily shaped, sized and applied to varying anatomical structures.

HYDROSORB™ Bioresorbable Implants

Our HYDROSORB™ bioresorbable family of surgical implant revenues were $3,803,000, $9,882,000 and $5,544,000 for the years ended December 31, 2004, 2003, and 2002, respectively.  The HYDROSORB™ product line accounted for 55.8% of our product revenues in 2004.  Although our quarterly sales of these implants have been irregular, we currently do not observe seasonal trends for demand of the HYDROSORB™ products from Medtronic.

The HYDROSORB™ BoomerangÒ, HYDROSORB™ Cornerstone™ HSR, HYDROSORB™ Mesh and HYDROSORB™ Telamon® products have received FDA clearance in the United States for certain graft containment applications, and have received the CE Mark in Europe for spinal interbody fusion procedures.  The HYDROSORB™ Spine System has received FDA clearance in the United States for use in spinal fusion procedures, in conjunction with traditional rigid fixation, as a means to maintain the relative position of weak bony tissue such as autografts.  The HYDROSORB™ Shield has received FDA clearance in the United States for minimizing the attachment of soft tissue, and has received the CE Mark in Europe for the control of post-operative adhesions in spine surgery.

Thin Film Bioresorbable Implants

We sold off a significant portion of the Thin Film product line to MAST Biosurgery AG and its U.S. subsidiary (MAST) in 2004 for $7,000,000 in upfront fees plus $2,000,000 in cash or 19% equity in MAST Biosurgery and other considerations outlined in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section.  Also, we entered into a distribution and supply agreement with Senko Medical Trading Co. (“Senko”) for the retained rights to market Thin Film products in Japan.  The terms of the agreement include a $1,500,000 upfront license fee, which was received in July 2004, a $1,250,000 milestone related to a regulatory submission, which was received in the third quarter of 2004, a $250,000 milestone for a regulatory clearance, plus manufacturing revenues and royalties for a three year-period following initiation of commercialization.  We are preparing to sell Thin Film implants to Senko for distribution in Japan following our 2004 submission of a regulatory application for Thin Films to the Japanese Ministry of Health, Labour and Welfare (“MHLW”).  We expect regulatory clearance to be received in 2005 or early 2006.

CMF Bioresorbable Implants

In September 2002, we sold substantially all of the assets of our CMF product line to Medtronic and granted them an exclusive license to certain related intangible assets, along with exclusive rights to the use of our bioresorbable implants for repair of the bone harvest site in the iliac crest, for what resulted in total consideration of $15,500,000.  In accordance with the terms of the Agreement,

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we received an initial payment of $13,000,000 from Medtronic and a first milestone payment of $1,000,000 in the fourth quarter of 2002.  A final milestone payment of $1,500,000 was received in 2004.  The agreement also allowed us to receive up to $5,000,000 if and when we completed successful clinical evaluations for a new faster-resorbing polymer product, as defined in this agreement.  In January 2004, we received a $5,000,000 milestone payment from Medtronic and it was recognized as gain on sale of assets, related party, in the accompanying statements of operations. In a separate, but simultaneous transaction, we paid Medtronic $4,000,000 to purchase a waiver of the right of first offer to market our Thin Films in certain fields.

Market and Competition

We compete with many other pharmaceutical, biotechnology and medical device companies as well as universities, government agencies and private organizations that are involved in varying degrees in the discovery, development and commercialization of medical technologies and therapeutic products. 

The field of regenerative medicine is rapidly progressing, as many organizations are initiating or expanding their research efforts in this area.  Most of these organizations are involved in research using cell sources such as bone marrow, embryonic and fetal tissue, umbilical cord and peripheral blood, muscle (which uses skeletal myoblasts (cells involved in muscle formation)), and regenerative capable cells from adipose tissue, which include adult stem cells.  We work exclusively with adult regenerative cells from adipose tissue.

Companies performing regenerative cell research and development include, among others, Aastrom Biosciences, Inc., Baxter International, Inc.,BioHeart, Inc., Cellerix SA, Genzyme, Inc., Geron Corporation, Medtronic, MG Biotherapeutics, a joint venture between Genzyme and Medtronic, Osiris Therapeutics, Inc., Stem Cells, Inc., and ViaCell, Inc.  We cannot with any accuracy forecast when or if these companies are likely to bring cell therapies to market.

We are aware of two ongoing clinical studies using adipose-derived regenerative cells.  One is sponsored by Cellerix, which is performing a 50 patient, Phase IIb clinical trial in Spain where adipose-derived regenerative cells are being used to treat fistulas associated with Crohn’s disease.  The other is sponsored by the University of Tokyo, where researchers are examining the potential of adipose-derived regenerative cells in breast tissue augmentation.  Our researchers are currently acting as consultants to both groups in various capacities. 

One of the most studied areas for regenerative cells is cardiovascular disease, due to its growing prevalence worldwide.  According to the American Heart Association’s “Heart Disease and Stroke Statistics 2005” report, heart failure affects an estimated five million Americans each year.  The report added that there have been 13 million cases of coronary heart disease and of those, 865,000 have been new or recurrent cases of myocardial infarction, which is the disease that our most advanced program targets. 

Companies with advanced research and development programs for regenerative treatments of cardiovascular disease include Baxter, BioHeart, Genvec, MG Biotherapeutics, Osiris, and ViaCell.  A Phase I study has been initiated at St. Elizabeth’s Medical center in Boston using stem cells extracted from peripheral blood as an investigational treatment for myocardial ischemia.  BioHeart is currently recruiting patients in the United States for a Phase I clinical study on the investigational product MyoHeart^TM, an autologous, skeletal myoblast cell therapy for heart disorders, which is delivered via a percutaneous catheter system. BioHeart is also conducting a Phase II trial in Europe evaluating MyoHeart™ for congestive heart failure.  Using similar technology, Genvec has completed a Phase I trial using skeletal myoblasts, and MG Biotherapeutics is currently recruiting 200 patients in the United States and Europe for a Phase II study with their investigational, autologous skeletal myoblast cell therapy for transplantation into the heart during bypass surgery. Osiris Therapeutics, Inc. is planning to begin Phase I clinical trials in early 2005 for Provacel^TM, an investigational, allogeneic, adult, mesenchymal (bone-marrow-derived) stem cell therapy for acute myocardial infarction.  ViaCell, Inc. is currently in pre clinical development for cardiac disease dealing with congestive heart failure and myocardial infarction.

The only regenerative cell product or service currently marketed by us is our cell banking service, which is being offered on a limited basis, to surgical patients undergoing liposuction procedures.  While we are not aware of any other provider of cell banking comparable to our own, there are various companies engaged in umbilical cord blood and bone marrow stem cell preservation.

In regard to our bioresorbable technology, we compete primarily with titanium, allograft tissue (cadaver bone), and polyetheretherketone (PEEK) polymer products.  We believe that an increasing number of other companies are developing, or are offering, bioresorbable devices.  Stryker, Inc., Interpore Cross (Biomet), and Synthes are three companies that we are aware of who distribute both bioresorbable and titanium implants.  Additionally, surgeons have historically been slow to adopt the use of new medical device technologies as alternatives for long-established, well-marketed devices, such as permanent bone fixation implants and allograft tissue.

Many of our competitors and potential competitors have substantially greater financial, technological, research and development, marketing and personnel resources than we do.  These competitors may also have greater experience in developing products, conducting clinical trials, obtaining regulatory approvals, and manufacturing and marketing such products.  Some of these competitors

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may obtain patent protection, approval or clearance by the FDA or from foreign countries, or may achieve product commercialization earlier than we can, any of which could materially adversely affect our business or results of operations.  We cannot be assured that our competitors will not succeed in developing alternative technologies and products that are more effective, easier to use or more economical than those which have been or are being developed by us or that would render our technology and products obsolete and noncompetitive in these fields.  In addition, even if our products are technologically superior, it is possible that competitors’ superior marketing power could defeat us in the marketplace.  Furthermore, Medtronic may pursue parallel development of other technologies or products, which may result in Medtronic developing additional products that will compete with our bioresorbable spine and orthopedic products.  This would in turn induce Medtronic to de-emphasize marketing of our products in favor of more profitable products.   

Research and Development

Research and development expenses were $11,007,000, $9,071,000 and $5,605,000 for the years ended December 31, 2004, 2003 and 2002, respectively.  For 2004, $7,449,000 was allocated toward our regenerative cell technology and $3,049,000 was allocated toward our bioresorbable technology.

Our regenerative cell technology research and development efforts in 2004 focused on two primary areas:

•                  Developing the Celution™ System to isolate a patient’s own regenerative cells from adipose tissue in real-time; and

•                  Conducting preclinical research to develop specific therapies from adipose-derived regenerative cells for cardiovascular disease, spine and orthopedic conditions, gastrointestinal disorders, and new approaches for aesthetic and reconstructive surgery.

Celution™ System developments in 2004 include the filing and receipt of the first of multiple 510(k) applications that will be required by the U.S. Food and Drug Administration (FDA) in order for us to commercialize a product.

Our preclinical research in 2004 focused predominantly on developing applications for cardiovascular disease, which include myocardial infarction and congestive heart failure.  We presented data in conjunction with Cedars-Sinai Medical Center in Los Angeles, from a controlled study on 13 pigs in September 2004, which showed that the animal’s own adipose-derived regenerative cells imparted a statistically significant improvement in left ventricular ejection fraction, a measure of the heart’s ability to pump oxygenated blood throughout the body.  The study also showed that injection of these cells in pigs was safe and well tolerated.

We also have ongoing preclinical collaborations with several other major U.S. and European academic research institutions.  Our collaborators include the University of California, Los Angeles, where a team directed by W. Robb MacLellan, M.D., is working with us jointly on a National Institutes of Health Small Business Innovation Research grant worth up to $950,000.  We also have research underway both internally and with a collaborator in Europe exploring potential orthopedic applications combining adipose-derived regenerative cells with our bioresorbable technology. 

In 2004, our bioresorbable technology research and development efforts resulted in multiple new spine and orthopedic products and product advancements in conjunction with existing products sold to our distributor Medtronic.  This included the development and FDA clearance for a radiographically identifiable version of our HYDROSORB™ Spine System, which is the first and only resorbable spinal implant to include a radiopaque marker fabricated from a resorbable material.  It will allow physicians to visualize and monitor the position and placement of plates, screws, or other implants over time without obstructing the view of the healing bone.

Additionally, our bioresorbable research and development efforts focused on expanding the applications of our bioresorbable technology geographically; specifically, we have begun efforts to market our Thin Film products in Japan.  In September 2004, we submitted an application to the MHLW for approval to market SurgiWrap™ and CardioWrap™.  We expect to obtain regulatory clearance from the MHLW in 2005 or early 2006.

Products and Services

We currently manufacture a line of surgical implants derived from our bioresorbable technology.  These implants are marketed in the United States, Europe and/or other countries for the repair and regeneration of tissue.  We manufacture these products solely in the United States at our San Diego facility. 

The HYDROSORB™ line of bioresorbable spine and orthopedic products is manufactured by us and distributed exclusively by Medtronic.  HYDROSORB™ is a trademark of Medtronic.  In 2004, this product line accounted for 55.8% of our total revenues.

In 2004, the Thin Film product line accounted for 32.8% of our total revenues.  In May 2004, we sold most, but not all, of our

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intellectual property rights and tangible assets related to our bioresorbable Thin Film product line to MAST and its subsidiaries.  As part of the Thin Film disposition agreement, and for a period of up to one year, we must act in the capacity of a back-up supplier to MAST.  Under the back-up supply agreement, we have agreed in nearly all cases to supply product ordered by MAST at our manufacturing cost.

In July 2004, we entered into a Distribution Agreement with Senko.  Under this agreement, we granted to Senko an exclusive license to sell and distribute certain Thin Film products in Japan.  Specifically, the license covers Thin Film products with the following indications: anti-adhesion, soft tissue support, and minimization of the attachment of soft tissues throughout the body.

Within our regenerative cell technology program, we have not yet developed regenerative cell related therapies or treatments for commercial use.  In September of 2004, we received 510(k) clearance for the MacroPore Puricel Lipoplasty System, a point-of-care adipose tissue extraction system, which is designed to extract and collect adipose tissue.  This is the first of multiple 510(k) applications that will be required by the FDA in order for us to commercialize a product.

Additionally, we have a California state-licensed tissue bank facility for the preservation of extracted regenerative cells, which is being offered on a limited basis to surgical patients undergoing liposuction procedures. Typically arranged through a patient’s physician, cell preservation is the process by which regenerative cells, taken from a liposuction or other procedure, are stored (cryopreserved) in a liquid nitrogen freezer at -320°F (-196°C) exclusively for the patient who preserved them.  The cells can be preserved indefinitely.

The following table outlines our current line of 510(k)-cleared medical devices and the date they received clearance (excludes divested product lines):

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In addition, we have received marketing authorization for the sale of our products in the following countries:

CORNERSTONE, HYDROSORB and TELAMON are trademarks of Medtronic, Inc.

Customers

Medtronic is our primary distributor and our principal customer, directly accounting for $4,085,000 or 59.9% of our revenues for the year ended December 31, 2004, $12,893,000 or 91.5%, of our revenues for the year ended December 31, 2003, and $8,605,000, or

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93.9% of our revenues for the year ended December 31, 2002.

Under our global co-development and supply agreement with Medtronic, we co-develop bioresorbable implants for spinal or reconstructive fixation, stabilization and fusion. Medtronic has exclusive worldwide rights to market and sell all of the bioresorbable products that we co-develop for this application through 2012.  Both companies own an undivided, one-half interest in any inventions we jointly develop. Medtronic continues to retain its right of first offer for distributorship to our bioresorbable plates and mesh for orthopedic applications until January, 2006. Currently our only commercially available product line under this agreement is the HYDROSORB™ family of spine and orthopedic implants.

In May 2004, we sold most, but not all, of our intellectual property rights and tangible assets related to our Thin Film product line to MAST.  As part of the Thin Film disposition agreement, and for a period of up to one year, we must act in the capacity of a back-up supplier to MAST.  Under the back-up supply agreement, we have agreed in nearly all cases to supply product ordered by MAST at our manufacturing cost. Thin Film revenues attributable to sales to MAST were $1,678,000, or 24.6% of our revenues for the year ended December 31, 2004.

In July 2004, we entered into a Distribution Agreement with Senko. Under this agreement, we granted to Senko an exclusive license to sell and distribute certain Thin Film products in Japan.  The Distribution Agreement with Senko commences upon “commercialization.”  Following commercialization, the Distribution Agreement has a five-year duration and is renewable for an additional five years after reaching mutually agreed minimum purchase guarantees.

Sales by Geographic Region

We sell our products predominantly in the United States and to a lesser extent internationally through independent distributors.  International sales may be limited or disrupted by political instability, price controls, acts of war, trade restrictions and changes in tariffs.  Our existing distribution agreements all provide for payment in U.S. dollars and we intend to include similar payment provisions in future distribution agreements.  Fluctuations in currency exchange rates may affect demand for our products by increasing the price of our products relative to the currency of the countries in which the products are sold.

For the year end ended December 31, 2004, we recorded $6,818,000 in revenues, including $6,602,000 of sales in the United States and $216,000 of sales outside the United States.  For the year ended December 31, 2003, we recorded $14,088,000 in revenues, including $13,727,000 of sales in the United States and $361,000 of sales outside the United States.  For the year ended December 31, 2002, we recorded $9,166,000 in revenues, including $8,855,000 of sales in the United States and $311,000 of sales outside the United States.

We hope that our future sales in Japan will increase as a result of our Distribution Agreement with Senko.

Working Capital

We generally build products to order although for selected products we may from time to time maintain an inventory of approximately three to five months of sales.  Although capital expenditures may vary significantly depending on a variety of factors, including sales, we presently intend to spend approximately $500,000 on capital equipment purchases in 2005 of which a portion may be paid with our current cash reserve.

Raw Materials

We currently purchase the high molecular weight, medical grade, lactic acid copolymer used in manufacturing most of our bioresorbable products from a single qualified source, B.I. Chemicals, Inc.  Although we have a contract with B.I. Chemicals, which guarantees continuation of supply through August 15, 2005, we cannot guarantee that they will elect to continue the contract beyond that date, or that they will not elect to discontinue the manufacture of the material.  They have agreed that if they discontinue manufacturing they will either find a replacement supplier, or provide us with the necessary technology to self-manufacture the material, either of which could mean a substantial increase in material costs.  Also, despite this agreement, they might fail to fulfill their obligations.  Under the terms of the contract, B.I. Chemicals, Inc. may choose to raise their prices upon nine months prior notice which may also result in a substantially increased material cost.  Although we believe that we would be able to obtain the material from at least one other source in the event of a failure of supply, there can be no assurance that we will be able to obtain adequate increased commercial quantities of the necessary high quality within a reasonable period of time or at commercially reasonable rates.  Lack of adequate commercial quantities or inability to develop alternative sources meeting regulatory requirements at similar prices and terms within a reasonable time or any interruptions in supply in the future could have a significant negative effect on our ability to manufacture products, and, consequently, could have a material adverse effect on the results of our operations, cash flows and financial condition.

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Intellectual Property

Our success depends in large part on our ability to protect our proprietary technology and information, and operate without infringing on the proprietary rights of third parties. We rely on a combination of patent, trade secret, copyright and trademark laws, as well as confidentiality agreements, licensing agreements and other agreements, to establish and protect our proprietary rights.  Our success also depends on our ability to obtain patents on our technology.

With respect to our regenerative cell technology, we are the exclusive, worldwide licensee from the Regents of the University of California to one United States patent (U.S. Patent No. 6,777,231) related to isolated adipose derived stem cells that can differentiate into two or more of a variety of cell types, which was issued in August 2004.  In addition, we have been granted certain exclusive and non-exclusive perpetual license rights to five U.S. patent applications and 20 corresponding international patent applications through a license agreement with the Regents of the University of California. We have also filed applications for 19 additional United States patents, as well as 24 corresponding international patent applications, relating to our regenerative cell technology. 

Our regenerative cell technology license agreement with the Regents of the University of California contains certain developmental milestones, which if not achieved could result in the loss of exclusivity or loss of the license rights. The loss of such rights could significantly impact our ability to continue the development of the regenerative cell technology and/or commercialize related products. Also, our power as licensee to successfully use these rights to exclude competitors from the market is untested.  In addition, further legal risk arises from a lawsuit, filed by the University of Pittsburgh in the fourth quarter of 2004, seeking a determination that its assignors, rather than the University of California’s assignors, are the true inventors of U.S. Patent No. 6,777,231. If the University of Pittsburgh wins the lawsuit, our license rights to this patent could be nullified or rendered non-exclusive with respect to any third party that might license rights from the University of Pittsburgh, and our strategy related to our regenerative cell technology could be materially adversely affected.

We cannot assure that any of the pending patent applications will be issued, that we will develop additional proprietary products that are patentable, that any patents issued to us will provide us with competitive advantages or will not be challenged by any third parties or that the patents of others will not prevent the commercialization of products incorporating our technology. Furthermore, we cannot assure you that others will not independently develop similar products, duplicate any of our products or design around our patents.

With respect to our bioresorbable implant products and technology, we have obtained 13 U.S. patents, three of which were sold in product line dispositions.  Our three U.S. patents related to the design of our macro-porous bioresorbable sheets for skeletal repair and regeneration were issued in July 1999, August 2001 and March 2004.  Our three U.S. patents for the design of our high torque bioresorbable screws were issued in August 2001, February 2002 and November 2002.  Our U.S patent related to our membrane with tissue guiding surface corrugations was issued in May 2002.  Our two U.S. patents related to our bioresorbable barrier film for the control of postsurgical adhesions were issued in March 2003 and January 2004 and assigned to MAST as part of the Thin Film product line sale agreement.  Our U.S. patent related to stereotaxic detachable needle extensions was issued in June 2003.  Our U.S. patent related to non-scatterable radio-opaque material for imaging applications was issued in October 2003.  Our U.S. patent related to a resorbable posterior spinal fusion system was issued in April 2004.  Our U.S. patent for a cranial flap fixation device was issued in June 2004 and assigned to Medtronic pursuant to the September 2002 CMF product line sale agreement.  We also have two Australian patents related to our bioresorbable mesh, one Australian patent for the design of our high torque bioresorbable screws and another Australian patent related to our membrane with tissue guiding surface corrugations.  Our four Australian patents were issued in August 2000, January 2003 and September 2003.  Each of our patents will expire 20 years from the filing date of the original patent application.  In addition, we have filed applications for 14 additional U.S. patents as well as 33 corresponding international patents relating to our bioresorbable technology.  

Patent law outside the United States is uncertain and in many countries is currently undergoing review and revisions.  The laws of some countries may not protect our proprietary rights to the same extent as the laws of the U.S.  Third parties may attempt to oppose the issuance of patents to us in foreign countries by initiating opposition proceedings.  Opposition proceedings against any of our patent filings in a foreign country could have an adverse effect on our corresponding patents that are issued or pending in the U.S.  It may be necessary or useful for us to participate in proceedings to determine the validity of our or our competitors’ patents that have been issued in countries other than the U.S.  This could result in substantial costs, divert our efforts and attention from other aspects of our business, and could have a material adverse effect on our results of operations and financial condition.  We currently have pending patent applications in Europe, Australia, Japan, Canada, China, Korea, and Singapore, among others.

Litigation, which would result in substantial costs to us and diversion of effort on our part, may be necessary to enforce or confirm the ownership of any patents issued or licensed to us or to determine the scope and validity of third party proprietary rights.  If our competitors claim technology also claimed by us and prepare and file patent applications in the United States, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office or a foreign patent office to determine priority of invention, which could result in substantial costs to and diversion of effort, even if the eventual outcome is favorable to us.

Any such litigation or interference proceeding, regardless of outcome, could be expensive and time consuming.  We may incur

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substantial legal costs as a result of the University of Pittsburgh lawsuit, and our president, Marc Hedrick, M.D., is a named individual defendant in that lawsuit because he is one of the inventors identified on the patent.  Litigation could subject us to significant liabilities to third parties and require disputed rights to be licensed from third parties or require us to cease using certain technology.

Our commercial success will also depend, in part, on our ability to avoid infringing patents issued to others.  If we were judicially determined to be infringing any third party patent, we could be required to pay damages, alter our products or processes, obtain licenses or cease certain activities.  If we are required in the future to obtain any licenses from third parties for some of our products, there can be no guarantee that we would be able to do so on commercially favorable terms, if at all.  U.S. patent applications are not immediately made public, so we might be surprised by the grant to someone else of a patent on a technology we are actively using.  As noted above regarding the University of Pittsburgh lawsuit, even patents issued to us or our licensors might be judicially determined to belong in full or in part to third parties.

In addition to patent protection, we rely on unpatented trade secrets and proprietary technological expertise.  We cannot assure you that others will not independently develop or otherwise acquire substantially equivalent techniques, or otherwise gain access to our trade secrets and proprietary technological expertise or disclose such trade secrets, or that we can ultimately protect our rights to such unpatented trade secrets and proprietary technological expertise.  We rely, in part, on confidentiality agreements with our marketing partners, employees, advisors, vendors and consultants to protect our trade secrets and proprietary technological expertise.  We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach or that our unpatented trade secrets and proprietary technological expertise will not otherwise become known or be independently discovered by competitors. 

Failure to obtain or maintain patent protection, or protect trade secrets, for any reason, third party claims against our patents, trade secrets or proprietary rights, or our involvement in disputes over our patents, trade secrets or proprietary rights, including involvement in litigation, could have a substantial negative effect on the results of our operations, cash flows and financial condition.

Government Regulation

Most medical devices and treatments for use in humans, including our bioresorbable protective sheets, plates, and screws, are subject to stringent government regulation in the United States by the Food and Drug Administration, or “FDA,” under the federal Food, Drug and Cosmetic Act, or “FDC” Act.  The FDA regulates the clinical testing, manufacture, safety, labeling, sale, distribution and promotion of medical devices.  Included among these regulations are premarket clearance, premarket approval, biologic license application, new drug application, and Quality System Regulation, or “QSR,” requirements.  Other statutory and regulatory requirements govern, among other things, registration and inspection, medical device listing, prohibitions against misbranding and adulteration, labeling and postmarket reporting. The regulatory process may be lengthy, expensive and uncertain. Securing FDA approvals and clearances may require us to submit extensive clinical data and supporting information to the FDA. Failure to comply with applicable requirements can result in application integrity proceedings, fines, recalls or seizures of products, injunctions, civil penalties, total or partial suspensions of production, withdrawals of existing product approvals or clearances, refusal to approve or clear new applications or notifications, and criminal prosecution.

Under the FDC Act, medical devices are classified into Class I, Class II or Class III devices, based on their risks and the control necessary to reasonably ensure their safety and effectiveness.  Class I devices are subject to general controls such as labeling, premarket notification and adherence to QSR requirements.  Class II devices are subject to general controls, and may be subject to specific controls such as performance standards, postmarket surveillance and patient registries.  Class II devices require premarket notification to the FDA in the form of a 510(k) application that demonstrates the new device to be “substantially equivalent” to an existing FDA 510(k) cleared device.  Generally, Class III devices, which include certain life-sustaining, life-supporting and implantable devices or new devices which have been found not to be substantially equivalent to certain legally marketed devices, must receive premarket approval from the FDA.  All of our implant products to date are Class II medical devices.

Before any new Class II or III medical device may be introduced to the market, the manufacturer generally must obtain either premarket clearance through the 510(k) premarket notification process or premarket approval through the lengthier Premarket Approval Application, or “PMA,” process.  The FDA will grant a 510(k) premarket notification if the submitted data establishes that the proposed device is “substantially equivalent” to a legally marketed Class I or Class II medical device.  The FDA may request data, including clinical studies, before it can make a determination of substantial equivalence.  It generally takes from three to 12 months from submission to obtain 510(k) premarket clearance, although it may take longer.  There is no assurance that clearance will be granted.  We must file a PMA if one of our products is found not to be substantially equivalent to a legally marketed Class II device or if it is a Class III device for which the FDA requires PMAs.  A PMA must be supported by extensive data to demonstrate the safety and effectiveness of the device, including laboratory, preclinical and clinical trial data, as well as extensive manufacturing information.  Before initiating human clinical trials on devices that present a significant risk, we must first obtain an Investigational Device Exemption, or IDE, for the proposed medical device.  Obtaining FDA approval of the Investigational Device Exemption allows the sponsor to begin the collection of clinical data according to a protocol that must be approved by the FDA.  Several factors influence the overall time frame of the IDE process.  These include: the number of patients required for statistical significance, the

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requirement for a pilot (safety) study in advance of initiating a pivotal study, and the duration of follow-up required before the IDE can be closed and the PMA prepared for submission to FDA. This follow-up period typically ranges from 12-24 months on the last patient to be enrolled in the study.  Toward the end of the PMA review process, the FDA will generally conduct an inspection of the manufacturing facilities to ensure compliance with QSRs.  Approval of a PMA could take up to one or more years from the date of submission of the application or petition; however, the entire process of IDE submission /approval, clinical data collection, patient follow-up, PMA preparation and approval typically requires 4 years or more.  The PMA process can also be expensive and uncertain, and there is no guarantee of ultimate approval.

Modifications or enhancements of products that could affect the safety or effectiveness or effect a major change in the intended use of a device that was either cleared through the 510(k) process or approved through the PMA process may require further FDA review through new 510(k) or PMA submissions.

As a medical device manufacturer, we are subject to periodic inspections by the FDA to ensure that devices continue to be manufactured in accordance with QSR requirements.  We are also subject to postmarket reporting requirements for deaths or serious injuries when a device may have caused or contributed to death or serious injury, and for certain device malfunctions that would be likely to cause or contribute to a death or serious injury if the malfunction were to recur.  Postmarket reporting also may be required for certain corrective actions undertaken for distributed devices.  If safety or effectiveness problems occur after the product reaches the market, the FDA may take steps to prevent or limit further marketing of the product.  Additionally, the FDA actively enforces regulations prohibiting marketing of devices for indications or uses that have not been cleared or approved by the FDA.

Under the terms of our development and supply agreement with Medtronic, Medtronic is responsible for preparing and filing applications for, and obtaining regulatory approval of the products we co-develop for use in spinal fixation, stabilization or fusion applications.  We or our marketing partners may not be able to obtain necessary 510(k) clearances or PMA approvals to market the products we are developing in the United States for their intended use on a timely basis, if at all.

We must comply with extensive regulations from foreign jurisdictions regarding safety, manufacturing processes and quality.   These regulations, including the requirements for marketing authorization, may differ from the United States FDA regulatory scheme.  Specifically, in regard to our licensing agreement with Senko, marketing authorization from the Japanese Ministry of Health, Labour and Welfare is necessary for commercialization of the Thin Film product line in Japan.

We may not be able to obtain marketing authorization in all of the countries where we intend to market our products, may incur significant costs in obtaining or maintaining our foreign marketing authorizations, or may not be able to successfully commercialize our current or future products in any foreign markets.  Delays in receipt of marketing authorizations for our products in foreign countries, failure to receive such marketing authorizations or the future loss of previously received marketing authorizations could have a material adverse effect on our results of operations, cash flows and financial condition.

Staff

As of December 31, 2004, we had 99 full-time employees, comprised of 55 employees in research and development, 16 employees in manufacturing, 21 employees in management and finance and administration and 7 employees in sales and marketing.  From time to time, we also employ independent contractors to support our administrative organizations.  Our employees are not represented by any collective bargaining unit and we have never experienced a work stoppage.

Web Site Access to SEC Filings

We maintain an Internet website at www.macropore.com.  Through this site, we make available free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (SEC).  In addition, we publish on our website all reports filed under Section 16(a) of the Exchange Act by our directors, officers and 10% stockholders.

These materials are accessible via the Investor Relations section of our website within the “Filings & Reports” link.  Some of the information is stored directly on our website, while other information can be accessed by selecting the provided link to the section on the SEC website, which contains filings for our company and its insiders.

Item 2.  Property

Our main facility which we use for our corporate headquarters and for manufacturing is located at 6740 Top Gun Street, San Diego, California.  We currently lease approximately 27,000 square feet of space at this location of which approximately 6,000 square feet is laboratory space, 12,000 square feet is office space and 9,000 square feet is manufacturing space.  Our lease has a five-year term, expiring in 2008.  We also lease:

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•                    14,000 square feet, of which approximately 4,000 square feet is for research and development and 10,000 square feet is office space, at 6749 Top Gun Street, San Diego, California for a five-year term expiring in 2006.  We currently sublease 6,000 square feet of this office and warehouse space at the rate charged per square foot in our current lease agreement.  We sublease approximate 5,000 square feet to MAST and the remainder to another unrelated party. 

•                    16,000 additional square feet for research and development activities located at 6749 Top Gun Street, San Diego, California for a five-year term expiring 2008. 

We pay an aggregate of approximately $60,000 in rent per month for our properties.  The aggregate sublease amount is $6,000 per month.

Item 3.  Legal Matters

None

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

None

PART II

Item 5.  Market for Registrant’s Common Equity and Related Stockholder Matters

Market Prices

Our common stock is quoted on the Frankfurt Stock Exchange under the symbol “XMP.”  There is no established public trading market in the United States for our common stock.  The following table shows the high and low sales prices for our common stock for the periods indicated, as reported on Xetra, the Frankfurt Stock Exchange’s Exchange Electronic Trading System.  These prices do not include retail markups, markdowns or commissions.

All of our outstanding shares are represented by a global stock certificate issued in the name of Seydler AG Wertpapierhandelsbank and deposited with Clearstream Banking AG, Frankfurt, Germany, the German securities depository.  As of January 31, 2005, based on information provided by Clearstream, we believe that the number of beneficial owners of our common stock held through the global stock certificates is approximately 10,900.

Dividends

We have never declared or paid any dividends and do not currently anticipate paying any cash dividends on our outstanding shares of common stock in the foreseeable future.

German Securities Laws

As a United States company with securities trading on a German stock exchange, we are subject to various laws and regulations in both jurisdictions.  Some of these laws and regulations, in turn, can affect the ability of holders of our securities to transfer or sell those securities.

There are no limitations imposed by German law or our certificate of incorporation or bylaws on the right of owners to hold or vote the shares.

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Recent Sales of Unregistered Securities

None

Equity Compensation Plan Information

(1)  The maximum number of Shares shall be cumulatively increased on the first January 1 after the Effective Date and each January 1 thereafter for 9 more years, by a number of Shares equal to the lesser of (a) 2% of the number of Shares issued and outstanding on the immediately preceding December 31, and (b) a number of Shares set by the Board.

On August 24, 2004, the 2004 Equity Incentive Plan of Macropore Biosurgery, Inc. (the “Plan”) became effective upon approval by our Board of Directors.  The Plan is designed to provide our employees, directors and consultants the opportunity to purchase our common stock through non-qualified stock options, stock appreciation rights, restricted stock units, or restricted stock and cash awards.  The Compensation Committee of the Board shall administer the Plan and determine the number of shares underlying each award, the vesting of such shares and other important terms of awards pursuant to the terms of the Plan.  Awards may be granted under the Plan over a ten-year period and the Board has initially reserved 3,000,000 shares of common stock for issuance under the Plan.  The maximum number of shares reserved for issuance under the Plan may be cumulatively increased (subject to Board discretion) on an annual basis beginning January 1, 2005, as provided in the footnote to the Equity Compensation Plan Information table.

Item 6.  Selected Consolidated Financial Data

The selected data presented below under the captions “Statements of Operations Data,” “Statements of Cash Flows Data” and “Balance Sheet Data” for, and as of the end of, each of the years in the five-year period ended December 31, 2004, are derived from the financial statements of MacroPore Biosurgery, Inc.  The consolidated balance sheets as of December 31, 2004 and 2003, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, which have been audited by KPMG LLP, an independent registered public accounting firm, and their report thereon, are included elsewhere in this annual report.  The consolidated balance sheet as of December 31, 2002, which has been audited by KPMG LLP, and the consolidated financial statements as of December 31, 2001 and 2000 and for each of the years in the two-year period ended December 31, 2001, which have been audited by Arthur Andersen LLP, independent auditors, their reports thereon are included with annual reports previously filed with the Securities and Exchange Commission.

The information contained in this table should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes thereto included elsewhere in this report.

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains certain statements that may be deemed “forward-looking statements” within the meaning of United States securities laws.  All statements, other than statements of historical fact, that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements.  Such statements are based upon certain assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate.  The forward-looking statements included in this report are also subject to a number of material risks and uncertainties, including but not limited to the risks described under the “Risk Factors” section in this Management’s Discussion and Analysis of Financial Conditions and Results of Operations.  We encourage you to read those descriptions carefully.  We caution you not to place undue reliance on the forward-looking statements contained in this report.  These statements, like all statements in this report, speak only as of the date of this report (unless an earlier date is indicated) and we undertake no obligation to update or revise the statements except as required by law.  Such forward-looking statements are not guarantees of future performance and actual results will likely differ, perhaps materially, from those suggested by such forward-looking statements.  Finally, we strongly emphasize that our reported net loss of $2,090,000 for the year ended December 31, 2004 should not be considered predictive of future results.  This is because we recognized $13,883,000 as gain on the sale of assets, related party during the year ended December 31, 2004 that related to our sale of our CMF product line to Medtronic initiated in September 2002. 

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Overview

During 2004, we continued to shift our focus toward the discovery and development of therapies for cardiovascular disease, spine and orthopedic conditions, gastrointestinal disorders and new approaches for aesthetic and reconstructive surgery using regenerative cells from adipose tissue.  Adipose tissue is the richest and most accessible source for regenerative cells in the human body.  This tissue contains adult stem cells, angiogenic cells (blood vessel forming) and other regeneration-promoting cells.  Additionally, we continue to develop and manufacture the HYDROSORB™ family of FDA-cleared bioresorbable spine and orthopedic implants, which are distributed exclusively through Medtronic, Inc (“Medtronic”). Medtronic owns approximately 7.2% of our common stock and is a related party.

Our primary regenerative cell research program, currently in preclinical testing, targets cardiovascular disease, including myocardial infarction.  Additionally, we have a pipeline of preclinical investigational therapies that target multiple therapeutic areas.  To facilitate the processing and delivery of adipose-derived regenerative cells, we are designing a proprietary point-of-care system, Celution™, to isolate and concentrate a patient’s own regenerative cells in real-time.  Our goal is to commercialize systems that may be used universally across multiple therapeutic applications.  The commercialization model will be based on the sale of devices and related consumables.

Developments during 2004 that reflect our transition of focus toward our regenerative cell technology program include:

•                  The receipt of a 510(k) clearance from the U.S. Food and Drug Administration (FDA) for a point-of-care adipose tissue extraction system;

•                  The release of positive data from a preclinical study in myocardial infarction;

•                  An award of up to $950,000 in National Institutes of Health (NIH) Small Business Innovation Research (SBIR) grant funding;

•                  The issuance of a U.S. patent to the University of California related to adult stem cells isolated from adipose tissue for which we are the exclusive, worldwide licensee; and

•                  The initiation of multiple preclinical studies with university collaborators to discover treatments for cardiovascular disease, spine and orthopedic conditions, and novel approaches for aesthetic and reconstructive surgery.

Simultaneously, we experienced a reduction in orders from Medtronic for HYDROSORB™ products during the second, third and fourth quarters of 2004 as a result of their inventory stocking patterns, as well as marketing efforts by Medtronic which were significantly less vigorous than we had anticipated and resulted in slower than anticipated end-use market penetration.  During the third and fourth quarters of 2003 and the first quarter of 2004, Medtronic placed initial stocking orders for newly released HYDROSORB™ products, which provided them with sufficient stock for 2004. 

For the next several years we will fund the research and development of our regenerative cell technology through:

•                  Existing cash reserves;

•                  Profits, if any, from HYDROSORB™ and Thin Film product sales;

•                  Cash flows related to recent product line divestitures and licensing agreements; and

•                  Licensing fees and/or equity agreements connected with potential regenerative cell technology partnerships.

During this time, we expect to:

•                  Complete the engineering and design of our point-of-care regenerative cell technology system and seek relevant regulatory clearances;

•                  Continue preclinical development of regenerative cell therapies for cardiovascular disease, our primary area of focus, as well as for spine and orthopedic conditions, gastrointestinal disorders and new approaches for aesthetic and reconstructive surgery, among others;

•                  Expand our intellectual property position related to our regenerative cell program;

•                  Advance regenerative cell technology programs into clinical development;

•                  Form at least one key therapeutic development collaboration for therapeutic applications outside the area of cardiovascular disease; and

•                  Pursue available grant opportunities.

As part of this strategy, in 2004 we sold off a significant portion of our Thin Film product line to MAST Biosurgery AG (MAST) for $7,000,000 in upfront fees plus $2,000,000 in cash or 19% equity in MAST and other considerations outlined below.  Also, in the third quarter of 2004 we entered into a distribution agreement with Senko Medical Trading Co. (“Senko”) whereby we granted Senko our retained rights to market Thin Film in Japan. As part of this agreement, we received an upfront license fee of $1,500,000 in July 2004, plus a $1,250,000 milestone for submitting a regulatory application for Thin Film to the Japanese Ministry of Health, Labour and Welfare (“MHLW”), which we received in October 2004. We are also entitled to receive $250,000 following regulatory clearance

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from the MHLW plus manufacturing revenues and royalties for a three year-period following initiation of commercialization. However, we acknowledge that the MHLW has not yet issued its final approval and further significant delays are possible.  Additionally, we received $6,500,000 in two payments from Medtronic in 2004 related to the sale of our craniomaxillofacial (“CMF”) product line to Medtronic in 2002.

Furthermore, we are closely monitoring the progress of the HYDROSORB™ business and remain cautiously optimistic regarding the eventual success of the product family.  This success will depend significantly on the efforts of Medtronic to market the products and obtain additional regulatory clearances and approvals for the product line.

It is possible that we may need to seek capital through additional divestitures or the sale of equity securities, especially if we do not receive sufficient money from therapeutic development collaborations or positive cash flow from HYDROSORB™ and Thin Film revenues.

Total revenues for the year ended December 31, 2004 were $6,818,000 compared to $14,088,000 for 2003, a decrease of 51.6%.  Of the total revenue in 2004, $3,803,000 is attributable to sales of HYDROSORB™ products to Medtronic. For a complete breakdown of revenues for the year ended December 31, 2004, see the table located in the results of operations section.

Net loss for the year ended December 31, 2004 was $2,090,000, compared to a net loss of $9,283,000, for 2003.  The 2004 loss is not indicative of the loss levels we expect to experience in the future, because it contains the following mitigating components:

•                  The receipt and recognition of a $1,500,000 payment in the third quarter of 2004 as a result of completing the final milestone related to the September 2002 sale of the CMF product line;

•                  The recognition of $7,383,000 in the third quarter of 2004 associated with the completion of our obligations related to the September 2002 sale of our CMF product line to Medtronic, which was previously reported as deferred gain on sale of assets, related party on our balance sheet; and

•                  A one-time $5,000,000 gain in the second quarter of 2004 related to the completion of the clinical research regarding Faster Resorbing Polymers.

Adjusted net loss for the year ended December 31, 2004 is outlined in the table below.

(1)       We believe adjusted net loss is a useful measure by which investors can evaluate our operating performance on a comparable basis, unaffected by the large gains we recognized in 2004.

The increase in the adjusted net loss for the year ended December 31, 2004 reflects our decrease in HYDROSORB™ revenues during 2004, with a simultaneous increase in research and development expenses related to our regenerative cell technology program, compared to the same periods in 2003.

2005 Financial Projections

For the next several years, we expect to incur increasing losses as we invest into the research and development of our regenerative cell technology and until the first regenerative cell technology products become commercialized.  

In 2005, we expect bioresorbable technology-related revenues to be $6,000,000 to $9,000,000. This is in part due to ongoing market demand for the HYDROSORB™ product family and in part due to anticipated stocking orders for the radiographically identifiable Spine System products, which we received FDA clearance for in August 2004.  However it should be noted that on July 19, 2004, we withdrew our 2004 revenue guidance because of our assessment that we were not able to reliably project HYDROSORB™ product revenues.  We believe that our visibility challenges have not been fully resolved.

Additionally, we will continue our efforts to prepare for the commercialization of the Thin Film products in Japan, which we anticipate to occur in 2005 or early 2006.  Commercialization of the Thin Film product line may result in revenues related to stocking orders and royalty payments from Senko, provided MAST does not exercise its option for Thin Film-related interests and rights in Japan.  If MAST does exercise their option, they are required to make a $3,000,000 payment to us and equally share with us their gross profits and royalties from Senko for a three-year period post-commercialization. 

Further, we expect our research and development expenses in 2005 to be in the range of $11,000,000 to $13,000,000, as we

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continue preclinical studies and prepare to enter clinical studies in 2006 related to our regenerative cell technology program.  We expect our domestic and international sales and marketing expenses to decline significantly this year as we will no longer incur expenses related to Thin Film independent sales representatives. 

In regard to our cash reserve, we expect to bolster our current position by entering into co-development partnerships related to the regenerative cell technology or seek capital through additional divestitures or the sale of equity securities.  At present, we believe we have enough liquid assets to support our operations through at least December 31, 2005. 

Disposition of Product Lines

Sale of Craniomaxillofacial Product Line

In September 2002, we entered into an Asset Purchase Agreement (the “Agreement”) to sell assets related to our CMF implant and accessory product line to Medtronic for what resulted in total net consideration of $15,500,000.  In accordance with the terms of the Agreement, we received an initial payment of $13,000,000 from Medtronic and a first milestone payment of $1,000,000 in the fourth quarter of 2002.  A final milestone payment of $1,500,000 was received in 2004. 

The Agreement requires us not to market in the craniomaxillofacial field, for five years, any products that compete with the acquired product line.  Additionally, during the technology transfer transition period, we agreed to be a back-up supplier of CMF products to Medtronic at a price equal to our cost of manufacture. 

The Agreement also allowed us to receive up to $5,000,000 if and when we completed successful clinical evaluations for a new faster-resorbing polymer product, as defined in the Agreement.  In January 2004, we received a $5,000,000 milestone payment from Medtronic and it was recognized as gain on sale of assets, related party, in the accompanying statements of operations.

In a separate, but simultaneous transaction, we paid Medtronic $4,000,000 in cash to amend an existing Development and Supply Agreement (the “Amended Development Agreement”, and collectively with the Asset Purchase Agreement, the “Agreements”) to remove a preexisting contractual right of first offer for distributorship by Medtronic of our bioresorbable thin film products for use in various types of soft tissue surgical applications.  Medtronic will retain its right of first offer for distributorship of our other bioresorbable products in all fields, as well as to our bioresorbable thin film products for use in the spinal application field.  In addition, the term of the Amended Development Agreement with Medtronic was extended to September 30, 2012.

We accounted for the net proceeds of the Agreements as deferred gain on sale of assets, related party.  This gain was to be recognized only as certain events occurred.  For instance, we recognized a portion of the deferred gain upon the sale of the CMF products to Medtronic under our back-up supply arrangement, which provides for sales of the CMF products to Medtronic at cost.  The amount of the deferred gain recognized correlated to the gross margin normally charged by us on similar products.  The remainder of the deferred gain was recognized in the third quarter of 2004 when the technology and know-how transfer was completed pursuant to the contract terms.

During the third quarter of 2004, we completed all remaining performance obligations related to the 2002 sale of the CMF product line to Medtronic.  Accordingly, we recorded $7,383,000 as a component of gain on sale of assets, related party, in the accompanying statements of operations, representing the remaining balance that had theretofore been reported as deferred gain on sale of assets, related party.

Pursuant to the sale of the CMF product line, we were obliged to transfer certain “know-how,” including manufacturing processes, patents, and other intellectual property, to Medtronic.  If such know-how was transferred within a certain time frame defined in the Agreement, we would become entitled to a $2,000,000 milestone payment.

In the second quarter of 2004, we provided notice to Medtronic that the requisite know-how associated with the transferred CMF product line had been transferred, pursuant to the terms of, and within the timeframe specified by, the Agreement.   Medtronic did not agree that know-how transfer had been completed and asserted that, in any case, the maximum payment due to us was $1,000,000 rather than $2,000,000. 

To avoid the risk and expense of arbitration, in the third quarter of 2004 we agreed to accept a negotiated settlement with Medtronic in the amount of $1,500,000 related to the know-how transfer.  The $1,500,000 payment has been recognized as gain on sale of assets, related party, in the accompanying statements of operations.

Sale of Thin Film Product Line

In May 2004, we sold most, but not all, of our intellectual property rights and tangible assets related to our Thin Film product line to MAST and one of its subsidiaries.  We have received $7,000,000 in cash and might receive the following additional contingent

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consideration:

•                    $200,000, payable only upon receipt of 510(k) clearance from the U.S. Food and Drug Administration for a hernia wrap product (thin film combination), and

•                    $2,000,000 on or before the earlier of (i) May 31, 2005 or (ii) 15 days after the date upon which MAST has hired a Chief Executive Officer, provided the Chief Executive Officer has held that position for at least four months and meets other requirements specified in the sale agreement.  If MAST had not hired a Chief Executive Officer by January 31, 2005, MAST may, at its sole option, provide us on May 31, 2005 with a 19% equity interest in the MAST business that is managing the Thin Film assets at May 31, 2005 instead of making the $2,000,000 cash payment.  We believe that MAST hired a CEO in late 2004 and, thus, became obliged to pay the $2,000,000 obligation in early 2005.  However, MAST has objected to our interpretation of the agreement and maintains that the individual hired does not qualify as the CEO under its terms.  Regardless, MAST’s obligation is due to us no later than May 31, 2005.

As part of the Thin Film disposition agreement, and for a period of up to one year, we must provide training to MAST representatives in all aspects of the manufacturing process related to the transferred Thin Film product line, and act in the capacity of a back-up supplier to MAST.  Under the back-up supply agreement, we have agreed in nearly all cases to supply product ordered by MAST at our manufacturing cost.

Because of these and other additional performance requirements, we did not initially recognize any gain on sale of the Thin Film assets in our statement of operations.  Instead, we initially recorded approximately $6,450,000 as deferred gain on sale in the balance sheet.  The amount recorded as deferred gain on sale does not include the potential contingent consideration described above, which will only be added to the deferred gain on sale when the contingencies are resolved. 

We do not expect to complete our performance obligations until the second quarter of 2005 and, accordingly, will not recognize the majority of the deferred gain until that time.  However, in 2004 we recognized $772,000 of the deferred gain as revenues related to the sale of Thin Film products to MAST under the back-up supply agreement at cost.  This was necessary to state revenues and gross margin at the amount we would normally charge for selling the same product in an unencumbered transaction.

Even after consummation of the Thin Film asset disposition, we retained all rights to Thin Film business in Japan (subject to a purchase option of MAST, as described below), and we received back a license of all rights to Thin Film technologies in the:

•                    Spinal field, exclusive at least until 2012, and

•                    Field of regenerative medicine, non-exclusive on a perpetual basis

The sale agreement grants MAST a “Purchase Right” to acquire our Thin Film-related interests and rights for Japan at the following terms:

•                  If MAST exercises its option on or before May 31, 2005, the purchase price will be $3,000,000.

•                  After May 31, 2005 but before May 31, 2007, the exercise price of the Purchase Right will be equal to the fair market value of the Japanese business, but in no event will be less than $3,000,000.  Moreover, between June 1, 2005 and May 31, 2007 MAST will have a right of first refusal to match the terms of any outside offer to buy our Japanese Thin Film business.

If MAST exercises the Purchase Right, MAST will become obligated to reimburse us for certain costs we have incurred or will incur related to product development and protection of intellectual property rights in the country of Japan.  Moreover, under certain circumstances MAST must share certain milestone payments and gross profits with us, if MAST exercises the Purchase Right and begins marketing Thin Film products in Japan.

Thin Film Distribution Agreement

In the third quarter of 2004, we entered into a Distribution Agreement with Senko.  Under this agreement, we granted to Senko an exclusive license to sell and distribute certain Thin Film products in Japan.  Specifically, the license covers Thin Film products with the following indications:

•                  Anti-adhesion,

•                  Soft tissue support, and

•                  Minimization of the attachment of soft tissues throughout the body.

The Distribution Agreement with Senko commences upon “commercialization.”  In simplest terms, commercialization occurs when one or more Thin Film product registrations are completed with the MHLW. 

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Following commercialization, the Distribution Agreement has a duration of five years and is renewable for an additional five years after reaching mutually agreed minimum purchase guarantees.

We received a $1,500,000 upfront license fee from Senko.  We have recorded the $1,500,000 received as deferred license fee revenue in the accompanying balance sheet.  Half of the license fee is refundable if the parties agree commercialization is not achievable and a proportional amount is refundable if we terminate the arrangement, other than for material breach by Senko, before three years post-commercialization. 

Accordingly, we will begin to recognize this $1,500,000 license fee as revenues only after commercialization has been achieved.  Moreover, we will not recognize all of the revenues at one time – instead, we will reflect the fee in revenues on a systematic basis over the expected period of time we anticipate that Senko will benefit from the arrangement.  However, we will not recognize deferred license fee revenue in the statements of operations if this would cause the remaining deferred license fee revenue balance to fall below the amount that we potentially would have to refund to Senko.

We will also be entitled to earn additional payments from Senko based on achieving defined milestones.  We will recognize such payments as revenues when the performance criteria for a milestone have been met, presuming that achievement of the milestone involves substantive effort and the fees received are commensurate with the level of effort expended.  On September 28, 2004, we notified Senko of completion of the initial regulatory application to the MHLW for the Thin Film product.  As a result, we became entitled to a nonrefundable payment of $1,250,000, which we received in October 2004 and recorded as deferred development revenue.  Of the amount deferred, we recognized $158,000 as development revenues in the year ended December 31, 2004.  The amount recognized as development revenues represents the relative fair value of the completed milestone as compared with the fair value of all milestones expected to be necessary to achieve regulatory approval by the MHLW.

Results of Operations

Years ended December 31, 2004 and 2003 compared to years ended December 31, 2003 and 2002, respectively.

Revenues

The following table summarizes the components of our revenues for the years ended December 31, 2004, 2003, and 2002:

Note: Certain prior period amounts have been reclassified to conform to current period presentation.

•                  Spine and orthopedic revenues represent sales of bioresorbable implants used in spine and orthopedic surgical procedures.  In the second half of 2003 and first quarter of 2004, Medtronic (our sole distributor of spine and orthopedic products) placed initial stocking orders for our newly developed HYDROSORB™ products.  We had anticipated that demand for these products from Medtronic’s customers would draw down these inventories sufficiently to require Medtronic to buy substantial additional amounts this year.  However, sales to Medtronic through, and especially in, the second half of 2004 were well below our expectations.  End-user demand has not increased as we thought it would, primarily because of inadequate marketing efforts by Medtronic.  Medtronic also markets competing products, some of which generate a higher profit margin for Medtronic.  The increase in spine and orthopedics revenue in 2003 as compared to 2002 resulted primarily from filling orders of HYDROSORB™ products.  Refer to “The future” discussion below for our expectations regarding the outlook for future spine and orthopedic revenues.  Note that Medtronic owns

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approximately 7.2% of our outstanding common stock.

•                  Thin Film product revenues represent sales of SurgiWrap™ bioresorbable Thin Film used to support and reinforce soft tissues and to minimize tissue attachment to the device in case of contact with the viscera (organs of the body).  The revenue increase in 2004 primarily relates to initial stocking orders placed by MAST following the acquisition of Thin Film product rights from us in the second quarter of 2004.  We are obliged by contract to sell these products to MAST at our manufacturing cost.  Of the revenues reported during 2004, $772,000 relates to the recognition of a portion of the deferred gain related to sale of Thin Film assets to MAST.  This recognition policy is necessary to state our revenues and gross margin at the amount we would normally charge for selling the same product in an unencumbered transaction.  The increase in Thin Film revenue in 2003 as compared to 2002 was attributable to a full year of sales of this product line in 2003 versus sales in only the second half of 2002.  Refer to “The future” discussion below for expected trends regarding future Thin Film revenues.

•                  The CMF product revenues represent sales of the CMF line of products used for trauma and reconstructive procedures in the midface and craniofacial skeleton (the head and skull).  We sold this product line to Medtronic in 2002.  As with the Thin Film products, we sold CMF products at cost in 2002, 2003 and 2004 under a contractual back-up supply agreement and we recognized a portion of the deferred gain related to sale of assets in order to reflect the gross margin which would otherwise have been associated with such sales. The decrease in CMF product revenue in 2003 and 2004 reflects Medtronic transitioning the manufacturing of CMF products to its own facilities.  During the third quarter of 2004, we completed all remaining performance obligations related to the 2002 sale of the CMF product line to Medtronic.  Therefore, we do not expect to earn any CMF product revenue in the future.

•                    The research grant revenue relates to our agreement with the National Institutes of Health (“NIH”).  Under this arrangement, the NIH reimburses us for “qualifying expenditures” relating to research on Adipose-Derived Cell Therapy for Myocardial Infarction.  To receive funds under the grant arrangement, we are required to (i) demonstrate that we incurred “qualifying expenses,” as defined in the grant agreement between the NIH and us, (ii) maintain a system of controls, whereby we can accurately track and report all expenditures related solely to research on Adipose-Derived Cell Therapy for Myocardial Infarction, and (iii) file appropriate forms and follow appropriate protocols established by the NIH.  As of June 30, 2004, we had completed Phase I of the research grant and incurred the full amount of qualifying expense for reimbursement of $100,000.  In the third quarter of 2004, the NIH authorized us to begin Phase II of the research grant which entitled us to receive up to $850,000 (subject to availability of funds and satisfactory progress towards meeting the goals and objectives of our grant application).  Our policy is to recognize revenues under the NIH grant arrangement as the lesser of (i) qualifying costs incurred (and not previously recognized) for which we are entitled to funding or (ii) the amount determined by comparing the outputs generated to date versus the total outputs expected to be achieved under the research arrangement.  During the second half of 2004, we incurred $222,000 in qualifying expenditures plus $6,000 in allowable grant fees, for a total of $228,000 in reimbursements related to Phase II of the research grant.  We have recorded revenues for the same amount.

•                  Under a Distribution Agreement with Senko we are entitled to earn payments based on achieving the following defined milestones:

•                  Upon notifying Senko of completion of the initial regulatory application to the MHLW for the Thin Film product, we were entitled to a nonrefundable payment of $1,250,000.  We so notified Senko on September 28, 2004, received payment in October of 2004, and recorded deferred development revenue.  Of the amount deferred, we have recognized development revenues of $158,000, representing the relative fair value of the completed milestone as compared with the fair value of all milestones expected to be necessary to achieve regulatory approval by the MHLW;

•                  Upon the achievement of commercialization of the thin film product line in Japan, we are entitled to a nonrefundable payment of $250,000.  As of December 31, 2004, commercialization had not occurred; however, commercialization is expected in 2005 or early 2006.

The future:  We sell our spine and orthopedic products exclusively to Medtronic at fixed selling prices that are subject to adjustment biannually (based on Medtronic’s selling prices to its customers).  Our revenue from this product line is dependent upon the market’s adoption of our technology, which is largely dependent upon Medtronic’s marketing efforts and pricing strategies.  To increase our revenues from spine and orthopedic products, we depend largely on Medtronic’s ability and commitment to build and expand HYDROSORB™ market share. Additionally, because our HYDROSORB™  products are relatively new to the market, and because our internal estimates of second quarter 2004 HYDROSORB™ sales were proven inaccurate, we concluded that we were unable to accurately forecast Medtronic’s, and Medtronic’s customers’ demand.  Therefore, in July 2004, we retracted our previously stated revenue guidance for 2004.  Our sales remained weak in the third and fourth quarters of 2004.  We continue to believe in the medical value of this product line, but there are significant uncertainties regarding the vigor of Medtronic’s marketing efforts and the

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rate of adoption by physicians.  In August of 2004, we received FDA clearance for our radiographically identifiable Spine System products.  We currently expect market demand, and therefore revenues, for these and our other HYDROSORB™ products to increase in 2005 from 2004 levels, particularly as Medtronic and its customers seek to employ our radiographically identifiable Spine System products.

We became entitled to receive up to $850,000 in additional grants related to Adipose-Derived Cell Therapy for Myocardial Infarction as defined by the NIH grant agreement for Phase II research for which we have or expect to incur “qualifying expenses” in 2004 and 2005 subject to availability of NIH funds and satisfactory progress toward meeting the goals and objectives of our grant application.  We expect to recognize the remaining grant of approximately $600,000 in revenues during 2005 and 2006.

We will continue to recognize revenue from the milestone payment from Senko, based on the fair value of the milestones completed relative to the total efforts expected to be necessary to obtain regulatory clearance with the MHLW.  Obtaining regulatory clearance with the MHLW is expected in 2005 or early 2006, but could potentially continue through 2007 as we perform additional clinical study(s), revise documentation, and negotiate reimbursement points with the MHLW.

To the extent that sales of our spine and orthopedic products to Medtronic (and to Medtronic’s customers) recover to any significant degree, we expect the percentage of revenues attributable to Medtronic to increase as sales of Thin Film become a lower percentage of our overall sales revenue, although this may change when commercialization of the Thin Film products in Japan occurs and we begin Thin Film shipments to Senko.

As MAST begins to assume the manufacturing process, we expect domestic revenue from Thin Film products to decline and end in 2005. 

Cost of revenues

Cost of revenues includes material, manufacturing labor, overhead costs and an inventory provision.  The following table summarizes the components of our cost of revenues for the years ended December 31, 2004, 2003, and 2002:

•                  The cost of revenues, as a percent of revenues (excluding inventory provision amounts), increased 53.2% in the year ended December 31, 2004 as compared to 2003, and decreased 13.0% in 2003 as compared to 2002.  The increase in 2004 from 2003 was due to higher cost of revenues associated with the Thin Film products than other product lines (product mix) as well as a lack of inventory production (generated by declining sales demand) to absorb fixed manufacturing and labor expense.  The decrease in 2003 from 2002 was primarily attributable to increased sales revenue that allowed us to absorb more of our manufacturing labor and overhead costs.  Excess manufacturing capacity expensed in 2004 was $1,119,000 as compared to $423,000 in 2003 and $1,145,000 in 2002. 

•                  The $242,000 inventory provision during the year ended 2004 with no comparable charges in 2003 related to excess inventory.  Such inventory was produced in consideration of our responsibility to be a back-up supplier for the CMF product line.  We sold the assets related to this product line to a subsidiary of Medtronic in September 2002.  In April of 2004, Medtronic indicated that it would no longer purchase CMF inventory from us under the back-up supply arrangement, leading to our determination that the remaining CMF inventory on hand would not be recoverable.  The $1,395,000 inventory provision recorded in 2002 was directly related to the CMF asset sale, as the remaining unsold inventory in our CMF bone fixation implants and accessories product line inventory would no longer be recoverable.

The future:  Ceasing to manufacture the CMF product line and the May 2004 sale of our non-Japan bioresorbable Thin Film product line will deprive us of economies of scale and will negatively impact our margins unless other sources of revenue grow large enough to compensate for the lost revenue. 

Research and development expenses

Research and development expenses include costs associated with the design, development, testing and enhancement of our products, regulatory fees, the purchase of laboratory supplies and pre clinical studies.  It excludes related stock based compensation

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expenses.  The following table summarizes the components of our research and development expenses for the years ended December 31, 2004, 2003, and 2002:

•                    Regenerative cell technology expenses relate to the development of a technology platform that involves using adipose (fat) tissue as a source for autologous regenerative cells for therapeutic applications.  The increases in regenerative cell technology expenses as compared with 2003 and 2002 result primarily from the hiring of additional researchers, engineers and support staff.  We incurred an additional $1,370,000 in labor-related expenses in the year ended December 31, 2004, as compared with 2003.  We incurred an additional $1,612,000 in labor-related expenses in the year ended December 31, 2003, as compared with 2002.  The remainder of the increases related to increases in legal, research supplies, consulting fees and facility expenses of $1,660,000, and $2,448,000, in the years ended December 31, 2004 and 2003 as compared with 2003 and 2002, respectively.

•                    Bioresorbable polymer surgical implants platform technology is used for development of spine and orthopedic products.  The decrease in research and development costs associated with bioresorbable polymer implants in 2004 as compared with 2003 was a result of the successful completion of development of our bioresorbable Thin Film product line in late 2003, as well as a strategic decision to strongly focus our research and development efforts on our regenerative cell technology.  The decrease in 2003 costs as compared to 2002 related primarily to the discontinuance of development of the CMF product line that was sold to Medtronic in 2002. 

•                  In 2004, we entered into an agreement with the NIH to reimburse us for up to $950,000 (Phase I $100,000 and Phase II $850,000) in “qualifying expenditures” related to research on Adipose-Derived Cell Therapy for Myocardial Infarction.  In 2004, we incurred a total of $117,000 of direct qualifying expenses relating to Phase I and $222,000 of direct qualifying expenses related to Phase II, for a total cost relating to NIH grants of $339,000.

•                    Under a Distribution Agreement with Senko we are responsible for the completion of the initial regulatory application to the MHLW and commercialization of the Thin Film product line in Japan.  Commercialization occurs when one or more Thin Film product registrations are completed with the MHLW.  In 2004, we have incurred $170,000 of expenses related to this regulatory and registration process. 

The future:  We are developing a system to isolate autologous, homologous-use, regenerative cells.  Simultaneously, we are generating scientific knowledge through internal research to support the clinical use of these cells and have made significant progress in understanding the potential clinical applications.  Our most advanced research and development program is in the repair of cardiovascular muscle tissue that is damaged after a heart attack.  Our strategy is to continue to increase our research and development efforts in this field and we anticipate expenditures in this area of research to be approximately $8,000,000 to $10,000,000 in 2005.  We are also researching therapies for spine and orthopedic conditions, gastrointestinal disorders and new approaches for aesthetic and reconstructive surgery.  The expenditures will primarily relate to developing therapeutic applications and the conducting pre clinical studies on harvesting therapeutically useful quantities of regenerative cells for cardiac tissue repair, bone regeneration, cosmetic and reconstructive surgery. 

We expect that our current research and development expenditures in the bioresorbable platform technology will decrease as compared with past levels because of the sale of our CMF and Thin Film (non-Japan territory) product lines.  However, we will continue to invest in product development for biomaterial/polymer products to develop our pipeline of new and next generation spine and orthopedic products.

We were successful with Phase I of the NIH research on Adipose-Derived Cell Therapy for Myocardial Infarction.  Therefore, we were awarded Phase II of the NIH research grant.  We expect additional research expenses to be incurred related to Phase II of this project in 2005 and 2006.

Sales and marketing expenses

Sales and marketing expenses include costs of marketing personnel, tradeshows, and promotional activities and materials.  It excludes related stock based compensation expenses.  Medtronic is responsible for the distribution, marketing and sales support of our

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spine and orthopedic devices.  Our bioresorbable Thin Film product line (before the sale of the non-Japan Thin Film business to MAST in May 2004) was distributed domestically through a dedicated sales force, independent sales representatives and internationally through independent distributors.  As of May 13, 2004, all Thin Film products (except for the Japan territory) are sold exclusively to MAST under a back-up supply agreement.  The following table summarizes the components of our sales and marketing expenses for the years ended December 31, 2004, 2003, and 2002:

•                  General corporate marketing expenditures relate to expenditures for maintaining our corporate image and reputation within the research and surgical communities.  The increase in 2004 as compared to 2003 was due to an educational program which we voluntarily (and not as a result of any commitment to Medtronic) created in 2004 to inform end-users and Medtronic’s sale teams of the benefits and surgical applications for our biomaterials products.  The decrease in 2003 expenses as compared with 2002 related to our decision to discontinue supplementing Medtronic’s marketing of spine and orthopedics and CMF product lines.

•                  Domestic sales and marketing related to expenses associated with managing our domestic bioresorbable Thin Film product distribution, which included independent sales representatives and our domestic Thin Film sales consultants and marketing staff.  The sharp decrease in 2004 as compared to 2003 was due to the transfer of our sales force and marketing staff to MAST upon the sale of the Thin Film product line to MAST in May 2004.  The increase in 2003 as compared with 2002 related to the increased salary cost of our Thin Film sales force and marketing team, who were employed for the full year in 2003 versus only the second half of 2002.