**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


Washington,
D.C. 20549


-----------------


**Form
10-K**





**ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF**


**THE
SECURITIES EXCHANGE ACT OF 1934**





**For
      the fiscal year ended December 31, 2004**
    **Commission
      file number: 0-19890**





**LifeCell
Corporation**


(Exact
name of registrant as specified in its charter)





**Delaware**
    
    **76-0172936**(State
      or other jurisdiction of
    
    **(**I.R.S.
      employerIncorporation
      or organization)
    
    identification
      no.)





**One
Millennium Way**


**Branchburg,
New Jersey 08876**


(Address
of principal executive offices, including zip code)





**(908)
947-1100**


(Registrant’s
telephone number, including area code)








**SECURITIES
REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:**


**None**





**SECURITIES
REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:**


**Common
Stock, par value $.001 per share**





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 **Ö** No
__





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 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. [ **Ö** ]





Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act).





Yes **Ö** No
__





The
aggregate market value of voting Common Stock held by non-affiliates of
registrant, based upon the last sale price of the Common stock reported on the
Nasdaq Stock Market as of the last business day of the registrant’s most
recently completed second quarter (June 30, 2004) was approximately
$317,618,000.





The
number of shares of registrant’s Common Stock outstanding as of March
4 **,** 2005:
29,243,784.







Table
      Of Contents





PART
      I
    
    PageItem
      1.
    Business
    3General
    3Technology
    3Products
    5Industry
      and Market Data
    6Marketing
      and Distribution
    7Tissue
      Procurement
    7Government
      Regulation
    8Research
      and Development
    12Patents,
      Proprietary Information & Trademarks
    13Competition
    14Employees
    14Risk
      Factors
    15Special
      Note Regarding Forward-Looking Statements
    21Supervision
      and Regulation - Securities and Exchange Commission
    21Item
      2.
    Properties
    21Item
      3.
    Legal
      Proceedings
    21Item
      4
    Submission
      of Matters to a Vote of Security Holders
    21PART
      IIItem
      5.
    Market
      for Registrant's Common Equity, Related Stockholder Matters and IssuerPurchases
      of Equity Securities
    22Dividend
      Policy
    22Item
      6.
    Selected
      Financial Data
    23Item
      7.
    Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
    24General
      and Background
    24Critical
      Accounting Policies
    24Results
      of Operations
    25Liquidity
      and Capital Resources
    28Item
      7A.
    Quantitative
      and Qualitative Disclosures About Market Risk
    30Item
      8.
    Financial
      Statements and Supplementary Data
    30Item
      9.
    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
    30Item
      9A.
    Controls
      and Procedures
    30Item
      9B.
    Other
      Information
    31PART
      IIIItem
      10.
    Directors
      and Executive Officers of the Registrant
    31Item
      11.
    Executive
      Compensation
    35Item
      12.
    Security
      Ownership of Certain Beneficial Owners and Management
    39Item
      13.
    Certain
      Relationships and Related Transactions
    40Item
      14.
    Principal
      Accounting Fees and Services
    41PART
      IVItem
      15.
    Exhibits,
      Financial Statement Schedules
    42


2




PART
      I





This
Annual Report on Form 10-K contains, in addition to historical information,
“forward-looking statements” (within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended) that involve risks and uncertainties. See
“Business—Special Note Regarding Forward-Looking Statements.”





Item
      1.
    Business






GENERAL


LifeCell ® develops
and markets products made from human tissue for use in reconstructive,
urogynecologic and orthopedic surgical procedures to repair soft tissue defects.
Our patented tissue processing technology produces a unique regenerative tissue
matrix - a complex three-dimensional structure that contains vascular channels,
proteins, and growth factor binding sites - that provides a complete template
for the regeneration of normal human tissue. We currently market several
products to a broad range of markets: AlloDerm ® for
plastic reconstructive, general surgical, burn and periodontal procedures;
Cymetra ® , a
particulate form of AlloDerm; Repliform ® for
urogynecologic procedures; GraftJacket ®  and
GraftJacket ®  Xpress
for orthopedic applications and lower extremity ulcerations; and
AlloCraft TM DBM for
bone grafting procedures. We also distribute cryopreserved allograft skin for
use as a temporary wound dressing in the treatment of burns. Our research and
development programs are primarily focused on extending the utilization of our
regenerative tissue matrix into other therapeutic areas and investigating the
application of our core technology to other tissues.





We were
incorporated in the State of Delaware in 1992 as the successor to a Delaware
corporation that was incorporated in 1986. Our address is One Millennium Way,
Branchburg, New Jersey 08876, our phone number is (908) 947-1100, and our
website address is www.lifecell.com . The
information contained on our website does not constitute a part of this
report.








TECHNOLOGY


Our
patented tissue processing technology produces a unique regenerative tissue
matrix - a complex three-dimensional structure that contains proteins, growth
factor binding sites and vascular channels - that provides a complete template
for the regeneration of normal human tissue. To date, our product development
programs have been generated from the following proprietary
technologies:





•
    methods
      for producing an acellular tissue matrix by removing antigenic cellular
      elements while stabilizing the matrix against damage;





•
    methods
      for cell preservation by manipulating cells through signal transduction
      (i.e., manipulation of cellular metabolism) to protect cells during
      prolonged storage; and





•
    methods
      for freeze-drying biological cells and tissues without the damaging
      effects of ice crystals.





Tissue
Matrix Technology





Our
tissue matrix technology removes antigenic cells from the tissue matrix to
eliminate the potential for specific rejection of the transplanted tissue. Our
tissue matrix technology also:





•
    stabilizes
      the tissue matrix by preserving its natural structure and biochemical
      properties that allow for cell repopulation; and





•
    allows
      for extended storage by freeze-drying the tissue matrix without
      significant ice crystal damage, thus avoiding a non-specific immune
      response upon transplantation.




3


Soft
tissue, such as dermis, heart valves, blood vessels and nerve connective tissue,
contains a complex, three-dimensional structure consisting of multiple forms of
collagen, elastin, proteoglycans, other proteins, growth factor binding sites
and blood vessels (the “tissue matrix”). Together, the tissue matrix and the
cells that populate it form the soft tissues of the body and other tissue types.
As part of the body’s natural remodeling process, cells within a tissue
continuously degrade and, in the process, replace the tissue matrix. However, in
the event that a large portion of the tissue matrix is destroyed or lost because
of trauma or surgery, the body cannot regenerate the damaged portion. The only
method of replacing large sections of the tissue matrix is through
transplantation.





Soft
tissue transplants from one part of the patient’s body to another (“autograft”)
generally are successful, however, the procedure results in the creation of an
additional wound site. Historically, the ability to transplant tissue from one
person to another (“allograft”) has been limited because the donor’s cells
within the transplanted tissue may trigger an immune response, resulting in
rejection of the transplanted tissue. We believe that previous attempts to
remove cells from soft tissue grafts before performing an allograft transplant
have resulted in disruption or damage of the tissue matrix, causing an
inflammatory response and rejection of the tissue following
transplantation.





We
believe our tissue matrix technology offers the following important
benefits:





***Natural
Tissue Regeneration.*** Tissue
grafts produced with our tissue matrix technology retain the structural and
biochemical properties that support normal cell repopulation and normal soft
tissue regeneration. In addition, in our pre-clinical studies with dermis and
preliminary animal studies with heart valve leaflets, nerve connective tissue
grafts and vascular grafts processed using our technology, we have shown that
such tissues can be remodeled by the recipient’s own cells and eventually become
the recipient’s own tissue.





***Multiple
Potential Applications.*** We
believe that our tissue matrix technology has the potential to generate
additional products with multiple clinical applications. In addition to the
current commercial applications of our proprietary tissue products, we believe
that these products may provide additional benefits in other clinical
applications.





***Safety.*** Our
tissue matrix technology yields products that can revascularize and integrate
into the body’s own tissues, thereby allowing the patient’s immune cells to
penetrate into the transplanted tissue and thus aid in preventing infections. In
contrast, certain synthetic implants do not allow penetration of the patient’s
immune cells, thereby compromising the body’s natural ability to fight
infections. Our processed human tissue products have a proven safety record of
over ten years and with over 650,000 tissue grafts processed and distributed to
date.





***Prolonged
Shelf Life.*** Our
tissue matrix technology allows extended storage and ease of transportation of
products. AlloDerm, Repliform and GraftJacket can be stored at normal
refrigerated temperatures for up to two years. In contrast, traditionally
processed skin allografts require low temperature (-80°C) storage and shipping
with dry ice. Cymetra and GraftJacket Xpress can be stored at normal
refrigerated temperatures for up to one year. AlloCraft DBM can be stored at
ambient temperature for up to two years.





***Compatibility
with Other Technologies.*** Human
tissues processed with our technology retain important biochemical components,
such as proteoglycans and hyaluronic acid. These biochemical components bind
growth factors and interact with cells that are involved in tissue regeneration.
Therefore, we believe it may be possible to use our technology to develop
tissue-based delivery vehicles for these factors and cells.





4




PRODUCTS





Reconstructive
Tissue Products





AlloDerm
Regenerative Tissue Matrix





AlloDerm
is donated human cadaveric skin that has been processed with our tissue matrix
technology. We believe that AlloDerm is the only human tissue product on the
market today that supports the regeneration of normal human soft tissue.
Following transplant, AlloDerm is revascularized (i.e., blood supply is
restored) and repopulated with the patient’s own cells becoming engrafted into
the patient. AlloDerm is a versatile tissue and has multiple surgical
applications.





AlloDerm
is marketed to plastic reconstructive and general surgeons as an “off-the-shelf”
alternative to autograft tissue and synthetic materials. AlloDerm is
predominately used in plastic reconstructive, general surgical, burn and
periodontal procedures:





•
    as
      an implant for soft tissue reconstruction or tissue deficit correction;





•
    as
      a graft for tissue coverage or closure; and





•
    as
      a sling to support tissue following nerve or muscle damage.





In these
procedures, alternatives to using AlloDerm include autologous tissue, synthetic
and biosynthetic materials. We believe the disadvantages of using autologous
tissue are the creation of a separate donor site wound and the associated pain,
morbidity and scarring from this additional wound. Additionally, we believe the
disadvantages of using synthetic materials are the susceptibility of synthetics
to infection, encapsulation (scarring), the graft moving away from the
transplanted area (mobility), and erosion of the graft through the skin
(extrusion). Some biosynthetic materials may include bovine collagen, which
requires patient sensitivity testing.





AlloDerm
was first used in the treatment of third-degree and deep second-degree burns
requiring skin grafting in 1994 to replace lost dermis. The use of AlloDerm in
burn grafting has clinically shown performance equivalent to autograft in
reducing the occurrence and effects of scar contracture, the progressive
tightening of scar tissue that can cause joint immobility, while significantly
reducing donor site trauma. We believe that AlloDerm provides significant
therapeutic value when used in burn grafting over a patient’s mobile
joints.





Today,
AlloDerm is predominately used as a subcutaneous implant for the replacement of
soft tissue in head and neck reconstructive procedures and in general surgical
procedures. For example, in surgical repair of abdominal wall defects, AlloDerm
is used to repair defects resulting from trauma, previous surgery, hernia
repair, infection, tumor resection or general failure of the musculofacial
tissue. We believe that AlloDerm provides a novel alternative to synthetic
materials and autologous tissue because of its unique functional, biomechanical
and regenerative properties. AlloDerm is also used in cancer reconstruction
procedures including breast reconstruction following mastectomy
procedures.





Periodontal
surgeons use AlloDerm to increase the amount of attached gum tissue supporting
the teeth as an alternative to autologous connective tissue grafts excised from
the roof of the patient’s mouth and then transplanted to the gum. BioHorizons
Implant Systems, Inc. is our exclusive distributor of AlloDerm and
AlloDerm  GBR ® for use
in periodontal applications in the United States and certain international
markets.





Cymetra
Micronized AlloDerm Tissue


Cymetra
Micronized AlloDerm Tissue is made from AlloDerm sheets that are micronized at a
low temperature to create a particulate form of AlloDerm suitable for delivery
through a canula. This form allows a non-surgical alternative in reconstructive
plastic and other procedures to replace damaged or inadequate integumental
tissue, such as correction of soft tissue defects and depressed scars or to
replace integumental tissue lost through atrophy. Cymetra does not require
patient sensitivity testing and similar to AlloDerm, promotes the regeneration
of normal human soft tissue.




5


Urogynecologic
Tissue Repair Products





Repliform
Regenerative Tissue Matrix





Repliform
is the trade name for our proprietary tissue matrix product intended for use in
repairing damaged or inadequate integumental tissue in urogynecologic surgical
procedures. Since 1997, surgeons have used Repliform in urogynecologic
procedures as a bladder sling in the treatment of stress urinary incontinence
and for the repair of pelvic floor defects.





Some
forms of female stress urinary incontinence can be treated with a sling
procedure, which involves lifting and supporting the bladder neck to provide
urethral support and compression. Repliform is used by surgeons as the sling
material in these types of procedures.





Cystocele,
rectocele and other pelvic floor conditions occur frequently in women and
require soft tissue surgical repair. These conditions are particularly common
after multiple vaginal births and cause significant discomfort to the patient.
It is common that these conditions exist together with urinary incontinence.
Therefore, it is becoming the current standard of care to correct pelvic floor
conditions at the same time as a sling or suspension procedure to ensure that
there are no conditions that can adversely affect patient outcome. Repliform is
also used by surgeons to reinforce the pelvic floor.





Currently,
materials used for slings and pelvic floor repair surgeries include autologous
tissue, synthetic materials and cadaveric fascia. The autologous tissue often is
taken from the patient’s thigh or abdomen resulting in a painful donor site. We
believe that Repliform used as a sling for urinary incontinence or pelvic floor
repair provides a safe and effective alternative that eliminates the need for a
donor site, will repopulate as the patient’s own tissue and will not erode
through the soft pelvic tissues. Boston Scientific Corporation is our exclusive
worldwide sales and marketing representative for Repliform for use in
urogynecologic surgical procedures.








Orthopedic
Tissue Repair Products





GraftJacket
Regenerative Tissue Matrix


GraftJacket
is the trade name for our proprietary tissue products intended for use in
repairing damaged or inadequate integumental tissue in orthopedic surgical
procedures, such as for rotator cuff tendon reinforcement. Graft Jacket is also
used for the the treatment of lower extremity ulcerations. Wright Medical is our
exclusive distributor for GraftJacket in the United States.





AlloCraft
DBM


AlloCraft
DBM is a proprietary human tissue-based bone-grafting product that combines
demineralized bone and acellular dermal matrix to form a putty. AlloCraft DBM is
intended to promote bone formation through revascularization and ultimately
repopulation of the implant site with bone forming cells. Stryker Corporation is
our exclusive distributor for AlloCraft DBM in the United States.





INDUSTRY
AND MARKET DATA





The table
below contains estimated market data for our major product applications. The
estimates were derived from statistical data, market research, company
estimates, industry publications and other publicly available information. While
we believe that the data sources we used to develop our target market estimates
are reliable, we have not independently verified the data and we do not make any
representation as to the accuracy of the information. Additionally, we have not
sought consent to identify the sources of such information in our report.




6




Product
      / Clinical Applications
    
    Targeted
      Annual Procedures (1)
    
    Revenue
      per Procedure (2)AlloDermHead
      and neck
    
    70,000
    
    $200
      - $800Abdominal
      wall
    
    135,000
    
    $1,300
      - $6,500Breast
      reconstruction
    
    55,000
    
    $1,400
      - $1,900RepliformBladder
      sling
    
    100,000
    
    $300
      - $600Pelvic
      floor reconstruction
    
    55,000
    
    $600
      - $1,200GraftJacketRotator
      Cuff
    
    60,000
    
    $550
      - $700Lower
      extremity ulcerations
    
    160,000
    
    $400AlloCraftDBMSpine
      procedures
    
    200,000
    
    $600
      - $1,000


(1)
    The
      targeted annual procedures represents our estimate of the number of
      procedures where our products could be used, not the actual number of
      procdures where our products are used.





(2)
    Revenue
      per procedure represents our estimate of the product revenue per procedure
      that could be recognized by us in each of the targeted
      applications.





MARKETING AND
DISTRIBUTION





We
currently market AlloDerm in the United States for plastic reconstructive,
general surgical and burn applications through our direct sales and marketing
organization. Our direct sales and marketing representatives also market Cymetra
to hospital-based surgeons. As of December 31, 2004, we had a sales, marketing
and customer service staff of 49 persons, including 37 domestic sales personnel.
Our sales representatives are responsible for interacting with ear, nose and
throat surgeons; plastic surgeons; burn surgeons; and general surgeons; and
educating them regarding the use and anticipated benefits of AlloDerm and
Cymetra. We also participate in numerous national fellowship programs, national
and international conferences and trade shows, and we participate in or fund
certain educational symposia.





BioHorizons
Implant Systems, Inc., is our exclusive distributor in the United States and
certain international markets of AlloDerm and AlloDerm GBR for use in
periodontal applications. Boston Scientific Corporation is our exclusive
worldwide sales and marketing agent for Repliform for use in urogynecology.
Wright Medical Group is our exclusive distributor in the United States for
GraftJacket. Stryker Corporation is our exclusive distributor in the United
States for AlloCraft DBM.





TISSUE
PROCUREMENT





We
receive donated human cadaveric tissue from tissue banks and organ procurement
organizations in the United States that comply with the FDA human tissue
regulations. In addition, we require supplying tissue banks and organ
procurement organizations to comply with procedural guidelines outlined by the
American Association of Tissue Banks (“AATB”). We conduct microbiological and
other rigorous quality assurance testing before our acellular human tissue
products are released for shipment.




7


In 2004,
we obtained all of our donated human cadaveric tissue from approximately 30
tissue banks and organ procurement organizations. We believe that we have
established adequate sources of donated human tissue to satisfy the expected
demand for our products in the foreseeable future. Although we have not
experienced any material difficulty in procuring adequate donated cadaveric
tissue, there is a risk that the future availability of donated human tissue
will not be sufficient to meet our demand.





We are
accredited by the AATB. The AATB is recognized for the development of industry
standards and its program of inspection and accreditation. The AATB provides a
standards-setting function and has procedures for accreditation similar to the
International Standards O rganization
(“ISO”) standards.






Government
Regulation




Overview





Government
regulation, both domestic and foreign, is a significant factor in the
processing, marketing and distribution of our current products and products that
we are developing. In the United States, our human tissue products are subject
to regulation by the FDA. The FDA administers the Federal Food, Drug and
Cosmetics Act (“FDC Act”) and the Public Health Service Act (“PHS Act”). These
statutes and implementing regulations govern the design, testing, manufacturing,
labeling, storage, record keeping, approval, advertising and promotion of our
products.





The FDA
does not apply a single regulatory scheme to human tissues and products derived
from human tissue. On a case-by-case basis, the FDA may choose to regulate such
products solely as human tissue if certain requirements are met. If the
applicable requirements are not met, the FDA will regulate human tissue and
products derived from human tissue as medical devices or biologics. A
fundamental difference in the treatment of products under these various
classifications is that the FDA generally permits products regulated solely as
human tissue to be commercially distributed without premarket clearance or
approval. In contrast, products regulated as medical devices or biologics
usually require such clearance or approval. The process of obtaining premarket
clearance or approval for a medical device or biologic is often expensive,
lengthy and uncertain.





Whether
regulated as human tissue, a medical device or a biologic product, once our
products are on the market, they are subject to pervasive and continuing
regulation by the FDA. We are subject to inspection at any time by the FDA and
state agencies for compliance with regulatory requirements. The FDA may impose a
wide range of enforcement sanctions if we fail to comply,
including:





• 
      fines;
      
      • 
      injunctions;
      
      • 
      civil penalties;
      
      • 
      recall or seizure of our products;
    
    • 
      total or partial suspension of production;
      
      •  refusal
      of the government to authorize the marketing of new products or to allow
      us to enter into supply contracts; and
      
      • 
      criminal prosecution




FDA’s
Human Tissue Regulation





The FDA’s
regulatory requirements for human tissue have been evolving in a complex fashion
and will continue to do so for some time to come. In 1993, the FDA adopted the
so-called “interim final rule” for human tissue for transplantation, which
imposed donor screening, testing and record keeping requirements. The rule was
finalized in 1997. Under the 1997 final rule, covered “human tissue” is any
tissue derived from a human body, which: (i) is intended for administration to
another human for the diagnosis, cure, mitigation, treatment or prevention of
any condition or disease; (ii) is recovered, processed, stored or distributed by
methods not intended to change tissue function or characteristics; (iii) is not
currently regulated as a human drug, biological product or medical device; (iv)
excludes kidney, liver, heart, lung, pancreas or any other vascularized human
organ; and (v) excludes semen or other reproductive tissues, human milk and bone
marrow. Establishments engaged in the procurement, processing and/or
distribution of human tissue are required to conduct donor screening and
infectious disease testing and to maintain records available for FDA inspection
documenting that the procedures were followed. Moreover, the FDA has the
authority to conduct inspections of tissue establishments and to detain, recall
or destroy tissue where the procedures were not followed or appropriate
documentation of the procedures is not available.




8


In 2001,
the FDA issued a final rule requiring manufacturers of human cellular and
tissue-based products, which the FDA calls "HCT/Ps," to register their
establishments and list their products with the FDA. Some aspects of the 2001
final rule had delayed effective dates but the rule is now fully effective. The
2001 final rule sets forth the FDA’s test for detremining whether an HCT/P is
eligible for tissue regulation (as opposed to medical device or biologic
regulation). The FDA will apply human tissue regulation to an HCT/P that is: (i)
minimally manipulated; (ii) intended for homologous use; (iii) is not combined
with a device (with limited exceptions); amd (iv does not have a systemic effect
and is not dependent upon metabolic activity for its primary function. HCT/Ps
generally may be commercially distributed without prior FDA clearance or
approval.





The FDA
has issued final regulations requiring tissue donors to be screened for relevant
communicable diseases and requiring manufacturers of HCT/Ps to follow good
tissue practice (“GTP”) in their recovery, processing, storage labeling,
packaging and distribution of HCT/Ps in order to prevent the introduction,
transmission or spread of communicable diseases. These regulations, which take
effect on May 25, 2005, demonstrate the FDA's increasing imposition of
significant and more costly regulatory requirements. This triad of new
regulations will supersede the 1997 final rule.




FDA
Status of Our Products





We
believe that our AlloDerm-based products generally satisfy the FDA’s
requirements to be considered “HCT/Ps” eligible for regulation solely as human
tissue. Accordingly, we have not obtained prior FDA clearance or approval for
commercial distribution of AlloDerm, Repliform, Cymetra, GraftJacket or
AlloCraft DBM. Nevertheless, because our products meet the definition of an
HCT/P, we must comply with the FDA’s donor screening, infectious disease
testing, record maintenance, establishment registration, product listing and GTP
requirements. Moreover, the FDA has the authority to inspect our facilities and
to detain, recall or destroy our products where we have failed to comply with
these requirements.





In 1996
we were notified by the FDA that AlloDerm used for the replacement or repair of
damaged or inadequate integumental tissue (i.e. tissue lining the surface of the
body or a body cavity) would be regulated as human tissue under the then
effective 1993 interim regulation governing human tissue. Relying upon this
determination, we have not obtained prior FDA approval for commercial
distribution of AlloDerm for use in the treatment of burns, plastic
reconstructive surgery procedures (such as facial sling and scar revision),
periodontal surgical procedures (such as free-gingival grafting and guided
tissue regeneration) and general surgical procedures. We believe that the new
tissue regulations do not significantly alter the status of our products when
used for these indications. Therefore, we continue to believe that AlloDerm for
these uses is solely regulated as human tissue.





We
believe that our decision not to obtain prior FDA clearance or approval for
commercial distribution of Repliform and Cymetra, which we began to market in
1999, is supported by the FDA’s regulations and by our correspondence with the
FDA regarding the status of these products as human tissue. Specifically, in
November 2000, the FDA requested detailed information about Repliform and
Cymetra. In February 2001, we responded to the FDA's request. In June 2001, the
FDA notified us that Repliform and Cymetra, as currently marketed, are subject
to regulation solely as human tissue.





In 2002,
we commenced commercial distribution of GraftJacket without seeking prior FDA
clearance or approval. GraftJacket is the trade name given to AlloDerm when it
is labeled for the intended use of repairing damaged or inadequate integumental
tissue in orthopedic surgery.




9


By letter
dated December 8, 2003, the FDA informed us of their determination that
GraftJacket for rotator cuff repair and periostium replacement are
non-homologous uses of AlloDerm that do not qualify for human tissue regulation.
Accordingly, the FDA took the position that GraftJacket requires premarket
clearance or approval as a medical device before it may be marketed for use in
rotator cuff repair. The FDA also took the position that, before GraftJacket may
be marketed for periosteum replacement, we must submit a filing with the FDA
requesting a formal determination as to whether medical device or biologic
regulation would apply.





In
the first quarter of 2004, FDA agreed to reconsider its GraftJacket
determination in light of additional information that we submitted on January
30, 2004, and on February 17, 2004. In these submissions, we requested reconsideration
of FDA’s decision, proposed certain labeling changes to GraftJacket to address
the FDA’s December 8, 2003 letter, and explained why we believe that the FDA
should accord HCT/P status to GraftJacket for rotator cuff repair and periosteum
replacement. On May 25, 2004, the FDA responded in writing indicating that
GtaftJacket for these purposes would be regulated as an HCT/P if labeled and
advertised as described in our submissions and subject to certain additional
requested labeling changes. On September 30, 2004 we submitted revised labeling
to the FDA for their review and they indicated their concurrence with the
revised labeling.





In 2003,
we commenced commercial distribution of AlloCraft DBM without obtaining FDA
clearance or approval based upon on our belief that AlloCraft DBM is eligible
for regulation solely as an HCT/P. On September 20, 2004, the FDA notified us by
written decision that after reviewing promotional materials for AlloCraftDBM,
they believe that it does not meet the criteria for regulation as an HCT/P. In
their letter to us, the FDA requested that we promptly file a Request for
Designation, or RFD, to initiate a proceeding in which the FDA would determine
the proper classifiaction and associated pre-market requirements. We filed a
preliminary RFD and met with FDA in an informal exchange of our respective
positions. We presented our position as to why AlloCraft DBM meets the
definition of an HCT/P. The FDA continues to reject our position and asserts
that they believe that AlloCraft DBM is most properly regulated as a medical
device (and not as a drug or biologic). We are considering whether to seek
510(k) clearance or PMA approval for AlloCraft DBM as a medical device or
further appeal this decision within the agency. The FDA has not requested that
we cease marketing AlloCraft DBM during the time that we are seeking clearance
or approval or appealing FDA’s determination, but there is no guarantee that FDA
will refrain from enforcement action. The FDA could require us to cease
marketing and/or recall product already sold until the FDA clearance or approval
is obtained. The FDA could also seek to impose enforcement sanctions against us
for marketing this product without such FDA authorization.




FDA
Medical Device Regulation





A medical
device generally may be marketed in the United States only with the FDA’s prior
authorization. Devices classified by the FDA as posing less risk are placed in
class I or class II. Class II devices (and some class I devices) generally
require the manufacturer to seek premarket clearance, or 510(k) clearance, from
the FDA prior to marketing through the filing of a "premarket notification,"
unless exempted from this requirement by regulation. Such clearance generally is
granted based upon a finding that a proposed device is substantially equivalent
in intended use and safety and effectiveness to a predicate device, which is a
legally marketed class I or II device that already has 510(k) clearance or that
is a pre-amendment class III device (in commercial distribution prior to May 28,
1976 and for which the FDA has not called for PMA applications (defined below)).
No assurance can be given that any medical device will ever receive 510(k)
clearance. Even if a device receives 510(k) clearance, any modification that
could significantly affect its safety or effectiveness or that would constitute
a major change in the intended use of the device, will require a new 510(k)
submission or, possibly, a PMA application. In addition to 510(k) clearance
requirements, class II devices can be subject to special controls (e.g.,
performance standards, post market surveillance, patient registries and FDA
guidelines) that do not apply to class I devices.




10


A medical
device that does not qualify for 510(k) clearance is placed in class III, which
is reserved for devices classified by the FDA as posing the greatest risk (e.g.,
life-sustaining, life-supporting or implantable devices, or devices that are not
substantially equivalent to a predicate device). A class III device generally
must undergo the premarket approval (“PMA”) process, which requires the
manufacturer to prove the safety and effectiveness of the device to the FDA’s
satisfaction. A PMA application must provide extensive preclinical and clinical
trial data and information about the device and its components regarding
manufacturing, labeling and promotion. As part of the PMA application review,
the FDA will inspect the manufacturer’s facilities for compliance with the
Quality System Regulation (“QSR”), which includes elaborate testing, control,
documentation and other quality assurance procedures. Upon submission, the FDA
determines if the PMA application is sufficient to permit a substantive review
and, if so, the PMA application is accepted for filing. The FDA then commences
an in-depth review of the PMA application, which we believe typically takes one
to three years, but which may take longer. Even after approval of a PMA
application, a new PMA application or a supplemental filing to an existing PMA
is required in the event of a modification to the device, its labeling or its
manufacturing process affecting the safety or efficacy of the device.





A
clinical study in support of a PMA application or 510(k) submission for a
“significant risk” device requires an Investigational Device Exemption (“IDE”)
application approved in advance by the FDA for a limited number of patients. The
IDE application must be supported by appropriate data, such as animal and
laboratory testing results. The clinical study may begin only with approval from
FDA and the appropriate Institutional Review Board (“IRB”) at each clinical
study site. If the device presents a “non-significant risk” to the patient, a
sponsor may begin the clinical study after obtaining IRB approval without the
need for FDA approval. In all cases, the clinical study must be conducted under
the auspices of an IRB pursuant to the FDA’s regulatory requirements intended
for the protection of subjects and to assure the integrity and validity of the
data.





If we
market medical device products, we will be subject to pervasive and continuing
regulation. We will have to comply with these requirements, including the FDA’s
labeling regulations, the QSR, the Medical Device Reporting (“MDR”) regulations
(which require that a manufacturer report to the FDA certain types of adverse
events involving its products), and the FDA’s general prohibitions against
promoting products for unapproved or “off-label” uses.




FDA
Biologics Regulation





Biologic
products are regulated under Section 351(a) of the PHS Act, as well as the FDC
Act. The PHS Act imposes a special additional licensing requirement, known as a
Biologic License. This license imposes very specific requirements upon the
facility and the manufacturing and marketing of licensed biologic products to
assure their safety, purity and potency. Some licensed biologic products are
also subject to batch release by the FDA. That is, the products from a newly
manufactured batch cannot be shipped until the FDA has evaluated either a sample
or the specific batch records and has given permission to ship the batch of
product. The PHS Act also grants the FDA authority to impose mandatory product
recalls and provides for civil and criminal penalties for
violations.





Before
conducting the required clinical testing of a biologic product, an applicant
must submit an IND to the FDA, containing preclinical data demonstrating the
safety of the product for human investigational use, information about the
manufacturing processes and procedures and the proposed clinical protocol.
Clinical trials of biologic products typically are conducted in three sequential
phases but may overlap. Phase 1 trials test the product in a small number of
healthy subjects, primarily to determine its safety and tolerance at one or more
doses. In Phase 2, in addition to safety, the efficacy, optimal dose and side
effects of the product are evaluated in a patient population somewhat larger
than the Phase 1 trial. Phase 3 involves further safety and efficacy testing on
an expanded patient population at geographically dispersed test sites.





All
clinical studies must be conducted in accordance with FDA-approved protocols and
are subject to the approval and monitoring of one or more IRBs. In addition,
clinical investigators must adhere to good clinical practices. Completion of all
three phases of clinical studies may take several years, and the FDA may
temporarily or permanently suspend a clinical study at any time.





Upon
completion and analysis of clinical trials, the applicant assembles and submits
a Biologic License Application containing, among other things, a complete
description of the manufacturing process. Before the license can be granted, the
applicant must undergo a successful establishment inspection. The FDA review and
approval of a biologic product is very onerous and can take several years.




11


In 2003,
the FDA announced that it will develop a policy for the approval of “follow-on
biologics,” which would allow a second manufacturer of the same product to be
licensed based upon less scientific data than the innovator. The FDA has not set
a timetable for the implementation of such a policy. Once on the market, a
licensed biologic is subject to all post-marketing requirements of both the PHS
Act and the FDC Act, including compliance with good manufacturing practice,
safety and other reporting requirements, and all relevant labeling, advertising
and promotion requirements. Non-compliance with these requirements may result in
regulatory action, including warning letters or untitled letters, license
suspension, and/or withdrawal from the market, product seizures, injunctions,
and/or criminal prosecutions.




National
Organ Transplant Act





Procurement
of certain human organs and tissue for transplantation is subject to the
restrictions of the National Organ Transplant Act (“NOTA”), which prohibits the
acquisition of certain human organs, including skin and related tissue for
valuable consideration, but permits the reasonable payment of costs associated
with the removal, transportation ,
implantation, processing, preservation, quality control and storage of human
tissue and skin. We reimburse tissue banks for their expenses associated with the recovery, storage and transportation of donated human skin
that they provide to us for processing. We include in our pricing structure
amounts paid to tissue banks to reimburse them for their expenses associated with the
recovery and transportation of the
tissue, in addition to certain costs associated with processing ,
preservation, quality control and storage of the tissue, marketing and medical
education expenses and costs associated with development of tissue processing
technologies.




Other
Regulation





A few
states such as Florida, California, New York and Maryland impose their own
regulatory requirements on transplanted human tissue. Noncompliance with state
requirements may include some or all of the risks associated with noncompliance
with FDA regulation, as well as other risks.





We are
also subject to various federal, state and local laws, regulations and
requirements relating to such matters as safe working conditions, laboratory and
manufacturing practices, and the use, handling and disposal of hazardous or
potentially hazardous substances used and produced in
connection with our research and development work.




International
Regulation





The
regulation of our products outside
the United States varies by country. Certain countries regulate our human tissue
products as a pharmaceutical product ,
requiring us to make extensive filings and obtain regulatory approvals before
selling our product . Certain
countries classify our products as human
tissue for transplantation but may restrict its import or sale.
Other countries have no applicable regulations regarding the import or sale of
products similar to our products, creating uncertainty as to what standards we
may be required
to meet.





Our human
tissue products are
currently distributed in several countries internationally. Additionally, we may
pursue clearance to distribute our products in certain other countries in the
future. The uncertainty of the regulations in each country may delay or impede
the marketing of our products in the future or impede our ability to negotiate
distribution arrangements on favorable terms. Certain foreign countries have
laws similar to NOTA. These laws may restrict the amount that we can charge for
our products and may restrict our ability to export or distribute our products
to licensed not-for-profit organizations in those countries. Noncompliance with
foreign country requirements may include some or all of the risks associated
with noncompliance with FDA regulation as well as other risks.




RESEARCH
AND DEVELOPMENT





Our
research and development is focused on leveraging our core understanding of
tissue and cellular engineering technology in order to develop biologics that
fulfill unmet clinical needs. Our strategy balances our investment in research
among short-, mid-, and long-term programs aimed at enhancing our current
products and ensuring a future stream of innovative new products. Our research
and development initiatives include programs designed to extend the use of our
current regenerative tissue matrix products into new surgical applications as
well as leveraging our core technology to other tissues, including tissues
recovered from non-human sources. We have a variety of research and development
programs designed to expand our product line in the rapidly growing biologic
market. Such programs include the investigation of novel biologics, alone or in
combination with our regenerative tissue matrix. Products that we develop in the
future may be regulated by the FDA as HCT/p’s, medical devices or
biologics.




12


Our
research activities are funded by current operations as well as research grants
obtained through external organizations including the National Institutes of
Health and the Department of Defense. Our research and development costs in
2004, 2003 and 2002 for all programs were approximately $7.9 million, $5.4
million and $5.0 million, respectively. Research grant revenues recognized
during 2004, 2003 and 2002 were $2.4 million, $1.7 million and $1.5 million,
respectively. See “Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Liquidity and Capital Resources.”





At
December 31, 2004, we had approximately $1.9 million of approved grant funding
available to fund future research. We continue to seek additional grant funding
for our research programs. Generally, we have the right to patent any
technologies developed from government grants and contract funding, subject to
the United States government’s right to receive a royalty-free license for
federal government use and to require licensing to others in certain
circumstances.




PATENTS,
PROPRIETARY INFORMATION AND TRADEMARKS





Our
ability to compete effectively with other companies is dependent materially upon
the proprietary nature of our technologies. We rely primarily on patents, trade
secrets and confidentiality agreements to protect our technologies **.**





Three
primary families of patents and patent applications protect our technology. One
United States patent and one allowed, but not yet issued, United States patent
application cover methods of producing our tissue-based products and products
made by some of these methods. Nine additional United States patents and six
pending United States patent applications supplement this patent and cover
methods and apparatus for freeze-drying without the damaging effects of ice
crystal formation. Six United States patents and one pending United States
patent application cover methods of extending the shelf life of platelets, red
blood cells and other blood cells.





We also
have applied for patent protection in several foreign countries. Because of the
differences in patent laws and laws concerning proprietary rights, the extent of
protection provided by United States patents or proprietary rights owned by or
licensed to us may differ from that of their foreign counterparts.





In
general, the patent position of biotechnology and medical product firms is
highly uncertain and involves complex legal, scientific and factual questions.
There is risk that other patents may not be granted with respect to the patent
applications filed by us. Furthermore, there is risk that one or more patents
issued or licensed to us will not provide commercial benefit to us or will be
infringed, invalidated or circumvented by others. The United States Patent and
Trademark Office currently has a significant backlog of patent applications, and
the approval or rejection of patents may take several years.





The
contents of United States patent applications are generally published eighteen
months after the initial filing date. Once published or issued, a United States
patent application or patent would constitute prior art from its filing date,
which might predate the filing date of one of our patent applications.
Conceivably, the publication or issuance of such a prior art patent application
or patent, or the discovery of “prior art” of which we are currently unaware,
could invalidate a patent of ours or our licensor or discourage
commercialization of a product claimed within such patent.





No
assurances may be given that our products or planned products may not be the
subject of infringement actions by third parties. Any successful patent
infringement claim relating to any products or planned products could have a
material adverse effect on our financial condition and results of operations.
Further, there can be no assurance that any patents or proprietary rights owned
by or licensed to us will not be challenged, invalidated, circumvented or
rendered unenforceable based on, among other things, subsequently discovered
prior art, lack of entitlement to the priority of an earlier, related
application or failure to comply with the written description, best mode,
enablement or other applicable requirements.




13


We
generally conduct a cursory review of issued patents prior to engaging in
research or development activities. If others already have issued patents
covering new products that we develop, we may be required to obtain a license
from others to commercialize such future products. There can be no assurance
that any such license that may be required could be obtained on favorable terms
or at all.





We may
decide for business reasons to retain certain knowledge that we consider
proprietary as confidential and elect to protect such information as a trade
secret, as business confidential information, or as know-how. In that event, we
must rely upon trade secrets, know-how and continuing technological innovation
to maintain our competitive position. There can be no assurance that others will
not independently develop substantially equivalent proprietary information or
otherwise gain access to or disclose such information.





We have
federal trademark or service mark registrations that we currently use for
LifeCell, which concerns processing and preserving tissue samples; AlloDerm,
which concerns our commercial acellular dermal graft product;
AlloDerm  GBR for
use in periodontal applications; Micronized AlloDerm, the particulate form of
AlloDerm; Cymetra, the brand name for Micronized AlloDerm; and Repliform, the
version of AlloDerm for urology and gynecology. We have filed trademark
registrations for ThromboSol, a formulation for extended storage of platelets.
GraftJacket is a registered trademark of Wright Medical Group.
AlloCraft  DBM is a
trademark of Stryker Corporation.




COMPETITION





The
biomedical field is undergoing rapid and significant technological change. Our
success depends upon our ability to develop and commercialize efficient and
effective products based on our technologies. Our products compete with other
allograft tissue products, autograft tissue, synthetic and animal based
products.





We
believe that for many current surgical applications, the principal form of
competition for our products is autograft tissue. Autograft procedures involve a
surgeon transplanting tissue from one part of a patient’s body to another part
of their body.





Our
Alloderm, Repliform and GraftJacket tissue products compete with synthetic
products marketed by large medical device companies such as Johnson &
Johnson, C.R. Bard, W.L. Gore & Associates, Mentor and Integra Life Sciences
Holdings Corporation. They also compete with animal derived products marketed by
companies such as Cook, Inc. and Tissue Science Laboratories, plc. Our
AllocraftDBM product competes with other similar bone putty products produced by
companies such as Regeneration Technologies, Inc., Osteotech, Inc., AlloSource,
Wright Medical, Isotis Orthobiologics and the Musculoskeletal Transplant
Foundation (“MTF”).





We
believe that there are many companies, academic institutions, tissue banks,
organ procurement organizations and tissue processors, including those
identified above, that are capable of developing products which may be
competitive with our current products. Additionally, many of these organizations
are well-established and may have substantially greater financial and other
resources, research and development capabilities and more experience in
conducting clinical trials, obtaining regulatory approvals, manufacturing and
marketing than we do and accordingly may succeed in developing
competing,products which may render our products or technology uncompetitive,
uneconomical or obsolete.




EMPLOYEES





At
December 31, 2004, we had 196 employees, of which 49 were employed in sales,
marketing and customer service; 93 in production and quality assurance; 27 in
research and development; and 27 in administration and accounting.




14


RISK
FACTORS





You
should carefully consider these risk factors in addition to our financial
statements and notes to such financial statements. In addition to the following
risks, there may also be risks that we do not yet know of or that we currently
think are immaterial that may also impair our business operations. If any of the
following risks occur, our business, financial condition or operating results
could be adversely affected.




Government
regulations could adversely affect the marketing of our current products and the
development and commercialization of products currently being developed by us.





We have
not obtained prior FDA clearance or approval for commercial distribution of any
of our human tissue-based products, because we believe that these products
qualify for regulation as HCT/P’s.





In 2003,
we commenced commercial distribution of AlloCraft DBM without obtaining FDA
clearance or approval based upon on our belief that AlloCraft DBM is eligible
for regulation solely as an HCT/P. The FDA has notified us that they believe
AlloCraftDBM does not meet the criteria for regulation as an HCT/P and it is
most properly regulated as a medical device. We are considering whether to seek
510(k) clearance or PMA approval for AlloCraft DBM as a medical device or
further appeal this decision within the agency. The FDA has not requested that
we cease marketing AlloCraft DBM during the time that we are seeking clearance
or approval or appealing FDA’s determination, but there is no guarantee that FDA
will refrain from enforcement action. The FDA could require us to cease
marketing and / or recall product already sold until the FDA clearance or
approval is obtained. The FDA could also seek to impose enforcement sanctions
against us for marketing this product without such FDA authorization.





We cannot
assure you that our other tissue-based products that we are currently marketing,
or that we may develop in the future will be regulated as HCT/P’s. The
regulation of each of our products is decided by the FDA on a case-by-case basis
and the agency’s position is subject to change. If the FDA chooses to regulate
any of our current or future products as a medical device, a biologic or a drug,
the process of obtaining FDA clearance or approval would be expensive, lengthy
and unpredictable. We anticipate that it could take from one to three years or
longer to obtain such clearance or approval. We do not know if such clearance or
approval could be obtained in a timely fashion, or at all. Such clearance or
approval process would almost certainly include a requirement to provide
extensive supporting clinical testing data. In addition, the FDA requires that
medical devices and biologics be produced in accordance with the Quality System
Regulation for medical devices or Good Manufacturing Practice regulation for
biologics. As a result, our manufacturing and compliance costs would increase
and any such future device and biologic, or drug products would be subject to
more comprehensive development, testing, monitoring and validation standards.





A few
states such as Florida, California, New York and Maryland impose their own
regulatory requirements on transplanted human tissue. We believe that we are in
compliance with such regulations. There can be no assurance that the various
states in which our products are sold will find that we are in compliance or
will not impose additional regulatory requirements or marketing impediments on
our products. Additionally, any disruption in our ability to market our current
products would adversely affect our revenues and cash flows.




The
FDA can impose civil and criminal sanctions and other penalties on us if we fail
to comply with the stringent FDA regulations applicable to our tissue
facilities.





Failure
to comply with any applicable FDA requirements could result in civil and
criminal enforcement actions and other fines and penalties that would increase
our expenses and adversely affect our cash flows. Tissue establishments must
engage in:





•
    donor
      screening and infectious disease testing;





•
    Good
      Tissue Practice;





•
    stringent
      record keeping; and





•
    establishment
      registration and product listing.




15


As a
result, our involvement in the processing and distribution of human tissue for
transplantation requires us to ensure that proper donor screening and infectious
disease testing are done appropriately and conducted under strict procedures. In
addition, we must maintain records, which are available for FDA inspectors
documenting that the procedures were followed. The FDA has authority to conduct
inspections of tissue establishments and to detain, recall or destroy tissue if
the procedures were not followed or appropriate documentation is not available.





Labeling
and promotional activities are also subject to scrutiny by the FDA and, in
certain instances, by the Federal Trade Commission. From time to time, the FDA
may modify such requirements, imposing additional or different requirements,
which may require us to alter our business methods.




The
National Organ Transplant Act (“NOTA”) could be interpreted in a way that could
reduce our revenues and income in the future.





Procurement
of certain human organs and tissue for transplantation is subject to the
restrictions of NOTA, which prohibits the acquisition of certain human organs,
including skin and related tissue for valuable consideration, but permits the
reasonable payment of costs associated with the removal, transportation,
implantation, processing, preservation, quality control and storage of human
tissue, including skin. We reimburse tissue banks for expenses incurred that are
associated with the recovery and transportation of donated cadaveric human skin
that we process and distribute. In addition to amounts paid to tissue banks to
reimburse them for their expenses associated with the procurement and
transportation of human skin, we include in our pricing structure certain costs
associated with:





•
    tissue
      processing;





•
    tissue
      preservation;





•
    quality
      control and storage of the tissue; and





•
    marketing
      and medical education expenses.





NOTA
payment allowances may be interpreted to limit the amount of costs and expenses
that we may recover in our pricing for our products, thereby negatively
impacting our future revenues and profitability. If we are found to have
violated NOTA’s prohibition on the sale of human tissue, we also are potentially
subject to criminal enforcement sanctions which may adversely affect our
operating results.




Our
products contain donated human cadaveric tissue and therefore have the potential
for disease transmission.





The
non-profit organizations that supply such tissue are required to follow FDA
regulations for screening donors for potential disease transmission. Such
procedures include donor testing for certain viruses, including HIV. Our
manufacturing process also has been demonstrated to inactivate concentrated
suspensions of HIV. While we believe such procedures are adequate to reduce the
threat of disease transmission, there can be no assurance that:





•
    our
      products will not be associated with transmission of disease;
  or





•
    a
      patient otherwise infected with disease would not erroneously assert a
      claim that the use of our products resulted in the disease
      transmission.





Any such
transmission or alleged transmission could have a material adverse effect on our
ability to market our products which may adversely affect our operating results
and could result in litigation and potentially increased expenses.




16


We
depend heavily upon a limited number of sources of human cadaveric tissue and
any interruption in the availability of human tissue would interfere with our
ability to process and market our products.





Our
business is dependent on the availability of donated human cadaveric tissue. We
currently receive human tissue from approximately 30 United States tissue banks
and organ procurement organizations. Although we have established what we
believe to be adequate sources of donated human tissue to satisfy the expected
demand for our human tissue products in the foreseeable future, we cannot be
sure that donated human cadaveric tissue will continue to be available at
current levels or will be sufficient to meet our needs. If our current sources
can no longer supply human cadaveric tissue or our requirements for human
cadaveric tissue exceed their current capacity, we may not be able to locate
other sources on a timely basis, or at all. Any significant interruption in the
availability of human cadaveric tissue would likely cause us to slow down the
processing and distribution of our human tissue products, which could adversely
affect our ability to supply the needs of our customers and adversely affect our
operating results and our relationships with our customers.




Negative
publicity concerning the use of donated human tissue in reconstructive cosmetic
procedures could reduce the demand for our products and negatively impact the
supply of available donor tissue.





Although
we do not promote the use of our human tissue products for cosmetic
applications, clinicians may use our products in applications or procedures that
may be considered "cosmetic." Negative publicity concerning the use of donated
human tissue in cosmetic procedures could reduce the demand for our products or
negatively impact the willingness of families of potential donors to agree to
donate tissue or tissue banks to provide tissue to us for
processing.




Increasing
our revenues and maintaining profitability will depend on our ability to
increase market penetration of our current products and to develop and
commercialize new products.





Much of
our ability to increase revenues and to continue to generate net income and
positive cash flows from operations will depend on:





•
    expanding
      the use and market penetration of our current products;
  and





•
    the
      successful introduction of our products in
development.





The use
of our products in certain procedures represent new methods of treatment.
Surgeons will not use our products unless they determine that the clinical
benefits to the patient are greater than those available from competing products
or therapies. Even if the advantage of our products is established as clinically
significant, surgeons may not elect to use such products for any number of
reasons. Consequently, surgeons, health care payers and patients may not accept
our current products or products under development. Broad market acceptance of
our products may require the training of numerous surgeons and clinicians, as
well as conducting or sponsoring clinical studies to demonstrate the benefits of
such products. The amount of time required to complete such training and studies
could result in a delay or dampening of such market acceptance. Moreover, health
care payers' approval of reimbursement for our products in development may be an
important factor in establishing market acceptance.





We may be
required to undertake time-consuming and costly development activities and seek
regulatory clearance or approval for new products. Although we have conducted
animal studies on many of our products under development that indicate that the
product may be feasible for a particular application, results obtained from
expanded studies may not be consistent with earlier trial results or be
sufficient for us to obtain any required regulatory approvals or clearances. The
completion of the development of any of our products under development remains
subject to all the risks associated with the commercialization of new products
based on innovative technologies, including:





•
    unanticipated
      technical or other problems;





•
    manufacturing
      difficulties; and





•
    the
      possibility of insufficient funds for the completion of such
      development.





If we are
unable to increase market penetration of our current products or commercialize
new products, our future revenues and profitability could be adversely
affected.




17


Changes
in third-party payer reimbursement practices regarding the procedures performed
with our products could adversely affect the market acceptance of our products
and our revenues.





Generally,
hospitals, surgeons and other health care providers purchase products, such as
the products being sold or developed by us, for use in providing care to their
patients. These parties typically rely on third-party payers,
including:





•
    Medicare;





•
    Medicaid;





•
    private
      health insurance; and





•
    managed
      care plans





to
reimburse all or part of the costs of acquiring those products and costs
associated with the medical procedures performed with those products.
Third-party payers have adopted cost control measures in recent years that have
had and may continue to have a significant effect on the purchasing practices of
many health care providers, generally causing them to be more selective in the
purchase of medical products. Significant uncertainty exists as to the
reimbursement status of newly approved health care products. We believe that
certain third-party payers provide reimbursement for medical procedures at a
specified rate without additional reimbursement for products, such as those
being sold or developed by us, used in such procedures. Adequate third-party
payer reimbursement may not be available for us to maintain price levels
sufficient for realization of an appropriate return on our investment in
developing new products. The FDA generally permits human tissue for
transplantation to be commercially distributed without obtaining prior FDA
approval of the product. In contrast, products regulated as medical devices or
biologics usually require such approval. Certain government and other
third-party payers refuse, in some cases, to provide any coverage for uses of
products for indications for which the FDA has not granted marketing approval.
Further, certain of our products are used in medical procedures that typically
are not covered by third-party payers or for which patients sometimes do not
obtain coverage. These and future changes in third-party payer reimbursement
practices regarding the procedures performed with our products could adversely
affect the market acceptance of our products and therefore also adversely affect
our revenues and results of operations.




We
are highly dependent upon independent sales and marketing agents and
distributors to generate our revenues.





Our
independent sales and marketing agents and distributors generated 27% of our
total product revenue in the year ended December 31, 2004. Boston Scientific
Corporation, our exclusive worldwide sales and marketing agent for Repliform
represented 12% of our total product revenues in 2004. Wright Medical, our
exclusive distributor for GraftJacket represented 7% of our total product
revenues in 2004. No other individual independent sales agent or distributor
generated more than 5% of our total product revenues in the year ended December
31, 2004.





If any of
our independent sales and marketing agents or distributors fails to adequately
market our products, our revenues could be adversely affected until a
replacement agent or distributor could be retained by us. Finding replacement
agents and distributors could be a time-consuming process during which our
revenues could be negatively impacted.




We
may need additional capital to develop and commercialize new products, and it is
uncertain whether such capital will be available.





We intend
to expend funds for our ongoing research and product development activities. We
may need additional capital, depending on:





•
    the
      number and types of research and product development programs undertaken;
      and





18


•
    the
      progress of our research and product development efforts and the
      associated costs relating to obtaining regulatory approvals, if any, that
      may be needed to commercialize some of our products currently under
      development.





Although
we believe that our current cash resources together with anticipated cash from
ongoing operating activities, committed research grant funding and remaining
availability under our credit facility will be sufficient to fund our planned
operations, research and development programs and fixed asset additions in the
foreseeable future, there can be no assurance that such sources will be
sufficient to meet our long-term needs and as a result, we may need additional
funding. We have no commitments for any future funding, and there can be no
assurance that we will be able to obtain additional financing in the future from
either debt or equity financings, collaborative arrangements or other sources on
terms acceptable to us, or at all. If adequate funds are not available, we
expect that we will be required to delay, scale back or eliminate one or more of
our product development programs. Any additional equity financing may be
dilutive to stockholders, and debt financing, if available, may involve
significant restrictive covenants. Collaborative arrangements, if necessary to
raise additional funds, may require us to relinquish our rights to certain of
our technologies, products or marketing territories.




The
Biomedical field is highly competitive and such competition could adversely
affect our revenues and results of operations.





The
biomedical field is undergoing rapid and significant technological change. Our
success depends upon our ability to develop and commercialize effective products
that meet medical needs.





Our
Alloderm, Repliform and GraftJacket tissue products compete with synthetic
products marketed by large medical device companies such as Johnson &
Johnson, C.R. Bard, W.L. Gore & Associates, Mentor and Integra Life Sciences
Holdings Corporation. They also compete with animal derived products marketed by
companies such as Cook, Inc. and Tissue Science Laboratories, plc. Our
AllocraftDBM product competes with other similar bone putty products produced by
companies such as Regeneration Technologies, Inc., Osteotech, Inc., AlloSource,
Wright Medical, Isotis Orthobiologics and the Musculoskeletal Transplant
Foundation (“MTF”). We believe that there are many companies, academic
institutions, tissue banks, organ procurement organizations and tissue
processors, including those identified above, that are capable of developing
products which may be competitive with our current products. Additionally, many
of these organizations are well-established and may have substantially greater
financial and other resources, research and development capabilities and more
experience in conducting clinical trials, obtaining regulatory approvals,
manufacturing and marketing than we do and accordingly may succeed in developing
competing products which may render our products or technology uncompetitive,
uneconomical or obsolete.




Our
success depends on the scope of our intellectual property rights and not
infringing the intellectual property rights of others. The validity,
enforceability and commercial value of these rights are highly uncertain.





Our
ability to compete effectively with other companies is materially dependent upon
the proprietary nature of our technologies. We rely primarily on patents and
trade secrets to protect our technologies. Third parties may seek to challenge,
invalidate, circumvent or render unenforceable any patents or proprietary rights
owned by or licensed to us based on, among other things:





•
    subsequently
      discovered prior art;





•
    lack
      of entitlement to the priority of an earlier related application;
    or


•
    failure
      to comply with the written description, best mode, enablement or other
      applicable requirements.


In
general, the patent position of biotechnology and medical product firms is
highly uncertain, still evolving and involves complex legal, scientific and
factual questions. We are at risk that:





•
    other
      patents may be granted with respect to the patent applications filed by
      us; and





•
    any
      patents issued or licensed to us may not provide commercial benefit to us
      or will be infringed, invalidated or circumvented by
others.




19


The
United States Patent and Trademark Office currently has a significant backlog of
patent applications, and the approval or rejection of patents may take several
years. Prior to actual issuance, the contents of United States patent
applications are generally not made public. Once issued, such a patent would
constitute prior art from its filing date, which might predate the date of a
patent application on which we rely. Conceivably, the issuance of such a prior
art patent, or the discovery of "prior art" of which we are currently unaware,
could invalidate a patent of ours or our licensor or prevent commercialization
of a product claimed thereby.





We
generally conduct a cursory review of issued patents prior to engaging in
research or development activities. If others already have issued patents
covering new products that we develop, we may be required to obtain a license
from them to commercialize such new products. There can be no assurance that any
necessary license could be obtained on favorable terms or at all.





There can
be no assurance that we will not be required to resort to litigation to protect
our patented technologies or other proprietary rights or that we will not be the
subject of additional patent litigation to defend our existing or proposed
products or processes against claims of patent infringement or other
intellectual property claims. Any of such litigation could result in substantial
costs and diversion of our resources.





We also
have applied for patent protection in several foreign countries. Because of the
differences in patent laws and laws concerning proprietary rights, the extent of
protection provided by United States patents or proprietary rights owned by or
licensed to us may differ from that of their foreign counterparts.





We may
decide for business reasons to retain certain knowledge that we consider
proprietary as confidential and elect to protect such information as a trade
secret, as business confidential information or as know-how. In that event, we
must rely upon trade secrets, know-how and continuing technological innovation
to maintain our competitive position. There can be no assurance that others will
not independently develop substantially equivalent proprietary information or
otherwise gain access to or disclose such information.




We
are exposed to potential product liability claims for which our product
liability insurance may be inadequate.





Our
business exposes us to potential product liability risks inherent in the
testing, manufacturing, marketing and use of medical products. Although we
maintain product liability insurance, we cannot be certain that:





•
    our
      insurance will provide adequate coverage against potential
      liabilities;





•
    adequate
      product liability insurance will continue to be available in the future;
      or





•
    our
      insurance can be maintained on acceptable terms.





The legal
expenses associated with defending against product liability claims and the
obligation to pay a product liability claim in excess of available insurance
coverage would increase our operating expenses and could adversely affect our
results of operations and cash flows.




*Future
sales of our common stock may depress our stock price.*





Sales of
a substantial number of shares of our common stock in the public market could
cause a decrease in the market price of our common stock. As of December 31,
2004, we had 29,126,000 shares of common stock outstanding. A significant
portion of our outstanding shares are freely tradeable. In addition, stock
options and warrants to purchase 5,264,000 shares of our common stock were
outstanding at December 31, 2004, of which 3,847,000 were vested. The
remainder represents stock options that will vest over the next four years. The
weighted-average exercise prices of such stock options and warrants are
substantially lower than the current market price of our common stock. We may
also issue additional shares of stock in connection with our business and may
grant additional stock options to our employees, officers, directors and
consultants under our stock option plans or warrants to third parties. If a
significant portion of these shares were sold in the public market, the market
value of our common stock could be adversely affected.





20


SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS


This
Annual Report on Form 10-K contains forward-looking statements made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Forward-looking statements typically are identified by use of terms such
as “may,” “will,” “should,” “plan,” “expect,” “anticipate,” “estimate” and
similar words, although some forward-looking statements are expressed
differently. Forward-looking statements represent our management’s judgment
regarding future events. Although we believe that the expectations reflected in
such forward-looking statements are reasonable, we can give no assurance that
such expectations will prove to be correct. All statements other than statements
of historical fact included in this Annual Report on Form 10-K regarding our
financial position, business strategy, products, products under development and
clinical trials, targeted procedures and revenue per procedure, markets,
budgets, plans or objectives for future operations are forward-looking
statements. We cannot guarantee the accuracy of the forward-looking statements,
and you should be aware that our actual results could differ materially from
those contained in the forward-looking statements due to a number of factors,
including the statements under “Risk Factors” set forth above and “Critical
Accounting Policies” in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations.”








SUPERVISION
AND REGULATION — SECURITIES AND EXCHANGE COMMISSION


We
maintain a website at http://www.lifecell.c o m. We
make available free of charge on our website all electronic filings with the SEC
(including proxy statements and reports on Forms 8-K, 10-K and 10-Q and any
amendments to these reports) as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC. We have also
posted policies, codes and procedures that outline our corporate governance
principles, including the charters of the board’s audit and nominating
committees, and the Company’s Code of Ethics covering directors and all
employees and the code of ethics for senior financial officers on the website.
These materials also are available free of charge in print to shareholders who
request them in writing. The information contained on our website does not
constitute a part of this report.








Item
      2.
    Properties




We lease
approximately 90,000 square feet of office, laboratory, production and warehouse
space in one building in Branchburg, New Jersey under a lease agreement that
expires in November 2010. The current monthly rental obligation under this lease
is approximately $80,000. We believe that our current facility will be
sufficient to meet our anticipated needs for the next several
years.




Item
      3.
    Legal
      Proceedings




The
previously reported complaint, filed in November 2003 in the Circuit Court of
Fairfax, Virginia, captioned Sun
Hee Jung v. Yongsook Victoria Suh, M.D., Victoria Plastic Surgery Center, Inc.
and LifeCell Corporation was
dismissed without prejudice in December 2004 when the plaintiff elected to take
a voluntary non-suit in this action. If the case is not re-filed within six
months from the date of the Order of Non-Suit, then the case will be dismissed
with prejudice and will be forever barred.




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




None.




21




PART
      II




Item
      5.
    Market
      for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities




Our
common stock is listed on the NASDAQ National Market under the symbol “LIFC.” On
March 4, 2005, the last reported sale price for our common stock on the NASDAQ
National Market was $9.06 per share. The following table sets forth the high and
low sales information for our common stock for the periods indicated, as
reported by the NASDAQ Stock Market.




Price
      Range2003
    
    High
    
    LowFirst
      Quarter
    
    $
    3.05
    
    $
    2.00Second
      Quarter
    
    
    6.23
    
    
    2.33Third
      Quarter
    
    
    7.40
    
    
    3.50Fourth
      Quarter
    
    
    7.06
    
    
    4.962004First
      Quarter
    
    $
    8.68
    
    $
    5.70Second
      Quarter
    
    
    11.50
    
    
    7.97Third
      Quarter
    
    
    11.34
    
    
    7.18Fourth
      Quarter
    
    
    11.05
    
    
    7.86




As of
March 4, 2005, we estimate that there are in excess of 8,000 beneficial holders
of our common stock.




Dividend
Policy





We have
not paid a cash dividend to holders of shares of common stock and do not
anticipate paying cash dividends to the holders of our common stock in the
foreseeable future. Additionally, pursuant to the terms of our loan agreement
with our bank, we are restricted from paying dividends on our common stock
without the bank’s consent.




22




Item
      6.
    Selected
      Financial Data




The
following table sets forth certain selected financial data of LifeCell for each
of the years in the five-year period ended December 31, 2004, derived from the
audited financial statements. This information should be read in conjunction
with “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and the Financial Statements and notes thereto included elsewhere in
this Annual Report on Form 10-K.





Year
      Ended December 31,*(In
      thousands, except for per share data)*
    
    2004
    
    2003
    
    2002
    
    2001
    
    2000Operations
      Statement Data:Revenues:Product
      revenues
    
    $
    58,751
    
    $
    38,577
    
    $
    32,935
    
    $
    26,560
    
    $
    21,330Research
      grant revenues
    
    
    2,376
    
    
    1,672
    
    
    1,493
    
    
    1,209
    
    
    1,442Total
      revenues
    
    
    61,127
    
    
    40,249
    
    
    34,428
    
    
    27,769
    
    
    22,772Costs
      and expenses:Costs
      of products sold
    
    
    17,755
    
    
    12,241
    
    
    10,134
    
    
    8,862
    
    
    6,949Research
      and development
    
    
    7,860
    
    
    5,396
    
    
    5,015
    
    
    4,351
    
    
    4,523General
      and administrative
    
    
    8,214
    
    
    5,594
    
    
    4,590
    
    
    4,098
    
    
    6,180Selling
      and marketing
    
    
    20,311
    
    
    14,940
    
    
    13,288
    
    
    11,978
    
    
    11,779Total
      costs and expenses
    
    
    54,140
    
    
    38,171
    
    
    33,027
    
    
    29,289
    
    
    29,431Income
      (loss) from operations
    
    
    6,987
    
    
    2,078
    
    
    1,401
    
    
    (1,520
    )
    
    (6,659
    )Interest
      and other income (expense), net
    
    
    222
    
    
    (28
    )
    
    (129
    )
    
    (550
    )
    
    (479
    )Income
      (loss) before income taxes
    
    
    7,209
    
    
    2,050
    
    
    1,272
    
    
    (2,070
    )
    
    (7,138
    )Income
      tax provision (benefit)
    
    
    25
    
    
    (16,622
    )
    
    (157
    )
    
    —
    
    
    —Net
      income (loss)
    
    
    7,184
    
    
    18,672
    
    
    1,429
    
    
    (2,070
    )
    
    (7,138
    )Preferred
      stock and deemed dividends
    
    
    —
    
    
    —
    
    
    —
    
    
    (1,591
    )
    
    (593
    )Net
      income (loss) to common shareholders
    
    $
    7,184
    
    $
    18,672
    
    $
    1,429
    
    $
    (3,661
    )
    $
    (7,731
    )Income
      (loss) per common share:Basic
    
    $
    0.26
    
    $
    0.85
    
    $
    0.07
    
    $
    (0.20
    )
    $
    (0.54
    )Diluted
    
    $
    0.22
    
    $
    0.70
    
    $
    0.06
    
    $
    (0.20
    )
    $
    (0.54
    )Shares
      used in computing income (loss)per
      share:Basic
    
    
    27,553
    
    
    22,094
    
    
    21,176
    
    
    18,240
    
    
    14,372Diluted
    
    
    31,974
    
    
    26,632
    
    
    24,696
    
    
    18,240
    
    
    14,372





As
      of December 31,2004
    
    2003
    
    2002
    
    2001
    
    2000Balance
      Sheet Data:Cash,
      cash equivalents and short-terminvestments
    
    $
    25,392
    
    $
    11,785
    
    $
    5,458
    
    $
    4,900
    
    $
    5,535Working
      capital
    
    
    38,911
    
    
    23,283
    
    
    11,466
    
    
    8,851
    
    
    5,330Total
      assets
    
    
    72,093
    
    
    58,273
    
    
    24,116
    
    
    23,131
    
    
    25,410Notes
      payable and term debt
    
    
    —
    
    
    —
    
    
    863
    
    
    2,197
    
    
    6,285Common
      stock, subject to redemption
    
    
    —
    
    
    —
    
    
    478
    
    
    1,935
    
    
    3,885Accumulated
      deficit
    
    
    (38,485
    )
    
    (45,669
    )
    
    (64,341
    )
    
    (65,770
    )
    
    (62,109
    )Total
      stockholders' equity
    
    
    63,448
    
    
    52,379
    
    
    17,719
    
    
    14,833
    
    
    8,904




23




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




The
following discussion of operations and financial condition of LifeCell should be
read in conjunction with the Financial Statements and notes thereto included
elsewhere in this Annual Report on Form 10-K.





Special
Note: Certain statements set forth below constitute forward-looking statements
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. See “Business—Special Note Regarding Forward-Looking
Statements” and “Business—Risk Factors.” In the following discussions, most
percentages and dollar amounts have been rounded to aid the presentation. As a
result, all such figures are approximations.




GENERAL
AND BACKGROUND


We
develop and market human-derived tissue based products for use in
reconstructive, urogynecologic and orthopedic surgical procedures to repair soft
tissue defects. Our patented technology produces a unique regenerative human
tissue matrix -- a complex three-dimensional structure that contains vascular
channels, proteins and growth factor binding sites -- that provides a complete
template for the regeneration of normal human tissue. Our current products
include: AlloDerm®, for plastic reconstructive, general surgical, burn and
periodontal procedures; Cymetra®, a particulate form of AlloDerm suitable for
injection; Repliform®, for urogynecologic surgical procedures; GraftJacket® and
GraftJacket Xpress, for orthopedic applications and lower extremety wounds; and
AlloCraftTMDBM, for bone grafting procedures. We market AlloDerm for plastic
reconstructive, general surgical and burn applications through our direct sales
organization. Our strategic sales and marketing partners include: Boston
Scientific for Repliform, Wright Medical Group, Inc. for GraftJacket, Stryker
Corporation for AlloCraftDBM and BioHorizons for periodontal applications of
AlloDerm. Our ongoing research and product development strategy is focused on
extending the utilization of our regenerative tissue matrix into new markets and
the application of our core technology to other tissues.




CRITICAL
ACCOUNTING POLICIES / ESTIMATES


We have
identified the policies below as critical to the understanding of our financial
statements. The application of these polices requires management to make
estimates and assumptions that affect the valuation of assets and expenses
during the reporting period. There can be no assurance that actual results will
not differ from these estimates. The impact and any associated risks related to
these estimates on our business operations are discussed below.





*Revenue
Recognition.* We
recognize revenue for product sales when title to products and risk of loss are
transferred to customers, which is generally when product is shipped to the
customer. Additional conditions for recognition of revenue are that collection
of sales proceeds is reasonably assured and we have no further performance
obligations. We utilize independent sales and marketing agents to supplement our
direct sales organization. For products marketed through our independent sales
and marketing agents, we recognize revenue when the products are delivered to
the third-party customer, as this is when title and risk of loss to the product
transfers. Amounts billed to customers for shipping and handling are included in
revenue at the time the related product revenue is recognized. Research grant
revenues are recognized at the time qualified expenses are incurred, unless we
have continuing performance obligations, in which case revenue is recognized
upon the satisfaction of such obligations.





*Accounts
receivable* . We
maintain an allowance for estimated bad debt losses on our accounts receivable
based upon our historical experience and any specific customer collection issues
that we have identified. Since our accounts receivable are not concentrated
within a relatively few number of customers, we believe that a significant
change in the liquidity or financial position of any one customer would not have
a material adverse impact on the collectability of our accounts receivable and
therefore our future operating results. While bad debt losses depend to a large
degree on future economic conditions affecting our customers, we do not
anticipate significant bad debt losses in 2005.




24


*Inventories* . We
value our inventory at the lower of cost or market, with cost being determined
on a first-in, first-out basis. We record a provision for excess and obsolete
inventory based primarily on inventory quantities on hand, our historical
product sales, and estimated forecast of future product demand and production
requirements. Although we believe that our current inventory reserves are
adequate, any significant change in demand or technological developments could
have a significant impact on the value of our inventory and therefore our future
operating results.





*Income
Taxes.* Significant judgment is required in determining our income tax provision. In the
ordinary course of business, there are many transactions and calculations where
the ultimate tax outcome is uncertain. Although we believe that our estimates
are reasonable, no assurance can be given that the final outcome of these
matters will not be different than that which is reflected in our historical
income tax provisions and accruals. Such differences could have a material
effect on our income tax provision and net income in the period in which such
determination is made.





We apply
an asset and liability approach to accounting for income taxes. Deferred tax
liabilities and assets are recognized for the expected future tax consequences
of temporary differences between the financial statement and tax bases of assets
and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. The recoverability of deferred tax assets
of $18.3 million is dependent upon our assessment of whether it is more likely
than not that sufficient future taxable income will be generated to utilize the
deferred tax asset. In the event we determine that future taxable income will
not be sufficient to utilize the deferred tax asset, a valuation allowance is
recorded. At December 31, 2004, the valuation allowance of $606,000 primarily
reflected uncertainties involving the realization of certain tax credits due to
the potential impact of future stock option exercises and shorter-term
expiration dates.




RESULTS
OF OPERATIONS





Years
Ended December 31, 2004 and 2003





Total
revenues for the year ended December 31, 2004 increased 52% to $61.1 million
compared to $40.2 million for the same period in 2003. The increase was
primarily attributable to a 52% increase in product revenues to $58.7 million in
the current period as compared to $38.6 million in the prior year.





Revenues
generated from the use of our products in reconstructive surgical procedures
increased 64% to $46.0 million in the year ended December 31, 2004 compared to
$28.1 million in 2003. The growth was primarily driven by increased demand for
AlloDerm in complex hernia repair procedures, partially offset by a decrease in
Cymetra revenues. AlloDerm revenues increased 79% to $42.5 million in the year
ended December 31, 2004 compared to $23.7 million in 2003. Cymetra revenues were
negatively impacted by competitive products in 2004 and we expect this trend to
continue in 2005.





Revenues
generated from the use of our Repliform product in urogynecologic surgical
procedures decreased 22% to $6.8 million in the year ended December 31, 2004
compared to $8.7 million for the same period in 2003. Demand for Repliform in
the treatment of stress urinary incontinence has been negatively affected by
competition from synthetic alternatives and we anticipate this trend to continue
in 2005.





Orthopedic
product revenue grew to $5.9 million in 2004 from $1.7 million in 2003. This
revenue growth resulted from increased demand for our Graft Jacket product,
which was launched in the first quarter of 2003, and AlloCraft DBM, which was
introduced on a limited basis in the fourth quarter of 2003. Graft Jacket and
AlloCraft DBM revenues were $4.1 million and $1.8 million, respectively, in 2004
compared to $1.5 million and $215,000 in 2003.





Our
independent sales and marketing agents and distributors generated 27% of our
total product revenue in the year ended December 31, 2004 and 38% in 2003.
Boston Scientific and Wright Medical represented 12% and 7%, respectively, of
our total product revenues in 2004 compared to 23% and 4%, respectively, for the
same period in 2003. No other individual independent sales agent or distributor
generated more than 5% of our total product revenues in the year ended December
31, 2004.




25


Total
revenues were also favorably impacted by a 42% increase in research grant
revenues, which totaled $2.4 million in 2004 compared to $1.7 million in 2003.
This increase was primarily due to an increase in research spending on projects
funded by approved research grants, since research grant revenues are recognized
when qualified expenses are incurred. As of December 31, 2004, approximately
$1.9 million of approved grant funding was available to fund future research and
development expenses through 2005.





Cost of
products sold for the year ended December 31, 2004 was $17.8 million, or 30% of
product revenues, compared to cost of products sold of $12.2 million, or 32% of
product revenue for the same period in 2003. In 2003, the cost of products sold
included costs related to the launch of AlloCraft DBM which increased the cost
of products sold as a percentage of product revenues.





Total
research and development expenses increased 46% to $7.9 million in the year
ended December 31, 2004 compared to $5.4 million for the same period in 2003.
The increase was primarily attributable to increased research and development
headcount, professional fees and expenses related to animal studies. Our
research and development initiatives include programs designed to extend the use
of our current regenerative tissue matrix products into new surgical
applications as well as leveraging our core technology to other
tissues.





General
and administrative expenses increased 47% to $8.2 million in the year ended
December 31, 2004 compared to $5.6 million for the same period in 2003. The
increase was primarily attributable to an increase in regulatory and acconting
professional fees, payroll and related expenses associated with increased
headcount and annual merit increases and depreciation expense associated with a
new fully integrated computer software system.





Selling
and marketing expenses increased 36% to $20.3 million for the year ended
December 31, 2004 compared to $14.9 million for the same period in 2003. The
increase was primarily attributable to: (i) higher selling expenses, principally
payroll, commissions and travel and entertainment resulting from increased
revenues and the expansion of our direct sales force and (ii) an increase in
marketing and medical education expenses for AlloDerm. Our independent sales and
marketing agents are paid agency fees based on the amount of product revenues
they generate for us. Selling and marketing expenses included agent fees of $4.0
million and $4.6 million, respectively, in 2004 and 2003. The decrease in agent
fees resulted from a decline in revenue generated through our independent sales
and marketing agents.





Interest
and other income (expense), net increased $250,000 in 2004 compared to 2003. The
net increase was primarily due to a $194,000 increase in interest income
primarily resulting from a higher level of investments and a $39,000 decrease in
interest expense resulting from the pay-off of outstanding debt in the third
quarter of 2003.





The
provision for income taxes was $25,000 in 2004 compared to a benefit of $16.6
million in 2003. Prior to the fourth quarter of 2003, no provision or benefit
for income taxes was recorded because we were in a net deferred tax asset
position and a full valuation allowance had been recorded. During the fourth
quarter of 2003, we re-evaluated the amount of valuation allowance on our
deferred tax assets and reduced the valuation allowance to reflect net deferred
tax assets that we believed were more likely than not of being realized. The
reduction in the valuation allowance resulted in the recognition of a non-cash
income tax benefit of $16.6 million in the fourth quarter of 2003. During the
fourth quarter of 2004, we further reduced the amount of the valuation allowance
which resulted in the recognition of a non-cash income tax benefit of $2.9
million. The income tax provision for the year ended December 31, 2004 is net of
the benefit recorded in the fourth quarter. The valuation allowance of $606,000
at December 31, 2004 applies to certain tax credits that, in the opinion of
management are more likely than not to expire before we can use
them.




26


Years
Ended December 31, 2003 and 2002





Total
revenues for the year ended December 31, 2003 increased 17% to $40.2 million
compared to $34.4 million for the same period in 2002. The increase was
primarily attributable to a 17% increase in product revenues to $38.6 million in
the current period as compared to $32.9 million in the prior year.





Revenues
generated from the use of our products in reconstructive surgical procedures
increased 24% to $28.1 million in the year ended December 31, 2003 compared to
$22.7 million in 2002. The growth was driven by increased demand for AlloDerm,
partially offset by a decrease in Cymetra revenues. AlloDerm revenues increased
38% to $23.7 million in the year ended December 31, 2003 compared to $17.2
million in 2002. Cymetra revenues have been negatively impacted by competitive
products, and we expect this trend to continue in 2004.





Revenues
generated from the use of our Repliform product in urogynecologic surgical
procedures decreased 14% to $8.7 million in the year ended December 31, 2003
compared to $10.1 million for the same period in 2002. Demand for Repliform in
the treatment of stress urinary incontinence has been negatively affected by
competition from synthetic alternatives, and we anticipate this trend to
continue in 2004.





Orthopedic
product revenue grew to $1.7 million in 2003 from $173,000 in 2002. This revenue
growth resulted primarily from the full market launch of our GraftJacket product
in the first quarter of 2003. In the fourth quarter of 2003, we introduced
AlloCraft DBM on a limited basis, and revenues from this product were not
significant in 2003.





Our
independent sales and marketing agents and distributors generated 38% of our
total product revenue in the year ended December 31, 2003 and 48% in 2002. One
of our independent agents, Boston Scientific Corporation, represented 23% of our
total product revenues in 2003 compared to 31% for the same period in 2002. No
other individual independent sales agent or distributor generated more than 5%
of our total product revenues in the year ended December 31, 2003.





Total
revenues were also favorably impacted by a 12% increase in research grant
revenues, which totaled $1.7 million in 2003 compared to $1.5 million in 2002.
This increase was primarily due to an increase in research spending on projects
funded by approved research grants, since research grant revenues are recognized
when qualified expenses are incurred. As of December 31, 2003, approximately
$3.4 million of approved grant funding was available to fund future research and
development expenses through 2005.





Cost of
products sold for the year ended December 31, 2003 was $12.2 million, or 32% of
product revenues, compared to cost of products sold of $10.1 million, or 31% of
product revenue for the same period in 2002. The increase in cost of products
sold as a percentage of products sold was primarily the result of costs related
to the launch of AlloCraft DBM.





Total
research and development expenses increased 8% to $5.4 million in the year ended
December 31, 2003 compared to $5.0 million for the same period in 2002. The
increase was primarily associated with higher spending on research focused on
the potential application of our tissue matrix technology to vascular tissue,
which is funded through a grant from the Department of Defense, and increased
spending on AlloCraft DBM product development and other product development
programs.





General
and administrative expenses increased 22% to $5.6 million in the year ended
December 31, 2003 compared to $4.6 million for the same period in 2002. The
increase was primarily attributable to an increase in payroll and related
expenses, professional fees and training and travel expenses associated with
training and implementation costs associated with a new fully integrated
computer software system.





Selling
and marketing expenses increased 12% to $14.9 million for the year ended
December 31, 2003 compared to $13.3 million for the same period in 2002. The
increase in 2003 was primarily attributable to higher selling expense associated
with the expansion of our direct sales force and an increase in marketing
expenses relating to the launch of AlloDerm for new surgical indications. Our
marketing agents are paid agency fees based on the amount of product revenues
they generate for us. Selling and marketing expenses include marketing agent
fees of $4.6 million and $5.7 million, respectively, in 2003 and 2002. The
decrease in agent fees resulted from the decrease in revenue generated through
our independent sales and marketing agents.




27


Interest
and other income (expense), net decreased $101,000 in the year ended December
31, 2003 compared to 2002. The net decrease was primarily due to a $124,000
decrease in interest expense resulting from a decrease in debt
outstanding.





Prior to
2003, no deferred provision or benefit for federal income taxes was recorded
because we were in a net deferred tax asset position and a full valuation
allowance had been recorded. During the fourth quarter of 2003, we re-evaluated
the amount of valuation allowance required in light of profitability achieved in
recent years and expected in future years. As a result, we reduced the valuation
allowance on deferred tax assets to an amount that we believe is more likely
than not of being realized based on our assessment of the likelihood of future
taxable income. The reduction in the valuation allowance resulted in the
recognition of a non-cash income tax benefit of $16.6 million in the fourth
quarter of 2003. At December 31, 2003, the valuation allowance primarily
reflected uncertainties involving the realization of certain tax credits and
loss carryforwards due to the potential impact of future stock option exercises
and shorter-term tax asset expiration dates. In 2003, we also realized $235,000
through the sale and transfer of $3.0 million of state tax net operating losses.
In 2002, we realized $248,000 through the sale and transfer of $3.2 million of
state tax net operating losses. The sales and transfers were made through the
Technology Business Tax Certificate Program sponsored by the New Jersey Economic
Development Authority.








LIQUIDITY
AND CAPITAL RESOURCES


As of
December 31, 2004, we had cash and cash equivalents and short-term investments
of $25.4 million and $1.7 million in long-term marketable securities compared to
$11.8 million and $6.7 million, respectively, at December 31, 2003. Working
capital increased to $39.0 million at December 31, 2004 from $23.2 million at
December 31, 2003. The increase in working capital resulted primarily from
increases in cash and cash equivalents, short-term investments and accounts
receivable, partially offset by an increase in accounts payable and accrued
liabilities.





Our
operating activities generated net cash of $8.7 million for the year ended
December 31, 2004 compared to $822,000 for the same period in 2003. The increase
in 2004 was principally due to higher net income excluding the non-cash tax
benefits, an increase in accounts payable and accrued liabilities, net of an
increase in accounts receivable. The increase in accounts payable and accrued
liabilities was primarily associated with higher accrued employee compensation
and benefits. The increase in accounts receivable resulted from the significant
increase in revenue in the fourth quarter of 2004 versus the fourth quarter of
2003.





Capital
expenditures were $3.2 million in 2004 and consisted primarily of manufacturing
equipment and computer hardware, software and related implementation costs. In
2003, capital expenditures totaled $2.5 million.





Our
financing activities generated $3.0 million for the year ended December 31, 2004
compared to $14.6 million for the same period in 2003. In 2004, the cash
generated from financing activities resulted from the exercise of common stock
options and warrants, while in 2003 cash generated by financing activities
resulted from the issuance of common stock, partially offset by the retirement
of all outstanding debt. At December 31, 2004, we had no debt outstanding under
our borrowing arrangements. In March 2004, the borrowing limit on our revolving
line of credit was increased to $4 million and the expiration was extended
through March 2005. We plan to maintain a revolving line of credit, however we
do not have a commitment beyond the current expiration date. The credit facility
is collateralized by our accounts receivable, inventory, intellectual property,
intangible and fixed assets and contains certain financial covenants and a
subjective acceleration clause. As of December 31, 2004, we were in compliance
with the covenants of our credit facility.





The
following table reflects a summary of our contractual cash obligations as of
December 31, 2004:





Payments
      Due by PeriodTotal
    
    Less
      than one year
    
    1
      to 3 years
    
    4
      to 5 years
    
    After
      5 yearsOperating
      leases
    
    $
    5,410
    
    $
    891
    
    $
    1,838
    
    $
    1,838
    
    $
    843Total
      contractual cash obligations
    
    $
    5,410
    
    $
    891
    
    $
    1,838
    
    $
    1,838
    
    $
    843




28


We
believe that our current cash resources together with anticipated product
revenues, committed research and development grant funding and remaining
availability under our credit facility will be sufficient to finance our planned
operations, research and development programs and fixed asset requirements in
the foreseeable future. However, we may need additional funds to meet our
long-term strategic objectives. Any additional equity financing may be dilutive
to stockholders, and debt financing, if available, may involve significant
restrictive covenants and we cannot assure that such financing will be extended
on terms acceptable to us or at all.




Inflation





We do not
believe that inflation has had a material impact on our results of operations
for the years ended December 31, 2004, 2003 and 2002.




New
Accounting Pronouncements





In
November 2004, the FASB issued SFAS No. 151, Inventory Costs — an amendment of
ARB No. 43, Chapter 4. The amendments made by SFAS No. 151 clarify that abnormal
amounts of idle facility expense, freights, handling costs, and wasted materials
(spoilage) should be recognized as current-period charges and require the
allocation of fixed production overheads to inventory based on the normal
capacity of the production facilities. SFAS No. 151 is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. Earlier
application is permitted for inventory costs incurred during fiscal years
beginning after November 23, 2004. We do not expect the adoption of this
recently-issued accounting pronouncement to have a material impact on its
financial position, cash flows, or results of operations.





In
December 2004, the FASB issued SFAS No. 123 (revised 2004, or “R”), Share-Based
Payment — a revision of FASB Statement No. 123 Accounting for Stock-Based
Compensation. SFAS No. 123 supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS No.
123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. Pro forma disclosure is no longer an alternative. The new standard
will be effective beginning July 1, 2005.





SFAS
123(R) permits public companies to adopt its requirements using one of the
following methods:





1. A
“modified prospective” method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS 123(R) for all
share-based payments granted after the effective date and (b) based on the
requirements of SFAS 123 for all awards granted to employees prior to the
effective date of SFAS 123(R) that remain unvested on the effective date.





2. A
“modified retrospective” method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based
on the amounts previously recognized under SFAS 123 for purposes of pro forma
disclosures either (a) all prior periods presented or (b) prior interim periods
of the year of adoption.





We have
not determined the method in which we will adopt SFAS 123(R).





As
permitted by SFAS 123, we currently account for share-based payments to
employees using Opinion 25’s intrinsic value method and, as such, generally
recognize no compensation cost for employee stock options. Accordingly, the
adoption of SFAS 123(R)’s fair value method will have a significant impact on
our results of operations, although it will have no impact on our overall
cash flows and financial position. The impact of adoption of SFAS 123(R) cannot
be predicted at this time because it will depend on levels of share-based
payments granted in the future. SFAS 123(R) also requires the benefits of tax
deductions in excess of recognized compensation cost to be reported as a
financing cash flow, rather than as an operating cash flow as required under
current literature.





Note 2
“Stock-Based Compensation” of our financial statements illustrates the effect on
net income if we had applied the fair value recognition provisions of SFAS 123
to all stock-based employee compensation. These pro forma amounts may not be
representative of the effects on reported net income for future years due to the
uncertainty of stock option grant volume, potential changes in assumptions and
other factors.




29




Item
      7a.
    Quantitative
      and Qualitative Disclosure About Market
Risk




We are
exposed to changes in interest rates primarily from our investments in certain
marketable securities, consisting principally of fixed income debt securities.
Although our investments are available for sale, we generally hold such
investments to maturity. Our investments are stated at fair value, with net
unrealized gains or losses on the securities recorded as accumulated other
comprehensive income (loss) in shareholders’ equity. Net unrealized gains and
losses were not material at December 31, 2004 or 2003.




Item
      8.
    Financial
      Statements and Supplementary Data




The
financial statements and supplementary financial information required to be
filed under this Item are presented commencing on page F-1 of the Annual Report
on Form 10-K, and are incorporated herein by reference.




Item
      9.
    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure




None.




Item
      9a.
    Controls
      and Procedures




Evaluation
of Disclosure Controls and Procedures





During
the fourth quarter of 2004, our management, including the principal executive
officer and principal financial officer, evaluated our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) related to the recording, processing, summarization, and
reporting of information in our reports that we file with the SEC. These
disclosure controls and procedures have been designed to ensure that material
information relating to us, including our subsidiaries, is made known to our
management, including these officers, by other of our employees, and that this
information is recorded, processed, summarized, evaluated, and reported, as
applicable, within the time periods specified in the SEC’s rules and forms. Due
to the inherent limitations of control systems, not all misstatements may be
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. Our controls and procedures can only provide
reasonable, not absolute, assurance that the above objectives have been
met.





Based on
their evaluation as of December 31, 2004, our principal executive officer and
principal financial officer have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) are effective to reasonably ensure that the information
required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms.




30


Management’s
Report on Internal Control Over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in Internal Control -
Integrated Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2004.





PricewaterhouseCoopers
LLP, the independent registered accounting firm that audited our consolidated
financial statements included in this Annual Report on Form 10-K, has audited
management’s assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2004. The report, which expresses
unqualified opinions on management’s assessment and on the effectiveness of our
internal control over financial reporting as of December 31, 2004, is included
herein.





Changes
in Internal Control Over Financial Reporting





There
have been no changes in our internal control over financial reporting that
occurred during our last fiscal quarter that have materially affected , or are
reasonably likely to materially affect, our internal control over financial
reporting.




Item
      9b.
    Other
      information




None.




PART
      III





Item
      10.
    Directors
      and Executive Officers of the Registrant







Background
of Directors





The
persons listed below served as directors of the Company during the year ended
December 31, 2004.





Nominee
    Age
    Position
      with the Company
    Director
      SincePaul
      G. Thomas
    49
    Chairman
      of the Board, President and Chief Executive Officer
    1998Michael
      E. Cahr(1)
      (2) (3)
    64
    Director
    1991David
      Fitzgerald(1)
      (2) (3)
    71
    Director
    2001James
      G. Foster(1)
      (2) (3)
    58
    Director
    1995Martin
      P. Sutter
    49
    Director
    2003




(1)
    Member
      of the Audit Committee of the Board of Directors.





(2)
    Member
      of the Compensation and Stock Option Committee of the Board of
      Directors.





(3)
    Member
      of the Nominating Committee of the Board of
Directors.





All
directors hold office until the next annual meeting of stockholders or until
their successors are elected and qualified; vacancies and any additional
positions created by board action are filled by action of the existing Board of
Directors.




31


***Paul
G. Thomas*** *.* Mr.
Thomas has served as Director, President and Chief Executive Officer of LifeCell
since October 1998. Mr. Thomas was elected Chairman of the Board in June 1999.
Prior to joining LifeCell, Mr. Thomas was President of the Pharmaceutical
Products Division of Ohmeda Inc., a world leader in inhalation anesthetics and
acute care pharmaceuticals. Mr. Thomas was responsible for the overall
operations of Ohmeda’s Pharmaceutical Division, which had worldwide sales of
approximately $200 million in 1997. Mr. Thomas received his M.B.A. degree with
an emphasis in Marketing and Finance from Columbia University Graduate School of
Business and completed his postgraduate studies in Chemistry at the University
of Georgia Graduate School of Arts and Science. He received his B.S. degree in
Chemistry from St. Michael’s College in Vermont, where he graduated Cum Laude.





***Michael
E. Cahr.*** **  Mr. Cahr
has been a director of LifeCell since July 1991. Mr. Cahr is currently President
of Saxony Consultants, an Illinois-based company that provides financial and
marketing expertise to organizations in the United States and abroad. From
February 2000 through March 2002, Mr. Cahr was President and Chief Executive
Officer of IKADEGA, Inc., a Northbrook, Illinois server technology company
developing products and services for the health care, data storage and
hospitality fields. He also served as Chairman of Allscripts, Inc., a leading
developer of hand-held device technology that provides physicians with real-time
access to health, drug and other critical information, from September 1997
through March 1999, and President, Chief Executive Officer and Chairman from
June 1994 to September 1997. Prior to Allscripts, Mr. Cahr was Venture Group
Manager for Allstate Venture Capital where he oversaw investments in technology
and biotech from 1987 to June 1994. Mr. Cahr serves as a director of Pacific
Health Laboratories, a publicly traded nutritional products firm that develops
and commercializes functionally unique nutritional products and a director of
Mpower Communications Corporation, a publicly traded AMEX company specializing
in providing data and voice services to businesses. Mr. Cahr received his
undergraduate degree in Economics from Colgate University and his M.B.A. degree
from Fairleigh Dickinson University. Mr. Cahr serves as Chairman of the
Company’s audit committee and compensation committee.





***David
Fitzgerald.*** ** Mr.
Fitgerald has been a director of LifeCell since December 2001. He served as
President and Chief Executive Officer of Howmedica, Inc. from 1980 until his
retirement in 1996. In 1988, he was named Executive Vice President of Pfizer
Hospital Products Group, a $1.3 billion group of medical device companies
including Howmedica. In 1992, he was also named Vice President of Pfizer Inc.
Mr. Fitzgerald serves as a director of Arthrocare Corp., a publicly traded
Nasdaq company specializing in soft tissue surgical technology and Orthovita,
Inc., a publicly traded Nasdaq company specializing in biomaterial products for
the restoration of the human skeleton.





***James
G. Foster.*** Mr.
Foster has been a director of LifeCell since March 1995. Mr. Foster was employed
by Medtronic, Inc., a medical technology company, from 1971 to 2001. From
December 1994 through his retirement in June 2001 he was Vice President and
General Manager of Medtronic Heart Valves. From February 1984 to December 1994,
Mr. Foster held various officer positions with Medtronic including Vice
President of Cardiac Surgery Sales & Strategic Planning in 1994, Vice
President and General Manager of Medtronic Neurological Implantables from 1992
through 1994, Vice President and General Manager of Medtronic Interventional
Vascular from 1990 through 1992, and Vice President and General Manager of
Medtronic Blood Systems from 1983 through 1989. Mr. Foster received his
undergraduate degree in English from St. Josephs University in Philadelphia and
a Masters degree in Management from the Sloan School at M.I.T. Currently, Mr.
Foster serves as a director of Arthrocare Corp., a publicly traded Nasdaq
company specializing in soft tissue surgical technology and as the lead director
of Neothermia, a privately held company specializing in breast and other biopsy
technology.





***Martin
P. Sutter.*** Mr.
Sutter has been a director of LifeCell since December 2003. Mr. Sutter is a
managing director at Essex Woodlands Health Ventures, one of the oldest and
largest venture capital organizations focused exclusively on health care. Essex
Woodlands Health Ventures currently holds approximately four percent of our
outstanding common stock. Mr. Sutter began his career in management consulting
with Peat Marwick, Mitchell & Co. in 1977 and shortly thereafter moved to
Mitchell Energy & Development Corporation where he held various positions in
operations, engineering and marketing. He founded the Woodlands Venture Capital
Company in 1984 and Woodlands Venture Partners, an independent venture capital
partnership, in 1988. He currently serves on the Board of Directors of Confluent
Surgical, Inc., a privately held company specializing in surgical sealants and
adhesion barriers; EluSys Therapeutics, Inc, a privately held company
specializing in developing products for patients with end-stage congestive heart
failure; Rinat Neuroscience Corporation, a privately held company specializing
in developing therapeutic antibodies; and Sontra Medical Corporation, a publicly
traded Nasdaq company specializing in non-invasive ultrasound-mediated skin
permeation technology.




32


Committees
of the Board of Directors





***Composition
of the Board of Directors*** *.*  Since the
adoption of the Sarbanes-Oxley Act in July 2002, there has been a growing public
and regulatory focus on the independence of directors. The Board of Directors
has determined that the members of the Audit Committee and the Nominating
Committee satisfy all such definitions of independence and that a majority of
our directors satisfy the Nasdaq definition of independence.





***Audit
Committee.*** During
2004, the
Audit Committee comprised Mr. Cahr, Mr. Fitzgerald and Mr. Foster. The Audit
Committee is empowered by the Board of Directors to, among other functions,
serve as an independent and objective party to monitor
our financial  reporting  process ,
internal control system and
disclosure control
system; review and
appraise the audit efforts of our independent registered public accounting firm;
assume direct responsibility for the appointment,  compensation ,
retention and oversight of the work of the independent registered public
accounting firm; and for the resolution of disputes between the independent
registered public accounting firm and our management regarding financial
reporting issues; and provide an open avenue of communication among the
independent registered public accounting firm, financial and senior management,
and our Board of Directors.





***Audit
Committee Financial Expert*** *.* The Board
of Directors has determined that Michael E. Cahr is an “audit committee
financial expert,” as such term is defined by the SEC. As noted above, Mr. Cahr,
as well as the other members of the Audit Committee, has been determined to be
“independent” within the meaning of SEC and Nasdaq regulations.





***Independence
of Audit Committee Members.*** ****** Our
common stock is listed on the Nasdaq National Market, and we are governed by the
listing standards applicable thereto. All members of the Audit Committee of the
Board of Directors have been determined to be “independent directors” pursuant
to the definition contained in Rule 4200(a)(15) of the National Association of
Securities Dealers’ Marketplace Rules and under the SEC’s Rule
10A-3.





***Nominating
Committee.*** ****** The Board
of Directors has established a Nominating Committee consisting of Mr. Cahr, Mr.
Fitzgerald and Mr. Foster. The Nominating Committee is empowered by the Board of
Directors to, among other functions, recommend
to the Board of Directors qualified individuals to serve on our Board of
Directors and to identify
the manner in which the Nominating Committee evaluates nominees recommended for
the Board.





***Compensation
Committee.*** During
2004, the Compensation Committee comprised Mr. Cahr, Mr. Fitzgerald and Mr.
Foster. The Compensation Committee reviews, approves and makes recommendations
to the Board of Directors on matters regarding the compensation of our senior
executive officers.





***Stock
Option Committee*** *.* During
2004, the Stock Option Committee comprised Mr. Cahr, Mr. Fitzgerald and Mr.
Foster. The Stock Option Committee administers our stock option
plans.




33


Background
of Executive Officers





The
following sets forth certain information regarding the Company’s executive
officers.





Name
    Offices
      Held
    Date
      of First Election
    AgePaul
      G. Thomas
    Chairman
      of the Board, President and Chief Executive Officer
    October
      1998
    49William
      E. Barnhart
    Senior
      Vice President, Quality and Regulatory Affairs
    August
      1999
    62Steven
      T. Sobieski
    Vice
      President, Finance and Administration
      &
      Chief Financial Officer
    June
      2000
    48Lisa
      N. Colleran
    Senior
      Vice President, Commercial Operations
    December
      2002
    47Young
      C. McGuinn
    Vice
      President, Manufacturing Operations
    July
      2004
    45


All
executive officers serve at the discretion of the Board of
Directors.








***Paul
G. Thomas*** *.* For
further background information regarding Mr. Thomas, see “Background of
Directors.”





***William
E. Barnhart*** joined
LifeCell in August 1999 as Sr. Vice President, Operations, and was named Senior
Vice President, Quality and Regulatory Affairs in July 2004. He has over 25
years of management experience in a variety of roles in drug and device
manufacturing and quality assurance. From March 1997 to September 1999, Mr.
Barnhart was Sr. Vice President, Quality Assurance for Centeon, LLC, a
multinational provider of pharmaceuticals and plasma derived biologics. From
1993 to 1997, Mr. Barnhart was Vice President, Quality Assurance for Ohmeda,
Inc. Prior to joining Ohmeda, Mr. Barnhart was Vice President of Operations,
Allergan U.S. Operations. In this capacity, he was responsible for general
management for five operations manufacturing prescription ophthalmics, biologics
and medical devices. Mr. Barnhart graduated from Miami University with a B.S.
degree and a M.S. degree in chemistry.





***Steven
T. Sobieski*** joined
LifeCell in June 2000 as Vice President, Finance and Chief Financial Officer. He
has over 20 years of financial management experience in a variety of roles in
public accounting and the medical technology field. Prior to joining LifeCell,
Mr. Sobieski was Vice President Finance at Osteotech, Inc, a publicly traded
Nasdaq company focused on developing and marketing human tissue-based products
for orthopedic applications, where he served in various positions from 1991 to
2000. From 1981 through 1991, he served in various positions of increasing
responsibility with Coopers & Lybrand. Mr. Sobieski received his B.S. degree
in Business Administration from Monmouth University and his M.B.A. degree with a
concentration in accounting from Rutgers University. He is a Certified Public
Accountant.





***Lisa
N. Colleran***  joined
LifeCell in December 2002 as Vice President, Marketing and Business Development,
and was named Senior Vice President, Commercial Operations in July 2004. She has
over 20 years of marketing experience. Prior to joining LifeCell, Ms. Colleran
served as Vice President/General Manager - Renal Pharmaceuticals for Baxter
Healthcare Corporation, a worldwide manufacturer and distributor of diversified
products, systems and services used primarily in the health care field, from
1997 until December 2002, and served in various other sales and marketing
positions at Baxter from 1983 through 1997. Ms. Colleran received her B.S.
degree from Molloy College and her M.B.A. degree from Loyola University of
Chicago.





***Young
C. McGuinn***  **** joined
LifeCell in July 2004 as Vice President, Manufacturing Operations. She has over
fifteen years of healthcare-related experience. Prior to joining LifeCell, Ms.
McGuinn served from 1998 to 2004 as Executive Director, Global Planning at Merck
Manufacturing Division, and served in various other supply-chain management and
engineering roles at Merck and Company from 1989 through 1998. Ms. McGuinn
received her Bachelor of Science degree from Manhattan College, and her Master
of Science degree from the University of Delaware.




34


Compliance
with Section 16 of The Securities Exchange Act of 1934





Section
16(a) of the Securities Exchange Act of 1934 ("Section 16(a)") requires that our
officers, directors and persons who own more than 10% of a registered class of
our equity securities to file statements on Form 3, Form 4 and Form 5 of
ownership and changes in ownership with the Securities and Exchange Commission.
Officers, directors and greater than 10% stockholders are required by the
regulation to furnish us with copies of all Section  16(a)
reports that they file.





Based
solely on a review of reports on Forms 3 and 4 and amendments thereto furnished
to us during our most recent fiscal year, reports on Form 5 and amendments
thereto furnished to us with respect to our most recent fiscal year and written
representations from reporting persons that no report on Form 5 was required, we
believe that no person who, at any time during 2004, was subject to the
reporting requirements of Section 16(a) with respect to us failed to meet such
requirements on a timely basis.





Code
of Ethics





We have
adopted a Code of Ethics for Senior Financial Officers that applies to our
principal executive officer, principal financial officer, principal accounting
officer and controller. A copy of our Code of Ethics for Senior Financial
Officers has been filed as Exhibit 14.1 to our Annual Report on Form 10-K for
the year ended December 31, 2003 and is available on our website.




Item
      11.
    Executive
      Compensation




The
following table provides certain compensation information concerning our Chief
Executive Officer and our next four most highly compensated executive officers
for the fiscal year ended December 31, 2004.





**Summary
Compensation Table**





Annual
      Compensation
    
    Long-Term
      CompensationName
      and Principal Position
      at
      December 31, 2004
    
    Year
    
    Salary
    
    Bonus
    
    Securities
      Underlying
      Options
    (1)
    All
      Other Compensation
    (2)Paul
      G. Thomas
    
    
    2004
    
    $
    370,000
    
    $
    250,000
    
    
    —
    
    $
    900Chairman
      of the Board, President
    
    
    2003
    
    $
    330,000
    
    $
    179,520
    
    
    100,000
    
    $
    900&
      Chief Executive Officer
    
    
    2002
    
    $
    303,200
    
    $
    160,696
    
    
    200,000
    
    $
    750William
      E. Barnhart
    
    
    2004
    
    $
    188,800
    
    $
    73,151
    
    
    —
    
    $
    900Senior
      Vice President,
    
    
    2003
    
    $
    196,900
    
    $
    67,104
    
    
    34,080
    
    $
    900Quality
      & Regulatory Affairs
    
    
    2002
    
    $
    188,400
    
    $
    59,911
    
    
    75,000
    
    $
    750Steven
      T. Sobieski
    
    
    2004
    
    $
    222,000
    
    $
    86,014
    
    
    —
    
    $
    1,200Vice
      President, Finance and
    
    
    2003
    
    $
    202,000
    
    $
    70,902
    
    
    35,100
    
    $
    1,200Administration
      & Chief Financial
    
    
    2002
    
    $
    193,300
    
    $
    59,150
    
    
    75,000
    
    $
    1,050OfficerLisa
      N. Colleran
    
    
    2004
    
    $
    232,400
    
    $
    89,318
    
    
    —
    
    $
    1,200SeniorVice
      President,
    
    
    2003
    
    $
    215,000
    
    $
    81,724
    
    
    50,000
    
    $
    42,765
    (3)Commercial
      Operations
    
    
    2002
    
    $
    5,788
    (4)
    $
    40,000
    (5)
    
    100,000
    
    
    —Young
      C. McGuinn
    
    
    2004
    
    $
    95,577
    (6)
    $
    34,526
    
    
    100,000
    
    $
    1,025Vice
      President,
    
    
    2003
    
    
    —
    
    
    —
    
    
    —
    
    
    —Manufacturing
      Operations
    
    
    2002
    
    
    —
    
    
    —
    
    
    —
    
    
    —




35


(1)
    Represents
      shares issuable pursuant to stock options granted under our stock option
      plans. These options vest 25% per year commencing on the first anniversary
      of the date of grant.





(2)
    Represents
      contributions made by us pursuant to our 401(k) Plan and/or stock purchase
      plan unless otherwise noted.





(3)
    Includes
      $41,565 of relocation related costs paid by the
Company.





(4)
    Employment
      commenced December 2002. Annual salary was
$215,000.





(5)
    Represents
      hiring bonus.





(6)
    Employment
      comenced July 2004. Annual salary was
$210,000.




Option
Grants in 2004





The
following table provides certain information with respect to options granted to
our Chief Executive Officer and to each of the executive officers named in the
Summary Compensation Table during the fiscal year ended December 31,
2004:





**Option
Grants in Last Fiscal Year**




Number
      of
      Securities
      Underlying
    
    Percent
      of
      Total
      Options
      Granted
      to
    
    Exercise
    
    Market
      Price
    
    
    
    Potential
      Realizable Value at Assumed Annual Rates of Stock Price Appreciation for
      Option Term(1)Name
    
    Options
      Granted
    (2)
    Employees
      in
      Fiscal
      Year
    
    Price
      per
      Share
    
    on
      Date
      of
      Grant ($)
    
    Expiration
      Date
    
    5%
    
    10%Young
      C. McGuinn
    
    
    100,000
    
    
    20.7
    %
    $
    9.03
    
    $
    9.03
    
    
    07/18/14
    
    $
    567,892
    
    $
    1,439,149


(1)
    The
      Securities and Exchange Commission (the “SEC”) requires disclosure of the
      potential realizable value or present value of each grant. The 5% and 10%
      assumed annual rates of compounded stock price appreciation are mandated
      by rules of the SEC and do not represent our estimate or projection of our
      future common stock prices. The disclosure assumes the options will be
      held for the full ten-year term prior to exercise. Such options may be
      exercised prior to the end of such ten-year term. The actual value, if
      any, an executive officer may realize will depend on the excess of the
      stock price over the exercise price on the date the option is exercised.
      There can be no assurance that the stock price will appreciate at the
      rates shown in the table.





(2)
    These
      options vest 25% per year commencing on the first anniversary of the date
      of grant.




Option
Exercises and Holdings





The
following table provides information concerning options exercised during 2004
and the value of unexercised options held by each of the executive officers
named in the Summary Compensation Table at December 31, 2004.





**Option
Values at December 31, 2004**





Shares
      Acquired
    
    Value
    
    Number
      of Securities Underlying
      Unexercised
      Options at December 31, 2004 (# of shares)
    
    Value
      of
      In-the-Money
      Options at
      December
      31, 2004 ($)(1)Name
    
    on
      Exercise (#shares)
    
    Realized
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    UnexercisablePaul
      G. Thomas
    
    
    40,000
    
    $
    317,732
    
    
    785,000
    
    
    215,000
    
    $
    5,324,490
    
    $
    1,437,650William
      E. Barnhart
    
    
    187,500
    
    $
    1,082,117
    
    
    46,020
    
    
    75,560
    
    $
    332,712
    
    $
    506,522Steven
      T. Sobieski
    
    
    —
    
    
    —
    
    
    221,275
    
    
    78,825
    
    $
    1,360,416
    
    $
    530,209Lisa
      N. Colleran
    
    
    —
    
    
    —
    
    
    62,500
    
    
    87,500
    
    $
    435,875
    
    $
    559,625Young
      C. McGuinn
    
    
    —
    
    
    —
    
    
    —
    
    
    100,000
    
    $
    —
    
    $
    119,000





(1)
    Based
      on $10.22 per share, the closing price of the common stock, as reported by
      the Nasdaq National Market, on December 31,
2004.




Compensation
of Directors





During
2004, non-employee directors were paid $1,500 per month regardless of the number
of Board meetings attended. Non-employee directors who serve on the Compensation
Committee were also paid $2,000 per year regardless of the number of committee
meetings attended. Non-employee directors who serve on the Audit Committee were
paid $4,000 per year regardless of the number of committee meetings attended.
Our directors who are employees of LifeCell receive no director fees. Directors
are reimbursed for their expenses for attendance at such meetings.




36


Newly
elected non-employee directors receive an option to purchase 25,000 shares of
common stock at an exercise price equal to the fair market value of a share of
common stock on such election date, and each of our non-employee directors
receives an annual option grant to purchase 10,000 shares of common stock on the
date of our Annual Meeting of Stockholders. Options granted under our Director
Stock Option Plans generally vest one year after the date of grant and expire
ten years after the date of grant.





Pursuant
to our 1993 Director Stock Option Plan, on July 15, 2004, Mr. Cahr, Mr. Foster,
Mr. Fitzgerald and Mr. Sutter were each granted options to purchase 10,000
shares of common stock at an exercise price of $10.19 per share.




Change
in Control and Severance Agreements





We have
entered into severance and change in control agreements with our executive
officers to ensure that we will have their continued dedication as executives
notwithstanding the possibility, threat or occurrence of a defined “change in
control.” Following are details of the agreements.




Paul G.
Thomas





In
December 2002, ** we
entered into a change in control agreement with Mr. Thomas. Under the agreement,
if within 12 months of a change in control there occurs a "trigger event," Mr.
Thomas will be entitled to receive all then accrued compensation and fringe
benefits, continuation of health and medical benefits and life insurance for a
period of 12 months and a cash payment equal to 2.9 times his current base
salary and performance bonus paid in the preceding year. Additionally, all stock
options or other unvested benefits under any compensation or employee benefit
plan shall immediately become vested and exercisable. A "trigger event" is
defined to include termination of employment by us other than for
"cause."





Additionally,
we have entered into a severance arrangement with Mr. Thomas. Pursuant to such
arrangement, Mr. Thomas is entitled to receive 12 months severance pay based on
his salary immediately prior to termination, health and medical benefits and
life insurance coverage if he is terminated by us without cause. Mr. Thomas is
also entitled to a bonus based on the bonus paid to Mr. Thomas in the previous
year, on a pro rata basis based on the number of months employed during the year
of termination.




William
E. Barnhart





In
December 2002, ** we
entered into a change in control agreement with Mr. Barnhart. Under the
agreement, if within 12 months of a change in control there occurs a "trigger
event," Mr. Barnhart will be entitled to receive all then accrued compensation
and fringe benefits, continuation of health and medical benefits and life
insurance for a period of 12 months and a cash payment equal to two times his
current base salary and performance bonus paid in the preceding year.
Additionally, all stock options or other unvested benefits under any
compensation or employee benefit plan shall immediately become vested and
exercisable. A "trigger event" is defined to include termination of employment
by us other than for "cause."




Steven T.
Sobieski





In
December 2002, we entered into a change in control agreement with Mr. Sobieski.
Under the agreement, if within 12 months of a change in control there occurs a
"trigger event," Mr. Sobieski will be entitled to receive all then accrued
compensation and fringe benefits, continuation of health and medical benefits
and life insurance for a period of 12 months and a cash payment equal to two
times his current base salary and performance bonus paid in the preceding year.
Additionally, all stock options or other unvested benefits under any
compensation or employee benefit plan shall immediately become vested and
exercisable. A "trigger event" is defined to include termination of employment
by us other than for "cause."





Additionally,
we have entered into a severance arrangement with Mr. Sobieski. Pursuant to such
arrangement, Mr. Sobieski is entitled to receive 12 months severance pay based
on his salary immediately prior to termination, health and medical benefits and
life insurance coverage if he is terminated by us without cause.




37


Lisa N.
Colleran





In
November 2002, we entered into compensation arrangements with Ms. Colleran upon
commencement of her employment. Pursuant to such arrangements, Ms. Colleran is
entitled to receive 12 months of salary, based on her salary immediately prior
to termination, and fringe benefits continuation and outplacement services if
she is terminated by us without cause, or she experiences a material reduction
in responsibilities or compensation following a change in control. Additionally,
following a change in control, as described in Section 17 of our 1992 Stock
Option Plan, all of her remaining unvested stock options shall vest
immediately.




38




Item
      12.
    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters





The
following table sets forth information as of March 4, 2005 with respect to (i)
persons known to us to be beneficial holders of five percent or more of either
the outstanding shares of common stock or the outstanding shares of Series B
preferred stock, (ii) our executive officers and directors and (iii) all of our
executive officers and directors as a group. Unless otherwise indicated, the
address of each such person is c/o LifeCell Corporation, One Millennium Way,
Branchburg, New Jersey 08876.


Amount
      and Nature of Beneficial Ownership(1)Common
      StockBeneficial
      Owner
    Shares
    %Arbor
      Capital Management(2)
    2,565,200
    8.77%One
      Financial Plaza120
      S. 6thStreet, Suite 1000Minneapolis,
      Minnesota 55402Samuel
      D. Isaly(3)
    1,981,500
    6.49%OrbiMed
      Capital LLCOrbiMed
      Advisors Inc.OrbiMed
      Advisors LLCc/o
      OrbiMed Advisors LLC767
      Third AvenueNew
      York, New York 10017Paul
      G. Thomas(4)
    746,780
    2.49%Chairman
      of the Board, President & Chief Executive OfficerMichael
      E. Cahr(5)
    159,856
    *DirectorDavid
      Fitzgerald(6)
    45,000
    *DirectorJames
      G. Foster(7)
    65,000
    *DirectorMartin
      P. Sutter(8)
    77,130
    *DirectorWilliam
      E. Barnhart
    2,939
    *Senior
      Vice President Quality and Regulatory AffairsSteven
      T. Sobieski(9)
    226,044
    *Vice
      President Finance & Chief Financial OfficerLisa
      N. Colleran(10)
    63,050
    *Senior
      Vice President Commercial OperationsYoung
      C. McGuinn
    76
    *Vice
      President Manufacturing OperationsAll
      executive officers and directors as a group(11)
    1,385,875
    4.55%





Notes
to Security Ownership table





*
    Less
      than 1%.





(1)
    Each
      beneficial owner’s percentage ownership of Common Stock is determined by
      assuming that options and warrants that are held by such person (but not
      those held by any other person) and that are exercisable or convertible
      within 60 days of February 28, 2005 have been exercised or converted.
      Options and warrants that are not exercisable within 60 days of February
      28, 2005 have been excluded. Unless otherwise noted, we believe that all
      persons named in the above table have sole voting and investment power
      with respect to all shares of Common Stock beneficially owned by
      them.





(2)
    Represents
      2,565,200 shares of Common Stock. Information with respect to the
      ownership of such stockholders was obtained from a Schedule 13D filed on
      December 31, 2004 and our stock records.




39


(3)
    These
      shares of Common Stock are owned as follows: 460,000 shares of Common
      Stock and 902,043 shares of Common Stock issuable upon exercise of a
      warrant are owned by Caduceus Private Investments, LP, 9,000 shares of
      Common Stock and 18,776 shares of Common Stock issuable upon exercise of a
      warrant are owned by OrbiMed Associates, LLC and 200,000 shares of Common
      Stock and 391,681 shares of Common Stock issuable upon exercise of a
      warrant are owned by PW Juniper Crossover Fund, L.L.C. Samuel D. Islay,
      OrbiMed Advisors LLC, OrbiMed Advisors Inc. and OrbiMed Capital LLC are
      deemed to beneficially own these shares by virtue of their mutual
      affiliation to the above indicated entities. Information with respect to
      the ownership of such stockholders was obtained from a Schedule 13D filed
      on December 31, 2004 and our stock records.





(4)
    Includes
      745,000 shares underlying stock options





(5)
    Includes
      50,000 shares underlying stock options





(6)
    Represents
      45,000 shares underlying stock options.





(7)
    Represents
      65,000 shares underlying stock options.





(8)
    Includes
      39,630 shares of Common Stock and 37,500 shares underlying stock options
      but excludes 1,300,000 shares of Common Stock owned by Essex Woodlands
      Health Ventures V LP. Mr. Sutter is a managing director of the general
      partner of the Essex Woodlands Health Ventures Fund V LP, however he
      disclaims beneficial ownership of the shares owned by the partnership.
      Ownership information was obtained from our stock records and a Form 4
      filed on May 28, 2004.





(9)
    Includes
      221,275 shares underlying stock options.





(10)
    Includes
      62,500 shares underlying stock options.





(11)
    See
      notes (4) through (10).





Equity
Compensation Plan Information





The
following table gives information about our common stock that may be issued upon
the exercise of options, warrants and rights under our Amended and Restated 1992
Stock Option Plan, 1993 Directors Stock Option Plan, 2000 Stock Option Plan and
2003 Directors Stock Option Plan as of December 31, 2004. These plans were our
only equity compensation plans in existence as of December 31,
2004.




Plan
      Category
    
    (a)
      Number
      of Securities to be Issued Upon Exercise of Outstanding Options, Warrantsand
      Rights
    
    (b)
      Weighted-Average
      Exercise
      Price
      of Outstanding Options,
      Warrants
      and Rights
    
    (c)
      Number
      of Securities Remaining Available for Future IssuanceUnder
      Equity Compensation PlansExcluding
      Securities Reflectedin
      Column (a)Equity
      Compensation PlansApproved by
      Shareholders
    
    
    3,733,202
    
    $
    4.58
    
    
    1,818,739Equity Compensation
      PlansNot
      Approved by Shareholders
    
    
    1,531,250
    (1)
    $
    2.35
    
    
    0TOTAL
    
    
    5,264,452
    
    $
    3.93
    
    
    1,818,739




(1)
    See
      “Note 9-Capital Stock, Options and Warrants” included in the financial
      statements for the year ended December 31, 2004. Included in commencing on
      page F-1 in this Annual Report on Form
10-K.




Item
      13.
    Certain
      Relationships and Related Transactions




We have
entered into change in control and severance agreements with our executive
officers. See “Item 11. *Executive
Compensation - Change in Control and Severance Agreements.”*





Any
transactions involving related parties in the future will be reviewed and
approved by our Audit Committee of the Board of Directors.




40




Item
      14.
    Principal
      Accounting Fees and Services




In
accordance with the requirements of the Sarbanes-Oxley Act of 2002 and the Audit
Committee's charter, all audit and audit-related work and all non-audit work
performed by our independent registered public accounting firm,
PricewaterhouseCoopers LLP (“PwC”) is approved in advance by the Audit
Committee, including the proposed fees for such work. The Audit Committee is
informed of each service actually rendered.





*Audit
Fees.* Audit
fees billed or expected to be billed to us by PwC for the audit of the financial
statements included in our Annual Reports on Form 10-K, and reviews of the
financial statements included in our Quarterly Reports on Form 10-Q, for the
years ended December 31, 2004 and 2003 totaled approximately $310,000 and
$162,000, respectively.





*Audit-Related
Fees.* We were
billed $19,000 and $28,000 by PwC for the fiscal years ended December 31, 2004
and 2003, respectively, for assurance and related services that are reasonably
related to the performance of the audit or review of our financial statements
and are not reported under the caption *Audit
Fees* above.





*Tax
Fees.* We were
billed an aggregate of $50,000 and $1,000 by PwC for the fiscal years ended
December 31, 2004 and 2003, respectively, for tax services, principally advice
regarding the preparation of income tax returns.





*All
Other Fees.* We did
not incur any fees for the fiscal years ended December 31, 2004 and 2003 for
permitted non-audit services.





*Other
Matters.* The
Audit Committee has considered whether the provision of the Audit-Related Fees
and Tax Fees are compatible with maintaining the independence of our principal
accountant.





Applicable
law and regulations provide an exemption that permits certain services to be
provided by our independent registered public accounting firm even if they are
not pre-approved. We have not relied on this exemption at any time since the
Sarbanes-Oxley Act was enacted.




41




PART
      IV





Item
      15.
    Exhibits,
      Financial Statement Schedules





( A )
DOCUMENTS INCLUDED IN THIS REPORT:





Financial
      Statements
    PageReport
      of Independent Registered Public Accounting Firm
    F-1Balance
      Sheets as of December 31, 2004 and 2003
    F-3Statements
      of Operations for the years ended December 31, 2004, 2003 and
      2002
    F-4Statements
      of Stockholders’ Equity for the years ended December 31, 2004, 2003 and
      2002
    F-5Statements
      of Cash Flows for the years ended December 31, 2004, 2003 and
      2002
    F-6Notes
      to Financial Statements
    F-7





Financial
Statement Schedules





All other
schedules are omitted because they are not applicable, not required, or because
the required information is contained in the Company’s financial statements and
the notes thereto.




42


( B )
EXHIBITS:





Exhibits
designated by the symbol * are filed with this Annual Report on Form 10-K.
All exhibits not so designated are incorporated by reference to a prior filing
as indicated.





Exhibits
designated by the symbol † are management contracts or compensatory plans or
arrangements that are required to be filed with this report pursuant to this
Item 15.





LifeCell
undertakes to furnish to any stockholder so requesting a copy of any of the
following exhibits upon payment to us of the reasonable costs incurred by us in
furnishing any such exhibit.





3.
    1
    Restated
      Certificate of Incorporation, as amended (incorporated by reference to
      Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period
      ended June 30, 1998, filed with the Securities and Exchange Commission
      ("the Commission") on August 10, 1998).3.
    2
    Amended
      and Restated By-laws (incorporated by reference to Exhibit 3.2 to the
      Company’s Quarterly Report on Form 10-Q for the period ended June 30,
      1996, filed with the Commission on August 14, 1996).10.
    1†
    LifeCell
      Corporation Amended and Restated 1992 Stock Option Plan, as amended
      (incorporated by reference to Exhibit 10.1 to the Company's Quarterly
      Report on Form 10-Q for the period ended June 30, 1998, filed with the
      Commission on August 10, 1998).10.
    2†
    LifeCell
      Corporation Second Amended and Restated 1993 Non-Employee Director Stock
      Option Plan, as amended (incorporated by reference to Exhibit 10.4 to the
      Company's Annual Report on Form 10-K for the fiscal year ended December
      31, 1996).10.
    3
    LifeCell
      Corporation 2003 Non-Employee Director Stock Option Plan (incorporated by
      reference to Annex B to the Company’s Definitive Proxy Statement on
      Schedule 14A filed on April 24, 2003).10.
    4
    Securities
      Purchase Agreement dated November 18, 1996, between LifeCell Corporation
      and the Investors named therein (incorporated by reference to Exhibit
      10.15 to the Company's Annual Report on Form 10-K for the fiscal year
      ended December 31, 1996).10.
    5
    Second
      Amended and Restated Voting Agreement dated as of April 13, 2000 among the
      Company and the Series B Preferred Shareholders (incorporated by reference
      to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q filed with
      the Commission on May 12, 2000).10.
    6
    Waiver
      Agreement dated as of March 11, 2002 among the Company and certain holders
      of the Series B preferred stock (incorporated by reference to Exhibit
      10.31 to the Company's Annual Report on Form 10-K for the fiscal year
      ended December 31, 2001).10.
    7
    Registration
      Rights Agreement dated November 18, 1996, between LifeCell Corporation and
      certain stockholders named therein (incorporated by reference to Exhibit
      10.17 to the Company's Annual Report on Form 10-K for the fiscal year
      ended December 31, 1996).10.
    8†
    Agreement
      dated October 5, 1998 between LifeCell Corporation and Paul G. Thomas
      (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly
      Report on Form 10-Q filed with the Commission on November 13,
      1998).10.
    9†
    Letter
      agreement dated September 8, 1998 between LifeCell Corporation and Paul G.
      Thomas, as amended by letter agreements dated September 9, 1998 and
      September 29, 1998 (incorporated by reference to Exhibit 10.3 to the
      Company’s Quarterly Report on Form 10-Q filed with the Commission on
      November 13, 1998).10.
    10
    Lease
      Agreement by and between Maurice M. Weill, Trustee for Branchburg Property
      and LifeCell Corporation dated June 17, 1999 (incorporated by reference to
      Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q filed with the
      Commission on November 15, 1999).10.
    11
    Amendment
      dated September 21, 1999 to Lease Agreement by and between Maurice M.
      Weill, Trustee for Branchburg Property and LifeCell Corporation
      (incorporated by reference to Exhibit 10.16 to the Company's Annual Report
      on Form 10-K for the fiscal year ended December 31,
  2000).




43




10.
    12
    Amendment
      dated April 7, 2000 to Lease Agreement by and between Maurice M. Weill,
      Trustee for Branchburg Property and LifeCell Corporation (incorporated by
      reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for
      the fiscal year ended December 31, 2000).10.
    13
    LifeCell
      Corporation Year 2000 Stock Option Plan (incorporated by reference to
      Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q filed with the
      Commission on July 28, 2000).10.
    14
    Form
      of Purchase Agreement dated September 1, 2000 between LifeCell Corporation
      and Certain Investors (incorporated by reference to Exhibit 10.1 of the
      Company’s Quarterly Report on Form 10-Q filed with the Commission on
      November 13, 2000).10.
    15†
    Form
      of Change in Control Agreement (incorporated by reference to Exhibit 10.26
      to the Company's Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000).10.
    16
    Stock
      Purchase Warrant dated October 31, 2000, issued to Prudential Securities
      Incorporated (incorporated by reference to Exhibit 10.27 to the Company's
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2000).10.
    17
    Stock
      Purchase Warrant dated October 31, 2000, issued to Gruntal & Co.,
      L.L.C. (incorporated by reference to Exhibit 10.28 to the Company's Annual
      Report on Form 10-K for the fiscal year ended December 31,
      2000).10.
    18
    Form
      of Purchase Agreement dated June 29, 2001 between LifeCell Corporation and
      Certain Investors (incorporated by reference to Exhibit 10.29 of the
      Company’s Form 8-K filed with the Commission on July 11,
      2001).10.
    19
    Form
      of Warrants dated July 10, 2001 between LifeCell Corporation and Certain
      Investors (incorporated by reference to Exhibit 10.31 of the Company’s
      Form 8-K filed with the Commission on July 11, 2001).10.
    20
    Form
      of Purchase Agreement dated August 11, 2003 between LifeCell Corporation
      and Certain Investors (incorporated by reference to Exhibit 99.2 of the
      Company’s Form 8-K filed with the Commission on August 13,
      2003).10.
    21
    Loan
      and Security Agreement dated January 15, 2003 between LifeCell Corporation
      and Silicon Valley Bank (incorporated by reference to Exhibit 10.32 of the
      Company’s Form 8-K filed with the Commission on February 14,
      2003).10.
    22
    Revolving
      Promissory Note in the principal amount of $2,000,000 between LifeCell
      Corporation and Silicon Valley Bank (incorporated by reference to Exhibit
      10.33 of the Company’s Form 8-K filed with the Commission on February 14,
      2003).10.
    23
    Modification
      Agreement dated March 31, 2004 to Loan and Security Agreement dated
      January 15, 2003 between LifeCell Corporation and Silicon Valley Bank
      (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly
      Report on Form 10-Q filed with the Commission on April 27,
      2004).10.
    24
    Amended
      and Restated Revolving Promissory Note dated March 31, 2004 in the
      principal amount of 4,000,000 between LifeCell Corporation and Silicon
      Valley Bank (incorporated by reference to Exhibit 10.1 of the Company’s
      Quarterly Report on Form 10-Q filed with the Commission on April 27,
      2004).14.
    1
    LifeCell
      Corporation Code of Ethics for Senior Financial Officers (incorporated by
      reference to Exhibit 14.1 of the Company’s Form 10-K filed with the
      Commission on March 15, 2004.23.
    1*
    Consent
      of PricewaterhouseCoopers LLP31.
    1*
    Certification
      of the Registrant’s Chief Executive Officer, Paul G. Thomas, pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.31.
    2*
    Certification
      of the Registrant’s Chief Financial Officer, Steven T. Sobieski, pursuant
      to Section 302 of the Sarbanes-Oxley Act of 2002.32.
    1*
    Certification
      of the Registrant’s Chief Executive Officer, Paul G. Thomas, and Chief
      Financial Officer, Steven T. Sobieski, pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.




44




Signatures




In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.





LIFECELL
      CORPORATION(Registrant)By:
    /s/ Paul G. ThomasPaul
      G. ThomasPresident,
      Chief Executive Officer andChairman
      of the Board of Directors





Dated:
March 10, 2005





In
accordance with the Securities Exchange Act of 1934, this report has been signed
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated:





Signature
    
    Title
    
    Date/s/
      Paul G. Thomas
    
    President,
      Chief Executive
    
    March
      10, 2005Paul
      G. Thomas
    
    Officer
      (Principal Executive Officer) and
      Chairman
      of the Board of Directors/s/
      Steven T. Sobieski
    
    Vice
      President and Chief Financial
    
    March
      10, 2005Steven
      T. Sobieski
    
    Officer
      (Principal Financial Officer)/s/
      Bradly C. Tyler
    
    Controller
    
    March
      10, 2005Bradly
      C. Tyler
    
    (Principal
      Accounting Officer)/s/
      Michael E. Cahr
    
    Director
    
    March
      10, 2005Michael
      E. Cahr/s/
      James G. Foster
    
    Director
    
    March
      10, 2005James
      G. Foster/s/
      David Fitzgerald
    
    Director
    
    March
      10, 2005David
      Fitzgerald/s/
      Martin P. Sutter
    
    Director
    
    March
      10, 2005Martin
      P. Sutter




45




Report
      of Independent Registered Public Accounting
Firm








To the
Board of Directors and Shareholders of LifeCell Corporation:





We have
completed an integrated audit of LifeCell Corporation’s 2004 financial
statements and of its internal control over financial reporting as of December
31, 2004 and audits of its 2003 and 2002 financial statements in accordance with
the standards of the Public Company Accounting Oversight Board (United States).
Our opinions, based on our audits, are presented below.





Financial
statements





In our
opinion, the financial statements listed in the index appearing under Item
15(a)(1) present fairly, in all material respects, the financial position of
LifeCell Corporation at December 31, 2004 and 2003, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2004 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.





Internal
control over financial reporting





Also, in
our opinion, management’s assessment, included in Management’s Report on
Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2004 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management’s assessment and on the
effectiveness of the Company’s internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.




F-1


A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.






PricewaterhouseCoopers
LLP





Florham
Park, NJ





March 10,
2005




F-2




LifeCell
      Corporation Balance Sheets




December
      31,*(dollars
      in thousands)*
    
    2004
    
    2003AssetsCurrent
      assetsCash
      and cash equivalents
    
    $
    10,084
    
    $
    7,387Short-term
      investments
    
    
    15,308
    
    
    4,398Receivables,
      less allowance of $114 in 2004 and $54 in 2003
    
    
    9,240
    
    
    5,876Inventories
    
    
    8,895
    
    
    8,830Prepayments
      and other
    
    
    312
    
    
    317Deferred
      tax assets
    
    
    3,501
    
    
    2,067Total
      current assets
    
    
    47,340
    
    
    28,875Investments
      in marketable securities
    
    
    1,694
    
    
    6,735Fixed
      assets, net
    
    
    8,332
    
    
    7,508Deferred
      tax assets
    
    
    14,201
    
    
    14,589Other
      assets, net
    
    
    526
    
    
    566Total
      assets
    
    $
    72,093
    
    $
    58,273Liabilities
      and Stockholders' EquityCurrent
      liabilitiesAccounts
      payable
    
    $
    1,727
    
    $
    1,260Accrued
      liabilities
    
    
    6,702
    
    
    4,332Total
      current liabilities
    
    
    8,429
    
    
    5,592Deferred
      revenue
    
    
    —
    
    
    130Other
      liabilities
    
    
    216
    
    
    172Commitments
      and contingenciesStockholders'
      equitySeries
      B preferred stock, $.001 par value, 182,205 shares
    authorized,0
      and 68,000 shares issued and outstanding in 2004 and 2003
    
    
    —
    
    
    —Undesignated
      preferred stock, $.001 par value 1,817,795shares
      authorized, none issued and outstanding
    
    
    —
    
    
    —Common
      stock, $.001 par value, 48,000,000 shares authorized;29,126,000
      and 25,592,000 shares issued and outstanding in 2004 and
    2003
    
    
    29
    
    
    26Common
      stock warrants, 1,519,000 and 2,000,000 outstanding in 2004 and
      2003
    
    
    2,590
    
    
    3,412Additional
      paid-in capital
    
    
    99,310
    
    
    94,610Accumulated
      other comprehensive income
    
    
    4
    
    
    —Accumulated
      deficit
    
    
    (38,485
    )
    
    (45,669
    )Total
      stockholders' equity
    
    
    63,448
    
    
    52,379Total
      liabilities and stockholders' equity
    
    $
    72,093
    
    $
    58,273




The accompanying notes are an integral part of these
financial statements.





F-3




LifeCell
      Corporation Statements of Operations





For
      the Year Ended December 31,*(dollars
      in thousands, except per share data)*
    
    2004
    
    2003
    
    2002Revenues:Product
      revenues
    
    $
    58,751
    
    $
    38,577
    
    $
    32,935Research
      grant revenues
    
    
    2,376
    
    
    1,672
    
    
    1,493Total
      revenues
    
    
    61,127
    
    
    40,249
    
    
    34,428Costs
      and expenses:Cost
      of products sold
    
    
    17,755
    
    
    12,241
    
    
    10,134Research
      and development
    
    
    7,860
    
    
    5,396
    
    
    5,015General
      and administrative
    
    
    8,214
    
    
    5,594
    
    
    4,590Selling
      and marketing
    
    
    20,311
    
    
    14,940
    
    
    13,288Total
      costs and expenses
    
    
    54,140
    
    
    38,171
    
    
    33,027Income
      from operations
    
    
    6,987
    
    
    2,078
    
    
    1,401Interest
      and other income (expense), net
    
    
    222
    
    
    (28
    )
    
    (129
    )Income
      before income taxes
    
    
    7,209
    
    
    2,050
    
    
    1,272Income
      tax provision (benefit)
    
    
    25
    
    
    (16,622
    )
    
    (157
    )Net
      income
    
    $
    7,184
    
    $
    18,672
    
    $
    1,429Net
      income per common share:Basic
    
    $
    0.26
    
    $
    0.85
    
    $
    0.07Diluted
    
    $
    0.22
    
    $
    0.70
    
    $
    0.06Shares
      used in computing net incomeper
      common share:Basic
    
    
    27,553,000
    
    
    22,094,000
    
    
    21,176,000Diluted
    
    
    31,974,000
    
    
    26,632,000
    
    
    24,696,000





The
accompanying notes are an integral part of these financial
statements.





F-4




LifeCell
      Corporation Statements of Stockholders’ Equity




Series
      B
      Preferred
      Stock
    
    Common
      Stock
    
    Common
      Stock Warrants
    
    Additional
      Paid-in
    
    Accumulated
      Comprehensive
    
    Accumulated
    
    Total
      Stockholders’*(dollars
      and shares in thousands)*
    
    Shares
    
    Amount
    
    Shares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Income
    
    Deficit
    
    EquityBalance
      at December 31, 2001
    
    
    102
    
    $
    —
    
    
    19,852
    
    $
    20
    
    
    2,284
    
    $
    4,002
    
    $
    76,581
    
    $
    —
    
    $
    (65,770
    )
    
    14,833Conversion
      of Series B preferred stock
    
    
    (28
    )
    
    —
    
    
    994
    
    
    1
    
    
    —
    
    
    —
    
    
    (1
    )
    
    —
    
    
    —
    
    
    —Reclassification
      of common stock,subject
      to redemption
    
    
    —
    
    
    —
    
    
    347
    
    
    —
    
    
    —
    
    
    —
    
    
    1,457
    
    
    —
    
    
    —
    
    
    1,457Net
      income
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    1,429
    
    
    1,429Balance
      at December 31, 2002
    
    
    74
    
    
    —
    
    
    21,193
    
    
    21
    
    
    2,284
    
    
    4,002
    
    
    78,037
    
    
    —
    
    
    (64,341
    )
    
    17,719Stock
      options exercised
    
    
    —
    
    
    —
    
    
    129
    
    
    —
    
    
    —
    
    
    —
    
    
    462
    
    
    —
    
    
    —
    
    
    462Warrants
      exercised
    
    
    —
    
    
    —
    
    
    224
    
    
    —
    
    
    (284
    )
    
    (590
    )
    
    982
    
    
    —
    
    
    —
    
    
    392Conversion
      of Series B preferred stock
    
    
    (6
    )
    
    —
    
    
    242
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Common
      stock issued for cash
    
    
    —
    
    
    —
    
    
    3,690
    
    
    5
    
    
    —
    
    
    —
    
    
    14,651
    
    
    —
    
    
    —
    
    
    14,656Reclassification
      of common stock,subject
      to redemption
    
    
    —
    
    
    —
    
    
    114
    
    
    —
    
    
    —
    
    
    —
    
    
    478
    
    
    —
    
    
    —
    
    
    478Net
      income
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    18,672
    
    
    18,672Balance
      at December 31, 2003
    
    
    68
    
    
    —
    
    
    25,592
    
    
    26
    
    
    2,000
    
    
    3,412
    
    
    94,610
    
    
    —
    
    
    (45,669
    )
    
    52,379Comprehensive
      income:Net
      Income
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    7,184
    
    
    7,184Unrealized
      securities gains
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    4
    
    
    —
    
    
    4Comprehensive
      income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,188Stock
      options exercised
    
    
    —
    
    
    —
    
    
    609
    
    
    1
    
    
    —
    
    
    —
    
    
    2,011
    
    
    —
    
    
    —
    
    
    2,012Warrants
      exercised
    
    
    —
    
    
    —
    
    
    475
    
    
    —
    
    
    (481
    )
    
    (822
    )
    
    1,818
    
    
    —
    
    
    —
    
    
    996Conversion
      of Series B preferred stock
    
    
    (68
    )
    
    —
    
    
    2,450
    
    
    2
    
    
    —
    
    
    —
    
    
    (2
    )
    
    —
    
    
    —
    
    
    —Income
      tax benefit from stock optionexercises
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    873
    
    
    —
    
    
    —
    
    
    873Balance
      at December 31, 2004
    
    
    —
    
    $
    —
    
    
    29,126
    
    $
    29
    
    
    1,519
    
    $
    2,590
    
    $
    99,310
    
    $
    4
    
    $
    (38,485
    )
    $
    63,448


The
accompanying notes are an integral part of these financial
statements.




F-5




LifeCell
      Corporation Statements of Cash Flows





For
      the Year Ended December 31,*(dollars
      in thousands)*
    
    2004
    
    2003
    
    2002Cash
      Flows from Operating Activities:Net
      income
    
    $
    7,184
    
    $
    18,672
    
    $
    1,429Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Depreciation
      and amortization
    
    
    2,357
    
    
    2,010
    
    
    2,296Deferred
      taxes
    
    
    (144
    )
    
    (16,656
    )
    
    —Provision
      for bad debt
    
    
    69
    
    
    61
    
    
    (56
    )Inventory
      net realizable value provision
    
    
    (173
    )
    
    266
    
    
    278Deferred
      revenues
    
    
    (130
    )
    
    (221
    )
    
    (221
    )Deferred
      rent expense
    
    
    44
    
    
    78
    
    
    24Loss
      on disposal of fixed assets
    
    
    8
    
    
    25
    
    
    —Changes
      in operating assets and liabilities:Receivables
    
    
    (3,433
    )
    
    (1,605
    )
    
    (477
    )Inventories
    
    
    108
    
    
    (2,729
    )
    
    (1,954
    )Prepayments
      and other
    
    
    8
    
    
    (60
    )
    
    62Accounts
      payable and accrued liabilities
    
    
    2,837
    
    
    981
    
    
    1,087Net
      cash provided by operating activities
    
    
    8,735
    
    
    822
    
    
    2,468Cash
      Flows from Investing Activities:Proceeds
      from maturities and sale of investments
    
    
    6,194
    
    
    —
    
    
    —Purchase
      of investments
    
    
    (12,088
    )
    
    (10,877
    )
    
    (6
    )Capital
      expenditures
    
    
    (3,151
    )
    
    (2,507
    )
    
    (576
    )Proceeds
      from sale of equipment
    
    
    —
    
    
    100
    
    
    —Net
      cash used in investing activities
    
    
    (9,045
    )
    
    (13,284
    )
    
    (582
    )Cash
      Flows from Financing Activities:Proceeds
      from issuance of common stock
    
    
    —
    
    
    15,682
    
    
    —Proceeds
      from issuance of long-term debt
    
    
    —
    
    
    1,451
    
    
    —Proceeds
      from exercise of common stock options and warrants
    
    
    3,007
    
    
    856
    
    
    —Principal
      payments on long-term debt
    
    
    —
    
    
    (2,314
    )
    
    (1,334
    )Offering
      fees
    
    
    —
    
    
    (1,028
    )
    
    —Net
      cash provided by (used in) financing activities
    
    
    3,007
    
    
    14,647
    
    
    (1,334
    )Net
      increase in cash and cash equivalents
    
    
    2,697
    
    
    2,185
    
    
    552Cash
      and cash equivalents at beginning of period
    
    
    7,387
    
    
    5,202
    
    
    4,650Cash
      and cash equivalents at end of period
    
    $
    10,084
    
    $
    7,387
    
    $
    5,202Supplemental
      Disclosure of Cash Flow Information:Cash
      paid during the year for interest
    
    $
    18
    
    $
    64
    
    $
    186Cash
      paid during the year for income taxes
    
    $
    258
    
    $
    336
    
    $
    40





The
accompanying notes are an integral part of these financial
statements.




F-6




LifeCell
      Corporation Notes To Financial Statements


*(December
31, 2004)*





1.
    ORGANIZATION


LifeCell
Corporation (“LifeCell” or “the Company”) develops and markets products made
from human tissue for use in reconstructive, urogynecologic and orthopedic
surgical procedures to repair soft tissue defects. The Company’s products are
subject to regulation by the United States Food and Drug Administration (the
“FDA”) as human tissue for transplantation. LifeCell was incorporated in
Delaware in 1992 for the purpose of merging with its predecessor entity, which
was formed in 1986. The Company began commercial sales of its first tissue
product during 1993.








2.
    ACCOUNTING
      POLICIES





Use
of Estimates





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




Cash
and Cash Equivalents and Investments in Marketable Securities





The
Company considers all highly liquid investments with an original maturity of
three months or less, when purchased, to be cash equivalents. Investments with
maturities in excess of three months but less than one year are classified as
short-term investments and are stated at cost, net of any unamortized premiums
or discounts, which approximates fair value.





The
Company classifies its marketable securities as available for sale. The
securities consist of fixed income debt securities, which are stated at fair
value, with net unrealized gains or losses on the securities recorded as
accumulated other comprehensive income (loss) in shareholders’ equity. Net
unrealized gains and losses were not material at December 31, 2004 or 2003.
Realized gains and losses are included in earnings and are derived using the
specific identification method for determining the cost of the securities.
Realized gains and losses were not material in 2004, 2003 or 2002.




Inventories





Inventories
are stated at the lower of cost or market, with cost being determined on a
first-in, first-out basis. Inventories on hand include the cost of materials,
freight, direct labor and manufacturing overhead. The Company records a
provision for excess and obsolete inventory based primarily on inventory
quantities on hand, the historical product sales and estimated forecast of
future product demand and production requirements.




Fixed
Assets





Fixed
assets are stated at cost less accumulated depreciation. Major expenditures that
improve or extend the life of the assets are capitalized whereas maintenance and
repairs are expensed as incurred. The cost of assets retired and the related
accumulated depreciation are removed from the accounts, and any gain or loss is
included in the results of operations. Depreciation of computer equipment and
furniture and fixtures is computed on the straight-line method based on the
estimated useful lives of the assets of three to five years. Depreciation of
machinery and equipment is computed on the straight-line method based on the
estimated useful lives of the assets of three to seven years. The cost of
leasehold improvements is depreciated over the shorter of the lease term or the
estimated useful life of the asset.




F-7


Deferred
Patent Costs





Deferred
patent costs amounted to $376,000 at December 31, 2004, net of $271,000 of
accumulated patent amortization, and are included in other assets, net in the
accompanying balance sheet. Such costs are amortized to expense on a
straight-line basis over the legal life of the patents. For the years ended
December 31, 2004, 2003 and 2002, amortization expense relating to deferred
patent costs was $38,000, $45,000 and $83,000, respectively.




Impairment
of Long-Lived Assets





The
Company records impairment losses on long-lived assets used in operations when
events and circumstances indicate that assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount of those assets. Management believes that the carrying value
of its long-lived assets reported on the balance sheet at December 31, 2004
represent recoverable value, and during 2004 and 2003 no impairment reviews were
required.




Revenue
Recognition





Product
revenues are recognized when title and risk of loss for the product is
transferred to the customer, which is generally when product is shipped to the
customer. The Company utilizes independent sales and marketing agents to
supplement its direct sales organization. These independent agents hold the
Company’s inventory on a consignment basis. For products marketed through
independent sales and marketing agents, the Company recognizes revenue when the
products are delivered to the third-party customer, as this is when title and
risk of loss to the product transfers. Additionally, amounts billed to customers
for shipping and handling are included in revenue at the time the related
product revenue are recognized.





Research
grant revenues are recognized at the time qualified expenses are incurred,
unless the Company has continuing performance obligations, in which case,
revenue is recognized upon the satisfaction of such obligations. Grant payments
received, but not yet earned, are recorded as deferred revenue.




Research
and Development Expense





Research
and development costs are expensed when incurred and primarily include salaries
and fringe benefits, professional fees, animal and clinical studies, supplies
and facilities costs.




Fair
Value of Financial Instruments





Financial
instruments consist of cash and cash equivalents, short-term and long-term
investments in marketable securities, accounts receivable, accounts payable and
certain current liabilities. Management believes the carrying amounts reported
in the balance sheet for these items approximate fair value.




Income
Taxes





Significant
judgment is required in determining the Company’s income tax provision. In the
ordinary course of business, there are many transactions and calculations where
the ultimate tax outcome is uncertain. Although the Company believes that its
estimates are reasonable, no assurance can be given that the final outcome of
these matters will not be different than that which is reflected in its
historical income tax provisions and accruals. Such differences could have a
material effect on the Company’s income tax provision and net income in the
period in which such determination is made.




F-8


The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes.” Under the asset-and-liability method of SFAS No. 109,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The recoverability of
deferred tax assets is dependent upon the Company’s assessment of whether it is
more likely than not that sufficient future taxable income will be generated to
utilize the deferred tax asset. In the event we determine that future taxable
income will not be sufficient to utilize the deferred tax asset, a valuation
allowance is recorded. At December 31, 2004, the valuation allowance primarily
reflected uncertainties involving the realization of certain tax credits due to
the potential impact of future stock option exercises and shorter-term tax asset
expiration dates. Under SFAS No. 109, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.




Comprehensive
Income





SFAS No.
130 “Reporting Comprehensive Income” establishes standards for reporting and
display of comprehensive income and its components in financial statements. It
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements.




Stock-Based
Compensation





The
Company follows Accounting Principles Board (APB) Opinion No. 25, “Accounting
for Stock Issued to Employees,” and related interpretations in accounting for
equity-based awards issued to employees and directors. No stock-based
compensation cost is reflected in net income, as all options granted under the
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant.





The
following table illustrates the effect on net income and earnings per share if
the company had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, to stock-based compensation
for the years ended December 31,:





*(dollars
      in thousands, except per share data)*
    
    2004
    
    2003
    
    2002Net
      income, as reported
    
    $
    7,184
    
    $
    18,672
    
    $
    1,429Less:
      Total stock-based compensation expensedetermined
      under fair value based methodfor
      all awards, net of related tax effects
    
    
    (1,498
    )
    
    (1,248
    )
    
    (1,223
    )Pro
      forma net income
    
    $
    5,686
    
    
    17,424
    
    
    206Net
      income per common share - basicAs
      reported
    
    $
    0.26
    
    $
    0.85
    
    $
    0.07Pro
      forma
    
    $
    0.21
    
    $
    0.79
    
    $
    0.01Net
      income per common share - dilutedAs
      reported
    
    $
    0.22
    
    $
    .70
    
    $
    0.06Pro
      forma
    
    $
    0.18
    
    $
    0.66
    
    $
    0.01





See Note
9 for additional information regarding the computations presented
above.




F-9




Concentrations of Credit Risk




Financial
instruments, which potentially subject the Company to concentrations of credit
risk, consist primarily of cash and cash equivalents, short- and long-term
investments and accounts receivable. The Company has investment policies that
limit investments of excess cash to investment grade securities. The Company
provides credit, in the normal course of business, to hospitals, medical
professionals and distributors. The risk with respect to accounts receivables is
mitigated because amounts due the Company are not concentrated within a
relatively few number of customers. The Company maintains an allowance for doubtful accounts and charges actual losses to the allowance when
incurred.





**Allowance
for Doubtful Accounts**


*(dollars
      in thousands)*
    
    Balance
      at
      Beginning
      of
      Period
    
    Charge
      (Benefit) to
      Costs
      and Expenses
    
    Write-offs
      and
      Deductions
      From
      Allowance
    
    Balance
      at
      End
      of PeriodDecember
      31, 2004
    
    $
    54
    
    $
    69
    
    $
    (9
    )
    $
    114December
      31, 2003
    
    
    40
    
    
    61
    
    
    (47
    )
    
    54December
      31, 2002
    
    
    114
    
    
    (56
    )
    
    (18
    )
    
    40




New
Accounting Pronouncements





In
November 2004, the FASB issued SFAS No. 151, Inventory Costs — an amendment of
ARB No. 43, Chapter 4. The amendments made by SFAS No. 151 clarify that abnormal
amounts of idle facility expense, freights, handling costs, and wasted materials
(spoilage) should be recognized as current-period charges and require the
allocation of fixed production overheads to inventory based on the normal
capacity of the production facilities. SFAS No. 151 is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. Earlier
application is permitted for inventory costs incurred during fiscal years
beginning after November 23, 2004. The Company does not expect the adoption of
this recently-issued accounting pronouncement to have a material impact on its
financial position, cash flows, or results of operations.





In
December 2004, the FASB issued SFAS No. 123 (revised 2004, or “R”), Share-Based
Payment — a revision of FASB Statement No. 123 Accounting for Stock-Based
Compensation. SFAS No. 123 supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS No.
123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values. Pro forma disclosure is no longer an alternative. The new standard
will be effective beginning July 1, 2005.





SFAS
123(R) permits public companies to adopt its requirements using one of the
following methods:





1. A
“modified prospective” method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS 123(R) for all
share-based payments granted after the effective date and (b) based on the
requirements of SFAS 123 for all awards granted to employees prior to the
effective date of SFAS 123(R) that remain unvested on the effective date.





2. A
“modified retrospective” method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based
on the amounts previously recognized under SFAS 123 for purposes of pro forma
disclosures either (a) all prior periods presented or (b) prior interim periods
of the year of adoption.





The
Company has not determined the method in which it will adopt SFAS 123(R).




F-10


As
permitted by SFAS 123, the Company currently accounts for share-based payments
to employees using Opinion 25’s intrinsic value method and, as such, generally
recognizes no compensation cost for employee stock options. Accordingly, the
adoption of SFAS 123(R)’s fair value method will have a significant impact on
the Company’s result of operations, although it will have no impact on its
overall cash flows and financial position. The impact of adoption of SFAS 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. SFAS 123(R) also requires the benefits of tax
deductions in excess of recognized compensation cost to be reported as a
financing cash flow, rather than as an operating cash flow as required under
current literature.








3.
    INVENTORIES


Inventories
consist of the following at December 31,:




*(dollars
      in thousands)*
    
    2004
    
    2003Unprocessed
      tissue and materials
    
    $
    4,347
    
    $
    4,453Tissue
      products in-process
    
    
    1,956
    
    
    1,592Tissue
      products available for distribution
    
    
    2,592
    
    
    2,785Total
      inventories
    
    $
    8,895
    
    $
    8,830


4.
    INVESTMENTS


Cash,
cash equivalents and investments consist of the following at December
31,:





2004
    
    2003*(dollars
      in thousands)*
    
    Carrying
      Value
    
    Fair
      Value
    
    Carrying
      Value
    
    Fair
      ValueCash
      and cash equivalents
    
    $
    10,084
    
    $
    10,085
    
    $
    7,387
    
    $
    7,387Short-term
      investments
    
    
    15,308
    
    
    15,290
    
    
    4,398
    
    
    4,397Long-term
      investments
    
    
    1,694
    
    
    1,687
    
    
    6,735
    
    
    6,744





The
Company’s long-term investments mature at various dates through May
2006.








5.
    FIXED
      ASSETS


Fixed
assets consist of the following at December 31,:





*(dollars
      in thousands)*
    
    2004
    
    2003Machinery
      and equipment
    
    $
    5,914
    
    $
    4,581Leasehold
      improvements
    
    
    7,656
    
    
    7,542Computer
      equipment, furniture and fixtures
    
    
    4,647
    
    
    3,58518,217
    
    
    15,708Accumulated
      depreciation and amortization
    
    
    (9,885
    )
    
    (8,200
    )Fixed
      assets, net
    
    $
    8,332
    
    $
    7,508





For the
years ended December 31, 2004, 2003 and 2002, depreciation and amortization
expense related to fixed assets was $2,319,000, $1,965,000 and $2,213,000,
respectively.








6.
    ACCRUED
      LIABILITIES


Accrued
liabilities consist of the following at December 31,:





*(dollars
      in thousands)*
    
    2004
    
    2003Employee
      compensation and benefits
    
    $
    3,341
    
    $
    1,985Tissue
      recovery expenses
    
    
    2,173
    
    
    1,478Marketing
      agent fees
    
    
    594
    
    
    432Operating
      expenses and other
    
    
    594
    
    
    437Total
      accrued liabilities
    
    $
    6,702
    
    $
    4,332




F-11


7.
    DEFERRED
      REVENUE


In March
1999, in conjunction with the signing of an agreement with an independent sales
and marketing agent, the Company issued 108,577 shares of common stock at a
premium of $506,000 over the closing market price of the Company’s common stock
on the date of issuance. This premium, which was recorded as deferred revenue,
represented a payment for marketing rights and was recognized over the five-year
term of the agreement,. The total equity investment was valued at $1.0 million
less offering costs of $100,000.





In
February 2000, in conjunction with the Company entering into an agreement with
an independent sales and marketing agent, the agent agreed to make a $600,000
payment in exchange for certain product marketing rights. The payment, which was
received in September 2000, was recorded as deferred revenue to be recognized
over the five-year term of the agreement. In February 2004, the Company
terminated the agreement and recognized the remaining $110,000 of deferred
revenue, representing the unamortized balance of payments received at the
inception of the agreement.








8.
    FINANCING
      ARRANGEMENTS AND LONG-TERM DEBT


In March
2004, the Company secured a $4 million revolving line of credit. The credit
facility is collateralized by the Company’s accounts receivable, inventory,
intellectual property, and intangible and fixed assets. The agreement contains
certain financial covenants and a subjective acceleration clause. The revolving
line of credit bears interest at the bank prime rate plus 0.75% and is available
through March 2005. There was no balance outstanding on this credit facility at
December 31, 2004.





In
January 2003, the Company secured a $4 million credit facility through a
financial institution consisting of a $2 million revolving line of credit and an
equipment line for up to an additional $2 million. The credit facility was
collateralized by the Company’s accounts receivable, inventory, intellectual
property, and intangible and fixed assets. The agreement contained certain
financial covenants and a subjective acceleration clause. The revolving line of
credit bore interest at the bank prime rate plus 0.75% and was available through
January 2004. The equipment term note bore interest at the bank prime rate plus
1.5%. In 2003, the Company received proceeds of $1,451,000 under the equipment
line portion of the credit facility and used part of the proceeds to repay all
of its existing debt. In September 2003, the Company repaid the entire
outstanding balance on the equipment line and the equipment line was
terminated.





Intere st expense
for the years ended December 31, 2004, 2003 and 2002 was $18,000, $57,000 and
$180,000, respectively.








9.
    CAPITAL
      STOCK, OPTIONS AND WARRANTS




Series
B Preferred Stock





Pursuant
to the terms of the Company's certificate of incorporation, the Series B
preferred stock automatically converted into common stock when the closing price
of the Company’s common stock averaged or exceeded $9.30 per share for 30
consecutive trading days. This condition was met on May 14, 2004, and
accordingly, all of the outstanding shares of Series B Preferred Stock of
LifeCell automatically converted on such date into an aggregate of 1,867,569
shares of the Company’s common stock.




Common
Stock





In August
2003, the Company sold 3,294,113 shares of its common stock at $4.25 per share
in a private placement to a group of institutional investors. In connection with
the private placement, in September 2003, the Company sold an additional 395,856
shares of its common stock at $4.25 per share to several holders of LifeCell's
Series B preferred stock, including one of the Company’s directors. These shares
were sold pursuant to a contractual right of the holders of the Series B
preferred stock to participate in the August 2003 private placement. The
aggregate net proceeds of the private placement were approximately $14.7 million
after deducting offering costs.




F-12


Options





The
Company’s Amended and Restated 1992 Stock Option Plan (the “1992 Plan”) provided
for the grant of options to purchase up to 2,500,000 shares of common stock
through January 16, 2002. In June 2000, the stockholders of the Company approved
the Year 2000 Stock Option Plan (the “2000 Plan”), which provides for the grant
of options to purchase up to 1,500,000 shares of common stock through March 1,
2010. In May 2003, the Company’s shareholders approved an amendment to the 2000
Plan increasing the number of shares reserved for issuance under the 2000 Plan
to 3,500,000. Common stock authorized for issuance under the 2000 Plan is
subject to adjustment in the event of certain changes in the Company’s
capitalization, a merger or a similar transaction. Such shares may be treasury
shares or newly issued shares or a combination of both.





Stock
options generally become exercisable ratably over a four-year period, beginning
on the first anniversary of the date of grant. To the extent not exercised,
options generally expire on the tenth anniversary of the date of grant, except
for employees who own more than 10 percent of all the voting shares of the
Company, in which event the expiration date is the fifth anniversary of the date
of grant. All options granted under the plans have exercise prices equal to the
fair market value at the date of grant.





In May
2003, the Company’s shareholders approved the LifeCell Corporation 2003
Non-Employee Director Stock Option Plan (the “Directors Plan”). Under the 2003
Directors Plan, options may be granted to purchase up to 750,000 shares of the
Company’s common stock through March 2013. The 2003 Directors Plan replaced the
Second Amended and Restated 1993 Non-Employee Director Stock Option Plan, which
terminated in July 2003. The provisions of the “Directors Plan” provide for an
initial grant of options to purchase 25,000 shares of common stock for newly
elected non-employee directors and an annual grant of an option to purchase
10,000 shares upon re-election to the Company’s Board. Options granted under the
Directors Plan have exercise prices equal to the fair market value at the date
of grant, vest one year after date of grant and expire on the tenth aniversary
of the date of grant.





A summary
of stock option activity for the years ended December 31, 2004, 2003 and 2002 is
as follows:





Total
      Stock Options
    
    Weighted-Average
      Exercise Price ($)Balance
      at December 31, 2001
    
    
    3,170,000
    
    
    3.77Granted
    
    
    717,000
    
    
    2.73Forfeited
      or canceled
    
    
    (209,000
    )
    
    4.64Balance
      at December 31, 2002
    
    
    3,678,000
    
    
    3.52Granted
    
    
    807,000
    
    
    5.03Exercised
    
    
    (79,000
    )
    
    4Forfeited
      or canceled
    
    
    (393,000
    )
    
    3.93Balance
      at December 31, 2003
    
    
    4,013,000
    
    
    3.77Granted
    
    
    523,000
    
    
    9.48Exercised
    
    
    (594,000
    )
    
    3.3Forfeited
      or canceled
    
    
    (209,000
    )
    
    4.93Balance
      at December 31, 2004
    
    
    3,733,000
    
    
    4.58




At
December 31, 2004, there were 1,134,000 options available for future grant under
the 2000 Plan and 685,000 under the Directors Plan.




F-13





A summary
of stock options outstanding under all plans at December 31, 2004 is as
follows:


Options
      Outstanding
    
    Options
      ExercisableRange
      of****
      Exercise
      Prices
    
    Number
      Outstanding
      at****December
      31, 2004
    
    Weighted-Average
      Remaining Contractual Life (Years)
    
    Weighted-
      Average
      Exercise****Price
    
    Number
      Exercisable
      at****December
      31,2003
    
    Weighted-
      Average****Exercise
      Price$
      1.64
    to
    $
      1.99
    
    31,000
    
    6.9
    
    $
      1.73
    
    26,000
    
    $
      1.732.00
    to
    2.99
    
    1,252,000
    
    7.3
    
    2.48
    
    826,000
    
    2.423.00
    to
    3.99
    
    737,000
    
    3.6
    
    3.82
    
    729,000
    
    3.824.00
    to
    4.99
    
    347,000
    
    4.3
    
    4.24
    
    346,000
    
    4.245.00
    to
    5.99
    
    711,000
    
    8.0
    
    5.39
    
    313,000
    
    5.546.00
    to
    6.99
    
    164,000
    
    3.8
    
    6.55
    
    134,000
    
    6.607.00
    to
    11.05
    
    491,000
    
    9.7
    
    9.69
    
    9,000
    
    10.17$
      1.64
    to
    $
      11.05
    
    3,733,000
    
    6.6
    
    $
      4.58
    
    2,383,000
    
    $
      3.78


In
addition to the amounts set forth in the tables above, during 1996 the Company
granted options to purchase 220,000 shares of common stock not pursuant to a
plan, to directors who resigned upon the closing of the sale of the Series B
preferred stock. During 2004, option holders exercised options to purchase
15,000 shares of common stock pursuant to these grants. At December 31, 2004,
options to acquire 13,000 shares of common stock remained outstanding with a
weighted-average exercise price of $3.75. The weighted-average remaining
contractual life of the outstanding option grants was one year as of December
31, 2004.





The
Company accounts for its employee stock-based compensation plans under APB No.
25 and its related interpretations. If compensation expense had been determined
based on the fair value as of the grant dates for awards in 2004, 2003 and 2002
consistent, with SFAS No. 123, the Company would have recorded stock-based
compensation expense of $1,498,000, $1,248,000 and $1,223,000 respectively. See
Note 2 “Stock-Based Compensation” for the pro forma effect on net
income.





Under the
provisions of SFAS No. 123, the weighted-average fair value of options granted
in 2004, 2003 and 2002 was $6.87, $3.63 and $2.22 per share, respectively. The
fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2004, 2003 and 2002, respectively: a
weighted-average risk-free interest rate of approximately 2.6% to
5.3% percent for all years; no expected dividend yield during the expected
life of the option; expected lives of 6 years for each grant and expected
volatility between 81 and 91 percent.








Common
Stock Warrants





The
following table summarizes information about common stock warrants outstanding
at December 31,




Warrants
      OutstandingExercise
      Price
    
    2004
    
    2003
    
    Expiration
      Date$
      1.92
    
    
    1,313,000
    
    
    1,750,000
    
    
    July
      10, 2006$
      5.00
    
    
    206,000
    
    
    250,000
    
    
    October
      27, 20051,519,000
    
    
    2,000,000


10.
    EMPLOYEE
      BENEFIT PLANS


The
Company maintains a 401(k) retirement savings plan, which covers all full-time
employees. The Company may, at its discretion, contribute amounts not to exceed
each employee’s contribution. Participant’s contributions may not exceed 15% of
their annual compensation, subject to annual dollar limits set by the Internal
Revenue Service. Participants are always 100% vested in their contributions.
Company contributions are fully vested after one year of employment. Total
Company contributions during 2004, 2003 and 2002 were $111,000, $86,000 and
$67,000, respectively.




F-14


The
Company also maintains an Employee Stock Purchase Plan to allow all full-time
employees to purchase the Company’s common stock on the open market using
employee and Company matching contributions. Total Company contributions during
2004, 2003, and 2002 were $27,000, $22,000 and $21,000,
respectively.





11.
    INCOME
      TAXES


Significant
components of the Company’s income tax expense (benefit) for the years ended
December 31, 2004, 2003 and 2002 were as follows:





*(dollars
      in thousands)*
    
    2004
    
    2003
    
    2002CurrentFederal
    
    $
    135
    
    $
    43
    
    $
    —State
    
    
    242
    
    
    (9
    )
    
    (155
    )DeferredFederal
    
    
    (431
    )
    
    (15,617
    )
    
    —State
    
    
    79
    
    
    (1,039
    )
    
    —Income
      tax provision (benefit), net
    
    $
    25
    
    $
    (16,622
    )
    $
    (155
    )




A
reconciliation of income taxes computed at the statutory federal income tax rate
of 34% to actual income taxe expense (benefit) for the years ended December 31,
2004, 2003 and 2002 follows:





*(dollars
      in thousands)*
    
    2004
    
    2003
    
    2002U.S.
      federal tax at statutory rate
    
    $
    2,451
    
    
    692
    
    $
    492State
      income taxes (net of federal benefit)
    
    
    212
    
    
    226
    
    
    93Sale
      of state tax net operating losses
    
    
    —
    
    
    (235
    )
    
    (248
    )Change
      in valuation allowance
    
    
    (2,647
    )
    
    (16,656
    )
    
    (492
    )Net
      operating losses utilized
    
    
    —
    
    
    (778
    )
    
    —Tax
      credits
    
    
    (109
    )
    
    —
    
    
    —Other
      non-deductible items
    
    
    118
    
    
    86
    
    
    —Alternative
      minimum taxes
    
    
    —
    
    
    43
    
    
    —Income
      tax provision (benefit)
    
    $
    25
    
    
    (16,622
    )
    
    (155
    )





In 2003,
the Company realized $235,000 through the sale and transfer of $3.0 million of
state tax net operating losses. In 2002, the Company realized $248,000 through
the sale and transfer of $3.2 million of state tax net operating losses. The
sales and transfers were made through the Technology Business Tax Certificate
Program sponsored by the New Jersey Economic Development
Authority.


F-15


The
principal components of the Company’s deferred tax assets as of December 31,
2004 and 2003 are as follows:


*(dollars
      in thousands)*
    
    2004
    
    2003Temporary
      differences:Deferred
      revenue
    
    $
    —
    
    $
    44Uniform
      capitalization of inventory costs
    
    
    192
    
    
    159Tax
      over book depreciation
    
    
    (1,041
    )
    
    (545
    )Other
      accruals and reserves
    
    
    325
    
    
    239Total
      temporary differences
    
    
    (524
    )
    
    (103
    )Federal
      tax losses and credits not currently utilizable
    
    
    17,917
    
    
    19,732State
      tax losses and credits not currently utilizable
    
    
    916
    
    
    1,627Total
      gross deferred tax assets
    
    
    18,309
    
    
    21,256Less
      valuation allowance
    
    
    (606
    )
    
    (4,600
    )Net
      deferred tax assets
    
    $
    17,703
    
    $
    16,656





At of
December 31, 2004, the Company had a net operating loss carryforward (“NOL”) for
federal income tax purposes of approximately $49.8 million expiring between 2006
and 2017.





The
federal NOL carryforwards are subject to limitation under the rules regarding a
change in stock ownership as determined by the Internal Revenue Code. As of
December 31, 2004 approximately $13.3 million of the Company’s NOL is subject to
an annual limitation under Internal Revenue Code Section 382.





At
December 31, 2004, the Company also had a NOL carryforward for state income tax
purposes of approximately $9.0 million, expiring between 2009 and 2010.
Additionally, the Company has approximately $935,000 of research and development
tax credit carryforwards for federal and state income tax purposes, which will
expire in varying amounts between 2004 and 2024.





Prior to
fourth quarter 2003, no provision or benefit for income taxes was recorded
because the Company was in a net deferred tax asset position and a full
valuation allowance had been recorded. During the fourth quarter of 2003, the
Company re-evaluated the amount of valuation allowance required based on
profitability achieved in 2003 and 2002 and expected in future years. As a
result, the Company reduced the valuation allowance to reflect net deferred tax
assets that we believed were more likely than not of being realized. The
reduction of the valuation allowance resulted in the recognition of a $16.6
million non-cash tax benefit in the fourth quarter of 2003.





In the
fourth quarter of 2004, the Company reduced the valuation allowance on deferred
taxes by $4.0 million. Approximately $1.1 million of the reduction resulted from
the write-off against the valuation allowance of certain tax credits where
future realization was determined to be remote. The remaining amount, which
resulted in the recognition of a $2.9 million non-cash tax benefit, resulted
from management’s determination that it is more likely than not that the benefit
of certain previously reserved federal net operating loss carryforwards and tax
credits would be realized. At December 31, 2004, the valuation allowance
primarily reflected uncertainties involving the realization of certain tax
credits due to the potential impact of future stock option exercises and
shorter-term expiration dates.


F-16




12.
    NET
      INCOME PER COMMON SHARE
 The
following table sets forth the computation of basic and diluted net income per
share for the years ended December 31, 2004, 2003 and 2002:





For
      the Year Ended December 31,*(dollars
      in thousands, except per share data)*
    
    2004
    
    2003
    
    2002Net
      income applicable tocommon
      stockholders
    
    $
    7,184
    
    $
    18,672
    
    $
    1,429Weighted-average
      common shares outstanding
    
    
    27,553,000
    
    
    22,094,000
    
    
    21,176,000Denominator
      for basic net income per share
    
    
    27,553,000
    
    
    22,094,000
    
    
    21,176,000Effect
      of dilutive securities:Series
      B preferred stock assuming conversion
    
    
    829,000
    
    
    2,658,000
    
    
    2,823,000Common
      stock warrants
    
    
    1,476,000
    
    
    993,000
    
    
    540,000Common
      stock options
    
    
    2,116,000
    
    
    887,000
    
    
    157,000Denominator
      for diluted net income per share
    
    
    31,974,000
    
    
    26,632,000
    
    
    24,696,000Basic
      net income per share
    
    $
    0.26
    
    $
    0.85
    
    $
    0.07Diluted
      net income per share
    
    $
    0.22
    
    $
    0.70
    
    $
    0.06





The
calculation of net income per share for the years ended December 31, 2004, 2003
and 2002 excludes potentially dilutive common stock equivalents consisting of
outstanding options to purchase 439,000, 1,207,000 and 2,726,000 shares of
common stock in 2004, 2003 and 2002, respectively, and warrants to purchase
250,000 and 334,000 shares of common stock in 2003 and 2002, respectively,
because their inclusion would be antidilutive.




13.
    COMMITMENTS
      AND CONTINGENCIES





Litigation





The
previously reported complaint, filed in November 2003 in the Circuit Court of
Fairfax, Virginia, captioned Sun
Hee Jung v. Yongsook Victoria Suh, M.D., Victoria Plastic Surgery Center, Inc.
and LifeCell Corporation was
dismissed without prejudice in December 2004 when the plaintiff elected to take
a voluntary non-suit in this action. If the case is not re-filed within six
months from the date of the Order of Non-Suit, then the case will be dismissed
with prejudice and will be forever barred.





FDA
Matters





The
Company believes that its human tissue based products generally satisfy the
FDA’s requirements to be considered eligible for regulation as human cellular
and tissue-based products, which the FDA calls "HCT/Ps. In September 2004, the
FDA notified the Company that they believe one of our products, AlloCraft DBM,
does not meet the criteria for regulation as an HCT/P and it is most properly
regulated as a medical device. The Company is considering whether to seek
approval for AlloCraft DBM as a medical device or further appeal this decision
within the agency. The FDA has not requested that the Company cease marketing
AlloCraft DBM during the time that we are seeking clearance or approval or
appealing FDA’s determination, but there is no guarantee that FDA will refrain
from enforcement action. The FDA could require us to cease marketing and / or
recall product already sold until the FDA clearance or approval is obtained. The
FDA could also seek to impose enforcement sanctions against us for marketing
this product without such FDA authorization. If the FDA requires us to cease
marketing, it may impair the carrying value of Allocraft DBM inventory on hand,
resulting in charge to results of operations in that period. At December 31,
2004, Allocraft DBM represented $215,000 of our total inventory.




F-17


Independent
Sales and Marketing Agency and Distributor Agreements





The
Company utilizes independent sales and marketing agents and distributors to
supplement its direct sales organization. The Company’s independent sales and
marketing agents and distributors generated 27%, 38% and 48% of total product
revenue in the years ended December 31, 2004, 2003 and 2002. One of the
Company’s sales and marketing agents generated 12% and one distributor generated
7% of total product revenues in 2004. No other individual independent sales
agent or distributor generated more than 5% of our total product revenues in the
year ended December 31, 2004.





Independent
sales and marketing agents hold Company inventory on a consignment basis. The
Company records product revenues when title to products transfers to third-party
customers. Our independent sales and marketing agents are paid agency fees based
on the amount of product revenues they generate for the Company. Such fees are
included in the statement of operations as selling and marketing expense at the
time that product revenues are recorded.





Leases





The
Company leases approximately 90,000 square feet for office, production and
laboratory space in one building under a lease agreement that expires in
November 2010. The lease contains a renewal option for an two additional
successive five-year periods. In addition, the Company is a party to various
other operating leases. Rental expense was $1,042,000, $1,021,000 and $949,000
for the years ended December 31, 2004, 2003 and 2002, respectively. The future
minimum lease payments under noncancelable leases with remaining terms in excess
of one year as of December 31, 2004, were as follows:





*(dollars
      in thousands)*
    
    Minimum
      Lease
      Payments2005
    
    $
    8912006
    
    
    9192007
    
    
    9192008
    
    
    9192009
      and beyond
    
    
    1,762Total
    
    $
    5,410





14.
    SEGMENT
      DATA


The
Company has one reportable business operating segment — the processing and
distribution of human tissue-based products. The Company’s products are used in
three primary surgical applications as summarized in the following
table:





*(dollars
      in thousands)*
    
    2004
    
    2003
    
    2002Reconstructive
    
    $
    46,028
    
    $
    28,115
    
    $
    22,650Urogynecology
    
    
    6,838
    
    
    8,734
    
    
    10,112Orthopedic
    
    
    5,885
    
    
    1,728
    
    
    173Total
      Product Revenues
    
    $
    58,751
    
    
    38,577
    
    $
    32,935




F-18


Product
revenues by geographic area for the years ended December 31, 2004, 2003 and
2002, are summarized as follows:





*(dollars
      in thousands)*
    
    2004
    
    2003
    
    2002United
      States
    
    $
    57,564
    
    $
    37,257
    
    $
    31,163Other
      countries
    
    
    1,187
    
    
    1,320
    
    
    1,772Total
      Product Revenues
    
    
    58,751
    
    
    38,577
    
    
    32,935








15.
    QUARTERLY
      FINANCIAL DATA (UNAUDITED)


Following
is a summary of unaudited quarterly results for the years ended December 31,
2004 and 2003:





*(dollars
      in thousands except per share amounts)*
    
    First
      Quarter
    
    Second
      Quarter
    
    Third
      Quarter
    
    Fourth
      Quarter2004Total
      revenues
    
    $
    13,753
    
    $
    15,103
    
    $
    15,617
    
    $
    16,654Product
      revenues
    
    
    13,345
    
    
    14,453
    
    
    14,947
    
    
    16,006Cost
      of products sold
    
    
    4,118
    
    
    4,509
    
    
    4,444
    
    
    4.684Net
      income
    
    
    883
    
    
    1,046
    
    
    1,113
    
    
    4,142(1
    )Income
      per share of common stock - basic
    
    
    0.03
    
    
    0.04
    
    
    0.04
    
    
    0.14Income
      per share of common stock - diluted
    
    
    0.03
    
    
    0.03
    
    
    0.03
    
    
    0.132003Total
      revenues
    
    $
    8,995
    
    $
    9,680
    
    $
    10,505
    
    $
    11,069Product
      revenues
    
    
    8,585
    
    
    9,143
    
    
    10,103
    
    
    10,746Cost
      of products sold
    
    
    2,540
    
    
    2,820
    
    
    2,995
    
    
    3.886Net
      income
    
    
    562
    
    
    380
    
    
    506
    
    
    17,224(2
    )Income
      per share of common stock - basic
    
    
    0.03
    
    
    0.02
    
    
    0.02
    
    
    0.68Income
      per share of common stock - diluted
    
    
    0.02
    
    
    0.01
    
    
    0.02
    
    
    0.56




(1)
    Includes
      a $2,860,000 tax benefit resulting from reversal of deferred tax asset
      valuation allowance.





(2)
    Includes
      a $16,656,000 tax benefit resulting from reversal of deferred tax asset
      valuation allowance.




F-19