**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

| **x**                                            | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**     |
|--------------------------------------------------|-----------------------------------------------------------------------------------------------|
| **For the fiscal year ended: December 31, 2006** |
| **or**                                           |
| **o**                                            | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from                to                **

**CommissionFile Number: 0-23678**

**BioSphere Medical, Inc.**

(Exact Name of Registrantas Specified in Its Charter)

| **Delaware**                                   | ** ** | **04-3216867**       |
|------------------------------------------------|------------|----------------------|
| (State or Other  Jurisdiction of Incorporation |       | (I.R.S. Employer     |
| or Organization)                               |       | Identification  No.) |

 

**1050 Hingham Street,Rockland, Massachusetts 02370**

(Address of PrincipalExecutive Offices) (Zip Code)

**(781) 681-7900**

(Registrant’s telephonenumber, including area code)

Securities registered pursuant to Section 12(b) of theAct:

**common stock, $.01 parvalue**

(Title of class)

Securities registered pursuant to Section 12(g) of theAct:

**None**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes  o    No  x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 orSection 15(d) of the Act. Yes  o    No  x

Indicate by check mark whether the registrant:(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  x    No  o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler  o    Acceleratedfiler  o    Non-acceleratedfiler  x

Indicate by check mark whether the registrant is ashell company (as defined in rule 12b-2 of the Act). Yes  o    No  x

The aggregate market value of voting common stock heldby non-affiliates of the registrant on June 30, 2006, was $65,821,973based on the closing price of the common stock as reported by the NASDAQNational Market as of such date.

The Registrant had 17,970,964 shares of common stockoutstanding as of March 1, 2007.

**Documentsincorporated by reference:**

Portionsof the Registrant’s Definitive Proxy Statement for the 2007 Annual Meeting ofStockholders of the Registrant are incorporated by reference into Part IIIof this Form 10-K.

 

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**BioSphere Medical, Inc.INDEX**

|                                         | ** ** | **Page**                                                                                                            | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|
| Part I—Financial  Information |       |                                                                                                                |       |   |   |
| Item 1.                            |       | Business                                                                                                            |       |   | 3 |   |   |
| Item 1A.                                |       | Risk Factors                                                                                                        |       |   | 20 |   |   |
| Item 1B.                                |       | Unresolved Staff Comments                                                                                           |       |   | 35 |   |   |
| Item 2.                                 |       | Properties                                                                                                          |       |   | 36 |   |   |
| Item 3.                                 |       | Legal Proceedings                                                                                                   |       |   | 36 |   |   |
| Item 4.                                 |       | Submission of Matters to a  Vote of Security Holders                                                                |       |   | 36 |   |   |
| Part II                            |       |                                                                                                                |       |   |   |   |   |
| Item 5.                                 |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       |   | 38 |   |   |
| Item 6.                                 |       | Selected Financial Data                                                                                             |       |   | 40 |   |   |
| Item 7.                                 |       | Management’s Discussion and  Analysis of Financial Condition and Results   of Operations                       |       |   | 41 |   |   |
| Item 7A.                                |       | Quantitative and Qualitative  Disclosures about Market Risk                                                         |       |   | 53 |   |   |
| Item 8.                                 |       | Financial Statements and  Supplementary Data                                                                        |       |   | 56 |   |   |
| Item 9.                                 |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                               |       |   | 77 |   |   |
| Item 9A.                                |       | Controls and Procedures                                                                                             |       |   | 77 |   |   |
| Item 9B.                                |       | Other Information                                                                                                   |       |   | 77 |   |   |
| Part III                           |       |                                                                                                                |       |   |   |   |   |
| Item 10.                                |       | Directors, Executive  Officers and Corporate Governance                                                             |       |   | 78 |   |   |
| Item 11.                                |       | Executive Compensation                                                                                              |       |   | 78 |   |   |
| Item 12.                                |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters.                    |       |   | 78 |   |   |
| Item 13.                                |       | Certain Relationships and  Related Transactions, and Director   Independence                                        |       |   | 79 |   |   |
| Item 14.                                |       | Principal Accountant Fees  and Services                                                                             |       |   | 79 |   |   |
| Part IV                            |       |                                                                                                                |       |   |   |   |   |
| Item 15.                                |       | Exhibits and Financial  Statement Schedules                                                                         |       |   | 79 |   |   |
| Exhibit Index                      |       |                                                                                                                | 80         |   |   |
| Signatures                              |       |                                                                                                                | 84         |   |   |

 

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**PART I**

*This annual reporton Form 10-K contains forward-looking statements that involve risks,uncertainties and assumptions that, if they never materialize or proveincorrect, could cause the results of BioSphere Medical, Inc. to differmaterially from those expressed or implied by such forward-looking statements.All statements other than statements of historical fact are statements thatcould be deemed forward-looking statements, including any projections ofrevenues, expenses, earnings or losses from operations, or other financialitems; any statements of the plans, strategies and objectives of management forfuture operations; any statements concerning product research, development,regulatory approval and commercialization timelines and expectations regardingmarket acceptance and market penetration for our products; any statements ofexpectation or belief; and any statements of assumptions underlying any of theforegoing. The risks, uncertainties and assumptions referred to above includerisks that are described in “Risk Factors” and elsewhere in this annual reporton Form 10-K and that are otherwise described from time to time inour Securities and Exchange Commission reports filed after this report on Form 10-K.*

*The forward-looking statements included in this annualreport on Form 10-K represent our estimates as of the date of thisannual report on Form 10-K. We specifically disclaim any obligationto update these forward-looking statements in the future. These forward-lookingstatements should not be relied upon as representing our estimates or views asof any date subsequent to the date of this annual report on Form 10-K.*

**Item 1.**                        BUSINESS

**OVERVIEW**

We develop, manufacture and market products formedical procedures using embolotherapy techniques. Embolotherapy is thetherapeutic introduction of various biocompatible substances into a patient’scirculatory system to occlude a blood vessel, either to arrest or preventhemorrhaging, or to devitalize the structure or organ by depleting its bloodsupply. Our core technologies consist of patented bioengineered polymers, whichare chemical compounds that we create through the application to medicalscience of engineering principles and manufacturing methods. These coretechnologies are used to produce miniature spherical embolic particles withuniquely beneficial properties for a variety of medical applications. By selectively blocking the target tissue’sblood supply, the deprived tissue will either become destroyed or devitalized,resulting in therapeutic benefit.

Our principal focus is the treatment of symptomaticuterine fibroids, which are noncancerous (benign) tumors growing within or onthe wall of the uterus, using a procedure called uterine fibroid embolization,or UFE. UFE is a minimally invasive procedure in which microspheres areinjected through a microcatheter into the blood vessels that supply the uterus.Blood flow guides these particles into the network of vessels thatpreferentially flow toward the fibroids, thereby blocking the blood supply to thefibroids, but not the surrounding healthy tissue. Most patients with uterinefibroids are not initially symptomatic and remain untreated until the patientexperiences symptoms such as abnormal bleeding, increased urinary frequency,pain, pelvic discomfort or fertility difficulties. Our products are gainingacceptance in this procedure, as well as in a number of other new andestablished medical treatments, including the use of microspheres in thetreatment of hypervascularized tumors like hepato-cellular carcinoma, or HCC,or primary cancer of the liver. Our strategy is to grow our embolotherapybusiness worldwide through increases in UFE and hypervascularized tumorembolization procedures, by increasing the awareness and availability of theseprocedures. Additionally, we expect to maintain our current technologyleadership by introducing new products and product improvements through bothinternally developed and externally acquired technologies, that improve andbroaden the use of embolotherapy techniques.

Our pioneering embolic products, Embosphere® Microspheres and EmboGold® Microspheres, have a number of beneficialproperties that we believe make them well suited for embolotherapy procedures. 

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Because of their uniform,spherical shape and soft, slippery surface, our particles are easy to injectthrough small catheters, resulting in an even distribution within the vesselnetwork. We provide these products in calibrated size ranges, so they can beselected to target occlusion of specific sized vessels designed to producepredictable results and optimize therapeutic benefit.

In November 2002, we received 510(k) clearancefrom the United States Food and Drug Administration, or FDA, to market ourEmbosphere Microspheres for UFE. Third-party clinical data and publicationssupport the safety, efficacy, cost-effectiveness and long-term durability ofthe UFE procedure. We believe that the medical community accepts UFE as aneffective option for most patients who are on drug therapy or are consideringundergoing surgery, such as hysterectomy or myomectomy, for treatment of theiruterine fibroids. For these reasons, we believe the number of UFE procedureswill increase at an accelerating rate. We were the first company to gainregulatory clearance to market a product for UFE in the United States. Over thepast two years, we focused on growing our Embosphere Microsphere businessthrough the development of physician referral networks and patient awarenessprograms. We continue to expand our sales and marketing organization tomaintain our leadership position in the field of UFE.

We also believe that there are growth opportunitiesfor other embolotherapy procedures, notably in the treatment ofhypervascularized tumors like primary liver cancer tumors. In May 2000, weobtained a worldwide exclusive royalty-bearing license to HepaSphereTMMicrospheres from Dr. Shinichi Hori. HepaSphere Microspheres havedifferent properties than Embosphere Microspheres and EmboGold Microspheres.Specifically, HepaSphere Microspheres have an ability to absorb fluids andexpand to four times their dry state in the body while maintaining theirspherical form. HepaSphere Microspheres occlude with a high degree ofconformity to the vessel wall. Additionally, HepaSphere Microspheres can beused to deliver a chemotherapeutic agent to specified areas of the body whenused in the treatment of liver tumors. We have CE mark approval to market ourHepaSphere Microspheres in the European Union for the treatment of primary andmetastatic liver cancer and are in early stage commercial introduction withlimited sales of this product. CE mark approval denotes conformity withEuropean standards for safety and allows certified devices to be placed in themarket in European Union countries. Under Japanese private import regulations, Dr. Hori,as the inventor and licensor of our HepaSphere Microspheres, has purchased fromus limited quantities of HepaSphere Microspheres for clinical evaluation anduse in the treatment of liver cancer. In the future, we intend to seekregulatory approval of the HepaSphere Microspheres in Japan, but do not expectthat such approval will be granted, if at all, in the near term. In March 2006,we instituted a voluntaryrecall of our HepaSphere Microspheres in Europe and Japan to correct apackaging defect that we identified while conducting aging studies routinelyperformed on all of our product packaging. HepaSphere Microspheres arecontained in a prefilled vial that was in turn previously packaged inside apaper pouch. We determined that a defect in the paper pouch may compromise thesterility of the outside of the vial. If the sterility of the outside of thevial was not maintained, there was the risk that a physician’s hands couldbecome contaminated when handling the vial. We are not aware of any adverseevents resulting from the defects in the paper packaging. Sales of HepaSphereMicrospheres outside of the United States resumed in the paper pouch packagingwith a shortened shelf life during the second quarter, and we launched a newpackaging configuration for HepaSphere Microspheres in the third quarterof 2006.

In November 2006, the FDA granted marketclearance for our proprietary QuadraSphereTM Microspheres, for treatment ofhypervascularized tumors and peripheral defects in the body’s circulatorysystem, known as arteriovenous malformations. Our QuadraSphere Microspheres areidentical in all respects to our HepaSphere Microspheres, which are marketedoutside of the United States for the treatment of primary and metastatic livercancer. The FDA clearancefor QuadraSphere Microsphere does not include specific indications for the treatmentof primary and metastatic liver cancer. FDA regulations require that we conductformal clinical trials prior to seeking to claim the use of QuadraSphereMicrosphere for the treatment of a specific disease or condition, such asprimary and metastatic liver 

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cancer,while European Union regulations do not require trials for this class ofmedical device. Accordingly, in order for us to seek FDA clearance to promotethe use of QuadraSphere Microsphere for the embolization of primary andmetastatic liver cancer, we must conduct clinical trials in the United States.

Also in 2006, wereceived the following regulatory approvals:

·       inJune 2006, the FDA granted market clearance for our SequitorTM SteerableGuidewire, or Sequitor, in the United States,

·       inAugust 2006, the FDA granted market clearance in the United States for ourEmboCath®  Plus Infusion Microcatheter, and

·       inthe third quarter of 2006, our Sequitor Guidewire and EmboCath Plus InfusionMicrocatheter were CE marked for marketing in the European Union.

Additionally, we have filed for marketing approval ofour Embosphere Microspheres in the People’s Republic of China and in Korea, andwe expect market release in 2007.

We believe that our microsphere technologies may haveseveral non-embolotherapy uses, including tissue bulking, for the treatment ofgastroesophageal reflux disease and for use in cosmetic dermatology and we havefiled a number of patent applications, and have issued U.S. patents, related tothe application of our technologies in these non-embolotherapy applications.Although our current focus is on embolotherapy markets, and significantadditional preclinical and clinical research in non-embolotherapy areas will berequired, we believe that these non-embolotherapy uses may provide us at somepoint in the future with development and commercialization opportunitiesthrough internal efforts or third-party licensing, collaboration or similaropportunities.

We were incorporated in Delaware in 1993. Ourprincipal executive offices are located at 1050 Hingham Street, Rockland,MA 02370, and our telephone number is (781) 681-7900. Unless thecontext otherwise requires, references in this annual report on Form 10-Kto “BioSphere,” “we,” and “our” refer to BioSphere Medical, Inc. and oursubsidiaries.

We maintain a website with the addresswww.biospheremed.com. We are not including the information contained in ourwebsite as part of, or incorporating it by reference into, this annual reporton Form 10-K. We make our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-Kand all amendments to those reports available free of charge on our website assoon as reasonably practicable after we electronically file those materialswith, or furnish those materials to, the United States Securities and ExchangeCommission, or SEC.

BioSphere MedicalTM,Embosphere®,EmboGold®, EmboCath®, Segway®, EmboCath® Plus, SequitorTM, HepaSphereTM, QuadraSphereTM,ask4UFE.com®, andPassthruTM are trademarks of BioSphere Medical, Inc. Other trademarksappearing in this annual report are the property of their respective holders.

**INDUSTRY OVERVIEW**

**EmbolotherapyMarkets**

Embolotherapy has been inuse for more than 20 years by interventional radiologists to mechanically blockthe flow of blood to treat certain peripheral tumors and arteriovenousmalformations and to control blood loss. In the past decade, interventionalradiologists around the world have adopted new embolotherapy procedures,including UFE and embolization for the treatment of certain cancers, inparticular primary liver cancer tumors. Moreover, we believe that an increasingnumber of affected 

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patientsare seeking alternative treatments with embolotherapy due to their desire forless invasive treatment options than those presented by non-embolotherapyprocedures.

**Uterine Fibroids**

Until recently,women suffering from uterine fibroids have had few treatment options. Theseexisting treatment options include the following:

·       **Hysterectomy.  **Hysterectomy is a surgical procedure toremove the uterus. While hysterectomy has a relatively low complication rate,it requires a hospital stay of several days, a recovery period of up to six toeight weeks, and results in loss of fertility. Furthermore, hysterectomies havebeen tied to adverse psychological effects, sexual and urinary dysfunction, aswell as the onset of early menopause. In addition, for many women who havetheir ovaries removed during hysterectomy, this treatment means extended hormonereplacement therapy.

·       **Myomectomy.  **Myomectomy is the surgical removal of theuterine fibroids without removal of the uterus. It is usually performed onwomen who wish to preserve their fertility. Only fibroids that can be easilyaccessed and excised are candidates for removal with this technique. Becausesome fibroids are difficult to identify while others are difficult to remove,there is a relatively high recurrence rate, between 10% and 60%, aftermyomectomy. Partly for this reason and because only a small percentage ofgynecologists are trained to perform this procedure, relatively fewmyomectomies are performed compared to the number of eligible patients.

·       **Drug Therapy and “Watchful Waiting.”  **Drug therapiesinclude non-steroidal anti-inflammatory drugs, oral contraceptive pills,progestational agents and gonadotropin-releasing hormone agonists. Physiciansmay choose to monitor women with less severe symptoms who elect against drugtherapy and those seeking to conceive and may determine to administer therapyonly if the patient’s condition worsens.

·       **Other Treatments.**   Other treatments for uterine fibroidsinclude high intensity focused ultrasound and global endometrial ablation. Highintensity focused ultrasound is a method of delivering ultrasonic energy to adiscrete point with resultant heat and tissue destruction, but without causinga significant temperature increase or cellular injury to tissue in the path ofthe ultrasound beam. Global endometrial ablation describes the minimallyinvasive application of energy to destroy the endometrial lining in women whoare experiencing severe menstrual bleeding and who do not desire futurepregnancy.

**Liver Cancer**

Liver cancer is one of the most prevalent forms ofcancer worldwide. There are several types of liver cancer.

Primary liver cancer is typically diagnosed at a stagethat is too advanced to cure surgically. Primary liver cancer refers to cancerthat begins within the liver itself. Chronic hepatitis B and chronichepatitis C, inflammations of the liver associated with the hepatitisvirus, are contributing factors to the development of primary liver cancer. Inthe United States approximately 80% of patients diagnosed with primary liver cancerare not surgical candidates. For these patients existing treatment options areprimarily designed to improve quality of life rather than cure the underlyingdisease. Metastatic liver cancer occurs when cancer begins in another part ofthe body, such as the colon, and then migrates, or spreads, to the liver. Inthe United States, metastatic liver cancer is more prominent than primary livercancer. However, the rate of primary liver cancer is expected to increasedramatically in the United States due to increased incidences of hepatitis C, akey risk factor for primary liver cancer. Outside the United States, there is ahigh 

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incidence of primary livercancer in areas where there are high rates of the hepatitis B and Cviruses, particularly Asia.

Numerous studies and medical publications indicatethat embolotherapy has been used for at least 20 years to treat livercancer. For example, particle embolization is commonly used in Japan to manageliver cancer patients. In the United States, embolic particles are commonlyinjected with chemotherapeutic agents to control and target distribution of thechemotherapy agents, thereby increasing the therapeutic exposure at a specificarea. Recently, a new, targeted approach to treating liver cancer usingradioactive particles has become available. These particles, which are similarto our Embosphere Microspheres, are delivered in a targeted fashion throughcatheters placed in the feeding vessels near the tumor site.

A number of other, lessinvasive technologies are either in use or in development to treat inoperableprimary liver cancer. One example of these technologies is selective tumorablation, which uses needle-like devices containing thermal energy or chemicalsthat are placed directly through the skin and into the tumor. However,application of this technique is practically limited to those with adequateliver function and relatively small tumors.

**Non-EmbolotherapyApplications**

Although our current focus is to develop ourembolotherapy business, we believe there may be alternative uses for our coretechnology in non-embolotherapy applications, particularly as bulking agents toreplace or supplement tissue support. Bulking agents are materials, injectedinto body sites, used to provide extra physical support where normal anatomicsupport is not present. These applications include gastroesophageal refluxdisease and cosmetic dermatology.

We have filed numerous patent applications fortechnologies related to non-embolotherapy applications. Although we arecurrently focusing our resources and efforts on the embolotherapy business andsignificant additional preclinical and clinical research in these areas wouldbe required, we believe that these non-embolotherapy uses may provide us withdevelopment and commercialization opportunities in the future.

**PRODUCTS**

Our innovative microsphere technology evolved out ofapproximately 15 years of research and development of polymer formulations usedin the field of biological separations and drug purification.

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The following tablessummarize information about our principal products and products in research anddevelopment.

**Principal Products**

| **PRODUCT**                           | ** ** | **CLEARED FOR THE FOLLOWING  INTENDED USES**                                                                    | ** ** | **GEOGRAPHIC APPROVALS**                                                                                                                                                                 |
|---------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Microsphere Products:**             |       |                                                                                                                           |       |                                                                                                                                                                                     |
| Embosphere Microspheres          |       | Uterine fibroids,  hypervascularized tumors and other arteriovenous malformations                                              |       | United States,  Canada, European Union, Argentina, Brazil, Colombia, Costa Rica, Ecuador,  Panama, Peru, Uruguay, Hong Kong, Taiwan and Australia and clinical  evaluation in China |
| EmboGold Microspheres                 |       | Hypervascularized tumors (other than uterine  fibroids) and arteriovenous malformations                                        |       | United States, Canada, European Union, Argentina,  Brazil, Colombia, Costa Rica, Ecuador, Panama, Peru, Uruguay, Hong Kong,  Taiwan and Australia                                   |
| HepaSphere Microspheres          |       | Primary and metastatic liver cancer                                                                                            |       | European Union                                                                                                                                                                           |
| QuadraSphere  Microspheres            |       | Hypervascularized tumors and arteriovenous  malformations                                                                      |       | United States                                                                                                                                                                            |
| **Delivery System Products:**         |       |                                                                                                                           |       |                                                                                                                                                                                     |
| EmboCath Infusion  Catheter           |       | Peripheral embolization procedures                                                                                             |       | United States, Canada, European Union, Argentina,  Brazil, Costa Rica, Panama and China                                                                                             |
| Segway Guidewire                      |       | Peripheral embolization procedures                                                                                             |       | United States, Canada, European Union, Argentina,  Brazil, Costa Rica, Panama and China                                                                                             |
| EmboCath Plus Infusion  Microcatheter |       | Infusion of various diagnostic, embolic and  therapeutic agents and super-selective angiography within peripheral  vasculature |       | United States, Canada and European Union                                                                                                                                                 |
| Sequitor Steerable  Guidewire         |       | Various diagnostic and interventional procedures  within peripheral vasculature                                                |       | United States, Canada and European Union                                                                                                                                                 |

 

**Products inResearch and Development**

| **PRODUCT CANDIDATE**                         | ** ** | **POTENTIAL MARKETS**                                                             | ** ** | **DEVELOPMENT STATUS**                   |
|-----------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|------------------------------------------|
| MR Microspheres (magnetic  resonance visible) |       | Uterine fibroids, hypervascularized tumors and other  arteriovenous malformations |       | Preclinical research—animal studies |
| Resorbable  Microspheres                      |       | Uterine fibroids, hypervascularized tumors and other  arteriovenous malformations |       | Preclinical research—feasibility    |

 

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**EmbosphereMicrospheres**

Our Embosphere Microspheres and EmboGold Microspheresproducts are intended for use in embolotherapy to block or control the bloodsupply to certain tumors and other vascular malformations. In November 2002,we received regulatory clearance in the United States from the FDA for use ofour Embosphere Microspheres in treating uterine fibroids. In April 2000,we received 510(k) marketing clearance from the FDA for our EmbosphereMicrospheres for hypervascularized tumors and arteriovenous malformations.

We believe that UFE will become the principalapplication for our microsphere products. The majority of our revenues arecurrently derived from the sale of our Embosphere Microspheres for UFE. Uterinefibroid embolization is a minimally invasive procedure, performed principallyby interventional radiologists, in which microspheres are injected through asmall catheter into the blood vessels that supply the uterus. Blood flow guidesthese particles into the network of vessels that preferentially flow toward thefibroids, thereby blocking the blood supply to the fibroids, but not to thesurrounding healthy tissue. The goal of the uterine fibroid embolizationprocedure is to eliminate the flow of blood to the uterine fibroids, therebycausing fibroid shrinkage and alleviating related symptoms, while preservingnormal uterine and ovarian function.

We believe that embolotherapy is a significantly moreattractive alternative for treatment of uterine fibroids, when compared to theinvasiveness of such surgical procedures as hysterectomy or myomectomy, or tohormone therapy and “watchful waiting.” Current therapies can have significantadverse side effects, including loss of fertility, lengthy recovery periods,high costs, discomfort and risk of recurrence of fibroids.

Although the effect of uterine fibroid embolization oncontinued fertility or fetal development has not been studied extensively, andour 510(k) clearance does not include women who intend future pregnancy,we believe that uterine fibroid embolization has the potential to preserve thefertility of at least some of the patients that would otherwise be lost throughhysterectomy or may be compromised by the use of current therapies ortechnologies, and to reduce or eliminate the risk of recurrence of the uterinefibroid tumor and the complications associated with myomectomy. Most uterinefibroid embolization procedures can be performed in less than one hour, whilethe patient is sedated, but awake. The patient often stays overnight in the hospitalto manage any discomfort and/or pain associated with the procedure andtypically returns to everyday activities in several days. In contrast,hysterectomy patients undergo general anesthesia and typically stay in thehospital for two to three days and have a recovery period lasting up to six toeight weeks.

We believe Embosphere Microspheres are also being usedin other disease areas and procedures, including embolization of primary livercancer tumors and arteriovenous malformations, although we are currentlydevoting most of our internal efforts to marketing and selling this product forUFE.

EmbosphereMicrospheres have a variety of characteristics that may make them preferable toother currently marketed particles. These include:

·       **Uniform Spherical Shape/Calibrated Particle Size.**   We areable to synthesize beads with uniform sizing and a spherical shape. Whenembolic materials are non-spherical or irregularly sized, as is the case withthe polyvinyl alcohol, or PVA particles that have been historically used inthese applications, clinicians find vessel targeting more difficult and mayalso experience an increased incidence in unwanted embolization of bloodvessels away from the site of the tumor.

·       **Compliant and Resilient Properties.**   We have developed asoft, elastic microsphere that has the capability to compress significantly,thus facilitating delivery through very small catheters known asmicrocatheters. Many clinicians prefer using microcatheters duringembolization, since such catheters minimize the frequency of artery or vesselspasm during the procedure. Vessel spasm can be of particular concern duringuterine fibroid embolization as it can disrupt the flow of blood, 

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which clinicians rely onduring embolization to direct the microspheres to the vessel targeted for occlusion.

·       **Hydrophilic Properties.**   As a result of the materialsused to manufacture microspheres, our products are hydrophilic, which meansthat they absorb moisture. This characteristic is important in that it preventsthe microspheres from clumping in the catheter or in the artery during theprocedure.

·       **Nonbiodegradability.**   Our microspheres are composed of asynthetic three-component polymer that is compatible with the human body. Thispolymer is insoluble and nonbiodegradable. We believe, therefore, that our EmbosphereMicrospheres are an appropriate agent for permanent vessel occlusion.

·       **Cell Adhesion.**   Our Embosphere Microspheres arecross-linked with a cell adhesion promoter composed of gelatin, which isdesigned to enhance a stable and complete occlusion of the vessel.

·       **Charged Surface Property.**   Our microspheres arepositively charged, enhancing attraction to the negatively charged blood vesselwall. This attachment to the vessel wall minimizes the potential for themicrospheres to migrate to nontargeted vessels.

Embosphere Microspheresare currently available in six sizes, from 40 to 1,200 microns. They aredesigned to precisely fit the blood vessels, resulting in targeted andcontrolled occlusion. They can be used with our accessory catheter products orwith other commercially available catheter and delivery systems.

**EmboGoldMicrospheres**

Our EmboGold Microspheresproduct was launched in the United States in September 2001 afterreceiving FDA clearance for treatment of hypervascularized tumors andarteriovenous malformations. In March 2002, we received CE mark approvalin the European Union. This product enhancement adds color to the microspheresfor improved visibility in the syringe during preparation and injection. We donot have FDA clearance to market our EmboGold Microspheres for use in thetreatment of uterine fibroids, and have determined not to seek such approval atthis time. We made this decision in 2003 because of reports that a small numberof patients treated with UFE using EmboGold Microspheres, which we believeconstitutes approximately 2% of the total number of patients receiving the UFEprocedure using EmboGold Microspheres, reported a delayed onset of pain and/orrash.

**HepaSphereMicrospheres**

HepaSphere Microspheres are marketed in the EuropeanUnion for the treatment of primary and metastatic liver cancer. Under Japaneseprivate import regulations, Dr. Hori, as the inventor and licensor of ourHepaSphere Microspheres, has purchased from us limited quantities of HepaSphereMicrospheres for clinical evaluation and use in the treatment of liver cancerand other malignant and benign tumors. In the future, we intend to seekregulatory approval of the HepaSphere Microspheres in Japan, but we do notexpect regulatory approval to market HepaSphere Microspheres in Japan in thenear term.

The productattributes of HepaSphere Microspheres are:

·  an ability to expand and absorb fluids, suchas saline, contrast agents and human serum, that create expansion to 4 timesits dry state diameter in the body—64 times its initial volume—whilemaintaining its spherical form;

·  a high degree of conformity to vessel anatomy;

·  a capability for complete occlusion of avessel with, on average, just a single particle; and

·  the ability to carry a chemotherapeutic agent.

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Like treatment of uterine fibroids, targeted liverembolotherapy is intended to starve the liver tumor without damaging thesurrounding tissue or causing any adverse side effects on other parts of thebody, such as those associated with chemotherapy and radiation. In May 2000,we obtained a worldwide exclusive royalty-bearing license to HepaSphereMicrosphere from Dr. Shinichi Hori.

In March 2006, we instituteda voluntary recall of our HepaSphere Microspheres in Europe and Japan tocorrect a packaging defect that we identified while conducting aging studiesroutinely performed on all of our product packaging. HepaSphere Microspheresare contained in a prefilled vial that was in turn initially packaged inside apaper pouch. We determined that a defect in the paper pouch may compromise thesterility of the outside of the vial. If the sterility of the outside of thevial was not maintained, there was the risk that a physician’s hands couldbecome contaminated when handling the vial. We are not aware of any adverseevents resulting from the defects in the paper packaging. We resumed sales ofHepaSphere Microspheres outside the United States in the paper pouch with ashortened shelf life during the second quarter, and we launched a new plasticpackaging configuration for HepaSpheres Microspheres in the third quarter of2006.

**QuadraSphereMicrospheres**

In November 2006, the FDA granted marketingclearance for our QuadraSphere Microspheres in the United States for thetreatment of hypervascularized tumors and peripheral arteriovenousmalformations. Our QuadraSphere Microsphere product is technically identical inall respects to our HepaSphere Microsphere product. However, the FDA clearancefor QuadraSphere Microspheres does not include specific indications for thetreatment of primary and metastatic liver cancer. FDA regulations require thatwe conduct formal clinical trials prior to seeking to claim the use ofQuadraSphere Microspheres for the treatment of a specific disease or condition,such as primary and metastatic liver cancer, while European Union regulationsdo not require trials for this class of medical device. Accordingly, in orderfor us to seek FDA clearance to promote the use of QuadraSphere Microspheresfor the embolization of primary and metastatic liver cancer, we must conductclinical trials in the United States.

The productattributes of QuadraSphere Microspheres are:

·       anability to expand and absorb fluids, such as saline, contrast agents and humanserum, that create expansion to 4 times its dry state diameter in the body—64times its initial volume—while maintaining its spherical form;

·       ahigh degree of conformity to vessel anatomy;

·       acapability for complete occlusion of a vessel with, on average, just a singleparticle; and

·       the ability to carry achemotherapeutic agent.

**Delivery Systems**

In 2006, we introduced our EmboCath Plus InfusionMicrocatheter and Sequitor Steerable Guidewire products, which are used todeliver embolization material into the target area. In developing these deviceswe sought to build on the advantages of our existing EmboCath Infusion Catheterand Segway Guidewire products by adding enhanced tracking, torque response,coating technology to the product lines and were specifically designed to beused together to optimize flexibility.

In August 2006, we received FDA clearance tomarket our EmboCath Plus Infusion Catheter. The EmboCath Plus Infusion Catheteris a microcatheter that is designed to be used to deliver embolic, diagnostic,and therapeutic agents into the peripheral vascular system for interventionalprocedures such as UFE and the embolization of hypervascular tumors.

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The productattributes of the EmboCath Plus Infusion Catheter are:

·       Controlleddelivery, featuring the largest internal lumen diameter in its class—0.028”—whichprovides a 10% greater flow rate than competitive products;

·       Aflexible, kink-resistant, durable design that offers optimal balance for agiletracking;

·       Aclear, chemo-compatible hub designed for smooth, fluent injection ofmicrospheres; and

·       Enhancedfluoroscopic ability via an extra-bright tip.

In June 2006,we introduced our Sequitor Steerable Guidewire, designed specifically for usewith our EmboCath Plus Infusion Catheter. Guidewires are used in most intravascularcatheter procedures to establish a support structure for, and to aid placementof, the catheter. Wedesigned our Sequitor Guidewire to address the needs of interventionalist withcharacteristics such as:

·       Adurable atraumatic polymer tip that reduces the risk of vascular spasm butretains its shape for selective vessel access;

·       Ahighly visible distal segment, comprised of a radiopaque coil and polymerjacket, which provides visibility under live imaging;

·       Aspecially tempered wire core designed to transmit one-to-one torque responsewithout kinking; and

·       PassthruTM lubricious,hydrophilic coating that facilities wire trackability.

**Other Products**

We also sell bariumdelivery kits and other ancillary products in the European Union. We purchasebarium from a third party and resell it for use in gastrointestinal medicaltesting. We sell other ancillary devices as medical products for hospital andphysician use. While we generated 11% and 13% of our revenues in 2006 and 2005,respectively, from these nonstrategic products, we expect these products to bea less significant component of our sales in 2007 and 2008.

**Products UnderDevelopment**

**MR Microspheres (magnetic resonancevisible sphere)**

Our MR Microsphere productunder development is intended to enhance our Embosphere Microspheres withfeatures that make the microspheres visible under magnetic resonance imaging,or MRI. Non-invasive detection of microspheres may be useful to enableimage-guided therapy as well as to optimize patient care. This productcandidate is currently in the preclinical research stage.

**ResorbableMicrospheres**

Our Resorbable Microsphereproduct under development is intended to enhance our Embosphere Microsphereswith features that would allow the microspheres to dissolve and be absorbedinto the body. This ability to dissolve once the desired therapeutic effect isachieved may be desirable for some patients. This product candidate iscurrently in the preclinical research stage.

**MANUFACTURING**

We currently produce andpackage all of our microsphere products at our facility located in Roissy,France. Manufacturing of microsphere products includes the synthesis andprocessing of raw materials and third-party manufactured compounds. In additionto the manufacturing of our microsphere products, we also manufacture andassemble our auxiliary products at our facility in France. The assembly and 

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packaging of delivery systems, which includesEmboCath, EmboCath Plus, Segway and Sequitor are all accomplished by medicaldevice contract manufactures in both the United States and Europe.

**MARKETING AND SALES**

We currently market our embolotherapy and deliverysystems products through a direct sales force of 34 persons in the UnitedStates and France and through distributors in Europe, Asia, Canada, the MiddleEast, Africa, South America and other parts of the world. Approximately 87% ofour revenue was generated through our direct sales force in 2006.

As part of our sales and marketing efforts, we attendmajor medical conventions throughout the world pertaining to our targetedmarkets and invest in market development, including physician training,referral network education and patient outreach. We work closely with majorinterventional radiology centers in the areas of training, therapy awarenessprograms, clinical studies and ongoing research.

No single customeraccounted for more than 10% of our revenue in 2006.

**RESEARCH ANDDEVELOPMENT**

Our research anddevelopment group is focusing on developing our product technology in threeareas:

·       continuousimprovement of our core technology;

·       newembolotherapy materials and platforms; and

·       complementaryembolotherapy products.

Our core technologies include microspheretechnologies, organic and inorganic polymer and surface chemistries formicrosphere design and development, and expertise and know-how in microspheremanufacturing.

During the fiscal yearsended December 31, 2006, 2005, and 2004, research and development expenseswere $2.29 million, $2.36 million and $2.11 million, respectively.

**COMPETITION**

We encounter, and expectto continue to encounter, competition in the sale of our current and futureembolotherapy and delivery system products. The primary competitiveembolotherapy product has been polyvinyl alcohol, or PVA particles, a productintroduced into the market more than 20 years ago. Our principal competitors inboth the fields of embolotherapy and the delivery systems used in the UFEprocedure are Angiodynamics Incorporated, Biocompatibles, Ltd., BostonScientific Corporation, Cook Incorporated, Cordis Corporation, a Johnson andJohnson Company, Pfizer, Inc. and Terumo Corporation, as well as companiesselling or developing non-embolotherapy solutions for the disease statestargeted by us. Currently, the primary products with which our microspherescompete for some of our applications are spherical PVA, sold by BostonScientific Corporation, Biocompatibles and Terumo, gel foam, sold by Pfizer,and non-spherical PVA, sold by Boston Scientific, Angiodynamics and Cook. Manyof our current competitors have, and our future competitors are likely to have,greater financial, operational, sales and marketing resources and moreexperience in research and development than we have. We compete primarily onthe basis of product performance, ease of use, degree of targeted embolization control,and quality of patient outcome. Within the field of uterine arteryembolization, we believe we are the market share leader and one of only twocompanies in the United States to have embolic products specifically indicatedfor use in UFE. Boston Scientific, which markets both a non-spherical PVAproduct and a spherical PVA product, is our principal competitor in this areaof the market. Based on both research and clinical studies conducted on ourproduct for UFE, we believe we offer physicians a 

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high degreeof ease of use, targeted delivery, durable vessel occlusion, and thereforesatisfactory short and long-term clinical outcomes, when compared to ourcompetitors.

**GOVERNMENTREGULATION**

*FDARegulation.**  *TheFDA, and other federal, state, local, and foreign authorities, regulate ourproducts and manufacturing activities. Pursuant to the Federal Food, Drug, andCosmetic Act and the regulations promulgated under that act, the FDA regulatesthe design, development, clinical trials, testing, manufacture, packaging,labeling, storage, distribution and promotion of medical devices. Before a newdevice that we develop can be introduced to the market, we must obtain marketclearance through a 510(k) notification or approval through a premarketapproval application. Additionally, the new cleared device may only beintroduced to the market if manufacturer quality system complies with 21CFR Part 820Quality System Regulations.

*Changesin Approved Devices.*   We must obtain new FDA 510(k) clearanceor premarket approval when there is a major change or modification in theintended use or indications for use of a legally marketed device or a change ormodification of the device, including product enhancements and product lineextensions, of a legally marketed device as required by FDA regulations.

*CurrentGood Manufacturing Practices / Quality System Regulations and Reporting.**  *The Federal Food, Drug, andCosmetic Act requires us to comply with Current Good Manufacturing PracticesQuality System Regulations. We must comply with various quality systemrequirements pertaining to all aspects of our product design and manufacturing process,including requirements for packaging, labeling and record keeping, complainthandling, corrective and preventive actions and internal auditing. The FDAenforces these requirements through periodic inspections of medical devicemanufacturers. In addition, the medical device reporting regulation requires usto inform the FDA whenever information reasonably suggests that one of ourdevices may have caused or contributed to death or serious injury, or when oneof our devices malfunctions, if the device would be likely to cause orcontribute to a death or a serious injury in the event the malfunctionrecurred. We believe that we, and all who manufacture our delivery systems, arein compliance with applicable Current Good Manufacturing Practices / QualitySystems Regulations and with medical device reporting requirements.

*Labelingand Advertising.*   Labeling and promotionalactivities are also subject to scrutiny by the FDA. Among other things,labeling violates the law if it is false or misleading in any respect or itfails to contain adequate directions for use. Moreover, product claims that areoutside the labeling either approved or cleared by the FDA violate the FederalFood, Drug, and Cosmetic Act.

Our product promotion is also subject to regulation bythe Federal Trade Commission under the Federal Trade Commission Act, whichprohibits unfair methods of competition and unfair or deceptive acts orpractices in or affecting commerce, as well as unfair or deceptive practicessuch as the dissemination of any false advertisement pertaining to medicaldevices.

*ImportRequirements.**  *Toimport a device, the importer must file an entry notice and bond with theUnited States Customs Service pending an FDA decision on the product’sadmissibility. All devices are subject to FDA examination before release fromCustoms. Any article that appears to be in violation of the Federal Food, Drug,and Cosmetic Act may be refused admission and a notice of detention and hearingmay be issued.

*ExportRequirements.*   Products for export from Europeand from the United States are subject to foreign countries’ importrequirements and the FDA’s or European regulating bodies’ exportingrequirements. In addition to the import requirements of foreign countries, wemust also comply with the U.S. laws governing the export of products regulatedby the FDA. However, foreign countries often require, among other things, anFDA certificate for products for export (Certificate for 

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Foreign Government).To obtain this certificate from the FDA, the device manufacturer must apply tothe FDA. The FDA certifies that the product has been granted clearance orapproval in the United States and that the manufacturing facilities are incompliance with Good Manufacturing Practices regulations at the time of thelast FDA inspection.

*Finesand Penalties for Noncompliance.**  *Failure to comply with applicableFDA regulatory requirements could result in, among other things, marketclearance or approval withdrawal, injunctions, market withdrawals, voluntary ormandatory patient/physician notifications, recalls, warning letters, productseizures, civil penalties, fines and criminal prosecutions. Federal TradeCommission enforcement can result in orders requiring, among other things,limits on advertising, corrective advertising, consumer redress, rescission ofcontracts and such other relief as may be deemed necessary.

*ForeignRegulations.**  *Medicaldevice laws and regulations are also in effect in many countries outside of theUnited States. These range from comprehensive device approval requirements forsome or all of our medical device products to simpler requests for product dataor certification. The number and scope of these requirements are increasing.Sales of medical devices in the European Union are subject to compliance withthe European Medical Device Directive. This directive contains requirements forquality system and Essential Requirements with which all manufacturers mustcomply. In February 2006, we obtained ISO 13485:2003 Quality ManagementSystems Requirements for Regulatory Purposes certification at our Frenchfacility and in April 2006 at our facility in Rockland, MA showing thatour Quality System complies with standards for quality management.

*Failureto Comply.**  *Failureto materially comply with applicable federal, state and foreign medical devicelaws and regulations would likely have a material adverse effect on ourbusiness. In addition, federal, state and foreign regulations regarding themanufacture and sale of medical devices are subject to future changes.

*EnvironmentalRegulations.**  *We aresubject to various federal, state, local and foreign laws and regulationsrelating to the protection of the environment, as well as health and safety. Inthe course of our business, we are involved in the handling, storage anddisposal of limited amounts of certain chemicals. The laws and regulationsapplicable to our operations include provisions that regulate the discharge ofmaterials into the environment. Usually these environmental laws andregulations impose “strict liability,” rendering a person liable without regardto negligence or fault on the part of such person. Such environmental laws andregulations may expose us to liability for the conduct of, or conditions causedby, others, or for acts that were in compliance with all applicable laws at thetime the acts were performed. We have not been required to expend materialamounts in connection with our efforts to comply with environmentalrequirements or that compliance with such requirements will have a materialadverse effect upon our capital expenditures, results of operations orcompetitive position. Failure to comply with applicable environmental andrelated laws could have a material adverse effect on our business. In addition,because the requirements imposed by such laws and regulations are frequentlychanged, we are unable to predict the cost of compliance with such requirementsin the future, or the effect of such laws on our capital expenditures, resultsof operations or competitive position.

*Anti-KickbackStatutes.**  *Thefederal healthcare program Anti-Kickback Statute prohibits persons fromknowingly and willfully soliciting, offering, receiving or providingremuneration, directly or indirectly, in exchange for or to induce either thereferral of an individual for, or the furnishing, arranging for or recommendinga good or service for which payment may be made in whole or part under afederal healthcare program such as Medicare or Medicaid. The definition ofremuneration has been broadly interpreted to include anything of value,including, for example, gifts, discounts, the furnishing of supplies orequipment, credit arrangements, payments of cash and waivers of payments.Several courts have interpreted the statute’s intent requirement to mean thatif any one purpose of an arrangement involving remuneration is to inducereferrals or otherwise generate business involving goods or services reimbursed

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in whole or in part underfederal healthcare programs, the statute has been violated. The law contains afew statutory exceptions, including payments to bona fide employees, certaindiscounts and certain payments to group purchasing organizations. Violationscan result in significant penalties, imprisonment and exclusion from Medicare,Medicaid and other federal healthcare programs. Exclusion of a manufacturerwould preclude any federal healthcare program from paying for its products. Inaddition, some enforcement officials have argued that kickback arrangements canprovide the basis for an action under the Federal False Claims Act, which isdiscussed in more detail below.

The Anti-Kickback Statute is broad and potentiallyprohibits many arrangements and practices that are lawful in businesses outsideof the healthcare industry. Recognizing that the Anti-Kickback Statute is broadand may technically prohibit many innocuous or beneficial arrangements, theOffice of Inspector General of Health and Human Services, or OIG, has issued aseries of regulations, known as the safe harbors, beginning in July 1991.These safe harbors set forth provisions that, if all the applicablerequirements are met, will assure healthcare providers and other parties thatthey will not be prosecuted under the Anti-Kickback Statute. The failure of atransaction or arrangement to fit precisely within one or more safe harborsdoes not necessarily mean that it is illegal or that prosecution will bepursued. However, conduct and business arrangements that do not fully satisfyeach applicable safe harbor may result in increased scrutiny by governmentenforcement authorities such as the OIG. Arrangements that implicate theAnti-Kickback Statute, and that do not fall within a safe harbor, are analyzedby the OIG on a case-by-case basis.

Government officials have focused recent enforcementefforts on, among other things, the sales and marketing activities ofhealthcare companies, and recently have brought cases against individuals orentities with personnel who allegedly offered unlawful inducements to potentialor existing customers in an attempt to procure their business. Settlements ofthese cases by healthcare companies have involved significant fines and/orpenalties and in some instances criminal pleas.

In addition to the Federal Anti-Kickback Statute, manystates have their own kickback laws. Often, these laws closely follow thelanguage of the federal law, although they do not always have the sameexceptions or safe harbors. In some states, these anti-kickback laws apply withrespect to all payors, including commercial health insurance companies.

*FalseClaims Laws.**  *Federalfalse claims laws prohibit any person from knowingly presenting, or causing tobe presented, a false claim for payment to the federal government or knowinglymaking, or causing to be made, a false statement to get a false claim paid.Manufacturers can be held liable under false claims laws, even if they do notsubmit claims to the government, if they are found to have caused submission offalse claims. The Federal Civil False Claims Act also includes whistle blowerprovisions that allow private citizens to bring suit against an entity orindividual on behalf of the United States and to recover a portion of anymonetary recovery. Many of the recent highly publicized settlements in thehealthcare industry related to sales and marketing practices have been casesbrought under the False Claims Act. The majority of states also have statutesor regulations similar to the federal false claims laws, which apply to itemsand services reimbursed under Medicaid and other state programs, or, in severalstates, apply regardless of the payor. Sanctions under these federal and statelaws may include civil monetary penalties, exclusion of a manufacturer’sproducts from reimbursement under government programs, criminal fines andimprisonment.

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*Privacyand Security.**  *TheHealth Insurance Portability and Accountability Act of 1996, or HIPAA, and the rules promulgatedthereunder require certain entities, referred to as covered entities, to complywith established standards, including standards regarding the privacy andsecurity of protected health information, or PHI. HIPAA further requires thatcovered entities enter into agreements meeting certain regulatory requirementswith their business associates, as such term is defined by HIPAA, which, amongother things, obligate the business associates to safeguard the covered entity’sPHI against improper use and disclosure. While not directly regulated by HIPAA,a business associate may face significant contractual liability pursuant tosuch an agreement if the business associates breaches the agreement or causesthe covered entity to fail to comply with HIPAA. In the course of our businessoperations, we have entered into several business associate agreements withcertain of our customers that are also covered entities. Pursuant to the termsof these business associate agreements, we have agreed, among other things, notto use or further disclose the covered entity’s PHI except as permitted orrequired by the agreements or as required by law, to use reasonable safeguardsto prevent prohibited disclosure of such PHI and to report to the coveredentity any unauthorized uses or disclosures of such PHI. Accordingly, we incurcompliance related costs in meeting HIPAA-related obligations under businessassociates agreements to which we are a party. Moreover, if we fail to meet ourcontractual obligations under such agreements, we may incur significantliability.

In addition, HIPAA’scriminal provisions could potentially be applied to a non-covered entity thataided and abetted the violation of, or conspired to violate HIPAA, although weare unable at this time to determine conclusively whether our actions could besubject to prosecution in the event of an impermissible disclosure of healthinformation to us. Also, many state laws regulate the use and disclosure ofhealth information, and are not necessarily preempted by HIPAA, in particularthose laws that afford greater protection to the individual than does HIPAA.Finally, in the event we change our business model and become a HIPAA coveredentity, we would be directly subject to HIPAA, its rules and its civil andcriminal penalties.

**PROPRIETARYTECHNOLOGY AND PATENT RIGHTS**

We seek to establish and protect our proprietarytechnologies and products by developing and using a strategy involving acombination of patents, copyrights, trademarks and trade secrets, as well as byentering into licensing agreements and utilizing confidentiality provisionswhere appropriate. We have implemented a patent strategy designed to maximizeour intellectual property rights. We are pursuing patent coverage in the UnitedStates and foreign countries to protect the technology, inventions andimprovements that we consider critical to the development of our products andbusiness.

In January 1998, we entered into an agreementwith L’Assistance Publique-Hopitaux De Paris, referred to as AP-HP, pursuant towhich AP-HP has granted us the exclusive right to use two United States patentsand their foreign counterparts that we jointly own with AP-HP relating toEmbosphere Microspheres. We are required to pay to AP-HP a royalty on thecommercial sale of any products that incorporate technology covered by thepatents. We may only sublicense these exclusive rights under the agreement withthe prior written consent of AP-HP, which consent cannot be unreasonablywithheld. The rights granted under the contract are for an initial period,which ends on September 16, 2009, and are renewable by mutual agreementbetween the parties. The agreement can be terminated on three months’ notice byeither party if the other party does not perform one or more of its obligationsunder the agreement and fails to cure its nonperformance during the noticeperiod. These jointly-owned U.S. and foreign counterpart patents will expire in2014 and 2012, respectively.

In 2000, we entered into an agreement with Dr. ShinichiHori, pursuant to which we have an exclusive royalty-bearing license toJapanese patent rights for our HepaSphere Microsphere product. These patentrights expire in 2012. We continue to develop this technology and we areprosecuting U.S. and foreign patent applications related to this technology.However, present applications may not issue as patents, and 

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these patents, if issued,may not provide us with sufficient protection against competitors. Further, wemay be required to obtain additional licenses concerning the Japanese patentapplication and any licenses, if obtained, may not be on terms that areacceptable to us.

In addition to those listed above, we have a number ofUnited States and foreign patents and pending applications related to ourmicrosphere technology and uses thereof. For example, we have at least fiveU.S. and three foreign patents, and four U.S. and ten foreign counterpartpending applications related to microspheres and uses thereof for tissuebulking, tissue construction, dermal augmentation, and the treatment ofgastroesophageal reflux disease, or GERD, and urinary incontinence. The issuedU.S. and foreign counterpart patents expire at various dates between 2019 and2020. We also have at least four U.S. and five foreign counterpart pendingapplications related to microspheres and uses thereof for drug delivery andgene therapy. Additionally, we have at least one patent in each of the U.S. andEurope, as well as at least one pending application in each of the U.S. andJapan, related to PVA microspheres useful for embolization and methods thereof.The U.S. and European PVA patents expire in 2019. Other U.S. and foreigncounterpart patent applications have also issued or are currently pending. Thesubjects of these patents and applications include new materials forembolization, new methods of using our materials for embolization and otherapplications, as well as new uses of our materials outside of embolization.

We currently ownthe following U.S. trademarks:

·       ask4UFE.com®

·       BioSphereMedicalTM

·       Embosphere®

·       EmboCath®

·       EmboCath® Plus

·       EmboGold®

·       PassthruTM

·       QuadraSphereTM

·       Segway®

·       SequitorTM

Our success depends to a significant degree upon ourability to develop proprietary products and technologies and to obtain patentcoverage for these products and technologies. We intend to continue to filepatent applications covering any newly developed products and technologies.However, as discussed above, there can be no guarantee that any of our pendingor future filed applications will be issued as patents. There can be noguarantee that the United States Patent and Trademark Office or some thirdparty will not initiate an interference proceeding involving any of our pendingapplications or issued patents. Finally, there can be no guarantee that ourissued patents or future issued patents, if any, will provide adequateprotection from competition, as further discussed below.

Patents provide some degree of protection for ourproprietary technology. However, the pursuit and assertion of patent rights,particularly in areas like medical device development, involve complex legaland factual determinations and, therefore, are characterized by significantuncertainty. Specifically, enforcement or defense of our patents againstpotential or actual third party infringers may impose a significant burden onour financial and human resources, and we may be limited in our ability toprotect all of our rights. If we enforce our patents against third parties,they may challenge the validity or 

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enforceability of ourpatents. We cannot predict whether we will be successful in enforcing ourpatents or defending their validity or enforceability.

In addition, the laws governing patent issuance andthe scope of patent coverage continue to evolve, particularly in life sciences,and the patent rights we possess, or are pursuing, generally cover ourtechnologies to varying degrees. As a result, we cannot ensure that patentswill issue from any of our patent applications or from applications licensed tous, or that any of our issued patents will offer meaningful protection. Inaddition, our issued patents or patents licensed to us may be successfullychallenged, invalidated, circumvented or rendered unenforceable so that ourpatent rights may not create an effective competitive barrier. Moreover, thelaws of some foreign countries may not protect our proprietary rights to thesame extent, as do the laws of the United States. There can be no assurancethat any patents issued to us will provide a legal basis for establishing an exclusivemarket for our products or provide us with any competitive advantages, or thatthe patents of others will not have an adverse effect on our ability to dobusiness or to continue to use our technologies freely. In view of thesefactors, the value of our intellectual property position is uncertain.

We have one granted European Patent, EP 1128816,related to PVA microspheres useful for embolization and methods thereof. Wehave validated this European patent in Germany, Spain, France, United Kingdom andItaly. On January 13, 2005, we were notified of a Notice of Oppositionsfiled by Biocompatibles UK Limited on December 23, 2004 against thisEuropean patent. We have filed a response to the Notice of Opposition and wefiled Auxiliary Claims in August 2005. Biocompatible UK Limitedsubsequently filed a response in 2006. We will continue defending our EuropeanPVA patent in this proceeding. While we are not able to predict the outcome ofthis proceeding, it will not impact our ability to sell our EmbosphereMicrosphere, HepaSphere Microsphere or QuadraSphere Microsphere products, whichare not comprised of PVA.

We may be subject to third parties filing claimsasserting that our technologies or products infringe on their intellectualproperty. We cannot predict whether third parties will assert such claimsagainst us or our licensees or against the licensors of technology licensed tous, or whether those claims will harm our business. If we are forced to defendagainst such claims, regardless of their merit or whether they are resolved infavor of or against us, our licensees or our licensors, we may face costlylitigation and diversion of management’s attention and resources. As a resultof such disputes, we may have to develop, at a substantial cost, non-infringingtechnology, or enter into licensing agreements. These agreements, if necessary,may be unavailable on terms acceptable to us, or at all, which could seriouslyharm our business or financial condition.

We also rely in part ontrade secret protection of our intellectual property. We attempt to protect ourtrade secrets by entering into confidentiality agreements with third parties,employees and consultants. Our employees also sign agreements assigning to ustheir interests in inventions and original expressions and any correspondingpatents and copyrights arising from their work for us. However, it is possiblethat these agreements may be breached, invalidated or rendered unenforceable,and, if so, our trade secrets could be disclosed to others, including ourcompetitors, and there may not be an adequate corrective remedy available.Despite the measures we have taken to protect our intellectual property,parties to our agreements may breach the confidentiality provisions in ourcontracts or infringe or misappropriate our patents, copyrights, trademarks,trade secrets and other proprietary rights. In addition, third parties mayindependently discover or invent competitive technologies, or reverse engineerour trade secrets or other technology. Therefore, the measures we are taking toprotect our proprietary technology may not be adequate.

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**EMPLOYEES**

As of December 31, 2006, we employed 83 persons.Of these employees, nine are primarily engaged in research, development andclinical activities, 26 are engaged in manufacturing, 38 are engaged in salesand marketing, and the remainder are engaged in finance and administration. Ofthese 83 persons, 45 are located in the United States and 38 are located inFrance.

Our employees in theUnited States are not covered by a collective bargaining agreement. In Europe,our employees are covered by the provisions of an agreement setting forthnational guidelines and standards for labor relations within our industry. Weconsider our relations with our employees to be good.

**Item 1A.**                RISK FACTORS

*Investingin our common stock involves a high degree of risk. The risks described beloware not the only ones facing our company. Additional risks not presently knownto us or that we deem immaterial may also impair our business operations. Anyof the following risks could materially adversely affect our business,operating results and financial condition and could result in a complete lossof your investment.*

**Risks Relating toOur Future Profitability, Our Financial Results and Need For Financing**

**Because we have a history of losses and our futureprofitability is uncertain, our common stock is a speculative investment.**

We have incurred operating losses since our inceptionand, as of December 31, 2006, had an accumulated deficit of approximately$81.65 million. We expect to spend substantial funds to continue research andproduct testing, to maintain sales, marketing, quality control, regulatory,manufacturing and administrative capabilities and for other general corporatepurposes. We expect to continue to incur operating losses in 2007, as we seekto execute on our business plan, including continuing to establish sales andmarketing capabilities and conducting research and development activities.

We may never becomeprofitable. If we do become profitable, we may not remain profitable on acontinuing basis. Our failure to become and remain profitable would depress themarket price of our common stock and impair our ability to raise capital andexpand, diversify or continue our operations.

**We will continue to need additional funds, and ifadditional capital is not available, we may have to limit or scale back ouroperations.**

We believe that our existing cash and other workingcapital, together with anticipated proceeds from  sales of our products, will be sufficient tofund our operating and capital requirements, as currently planned through atleast 2007.

Our currentlyplanned operating and capital requirements primarily include the need forworking capital to:

·       produceand manufacture our products;

·       supportour sales and marketing efforts for our Embosphere Microsphere products for UFEand other indications, as well as our other products for sale;

·       supportour research and development activities; and

·       fundour general and administrative costs and expenses.

However, our cash requirements may vary materiallyfrom those now planned due to a number of factors, including, withoutlimitation, the amount of revenues we generate from sales of our products, inparticular from the use of our Embosphere Microspheres for UFE; changes in ourUFE regulatory and 

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marketing programs;anticipated research and development efforts; cost and time involved inpreclinical and clinical testing; costs resulting from changes in the focus anddirection of our research and development programs; competitive advances thatmake it harder for us to market and sell our products; the timing and cost ofFDA regulatory review and, the market’s acceptance of any approved products.

We also expect to incur additional costs related toongoing research and development activities, preclinical studies, clinicaltrials, and the expansion of our manufacturing, laboratory and administrativecapabilities, as well as costs relating to further market development andcommercialization efforts. We may also need additional funds for possiblestrategic acquisitions of synergistic businesses, products and/or technologies.If adequate funds are not available, we may be required to delay, scale back oreliminate some of our research, development, sales and marketing initiatives,which would have a material adverse effect on our business, results ofoperations and ability to achieve profitability.

We may need to raise additional funds to develop andcommercialize our new products successfully. If we cannot fund these newproducts through cash generated from existing operations and cannot raise morefunds, we could be required to reduce our capital expenditures, scale back ourproduct development, reduce our workforce and license to others products ortechnologies that we otherwise would seek to commercialize ourselves. Althoughwe may seek additional funding through collaborative arrangements, borrowingmoney or the sale of additional equity securities, we may not receiveadditional funding on reasonable terms, or at all. Any sales of additionalshares of our capital stock are likely to dilute our existing stockholders.

Further, if we issueadditional equity securities, the new equity securities may have rights,preferences or privileges senior to those of existing holders of our commonstock. Alternatively, we may borrow money from commercial lenders, possibly athigh interest rates, which will increase the risk of your investmentin us.

**If operatingresults fluctuate significantly from quarter to quarter, then our stock pricemay decline.**

Our operatingresults could fluctuate significantly from quarter to quarter. Thesefluctuations may be due to a number of factors, including:

·       thetiming and volume of customer orders for our products;

·       procedurecancellations;

·       introductionor announcement of competitive products;

·       regulatoryapprovals;

·       productrecalls;

·       turnoverin our direct sales force;

·       timingand amount of expenses;

·       reductionsin orders by our distributors;

·       effectivenessof new marketing and sales programs;

·       changesin management;

·       negativepublicity; and

·       generaleconomic conditions.

Due to these fluctuations, our operating results insome quarters may not meet the expectations of our investors. In that case, ourstock price may decline.

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In addition, a large portion of our expenses,including expenses for facilities, equipment and personnel, are relativelyfixed. Accordingly, if our revenues decline or do not grow as much as weanticipate, we might not be able to improve our operating margins.

Failure to achieveanticipated levels of revenues could therefore significantly harm our operatingresults for a particular fiscal period.

**Risks Relating toOur Industry, Business and Strategy**

**If we do not achieve widespread market acceptance ofour microsphere products, our business prospects will be seriously harmed.**

Our microspheres are based on new technologies andtherapeutic approaches. In the United States, we began selling our firstmicrosphere product in the first half of 2000. In November 2002, wereceived FDA clearance to market our Embosphere Microspheres in the UnitedStates for specific use in the embolization of uterine fibroids. We have onlybegun to market and sell our HepaSphere Microspheres in the European Union inthe fourth quarter of 2005 and received marketing clearance for ourQuadraSphere Microspheres in November 2006. For the fiscal years ended December 31,2006 and 2005, we generated revenues primarily from the sales of our EmbosphereMicrospheres in North America and the European Union. Our success will dependupon increasing acceptance by the medical community, patients and third-partypayers that our Embosphere Microspheres and other products are medicallytherapeutic and cost effective. Our embolotherapy techniques are administeredby interventional radiologists. To date we have not achieved widespread marketacceptance of our Embosphere Microspheres or other products. In the treatmentof uterine fibroids using UFE, we believe that we have not yet achieved widespreadacceptance primarily because obstetrics and gynecology physicians may elect tooffer and provide other forms of treatment to their patients with uterinefibroids that do not require a referral to another specialist, such as aninterventional radiologist. The majority of our revenues are from the sale ofour Embosphere Microspheres for UFE. Accordingly, our future success willdepend upon obstetrics and gynecology physicians referring patients tointerventional radiologists to receive treatment using our EmbosphereMicrospheres in lieu of, or in addition to, receiving other forms of treatmentthat the obstetrics and gynecology physicians can otherwise provide directly.

Negative publicity associated with any adverse medicaleffects attributed to embolization treatments generally, or our productsspecifically, may create the market perception that our products are unsafe.For example, in UFE procedures patients commonly experience a day or twoof post-procedure abdominal pain or cramping. Other infrequently occurringcomplications may include allergic reactions, rashes, early onset of menopause,infertility and infection that may, in some cases, require a hysterectomy. We arealso aware that a small number of the patient population, which we believeconstitutes approximately 2% of those receiving the UFE procedure usingEmboGold Microspheres, reported a delayed onset of rash and/or pain.

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**Ifour microsphere products are not properly used or if the market concludes thatour products are not safe or effective, our business could be adverselyaffected.**

Our microspheres aredesigned to permanently occlude targeted blood vessels. There is some risk thatsome or all of the microspheres used in a medical procedure may travel in theblood system to sites other than the intended surgical site and occlude, orblock, other blood vessels, resulting in the potential for significant adversehealth effects on the patient or, in a worst case, even death. Moreover, to useour microspheres correctly for a particular medical procedure, trainedphysicians must select and use the proper size and quantity. A physician’sselection and use of the wrong size or quantity of our microspheres couldpotentially have significant adverse health effects on the patient, includingdeath. It is necessary for us to educate physicians about the selection and useof the proper size and quantity of microspheres in patient therapy. Inaddition, there is only limited data concerning the long-term health effects onpersons receiving embolotherapy using our microspheres. For example, the effectof UFE on continued fertility has not yet been specifically studied, and ourFDA clearance for Embosphere Microspheres currently does not include women whodesire future pregnancy.

If we are not able tosuccessfully educate physicians to properly use our product, or if the marketdetermines or concludes that any of our products are not safe or effective forany reason, we may be exposed to product liability claims, product recalls,fines or other penalties or enforcement actions by regulatory agencies andassociated adverse publicity. For example, in August 2005 we were named asa defendant in a product liability lawsuit in which the defendant, a minorchild, claims that he was rendered blind in both eyes as a result of the use ofour Embosphere Microsphere product during a nasal angiofibroma embolization.See “We may be exposed to product liability claims, and if we are unable toobtain or maintain adequate product liability insurance, then we may have topay significant monetary damages in a successful product liability claimagainst us.” While we have product liability insurance, we may not be able tomaintain such insurance at favorable rates, or at all, and any successfuljudgments against us could exceed our coverage. In addition, we have providedto our customers a satisfaction guarantee that requires us to accept the returnof any inventory and credit the entire amount of the original order if aproperly trained customer is not satisfied with the performance of ourmicrospheres or our delivery system products.

If we experience adversepublicity or are subject to product liability claims, excessive guaranteeclaims, recalls, fines and the like, we will be unable to achieve widespreadmarket acceptance of our microsphere products and achieve profitability. For example, in March 2006 we instituted avoluntary recall of our HepaSphere Microspheres in Europe and Japan to correcta packaging defect that we identified while conducting aging studies routinelyperformed on all of our product packaging. HepaSphere Microspheres arecontained in a prefilled vial that was in turn initially packaged inside a paperpouch. We determined that a defect in the paper pouch may compromise thesterility of the outside of the vial. If the sterility of the outside of thevial is not maintained, there is the risk that a physician’s hands can becomecontaminated when handling the vial. Although we are not aware of any adverseevents resulting from the defects in the paper packaging, our voluntary recallof this product could result in reputational harm or a perception that theproduct is not safe, either of which could adversely affect market acceptanceof our microsphere products.

**If wedo not successfully market and promote our Embosphere Microspheres for use inuterine fibroid embolization, our product revenues will not increase.**

In the first quarter of2003, we launched our ask4UFE campaign to increase awareness among patients,referring physicians, interventional radiologists and third-party payers of UFEas an alternative treatment for fibroids. We believe the majority of ourrevenues in the United States for the two years ended December 31, 2006were derived from the sale of Embosphere Microspheres for use in UFE. Althoughwe believe that EmboGold Microspheres accounted for a significant portion ofrevenue, we 

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currentlydo not intend to seek 510(k) clearance for use of EmboGold Microspheres inUFE. Because we do not intend to seek 510(k) clearance of EmboGoldMicrospheres, we believe that our future product revenues are substantiallydependent on our ability to achieve widespread acceptance of the use ofEmbosphere Microspheres for the treatment of UFE, and if we do not achieveincreased market acceptance, our product revenues, profitability and successwill be adversely affected. We are continuing to market EmboGold Microspheresfor use in hypervascularized tumors (other than uterine fibroids) andarteriovenous malformations. If we cease to market EmboGold Microspheres forany reason, we could incur substantial costs to write off and replace existinginventories. As of December 31, 2006, we had EmboGold inventory with a carryingvalue of $185,000, including in-process inventory of $91,000 and finished goodssyringes of $94,000. We currently believe no provision for the write-off orreplacement of EmboGold Microspheres inventory is required in the accompanyingfinancial statements.

**If wedo not maintain our relationships with the healthcare community, our growthwill be limited and our business could be harmed. If gynecologists,obstetricians, interventional radiologists and other healthcare providers donot recommend and endorse our products, our sales may decline or we may beunable to increase our sales and profits.**

Our relationships withgynecologists, obstetricians, interventional radiologists and other healthcare providers are critical to ourcontinued growth. We believe that these relationships are based on the qualityof our products, our long-standing commitment to embolotherapy treatments, ourmarketing efforts and our presence at medical society and trade associationmeetings. Any actual or perceived diminution in our reputation or the qualityof our products, or our failure or inability to maintain these other effortscould damage our current relationships, or prevent us from forming newrelationships, with healthcare professionals and cause our growth to be limitedand our business to be harmed.

In order for us to sellour products, healthcare professionals must recommend and endorse them. We maynot obtain the necessary recommendations or endorsements from this community.Acceptance of our products depends on educating the medical community as to thedistinctive characteristics, perceived benefits, safety, clinical efficacy andcost-effectiveness of our products compared to traditional methods of treatmentand the products of our competitors, and on training healthcare professionalsin the proper application of our products. If we are not successful inobtaining the recommendations or endorsements of gynecologists, obstetricians,interventional  radiologists and otherhealthcare professionals for our products, our sales may decline or we may beunable to increase our sales and profits.

**If we experience delays, difficulties or unanticipatedcosts in establishing the sales, distribution and marketing capabilitiesnecessary to successfully commercialize our products, we will have difficultymaintaining and increasing our sales.**

We are continuing todevelop sales, distribution and marketing capabilities in the United States,the European Union, Asia and in South America. In 2003 we began a marketingstrategy to promote UFE awareness and the benefits of our product for thetreatment of uterine fibroids. It will be expensive and time-consuming for usto develop a global marketing and sales force. Moreover, we may choose, or findit necessary, to enter into strategic collaborations to sell, market anddistribute our products. At December 31, 2006 we had a sales force of 25persons located principally in the United States. Competition for skilledsalespersons in the medical device industry is intense, and we may not be ableto provide adequate incentive to maintain our sales force or to attract newsales personnel or to establish and maintain favorable distribution andmarketing collaborations with other companies to promote our products. We haveonly limited sales and marketing experience both in the United States andinternationally and may not be successful in developing and implementing ourstrategy. Among other things, we need to:

·       provideor assure that distributors provide the technical and educational supportcustomers need to use our products successfully;

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·       establishand implement successful sales and marketing and education programs thatencourage our customers to purchase our products;

·       managegeographically dispersed operations; and

·       modifyour products and marketing and sales programs for foreign markets.

We currently havedistribution agreements with approximately 40 third-party distributors. Anythird party with whom we have established a marketing and distributionrelationship may not devote sufficient time to the marketing and sales of ourproducts, thereby exposing us to potential expenses in terminating suchdistribution agreements. For example, in 2002, our subsidiary, BSMA, ended adistribution agreement with a third party in part because of such party’s failureto achieve sales forecasts agreed upon by the parties. As a result ofsubsequent litigation BSMA was required to pay approximately $800,000 indamages arising from such termination and incurred additional legal andadministrative expenses incident to the legal proceeding. We and any of ourthird-party collaborators must also market our products in compliance withfederal, state and local laws relating to the providing of incentives andinducements. Violation of these laws can result in substantial penalties. If weare unable to successfully motivate and expand our marketing and sales forceand further develop our sales and marketing capabilities, or if ourdistributors fail to promote our products, we will have difficulty maintainingand increasing our sales.

**We will be required to expend significant resourcesfor research, development, testing and regulatory approval of our productsunder development, and these products may not be developed successfully.**

We are developingand commercializing products for medical applications using embolotherapytechniques. Most of our next-generation embolotherapy product candidates,including MR Microspheres and Resorbable Microspheres, are still in the earlystages of research and development. Our products may not provide greaterbenefits than current treatments or products, or alternative treatments orproducts under development. All of our products under development will requiresignificant additional research, development, engineering, preclinical and/orclinical testing, regulatory approval and a commitment of significantadditional resources prior to their commercialization. Our potential productsmay not:

·       bedeveloped successfully;

·       beproven safe and effective in clinical trials;

·       offertherapeutic or other improvements over current treatments and products;

·       meetapplicable regulatory standards or receive regulatory approvals;

·       becapable of production in commercial quantities at acceptable costs; or

·       besuccessfully marketed.

**We may be unable to grow revenues for certain of ourproducts, and if we do not develop and introduce new products, we may notachieve additional revenue opportunities.**

We derived approximately11% of our revenues for the period ended December 31, 2006, from the saleof nonstrategic medical products that we expect will constitute a lesssignificant portion of our revenues on an ongoing basis. These nonstrategicmedical products include barium delivery kits sold by us in the European Union,as well as other ancillary devices for hospital and physician use. In addition,we estimate that a significant portion of our revenues for the year ended December 31,2006, were derived from the sale of EmboGold Microspheres for UFE, anindication for which we do not have, and do not presently intend to seek,clearance from the FDA to market. We made the decision not to seek FDAclearance for our EmboGold Microsphere product because of reports that a smallnumber of patients treated with UFE using EmboGold Microspheres, which webelieve constitute approximately 2% of the 

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totalnumber of patients receiving the procedure, reported a delayed onset of rashand/or pain. Accordingly, we need to develop and introduce new applications forour embolotherapy technology and pursue opportunities for microsphere technologyin other medical applications. Any such new application for our embolotherapytechnology or microsphere technology will be subject to a number of risksinherent in the development and commercialization of a medical device product,including uncertainties with respect to the successful completion of clinicaltrials, our ability to achieve and maintain, and our willingness to seek,required regulatory approvals and our ability to successfully commercialize,market and sell these new applications assuming FDA approval is achieved. If,as a result of these or other risks, we are not successful in developing newapplications and products, we will not achieve new revenue opportunities.

**We may be exposed to product liability claims, and ifwe are unable to obtain or maintain adequate product liability insurance, thenwe may have to pay significant monetary damages in a successful productliability claim against us.**

The development and sale of medical devices entails aninherent risk of product liability. For example, if we are not able tosuccessfully educate physicians to properly use our products, if patientsexperience adverse side effects in procedures in which our products are used,or if the market determines or concludes that any of our products are not safeor effective for any reason, we may be exposed to product liability claims.Although we maintain insurance, including product liability insurance, wecannot provide assurance that any claim that may be brought against us will notresult in court judgments or settlements in amounts that are in excess of thelimits of our insurance coverage. Our insurance policies also have variousexclusions, and we may be subject to a product liability claim for which wehave no coverage. We will have to pay any amounts awarded by a court ornegotiated in a settlement that exceed our coverage limitations or that are notcovered by our insurance.

In August 2005 we were named as a defendant in alawsuit commenced in the Circuit Court, Twenty-Second Judicial Circuit, St. Louis,Missouri, which we refer to as the Pingel Claim. The lawsuit alleges, amongother things, that a juvenile patient suffered permanent bilateral blindness ina nasal angiofibroma embolization as a result of the use of our EmbosphereMicrospheres or the negligence of the healthcare providers or both factorscombined. Plaintiffs seek compensatory and punitive damages. Although wecurrently maintain product liability insurance coverage for our products,including the Embosphere Microsphere product that is the subject of the Pingelclaim, our existing insurance and any additional insurance we may subsequentlyobtain may not provide us with adequate coverage against all potential claims.For example, although our product liability insurer has agreed to vigorouslydefend us with regards to all of the counts set forth against us in the PingelClaim, the insurer has advised us in writing that any verdict against us forpunitive damages is specifically excluded from coverage. The insurer has alsoadvised us that it does not waive any other defenses to coverage that mayapply.

Any product liabilityclaim brought against us, with or without merit, could result in the increaseof our product liability insurance rates or the inability to secure additionalinsurance coverage in the future. A product liability claim, whethermeritorious or not, could be time consuming, distracting and expensive todefend, could be harmful to our reputation, could result in a diversion ofmanagement and financial resources away from our primary business and couldresult in product recalls. In any such case, our business may suffer.

**We instituted a voluntary recall of our HepaSphereMicrospheres product in the European Union and Japan, which may result indecreased market acceptance of this product and reputational harm, as well ashindering our ability to generate revenue from sales of the product.**

In March 2006, we instituteda voluntary recall of our HepaSphere Microspheres in Europe and Japan tocorrect a packaging defect that we identified while conducting aging studiesroutinely performed on all of our product packaging. We received CE markapproval to sell HepaSphere Microspheres in the 

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EuropeanUnion in 2004 and commercial launch began in late 2005. We also have hadlimited sales of HepaSphere Microspheres to Dr. Shinichi Hori, the inventor andlicensor of HepaSphere Microspheres, in Japan under private importrestrictions. HepaSphere Microspheres are contained in a prefilled vial thatwas in turn initially packaged inside a paper pouch. We determined that adefect in the paper pouch may compromise the sterility of the outside of thevial. If the sterility of the outside of the vial is not maintained, there isthe risk that a physician’s hands can become contaminated when handling thevial. Although we are not aware of any adverse events resulting from thedefects in the paper packaging, our voluntary recall of this product couldresult in reputational harm or a perception that the product is not safe, eitherof which could adversely affect market acceptance of our microsphere productsand result in decreased sales. In the third quarter of 2006 we launched a newplastic packaging configuration for our HepaShere Microsphere product designedto correct this defect.

**If we are not able to compete effectively, we mayexperience decreased demand for our products, which may result in pricereductions.**

We have many competitors in the United States andabroad, including medical device, biotechnology and other alternativetherapeutic companies, universities and other private and public researchinstitutions. We have experienced increased competition since receiving FDAapproval for use of our Embosphere Microspheres for UFE. Our success dependsupon our ability to develop and maintain a competitive position in both theembolotherapy and related delivery systems markets. Our key competitors in boththe fields of embolotherapy and the delivery systems used in the UFE procedureare Angiodynamics Incorporated, Biocompatibles, Ltd., Boston ScientificCorporation, Cook Incorporated, Cordis Corporation, a Johnson and JohnsonCompany, Pfizer, Inc. and Terumo Corporation. These and many of our othercompetitors have greater capabilities, experience and financial resources than wedo. As a result, they may develop products more quickly or at less cost, thatcompete with our microsphere products and related delivery systems. Inaddition, we may experience decreased demand for our products if these or othercompetitors announce that they have begun to develop products that compete withour products. For example, in 2004, some of our competitors provided free orreduced-price samples of competing forms of microspheres for the treatment ofmedical procedures for which our Embosphere Microspheres are indicated. Theavailability of these free or reduced-price samples has had, and may continueto have, a material adverse effect on our product revenues, primarily due to aloss of market share for the sale of our products. Currently, the primaryproducts with which our microspheres compete for some of our applications arespherical PVA sold by Boston Scientific, Terumo and Biocompatibles, and gelfoam sold by Pfizer and non-spherical PVA sold by Angiodynamics, BostonScientific and Cook. In addition, our competitors may develop technologies thatrender our products obsolete or otherwise noncompetitive.

We may not be able to improve our products or developnew products or technologies quickly enough to maintain a competitive positionin our market and continue to commercially develop our business. Moreover, wemay not be able to compete effectively, and competitive pressures may result inless demand for our products and impair our ability to become profitable.

In the treatment ofsymptomatic uterine fibroids, we also compete with obstetrics and gynecologyphysicians who elect to offer and provide other forms of treatment to theirpatients with uterine fibroids that do not require referral to anotherspecialist.

**If we fail to maintain, or in some instances obtain,an adequate level of reimbursement for our products by third-party payers,there may be no commercially viable markets for our products.**

The availability and levels of reimbursement bygovernmental and other third-party payers affects the market for any medicaldevice. We may not be able to sell our products profitably if reimbursement isunavailable or limited in scope or amount. Some insurance companies do notfully reimburse for 

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embolization procedures.These third-party payers may attempt to contain or reduce the costs ofhealthcare by lowering the rate at which providers are reimbursed forembolization procedures or challenging the prices that companies such as ourscharge for medical products. For example, on November 1, 2006, the Centersfor Medicare and Medicaid Services, or CMS, issued a preliminary rule, whichbecame final on January 1, 2007, providing for a single all-inclusivereimbursement code for UFE. This new code is inclusive of all servicesoccurring on the day of the procedure. This new physician reimbursement rate islower than the rate generally historically received by physicians. In someforeign countries, particularly the countries of the European Union where ourmicrosphere products are currently marketed and sold, the pricing of medicaldevices is subject to governmental control, and the prices charged for ourproducts have in some instances been reduced as a result of these controls.

Initiatives to limit thegrowth of healthcare costs, including price regulation, are underway in theUnited States and other major healthcare markets. For example, these proposalsinclude prescription drug benefit legislation recently enacted in the UnitedStates, and healthcare reform initiatives proposed in certain state and local jurisdictionsand other countries. While these initiatives have in many cases related topharmaceutical pricing, implementation of more sweeping healthcare reforms insignificant markets may limit the price of, or the level at which reimbursementis provided for, our products and may influence a physician’s selection ofproducts used to treat patients.

**If we do not recruit and retain senior management andother key employees we may not be able to successfully implement our businessstrategy.**

Our success is substantiallydependent on our ability to recruit and retain members of our senior managementand other key employees. Allof the agreements with our officers provide that their employment may beterminated either by the employee or by us at any time and without notice.Although we do not have any reason to believe that we may lose the services ofany of these persons in the foreseeable future, the loss of the services of anyof these persons might impede the achievement of our research, development, andcommercialization objectives. We do not carry key man life insurance onany of our executive officers or other personnel.

**If we make any acquisitions, we will incur a varietyof costs and may never successfully integrate the acquired business into ours.**

We may attempt to acquirebusinesses, technologies, services or products that we believe are a strategiccomplement to our business model. We may encounter operating difficulties andexpenditures relating to integrating an acquired business, technology, service orproduct. These acquisitions may also absorb significant management attentionthat would otherwise be available for ongoing development of our business.Moreover, we may never realize the anticipated benefits of any acquisition. Wemay also make dilutive issuances of equity securities, incur debt or experiencea decrease in the cash available for our operations, or incur contingentliabilities in connection with any future acquisitions.

**Because key stockholders beneficially own asignificant amount of our common stock, they may be able to exert control overus.**

As of March 1,2007, we believe that Sepracor Inc., or Sepracor, and funds affiliated withCerberus Capital Management, L.P., or Cerberus, beneficially ownedapproximately 22% and 14% of our outstanding common stock, respectively,including shares of common stock issuable upon the exercise of warrants andseries A preferred stock held by these stockholders. Moreover, two of ourdirectors are executive officers of Sepracor, and we have granted board observationrights to Cerberus. Accordingly, Sepracor and Cerberus may have significantinfluence over corporate actions requiring stockholder approval, such as theelection of directors, amendment of our charter documents and the approval ofmerger or significant asset sale transactions. In addition, the shares of ourseries A preferred stock held by 

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Sepracorand Cerberus entitled them to certain voting rights in accordance with theterms and conditions of the series A preferred stock. Specifically, we willneed the consent of holders of at least 50% of the series A preferred stockinitially purchased by Sepracor and Cerberus to undertake certain key corporateactions, including the following:

·       amendingour charter or bylaws in a manner that adversely affects the holders of seriesA preferred stock;

·       authorizingor issuing any equity security that is senior to or pari passu with the seriesA preferred stock; and

·       declaringor paying any dividends on, or redeeming or repurchasing any shares of, ourcapital stock, subject to customary exceptions.

The ownershipconcentration of Sepracor and Cerberus could cause the market price of ourcommon stock to decline. In addition, conflicts of interest between these keystockholders and us may arise, including with respect to competitive businessactivities and control of our management and our affairs.

**The holders of shares of our series A preferred stockhave rights that could adversely affect an investment in our common stock.**

The holders of our series A preferred stock have theright to an adjustment in the conversion rate of the series A preferred stockif we issue securities at a price below the purchase price paid by theseholders. These provisions could substantially dilute stockholders’ interest inBioSphere in the event of future financing transactions. The holders of seriesA preferred stock also have the right to receive a 6% dividend per annum which,at our election, may be paid in cash or additional shares of series A preferredstock. To date all such dividend payments have been made in additional sharesof series A preferred stock. If such dividends continue to be paid in stock,this dividend could also further dilute stockholders’ ownership interest. Inaddition, the holders of our series A preferred stock have the right toparticipate in future capital raising transactions by BioSphere. The existenceof this right may reduce our ability to establish terms with respect to, orenter into, any financing with parties other than the investors.

In the event that we enter into an acquisition orbusiness combination in which we sell all or substantially all of our assets orif there occurs a change of control of a majority of our common stockoutstanding prior to such transaction, the holders of our series A preferredstock will have the right to receive, before any distributions or payments tothe holders of our common stock, an amount in cash equal to their initialpurchase price, $8,000,000, plus an amount equal to any accrued but unpaiddividends, and will then participate with the holders of the common stock on apro rata basis with respect to the distribution of any remaining assets. Theexistence of this right may make it difficult for us to raise capital infinancing transactions with third parties and will also result in holders ofour common stock receiving less distributions or payments upon a change ofcontrol or asset sale than they would be entitled to receive if no preferentialpayments were required to be made to holders of our series A preferred stock.

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**Risks Relating toRegulatory Matters**

**If we do not obtain and maintain the regulatoryapprovals or clearances required to market and sell our products, then ourbusiness may be unsuccessful and the market price of our stock may decline.**

We are subject to regulation by government agencies inthe United States and abroad with respect to the design, manufacture,packaging, labeling, advertising, promotion, distribution and sale of ourproducts. For example, our products are subject to approval or clearance by theFDA prior to commercial marketing in the United States. Similar regulationsexist in most major foreign markets, including the European Union, LatinAmerica and Asia. The process of obtaining necessary regulatory approvals andclearances will be time-consuming and expensive for us. If we do not receiverequired regulatory approval or clearance to market our products, or if anyapprovals or clearances we have received are revoked or terminated, we may notbe able to commercialize our products and become profitable, and the value ofour common stock may decline.

We are also subject tonumerous U.S. and foreign regulatory requirements governing the conduct ofclinical trials, marketing authorization, pricing and third-partyreimbursement. The foreign regulatory approval process includes all of therisks associated with FDA approval described above, as well as risksattributable to the satisfaction of local regulations in foreign jurisdictions.Approval by the FDA does not assure approval by regulatory authorities of somecountries outside the United States. Many foreign regulatory authorities,including those in major markets such as Japan and China, have differentapproval procedures than those required by the FDA and may impose additionaltesting requirements for our medical device candidates.

**If the FDA or other regulatory agencies placerestrictions on, or impose additional approval requirements with respect to,products we are then marketing, we may incur substantial additional costs andexperience delays or difficulties in continuing to market and sell theseproducts.**

Even if the FDA grants us clearance with respect tomarketing any product, such products will be subject to ongoing regulatoryreview and restrictions, including the review of clinical results which arereported after such products are made commercially available, and restrictionson the indications for which we can market the product. The FDA can propose towithdraw approval if new clinical data or experience shows that a product isnot safe for use under the approved conditions of use. The marketing claims weare permitted to make in labeling or advertising regarding our microspheres arelimited to those consistent with any FDA clearance or approval. For example,because our EmboGold Microspheres are not cleared for specific use in UFE, wemay not promote them for this specific use. Although our QuadraSphereMicrospheres are technically identical in all respects to our HepaSphereMicrospheres, which are currently marketed in the European Union for use in theembolization of hepato-cellular carcinoma and hepatic metastasis, ourQuadraSphere Microspheres are not specifically indicated for use inhepato-cellular carcinoma and hepatic metastasis. FDA regulations require thatwe conduct formal clinical trials prior to seeking to claim the use of theQuadraSphere Microspheres for the treatment of a specific disease or condition,such as hepato-cellular cancer or hepatic metastasis, while European Unionregulations do not mandatorily require it for this class of medical devices. Accordingly,in order for us to seek FDA clearance to promote the use of QuadraSphereMicrospheres for the embolization of hepato-cellular carcinoma and hepaticmetastasis, we will be required to undertake clinical trials in the UnitedStates.

For our 510(k) cleared products, the FDA requiresus to submit to the FDA copies of our advertisements and labeling. If the FDAbelieves these materials, or statements made by our sales representatives orother company officials, promote our products for unapproved indications, theFDA could allege that our promotional activities misbrand our products.Specifically, the FDA could issue an untitled letter or warning letter, whichrequests, among other things, that we cease such promotional activities,including disseminating the advertisements and promotional labeling, and thatwe issue 

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corrective advertisementsand labeling, including sending letters to healthcare providers. The FDA alsocould take enforcement action including seizure of allegedly misbrandedproduct, injunction or criminal prosecution against us and our officers oremployees. If we repeatedly or deliberately fail to submit such advertisementsand labeling to the agency, the FDA could withdraw our approvals. The FDA alsomonitors manufacturers’ support of continuing medical education, or CME,programs where the programs involve the manufacturers’ or a competitor’sproducts to ensure that manufacturers do not influence the CME content as ameans of promoting their products for off-label uses.

We may in the future make modifications to ourmicrospheres or their labeling which we determine do not necessitate the filingof a new 510(k) notification. However, if the FDA does not agree with ourdetermination, it will require us to make additional 510(k) filings forthe modification, and we may be prohibited from marketing the modified productor the new claims until we obtain FDA clearance. Similarly, if we obtainpremarket approval, we may not be able to make product or labeling changesuntil we get further FDA approval.

If we fail to comply withapplicable federal, state or foreign laws or regulations, we could be subjectto enforcement actions which could affect our ability to develop, market andsell our products and product candidates successfully and could harm ourreputation and lead to decreased acceptances of our products by the market.

**Even if we obtain the necessary FDA clearances orapprovals, if we or our suppliers fail to comply with ongoing regulatoryrequirements our products could be subject to corrections, removals or recallsfrom the market or other enforcement action.**

We are subject tothe Medical Device Reporting, or MDR, regulations that require us to report tothe FDA if our products may have caused or contributed to patient death orserious injury, or if our device malfunctions and a recurrence of themalfunction would likely result in a death or serious injury. We must also filereports of device corrections and removals and adhere to the FDA’s rules onlabeling and promotion. Our failure to comply with these or other applicableregulatory requirements could result in enforcement action by the FDA, whichmay include any of the following:

·       untitledletters, warning letters, fines, product seizures, injunctions and civilpenalties;

·       administrativedetention, which is the detention by the FDA of medical devices believed to beadulterated or misbranded;

·       customernotification, or FDA orders for repair, replacement or refund;

·       voluntaryor mandatory recall of our products;

·       operatingrestrictions, partial suspension or total shutdown of production;

·       refusalto review premarket notification or premarket approval submissions;

·       rescissionof a substantial equivalence order or suspension or withdrawal of a premarketapproval; and

·       criminalprosecution.

If we are subject to anenforcement action, our ability to develop, market and sell our productssuccessfully would be adversely affected, our reputation could be harmed and wemay experience decreased market acceptance of our products.

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**We may be subject, directly or indirectly, to federaland state healthcare fraud and abuse laws and regulations and, if we are unableto fully comply with such laws, could face substantial penalties.**

Our operations may bedirectly or indirectly affected by various broad state and federal healthcarefraud and abuse laws, including the federal Anti-Kickback Statute, whichprohibit any person from knowingly and willfully offering, paying, solicitingor receiving remuneration, directly or indirectly, to induce or reward eitherthe referral of an individual, or the furnishing or arranging for an item orservice, for which payment may be made under federal healthcare programs, suchas the Medicare and Medicaid programs. If our past or present operations arefound to be in violation of these laws, we and our officers may be subject tocivil or criminal penalties, including large monetary penalties, damages,fines, imprisonment and exclusion from Medicare and Medicaid programparticipation. If enforcement action were to occur, our business and financialcondition would be harmed.

**Risks Relating toOur Intellectual Property**

**If we are unable to obtain patent protection for ourproducts, their competitive value could decline.**

We may not obtain meaningful protection for ourtechnology and products with the patents and patent applications that we own orlicense relating to our microsphere technology or other ancillary products. Inparticular, the patent rights we possess or are pursuing generally cover our technologiesto varying degrees, and these rights may not prevent others from designingproducts similar to or otherwise competitive with our Embosphere Microspheresand other products we commercialize. To the extent that our competitors areable to design products competitive with ours, we may experience less marketpenetration with our products and, consequently, we may have decreasedrevenues.

We do not know whether competitors have similar U.S.patent applications on file, since U.S. patent applications filed before November 28,2000, or for which no foreign patents will be sought are secret until issued,and applications filed after November 28, 2000, are publishedapproximately 18 months after their earliest priority date. Consequently, theUnited States Patent and Trademark Office could initiate interferenceproceedings involving our owned or licensed U.S. patent applications or issuedpatents. Further, there is a substantial backlog of patent applications at theUnited States Patent and Trademark Office, and the approval or rejection ofpatent applications may take several years.

We require our employees,consultants and advisors to execute confidentiality agreements. However, wecannot guarantee that these agreements will provide us with adequate protectionagainst improper use or disclosure of confidential information. In addition, insome situations, these agreements may conflict with, or be subject to, therights of third parties with whom our employees, consultants or advisors haveprior employment or consulting relationships. Further, others may independentlydevelop substantially equivalent proprietary information and techniques, orotherwise gain access to our trade secrets. Our failure to protect ourproprietary information and techniques may inhibit or limit our ability toexclude certain competitors from the market.

**If we become involved in expensive patent litigationor other proceedings to enforce or defend our patent rights, we could incursubstantial costs and expenses or substantial liability for damages or berequired to stop our product development and commercialization efforts.**

On January 13, 2005, we were notified of a Noticeof Oppositions filed by Biocompatibles UK Limited on December 23, 2004,challenging the patentability of the claims in our granted European Patent1128816, which relates to certain PVA microspheres, their use in embolizationand methods of manufacture related to such PVA microspheres. We will continuedefending our European PVA patent in this proceeding. While we are not able topredict the outcome of this patent opposition proceeding, it will not impactour ability to sell our Embosphere Microsphere, HepaSphere Microsphere orQuadraSphere Microsphere products, which are not comprised of PVA.

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With the exception of the European Oppositionproceeding just described, we are not currently involved in any otherlitigation or actions with third parties to enforce or defend our patentrights. However, in order to protect or enforce our patent rights, we may haveto initiate legal proceedings against third parties, such as infringement suitsor interference proceedings. By initiating legal proceedings to enforce ourintellectual property rights, we may also provoke these third parties to assertclaims against us and, as a result, our patents could be narrowed, invalidatedor rendered unenforceable by a court. Furthermore, we may be sued forinfringing on the intellectual property rights of others. We may find itnecessary, if threatened, to initiate a lawsuit seeking a declaration from acourt regarding the proprietary rights of others. Intellectual propertylitigation is costly and, even if we prevail, could divert management attentionand resources away from our business.

The patent position ofcompanies like ours generally is highly uncertain, involves complex legal andfactual questions, and has recently been the subject of much litigation. We maynot prevail in any patent-related proceeding. If we do not prevail in anylitigation, we could be required to pay damages, stop the infringing activity,or obtain a license. Any required license might not be available to us onacceptable terms, or at all. In addition, some licenses may be nonexclusive,and therefore our competitors may have access to the same technology licensedto us. If we fail to obtain a required license or are unable to design around apatent, we may be prevented from selling some of our products, which coulddecrease our revenues.

**If any of our licenses to use third-party technologiesin our products are terminated, we may be unable to develop, market or sell ourproducts.**

We are dependent onvarious license agreements relating to each of our current and proposedproducts that give us rights under intellectual property rights of thirdparties. In particular, we have an agreement with L’AssistancePublique-Hopitaux De Paris, pursuant to which L’Assistance Publique-Hopitaux DeParis has granted us exclusive rights to use two jointly owned patents relatingto Embosphere Microspheres. We also have an agreement with Dr. ShinichiHori pursuant to which we have an exclusive royalty-bearing license to Japanesepatent rights for our HepaSphere Microsphere product. We also have an agreementwith Archimmed SARL pursuant to which we have an exclusive royalty-bearinglicense to patent rights for our MR Microsphere product, which is indevelopment. Each of these agreements can be terminated on short notice by thelicensor if we default on our obligations under the license and fail to curesuch default after notice is provided. These licenses impose commercialization,sublicensing, royalty, insurance and other obligations on us. Our failure, orany third party’s failure, to comply with the terms of any of these licensescould result in our losing our rights to the license, which could result in ourbeing unable to develop, manufacture or sell products which contain thelicensed technology.

**Risks Relating tothe Production and Supply of Our Products**

**If we experience manufacturing delays or interruptionsin production, then we may experience customer dissatisfaction and ourreputation could suffer.**

If we fail to produce enough products at our ownmanufacturing facility or at a third-party manufacturing facility, we may beunable to deliver products to our customers on a timely basis, which could leadto customer dissatisfaction and could harm our reputation and ability tocompete. We currently produce and package all of our microsphere products inone manufacturing facility in France. In the United States, we have engaged BrivantMedical Engineering and Radius Medical Technologies, Inc. to supply ourguidewire products and Concert Medical to supply and package our catheterproducts. Either we or any third-party manufacturer would likely experiencesignificant delays or cessation in producing our products if a labor strike,natural disaster, local or regional conflict or other supply disruption were tooccur. If we are unable to manufacture and package our products at our facilityin France, we may be required to enter into arrangements with one or morealternative contract manufacturing companies.

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Even if we are able to identify alternative facilitiesto manufacture our products, if necessary, we may experience disruption in thesupply of our products until such facilities are available. Although we believewe possess adequate insurance for damage to our property and the disruption ofour business from casualties, such insurance may not be sufficient to cover allof our potential losses and may not be available to us on acceptable terms orat all. Our failure to deliver products on a timely basis could lead tocustomer dissatisfaction and damage our reputation. In addition, if we arerequired to depend on third-party manufacturers, our profit margins may belower, which will make it more difficult for us to achieve profitability.

Medical devicemanufacturers must adhere to the Quality System Regulation, or QSR, 21 Code ofFederal Regulation Part 820, which is enforced by the FDA through itsinspection program. The manufacturers may not be able to comply or maintaincompliance. If any third-party manufacturers we engage fail to comply, theirnoncompliance could significantly delay our receipt of new product premarketapprovals or result in FDA enforcement action, including an embargo on importeddevices. For a premarket approval device, if we change our manufacturingfacility or switch to a third-party manufacturer, we will be required to submita premarket approval application supplement before the change is implemented.

**Because we rely on a limited number of suppliers, wemay experience difficulty in meeting our customers’ demands for our products ina timely manner or within budget.**

We currentlypurchase key components and services with respect to our microspheres,catheters and guidewires from approximately ten third-party vendors, includingRadius Medical, from whom we purchase guidewires for our Segway Guidewireproduct, Concert Medical, from whom we purchase catheters for our EmboCathInfusion Catheters and EmboCath Plus Infusion Microcatheter products, andBrivant Medical Engineering, from whom we purchase guidewires for our SequitorSteerable Guidewire product. We generally do not have long-term agreements withany of our suppliers. Our reliance on our suppliers exposes us to risks,including:

·       thepossibility that one or more of our suppliers could terminate their services atany time without penalty;

·       thepotential inability of our suppliers to obtain required components;

·       thepotential delays and expenses of seeking alternative sources of supply;

·       reducedcontrol over pricing, quality and timely delivery due to difficulties inswitching to alternative suppliers; and

·       thepossibility that one or more of our suppliers could fail to be compliant withQuality System Regulations, 21 CFR Part 820.

Consequently, in the eventthat our suppliers delay or interrupt the supply of components for any reason,our ability to produce and supply our products could be impaired, which couldlead to customer dissatisfaction and be harmful to our reputation.

**Risks Relating toOur Foreign Operations**

**If we are unable to meet the operational, legal andfinancial challenges that we encounter in our international operations, we maynot be able to grow our business.**

Our worldwidemanufacturing and European sales operations are currently conducted primarilythrough our French subsidiary. Furthermore, we currently derive a portion ofour revenues from the sale of our microspheres and other products in theEuropean Union. For the years ended December 31, 2006 and 2005,approximately 24% and 27%, respectively, of our revenues were derived fromsales of our 

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microspheresand other products in the European Union. We are increasingly subject to anumber of challenges that specifically relate to our international businessactivities. Our international operations may not be successful if we are unableto meet and overcome these challenges, which would limit the growth of ourbusiness. These challenges include:

·       failureof local laws to provide the same degree of protection against infringement ofour intellectual property;

·       protectionistlaws and business practices that favor local competitors, which could slow ourgrowth in international markets;

·       therequirement that we obtain regulatory approval or clearance in each country inwhich we choose to offer and sell our products;

·       insome jurisdictions, strict government regulated price controls;

·       complexreimbursement procedures;

·       potentiallylonger sales cycles to sell products, which could slow our revenue growth frominternational sales; and

·       potentiallylonger accounts receivable payment cycles and difficulties in collectingaccounts receivable.

**Because we translate foreign currency frominternational sales into U.S. dollars and are required to make foreign currencypayments, we may incur losses due to fluctuations in foreign currency exchangerates.**

A significant portion ofour business is conducted in the European Union Euro. We recognize foreigncurrency gains or losses arising from our operations in the period incurred. Asa result, currency fluctuations between the U.S. dollar and the currencies inwhich we do business will cause foreign currency translation gains and losses,which may cause fluctuations in our future operating results. We do not currentlyengage in foreign exchange hedging transactions to manage our foreign currencyexposure.

**Risk Relating toOur Stock Price**

**Because the market price of our stock is highlyvolatile, investments in our stock could rapidly lose their value and we mayincur significant costs from class action litigation.**

The market price of our stock is highly volatile. FromJanuary 1, 2005 through March 1, 2007, the price of our common stockhas ranged from a low of $3.50 to a high of $9.43. As a result of thisvolatility, investments in our stock could rapidly lose their value. Inaddition, the stock market often experiences extreme price and volumefluctuations, which affect the market price of many medical device companiesand which are often unrelated to the operating performance of these companies.

When the market price of astock has been as volatile as our stock price has been, holders of that stockmay institute securities class action litigation against the company thatissued the stock. If any of our stockholders were to bring a lawsuit of thistype against us, even if the lawsuit is without merit, we could incursubstantial costs in defending the lawsuit. The lawsuit could also divert thetime and attention of our management.

**Item 1B.**               UNRESOLVEDSTAFF COMMENTS

None.

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**Item 2.**                        PROPERTIES

We currently lease office and manufacturing facilitiesin Rockland, Massachusetts, and Roissy, France. Our Rockland, Massachusettsoffice includes approximately 13,000 square feet of corporate offices andlaboratory space pursuant to a lease expiring on February 28, 2009 at acost of $19,500 per month. Our Roissy, France facility, where we produce our Embosphere Microspheres,HepaSphere Microspheres and QuadraSphere Microspheres as well as some ancillarydisposable devices, includes approximately 18,000 square feet of office,laboratory and manufacturing space and is leased through May 2010 at acost of $25,000 per month.

We believe that the leasedfacilities in Rockland, Massachusetts and in Roissy, France are suitable tomeet our current requirements and that suitable additional or substitute spacewill be available to us on commercially reasonable terms, if needed in thefuture.

**Item 3.**                        LEGALPROCEEDINGS

On August 17, 2005, alawsuit commenced in the Circuit Court, Twenty-Second Judicial Circuit,St. Louis, Missouri captioned *Brett Pingel by nextfriend Dawn LaRose vs. BioSphere Medical, Inc., Bruce Kirke Bieneman,M.D., St. Louis University Hospital, John Stith, M.D and St. Louis University.*The lawsuit alleges, among other things, that a patient suffered permanentbilateral blindness as a result of the use of our Embosphere Microspheres orthe negligence of the health care providers or both factors combined. Alldefendants have denied the allegations against them. Plaintiffs seek compensatoryand punitive damages. We carry product liability insurance and this case iscurrently being defended by our insurer under reservation of rights withrespect to the claim of punitive damages, for which an exclusion from coverageexists. We have filed an answer to this lawsuit in which we have denied theclaims being made. We intend to defend against the claims vigorously. However,we cannot give any assurance that we will prevail, and we are currently unableto predict the impact, financial or otherwise, of this product liabilitylitigation.

**Item 4.**                        SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submittedto a vote of security holders of the Company, through solicitations of proxiesor otherwise, during the quarter ended December 31, 2006.

**EXECUTIVE OFFICERS**

As of March 1,2007, our executive officers, their respective ages and their positions are asfollows:

| **Name**              | ** ** | ** ** | ** ** | **Age**                                                                        | ** ** | **Position** |
|-----------------------|------------|------------|------------|--------------------------------------------------------------------------------|------------|--------------|
| Richard J. Faleschini |       | 60         |       | President and Chief  Executive Officer                                         |
| Gary M. Saxton        |       | 46         |       | Executive Vice President  and Chief Operating Officer                |
| Martin J. Joyce       |       | 53         |       | Executive  Vice President and Chief Financial Officer |
| Peter C. Sutcliffe    |       | 57         |       | Vice President, Manufacturing                                                  |

* *

*RichardJ. Faleschini*has served as our President, and ChiefExecutive Officer since November 2004 and as a director of BioSphereMedical since March 2005. From 2003 to 2004, Mr. Faleschini served asVice President and General Manager of the gynecology division at AmericanMedical Systems Holdings, Inc., a supplier of medical devices to physiciansspecializing in the treatment of urological and gynecological disorders. From1999 to 2003, Mr. Faleschini was Vice President of Marketing and Sales forAmerican Medical Systems Holdings, Inc. From 1995 to 1999, he heldexecutive marketing and general management positions at Medtronic Inc., amedical technology company, with responsibilities in several sectors of theircardiac rhythm management, cardiac surgery, and interventional vascularbusinesses. His previous experience also includes executive marketing and salesmanagement responsibilities at Cordis 

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Corporation, BiomagneticTechnologies, and ATL/ADR Ultrasound. Mr. Faleschini received his B.S. inbiology and M.S. in physiology from Michigan Technological University.

*GaryM. Saxton*has served as our Executive Vice Presidentand Chief Operating Officer since January 16, 2006. He served as ourSenior Vice President and General Manager from March 2005 until January 2006,and served as our Vice President of Marketing and Sales from November 2004to March 2005. From 2001 to 2004, Mr. Saxton was a strategyconsultant in the medical device industry. From 1999 to 2001, he was the VicePresident of Sales and Marketing at Symphonix Devices, Inc. and the VicePresident of Marketing at CardioGenesis Corporation, both publicly tradedmedical device companies. Mr. Saxton also previously held severalmarketing and strategy positions within Medtronic, Inc., both in theUnited States and Japan, including Director, Strategic Plan and MarketDevelopment Manager. He began his private sector career with IBM Corporation ina variety of sales, marketing and finance roles. Before IBM, he served as aCaptain in the U.S. Army. Mr. Saxton holds a B.S. degree from the UnitedStates Military Academy, West Point, New York, and an M.B.A. from HarvardUniversity, Cambridge, Massachusetts.

*MartinJ. Joyce*has served as our Executive Vice Presidentand Chief Financial Officer since January 16, 2006. He served as our ChiefFinancial Officer and Vice President from September 2004 to January 2006.From 2000 to 2004, Mr. Joyce served as Managing Partner of Stratex GroupLLC, a provider of biopharmaceutical executive services to early-stagecompanies and venture investors. From 1996 to 2000, Mr. Joyce was NorthAmerican Chief Financial Officer for Serono Inc. a biotechnology company. Priorto serving as North American Chief Financial Officer, Mr. Joyce held avariety of senior level positions within Serono, in finance, sales, marketingand manufacturing. Mr. Joyce was previously employed at MilliporeCorporation and Bose Corporation focusing on strategic planning, productrationalization and return on investment analysis. Mr. Joyce received aB.S. in finance from Northeastern University and an M.B.A. from SuffolkUniversity, Boston, Massachusetts.

*PeterC. Sutcliffe*has served as our Vice President,Manufacturing since October 2002. From 2001 to 2002, Mr. Sutcliffeserved as the Vice President for North American Manufacturing for Whatman,Plc., a life science filtration company. From 1996 to 2001, he was the ChiefOperating Officer for HemaSure Inc., a manufacturer and supplier of bloodfilters. From 1982 to 1996, Mr. Sutcliffe held the position of VicePresident of Manufacturing for Corning Costar Company, a life science productscompany. Prior to Costar, he held manufacturing management positions withMillipore Corporation, a high technology bioscience company. Mr. Sutcliffeholds a B.S. in biology from the University of Richmond in Virginia and anM.B.A. from Sul Ross State University of Texas, Fort Bliss, Texas.

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**PART II**

**Item 5.**                        MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Our common stock trades on the NASDAQ Global Marketunder the symbol “BSMD”. On March 1, 2007, the last reported sale price ofour common stock on the NASDAQ Global Market was $6.80 and there wereapproximately 110 stockholders of record. This number does not includestockholders for whom shares are held in “nominee” or “street” name.

Thefollowing table shows the range of high and low sales prices per share of ourcommon stock for the last two fiscal years as reported on the NASDAQ GlobalMarket since July 1, 2006 and prior to that, the NASDAQ National Market.

| ** **     | ** ** | **2006** | ** ** |
|----------------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 9.43       |   | $ | 6.79 |   |
| Second Quarter |       | $        | 8.20       |   | $ | 5.56 |   |
| Third Quarter  |       | $        | 7.20       |   | $ | 4.84 |   |
| Fourth Quarter |       | $        | 7.66       |   | $ | 5.89 |   |

 

| ** **     | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 4.25       |   | $ | 3.50 |   |
| Second Quarter |       | $        | 5.00       |   | $ | 3.50 |   |
| Third Quarter  |       | $        | 6.20       |   | $ | 4.27 |   |
| Fourth Quarter |       | $        | 8.60       |   | $ | 4.57 |   |

 

We have not paid any cashdividends on our common stock since our inception and do not intend to pay anycash dividends in the foreseeable future.

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**Comparative StockPerformance**

The following graphcompares the cumulative total stockholder return on our common stock for thelast five fiscal years with the cumulative total return on (i) the TotalReturn Index for the Nasdaq Stock Market (US Companies) (the “Nasdaq MarketIndex (U.S.)”) and (ii) the Nasdaq Medical Equipment Index (the “NasdaqMedical Composite Index”). This graph assumes the investment of $100 on December 31,2001 in our common stock and each of the indices listed above, and assumesdividends are reinvested. We have not paid any dividends on our common stockand no dividends are included in the representation of our performance. Thestock price performance shown in the below graph is not necessarily indicativeof future price performance. Measurement points are the last trading day of thefiscal years ended December 31, 2002, 2003, 2004, 2005 and 2006.

Thegraph and table below are not “soliciting material,” are not deemed filed withthe SEC and are not to be incorporated by reference in any filing of ours underthe Securities Act of 1933, as amended, or the Exchange Act, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage in any such filing.

**COMPARISONOF 5 YEAR CUMULATIVE TOTAL RETURN*AMONG BIOSPHERE MEDICAL, INC., THE NASDAQ COMPOSITE INDEX (U.S.)AND THE NASDAQ MEDICAL EQUIPMENT INDEX**

| ** **                      | ** ** | **12/02** | ** ** | **12/03** | ** ** | **12/04** | ** ** | **12/05** | ** ** | **12/06** | ** ** |
|---------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
| BioSphere  Medical, Inc.   |       | 58.47     |       | 35.05     |       | 34.52     |       | 71.87     |       | 59.27     |       |
| Nasdaq Composite  Index (U.S.)  |       | 69.66     |       | 99.71     |       | 113.79    |       | 114.47    |       | 124.20    |       |
| Nasdaq Medical  Equipment Index |       | 84.83     |       | 123.84    |       | 150.14    |       | 162.67    |       | 173.54    |       |

 

*                    $100invested on December 31, 2001 in our common stock or in either the NasdaqComposite Index (U.S.) or Nasdaq Medical Equipment Index, includingreinvestment of dividends.

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**Item 6.**                        SELECTEDFINANCIAL DATA

Thefollowing selected consolidated financial data should be read in conjunctionwith “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” and our financial statements and related notes to thosestatements and other financial information included elsewhere in this annualreport on Form 10-K. Historical results are not necessarilyindicative of future results.

| **Year Ended December 31,**                                   | ** ** | ** ** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------|------------|
| **(in thousands, except per share amounts)**        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Statement of Operations Data:**                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                                    |       |       |       |       |       |       |       |       |       |       |       |
| Product sales                                                                |       | $          | 22,787     |       | $          | 18,484     |       | $          | 14,058     |       | $          | 12,803   |       | $ | 12,152 |   |
| License revenues                                                             |       | 104        |       | —     |       | 100        |       | —     |       | —     |       |
| Total revenues                                                               |       | 22,891     |       | 18,484     |       | 14,158     |       | 12,803     |       | 12,152     |       |
| Costs and expenses:                                                          |       |       |       |       |       |       |       |       |       |       |       |
| Costs of product sales                                                       |       | 6,958      |       | 6,303      |       | 6,646      |       | 5,558      |       | 3,261      |       |
| Research and development                                                     |       | 2,290      |       | 2,359      |       | 2,113      |       | 2,344      |       | 3,714      |       |
| Sales                                                                        |       | 7,583      |       | 5,807      |       | 5,271      |       | 5,881      |       | 4,985      |       |
| Marketing                                                                    |       | 3,666      |       | 2,458      |       | 2,279      |       | 3,681      |       | 3,074      |       |
| General, administrative and patent                                           |       | 5,561      |       | 4,219      |       | 4,154      |       | 3,359      |       | 4,263      |       |
| Litigation costs                                                             |       | —     |       | —     |       | 874        |       | —     |       | —     |       |
| Total costs and expenses                                                     |       | 26,058     |       | 21,146     |       | 21,337     |       | 20,823     |       | 19,297     |       |
| Loss from operations                                                         |       | (3,167     | )          | (2,662     | )          | (7,179     | )          | (8,020     | )          | (7,145     | )          |
| Other income (expense):                                                      |       |       |       |       |       |       |       |       |       |       |       |
| Interest income                                                              |       | 938        |       | 225        |       | 92         |       | 135        |       | 398        |       |
| Interest expense                                                             |       | (15        | )          | (15        | )          | (16        | )          | (27        | )          | (29        | )          |
| Other                                                                        |       | (80        | )          | (442       | )          | 379        |       | 583        |       | 214        |       |
| Loss before income taxes                                                     |       | (2,324     | )          | (2,894     | )          | (6,724     | )          | (7,329     | )          | (6,562     | )          |
| Income tax benefit (provision)                                               |       | —     |       | 93         |       | (117       | )          | (23        | )          | 181        |       |
| Net loss                                                                     |       | (2,324     | )          | (2,801     | )          | (6,841     | )          | (7,352     | )          | (6,381     | )          |
| Preferred stock dividends                                                    |       | (525       | )          | (495       | )          | (68        | )          | —     |       | —     |       |
| Net loss applicable to common stockholders                                   |       | $          | (2,849     | )          | $          | (3,296     | )          | $          | (6,909     | )          | $          | (7,352   | )          | $ | (6,381 | ) |
| Basic and diluted net loss per share applicable  to common stockholders |       | $          | (0.17      | )          | $          | (0.22      | )          | $          | (0.49      | )          | $          | (0.55    | )          | $ | (0.49 | ) |
| Basic and diluted  weighted average number of common shares outstanding      |       | 17,027     |       | 14,653     |       | 14,152     |       | 13,462     |       | 12,988     |       |

 

| **As of December 31,**             | ** ** | ** ** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|----------|------------|
| **(in thousands)**                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balance  Sheet Data:**                          |       |       |       |       |       |       |       |       |       |       |       |
| Cash, cash equivalents and marketable  securities |       | $          | 22,119     |       | $          | 8,774      |       | $          | 10,222     |       | $          | 7,575    |       | $ | 14,738 |   |
| Working capital                                   |       | 24,719     |       | 10,832     |       | 12,391     |       | 10,704     |       | 17,008     |       |
| Total assets                                      |       | 32,079     |       | 17,495     |       | 19,391     |       | 17,002     |       | 23,928     |       |
| Long-term debt and deferred licensing revenue     |       | 190        |       | 101        |       | 192        |       | 171        |       | 270        |       |
| Stockholders’  equity                        |       | 26,965     |       | 13,088     |       | 14,835     |       | 13,525     |       | 20,259     |       |
|                                                   |            |            |            |            |            |            |            |            |            |            |            |          |            |  |  |  |  |  |

 

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**Item 7.**                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*The following discussion of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and the related notes included elsewhere in this report.Some of the information contained in this discussion and analysis and set forthelsewhere in this report, including information with respect to our plans andstrategy for our business includes forward-looking statements that involverisks and uncertainties. You should review the section titled “Risk Factors”for a discussion of important factors that could cause actual results to differmaterially from the results described in or implied by the forward-looking statementscontained in the following discussion and analysis**.***

***Overview***

We develop, manufacture and market products formedical procedures using embolotherapy techniques. Embolotherapy is thetherapeutic introduction of various biocompatible substances into a patient’scirculatory system to occlude a blood vessel, either to arrest or preventhemorrhaging or to devitalize the structure or organ by occluding its bloodsupply. Our core technologies consist of patented bioengineered polymers, whichare chemical compounds that we create through the application to medicalscience of engineering principles and manufacturing methods. These coretechnologies are used to produce miniature spherical particles, ormicrospheres, with unique properties for a variety of applications. In atypical embolotherapy procedure using our products, an interventionalradiologist injects our microspheres through a catheter into the blood vesselsthat feed these target areas. By selectively blocking the target tissue’s bloodsupply, the deprived tissue will either become destroyed or devitalized,designed to result in therapeutic benefit.

We currently market and sell four microsphereproducts: our Embosphere® Microspheres, which are marketed for uterinefibroids, hypervascularized tumors and other arteriovenous malformations in theUnited States, the European Union and several other foreign markets; ourEmboGold® Microspheres, which are marketed forhypervascularized tumors and other arteriovenous malformations in theUnited States, the European Union and several other foreign markets; ourQuadraSphereTM Microspheres, which are marketed for the treatment ofhypervascularized tumors and other arteriovenous malformations in the UnitedStates; and HepaSphereTM Microspheres, which are marketed in the European Unionfor primary and metastatic liver cancer and are also sold in limited quantitiesin Japan to Dr. Shinichi Hori for clinical evaluation and use in treatingliver cancer pursuant to Japanese private import regulations. Our QuadraSphereMicrospheres are identical in all respects to our HepaSphere Microspheres. Forthe fiscal years ended December 31, 2006, and December 31, 2005, wegenerated revenues primarily from product sales of our Embosphere Microspheresin North America and the European Union. We also generated revenues fromproduct sales in other geographic territories, including the Middle East,Africa, South America and Asia. Product revenues also include the sale ofaccessory embolotherapy devices such as our EmboCath® Infusion Catheter, EmboCath® Plus Infusion Microcatheter, Segway® Guidewire and our SequitorTM Guidewire, as wellas our barium delivery kits and other ancillary medical devices sold exclusively in Europe. Wecurrently derive a majority of our revenues in the United States and theEuropean Union from the sale of Embosphere Microspheres for use in thetreatment of symptomatic uterine fibroids, which are noncancerous (benign)tumors growing within or on the wall of the uterus, using a procedure calleduterine fibroid embolization, or UFE.

Our principal focus is on growing our embolotherapybusiness worldwide through increases in UFE and hypervascularized tumorembolization procedures. Our marketing strategy is to promote the UFE procedurefor patients suffering with uterine fibroids through our ask4UFE.com® awareness and education program and also tospecifically promote our Embosphere Microspheres as the product of choice forthe UFE procedure. Our success will depend upon the continued acceptance by themedical 

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community, patients andthird-party payers of the UFE procedure, our Embosphere Microsphere product andour other products, as safe, medically therapeutic and cost effective.

We have experienced operating losses in each fiscalperiod since our inception. As of December 31, 2006, we had approximately$22.12 million in cash, cash equivalents and marketable securities, and anaccumulated deficit of approximately $81.65 million. Most of our expendituresto date have been for sales and marketing activities, general andadministrative expenses and research and development activities. We expect tocontinue to incur operating losses in 2007 as we seek to execute on ourbusiness plan, including continuing to establish sales and marketingcapabilities and conducting research and development activities.

On February 22, 2006, we sold 2,075,000 shares ofour common stock at a price of $7.00 to several investors in a privateplacement. We received net proceeds of approximately $13.50 million.

In March 2006, we instituteda voluntary recall of our HepaSphereMicrospheres in Europe and Japan tocorrect a packaging defect that we identified while conducting aging studiesroutinely performed on all of our product packaging. HepaSphere Microspheres,which are used in the treatment of primary and metastatic liver cancer, arecontained in a prefilled vial that was in turn initially packaged inside apaper pouch. We determined that a defect in the paper pouch could compromisethe sterility of the outside of the vial. If the sterility of the outside ofthe vial was not maintained, there was the risk that a physician’s hands couldbecome contaminated when handling the vial. We are not aware of any adverseevents resulting from the defects in the paper packaging. We recognized aninventory charge of approximately $30,000 related to the recall of HepaSphereMicrospheres during 2006. Sales of HepaSphere Microspheres outside of theUnited States resumed in the paper pouch packaging with a shortened shelf lifeduring the second quarter, and we launched the new plastic packaging configurationfor HepaSphere Microspheres in the third quarter of 2006.

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***Research and Development***

Thefollowing table identifies each of the programs for which we have incurredresearch and development expenses in the years ended December 31, 2006,and 2005 and the current development phase of each.

| **Product /  Product Candidate**                 | ** ** | ** **                                                                                                                                                                                                                                                                             | ** ** | **Development Status** |
|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|
| Embosphere® Microspheres               |       | Marketed for uterine  fibroids, hypervascularized tumors and other arteriovenous malformations in  the United States, Canada, European Union, Argentina, Brazil, Columbia, Costa  Rica, Ecuador, Panama, Peru, Uruguay, Hong Kong, Taiwan and Australia;  clinical evaluation in China |
| EmboGold® Microspheres                 |       | Marketed for  hypervascularized tumors and arteriovenous malformations in the United  States, Canada, European Union, Argentina, Brazil, Columbia, Costa Rica,  Ecuador, Panama, Peru, Uruguay, Hong Kong, Taiwan and Australia                                                        |
| HepaSphereTM  Microspheres(1)                |       | Marketed in the  European Union for primary and metastatic liver cancer                                                                                                                                                                                                                |
| QuadraSphereTM  Microspheres(2)              |       | Received market  clearance from the FDA for embolization of hypervascularized tumors and  peripheral arteriovenous malformations                                                                                                                                                       |
| EmboCath® Infusion Catheter            |       | Marketed for  infusion of various diagnostic, embolic and therapeutic agents and  super-selective angiography within peripheral and coronary vasculature in the  United States, Canada, European Union, Argentina, Brazil, Costa Rica,  Ecuador, Panama and China                      |
| Segway® Guidewire                      |       | Marketed for  placement of catheters within peripheral and coronary vasculature in the  United States, Canada, European Union, Argentina, Brazil, Costa Rica,  Ecuador, Panama and China                                                                                               |
| EmboCath® Plus Infusion  Microcatheter |       | Received market clearance from the FDA, and Health Canada, and received a CE  Mark in the European Union for infusion of various diagnostic, embolic and  therapeutic agents and super-selective angiography within peripheral  vasculature                                            |
| SequitorTM Steerable  Guidewire              |       | Marketed in the  United States, Canada, and in the European Union for various diagnostic and  interventional procedures within peripheral vasculature                                                                                                                                  |
| MR Microspheres (magnetic  resonance visible)    |       | Preclinical  research—animal studies                                                                                                                                                                                                                                              |
| Resorbable Microspheres                          |       | Preclinical  research—feasibility stage                                                                                                                                                                                                                                           |

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(1)          Pursuant to our CE Markapproval in the European Union, HepaSphere Microspheres are indicated for usein the embolization of blood vessels for therapeutic or preoperative purposesin the following procedures: embolization of hepato-cellular carcinoma and theembolization of hepatic metastasis. Hepato-cellular carcinoma refers to cancerwhich originates in the liver and hepatic metastasis refers to cancer which hasspread to the liver from other sites in the body. We have exclusive worldwiderights to the HepaSphere Microsphere technology under a license from Dr. ShinichiHori, subject only 

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to Dr. Hori’s rightto conduct clinical trials on our behalf in Japan, treat patients at RinkuMedical Center and Osaka Medical Center in Japan and engage in research atOsaka University.

(2)          In November 2006,we received marketing clearance in the United States from the FDA for ourQuadraSphere Microsphere product candidate for the treatment ofhypervascularized tumors and peripheral arteriovenous malformations. Althoughour QuadraSphere Microspheres are identical in all technical respects to ourHepaSphere Microspheres, our QuadraSphere Microspheres are not specifically indicatedfor use in hepato-cellular carcinoma and hepatic metastasis. FDA regulationsrequire that we conduct formal clinical trials prior to seeking to claim theuse of the QuadraSphere Microspheres for the treatment of a specific disease orcondition, such as hepato-cellular cancer or hepatic metastasis, while EuropeanUnion regulations do not mandatorily require it for this class of medicaldevices. Accordingly, in order for us to seek FDA clearance to promote the useof QuadraSphere Microspheres for the embolization of hepato-cellular carcinomaand hepatic metastasis in the United States, we will be required to undertakeclinical trials.

Research anddevelopment expenses relate primarily to:

·       researchto identify and evaluate new and innovative embolotherapy products based on ourplatform microsphere technology, such as our MR Microspheres;

·       preclinicaltesting and clinical trials of our HepaSphere Microsphere, Sequitor SteerableGuidewire, EmboCath Plus Infusion Microcatheter, and our QuadraSphereMicrosphere products;

·       developmentrelated to improving manufacturing processes; and

·       productand production facilities validation processes under FDA Good ManufacturingPractices.

Our research and development functions typically workon a number of projects concurrently. In addition, except for clinicalexpenses, a substantial amount of fixed research and development costs such assalary and salary-related benefits, rent, equipment depreciation, utilities,insurance and maintenance are shared among various programs. Accordingly, wehave not historically tracked specific costs for each of our research anddevelopment projects.

The successfuldevelopment of our product candidates is highly uncertain. We cannot reasonablyestimate or know the nature, timing and estimated costs of the effortsnecessary to complete the development of, or the period in which material netcash inflows are expected to commence from, any of our product candidates dueto the numerous risks and uncertainties associated with developing medicaldevices, including the uncertainty of:

·       thescope, rate of progress and cost of clinical trials and other research anddevelopment activities undertaken by us;

·       futureclinical trial results;

·       thecost, timing and success of regulatory approvals;

·       thecost, timing and success of establishing sales, marketing and distributioncapabilities;

·       thecost of establishing clinical and commercial supplies of our product candidatesand any products that we may develop;

·       theeffect of competing technological and market developments; and

·       thecost of filing, prosecuting, defending and enforcing any patent claims andother intellectual property rights.

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Any failure to completethe development of our product candidates in a timely manner, or at all, couldhave a material adverse effect on our operations, financial position andliquidity. A discussion of the risks and uncertainties associated withcompleting our projects on schedule, or at all, and some consequences offailing to do so, are set forth in “Risk Factors.”

***Critical Accounting Policies***

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us****to make estimates and judgments that affect the reportedamounts of assets and liabilities, revenues and expenses, and relateddisclosure at the date of our financial statements. The significant accountingpolicies which we believe are most critical in gaining an understanding of ourfinancial statements include policies and judgments relating to revenuerecognition, stock-based compensation, accounts receivable and inventories.Actual results could differ materially from these estimates. Our significantaccounting policies are summarized in Note 2 of the notes to our consolidatedfinancial statements. The significant accounting policies which we believe arethe most critical to gaining a full understanding of and evaluating ourreported financial results include the following:

*Revenue Recognition*

We apply the revenuerecognition guidelines summarized in Staff Accounting Bulletin, or SAB, No. 104,“Revenue Recognition.” We recognize revenue when products are shipped and thecustomer or distributor, takes ownership and assumes risk of loss, collectionof the relevant receivable is reasonably assured, persuasive evidence of anarrangement exists (a valid purchase order from an approved customer), thesales price is fixed or determinable, payment is not contingent on resale andwe do not have any continuing obligations to ensure resale. Revenue fromlicensing agreements is recognized ratably over the expected service period. Weestablish reserves for potential sales returns and evaluate the adequacy ofthose reserves based upon realized experience and expectations. Any significantchange in product satisfaction and any resulting credit returns could have a materialadverse impact on our revenues and operating results for the period or periodsin which such returns materialize.

*Stock BasedCompensation*

We adopted the provisions of Statement of FinancialAccounting Standards, No. 123R, “Share-Based Payment”, or SFAS 123R,beginning January 1, 2006, using the modified prospective transitionmethod. This statement requires us to measure the cost of employee services inexchange for an award of equity based on the grant-date fair value of the awardand to recognize cost over the requisite service period. Under the modifiedprospective transition method, financial statements for periods prior to thedate of adoption are not adjusted for the change in accounting. However, werecognize compensation expense for (a) all share-based payments grantedafter the effective date and (b) all awards granted to employees prior tothe effective date that remain unvested on the effective date. We recognizecompensation expense on fixed awards with pro rata vesting on a straight-linebasis over the awards’ vesting period.

Prior to January 1, 2006, we used the intrinsicvalue method to account for stock-based employee compensation under AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and therefore we did not recognize compensation expense inassociation with options granted at or above the market price of our commonstock at the date of grant.

As a result of adopting the new standard, stock-basedcompensation charges during the fiscal year ended December 31, 2006increased by approximately $1.28 million. Net loss applicable to commonstockholders for the year ended December 31, 2006, increased by $0.07 perbasic and diluted share. 

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However, the amount ofstock compensation expense recognized in any future period cannot be predictedat this time because it will depend on levels of share-based payments grantedin the future. The adoption of SFAS 123R did not require any cumulativeadjustments to our financial statements.

We estimate the fair valueof each option grant on the date of grant using the Black-Scholesoption-pricing model, which requires the consideration of several subjectiveassumptions, including the expected dividends on our common stock, the expectedvolatility of our common stock, the risk-free interest rate for the expectedoption term and the expected term of the option. Equity instrument valuationmodels, such as the Black-Scholes valuation model, are highly subjective. Anysignificant changes in any of our estimates and judgments, including those usedto select the inputs for the Black-Scholes valuation model, could have asignificant impact on the fair value of the equity instruments granted or soldand the associated compensation charge, if any, we record in our financialstatements.

*Accounts Receivable*

We continuously monitorcollections and payments from our customers and maintain a provision forestimated credit losses based upon our historical payment experience and anyspecific customer collection issues that we have identified. While such creditlosses have historically been within our expectations and the provisionsestablished, we cannot guarantee that we will continue to experience the samecredit loss rates that we have in the past. Substantially all of ourreceivables are due from hospitals, distributors, health care clinics, andmanaged care systems located throughout the United States, Canada, Europe, Asiaand South America. A significant portion of products sold, both foreign anddomestic, is ultimately funded through government reimbursement programs. As aconsequence, changes in these programs can have an adverse impact on ouroperating results and cash flows.

*Inventories*

We value our inventory atthe lower of the actual cost to purchase or manufacture the inventory or themarket value for such inventory. We regularly review inventory quantities inprocess and on hand and record a provision for production loss and obsoleteinventory based primarily on actual loss experience and on our estimatedforecast of product demand. A significant decrease in demand could result in anincrease in the amount of excess inventory quantities on hand. In the future,if our inventory is determined to be overvalued, we would be required torecognize such costs in our costs of product sales at the time of suchdetermination. Although we make every effort to ensure the accuracy of ourproduction process and forecasts of future product demand, any significantunanticipated changes in production yield or product demand could have asignificant impact on the value of our inventory and our reported operatingresults.

***Results of Operations***

***Years Ended December 31, 2006 and 2005***

*Revenue and Margin Overview*

| ** **              | ** ** | **For the Years Ended December 31,** | ** ** | **Increase/** | ** ** | **Increase/** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **2006**      | ** ** | **2005**      | ** ** | **(Decrease) ($)** | ** ** | **(Decrease) (%)** | ** ** |
| Total revenues          |       |                                                          | $          | 22,891        |       |          |       | $ | 18,484 |   |   |   | $ | 4,407 |   |   |   | 24 | % |   |
| Costs of product  sales |       |                                                          | 6,958      |          |       |          | 6,303      |   |   |   | 655 |   |   |   | 10 | % |   |
| Gross margin            |       |                                                          | $          | 15,933        |       |          |       | $ | 12,181 |   |   |   | $ | 3,752 |   |   |   | 31 | % |   |
| Gross margin %          |       |                                                          | 70         | %             |       |          | 66         | % |   |   | 4 | % |   |   |   |   |   |
|                         |            |                                                               |            |               |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*Revenues.*   Totalrevenues increased for the year ended December 31, 2006 as compared to theyear December 31, 2005 primarily due to the following:

·       anincrease in revenues from Embosphere and EmboGold microsphere sales in theUnited States of approximately $3.68 million, or 30%, on increased demand foruse in the treatment of uterine fibroids and liver tumors. This volume growthis partially due to the addition of five new sales territories in 2006 and, webelieve, to increased awareness of the UFE procedure resulting from additionallocal advertising and marketing;

·       anincrease in revenues from Embosphere and EmboGold microsphere sales outside ofthe United States of approximately $330,000, or 10%, on increased productvolumes. Revenues in 2006 included sales of approximately $60,000 to ourdistributor located in the People’s Republic of China, for use in clinicalevaluations, which were the first sales of Embospheres Microspheres to thisdistributor in China. We are still awaiting regulatory approval of Embospheres inthe People’s Republic of China;

·       Anincrease in revenues from the sale of our new HepaSphere Microsphere productoutside of the United States, which was first introduced in December 2005,and from the initial sales of our new QuadraSphere Microspheres product, whichwas approved in the United States for the treatment of hypervascularized tumorsand peripheral arterial venous malformations in November 2006, which on acombined basis totaled $182,000 in 2006;

·       revenuefrom a licensing agreement signed in October 2006 related to non-coreintellectual property, which totaled $104,000 in 2006; and

·       changesin foreign exchange rates during 2006 as compared to 2005 increased revenuesapproximately $51,000 as sales from our French subsidiary increased due to theweakening of the U.S. dollar versus the Euro, which averaged 1.25 dollars tothe Euro during 2006 as compared to 1.24 dollars to the Euro during 2005.

Revenues from our delivery system and other products,which include barium delivery kits and other ancillary products, wereconsistent with 2005.

*Costof Product Sales.**  *Costof product sales for the year ended December 31, 2006 increased from theyear ended December 31, 2005 primarily due to higher EmbosphereMicrosphere sales volume and, to a lesser extent, the recognition of equitycompensation costs of approximately $185,000 resulting from the adoption ofSFAS 123R in January 2006 and costs associated with an increase in writedowns for excess inventory of $180,000. During our routine quarterly review ofour inventory we determined that approximately $71,000 and $66,000 of inventoryrelated to our ancillary business in France and to our older generationdelivery systems, respectively, would not be realized due to our decision tophase these products out in 2007.

The gross margin improvement of 4% as a percentage ofrevenues for 2006 as compared to 2005 was primarily attributable to theincrease in sales in 2006 of Embosphere Microspheres in the United States,which provide our highest profit margins. Offsetting these improvements wereequity compensation costs and the increase in inventory write downs.

We expect thatfuture gross margin will be highly correlated with the following factors:

·       revenuegrowth;

·       mixof products sold;

·       productionlevels;

·       foreignexchange rate movements;

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·       termsand conditions of subcontracted manufacturer and supplier agreements; and

·       future inventory reserverequirements.

*Expense Overview*

| ** **                          | ** ** | **For the Years Ended December 31,** | ** ** | **Increase/** | ** ** | **Increase/** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| **(in thousands)**             | ** ** | ** **                                                    | ** ** | **2006**      | ** ** | **2005**      | ** ** | **(Decrease) ($)** | ** ** | **(Decrease) (%)** | ** ** |
| Research and  development           |       |                                                          | $          | 2,290         |       |          |       | $ | 2,359 |   |   |   | $ | (69 | ) |   |   | (3 | )% |   |
| Sales                               |       |                                                          | 7,583      |          |       |          | 5,807      |   |   |   | 1,776 |   |   |   | 31 | % |   |
| Marketing                           |       |                                                          | 3,666      |          |       |          | 2,458      |   |   |   | 1,208 |   |   |   | 49 | % |   |
| General,  administrative and patent |       |                                                          | 5,561      |          |       |          | 4,219      |   |   |   | 1,342 |   |   |   | 32 | % |   |
| Total operating expenses            |       |                                                          | $          | 19,100        |       |          |       | $ | 14,843 |   |   |   | $ | 4,257 |   |   |   |   |   |   |
|                                     |            |                                                               |            |               |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

* *

*Researchand Development Expense.**  *Total research and development expense in 2006 wasessentially unchanged when compared to 2005 as a decrease in overhead expensesand a reduction in spending on product development projects related to our newdelivery systems, which were released in 2006, was offset by an increase inclinical studies and equity compensation. Research and development expenseincluded $72,000 of equity compensation costs in 2006 due to the adoption ofSFAS 123R beginning in January 2006. We expect research and developmentexpenses will increase as we increase our focus on the development of embolotherapyproducts for clinical oncology.

*SalesExpense.**  *Salesexpense for 2006 increased over 2005 primarily due to increased recruiting,payroll and related expenses incurred with the expansion of the sales force inthe United States. We ended 2006 with 18 sales professionals in the UnitedStates, led by three regional sales managers. This represents a 50% increase inthe sales organization compared to 2005. In addition, sales expense included$325,000 of equity compensation costs in 2006 due to the adoption of SFAS 123Rbeginning in January 2006.

*MarketingExpense.**  *Marketingexpense for 2006 increased from 2005 primarily due to increased localpromotional activities, in an effort to build physician and patient demand forUFE in the United States and to the addition of resources to manage thisincrease in marketing programs.

*General,Administrative and Patent Expense.**  *General, administrative and patentexpenses for 2006 increased from 2005 primarily due to an increase incompensation and consulting costs. Included in general, administrative andpatent expense in 2006 is $680,000 of equity compensation costs due to theadoption of SFAS 123R beginning in January 2006. In addition, we incurredapproximately $155,000 in consulting costs to help us position the company forcontinued growth and approximately $45,000 in costs related to regulatorycompliance.

*InterestIncome, Net.**  *Forthe year ended December 31, 2006, interest income, net of interestexpense, increased to $923,000 as compared to $210,000 in 2005. The increase in2006 as compared to 2005 was due primarily to higher average daily-investedcash balances and to a lesser extent to higher interest rates on availableinvestment grade assets.

*Foreign Exchange Losses,Net.**  *Foreignexchange gains and losses primarily result from Euro to U.S. dollarforeign currency fluctuations on Euro denominated intercompany trade accounts.The foreign exchange losses during the year ended December 31, 2006totaled approximately $102,000 compared to the foreign exchange losses ofapproximately $444,000 in the comparable period of 2005. The decrease in theloss was primarily the result of lower Euro denominated intercompany tradereceivable and payable balances and to the fluctuation of the U.S. dollar ascompared to the Euro.

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***Years Ended December 31, 2005 and 2004***

*Revenue and Margin Overview*

| ** **              | ** ** | **For the Years Ended December 31,** | ** ** | **Increase/  (Decrease)** | ** ** | **Increase/  (Decrease) ** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|---------------------------|------------|---------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **2005**                  | ** ** | **2004**                        | ** ** | **($)** | ** ** | **(%)** | ** ** |
| Total revenues          |       |                                                          | $          | 18,484                    |       |                            |       | $ | 14,158 |   |   |   | $ | 4,326 |   |   |   | 31 | % |   |
| Costs of product  sales |       |                                                          | 6,303      |                      |       |                            | 6,646      |   |   |   | (343 | ) |   |   | -5 | % |   |
| Gross margin            |       |                                                          | $          | 12,181                    |       |                            |       | $ | 7,512 |   |   |   | $ | 4,669 |   |   |   | 62 | % |   |
| Gross margin %          |       |                                                          | 66         | %                         |       |                            | 53         | % |   |   | 13 | % |   |   |   |   |   |
|                         |            |                                                               |            |                           |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

* *

*Revenues.*   Revenuesincreased 31% in 2005 as compared to 2004 primarily due to the following:

·       anincrease in revenues from microspheres and delivery systems in the UnitedStates of approximately $3.68 million, or 41%, as Embosphere Microsphere salesvolume levels continued to increase as we execute our strategies to grow theUFE business in the United States;

·       anincrease in revenues from microspheres and delivery systems outside the UnitedStates of $635,000, or 22%, driven by an increase in Embosphere Microspheresales volumes in France, Germany and the United Kingdom. In April 2005, webegan a year-long patient awareness program in France targeted at potential UFEpatients through medical gynecologists’ offices, which we believe hascontributed to the increase in sales volumes; and

·       anincrease in revenues from other products, which include barium delivery kitsand other ancillary products, of approximately $100,000, or 4%, as a result ofthe timing of several hardware sales in the first quarter of 2005.

Offsetting these increases was a decrease in licensingrevenue of $100,000 as a result of the conclusion of a five-month agreement forthe development of Embosphere Microspheres for the use in the prevention ofgastroesphageal reflex disease, or GERD, which began in 2004 and did not renewin 2005.

*Costof Product Sales.**  *Costof product sales for the year ended December 31, 2005 decreased from theyear ended December 31, 2004 primarily due to the $1.13 million write-offfor work-in-process inventory disposals in 2004 due to manufacturing processimprovements, and product replacements resulting from shelf life limitationsthat we recorded during 2004 and did not occur in 2005.

The gross marginimprovement of 13% as a percentage of revenues for 2005 as compared to 2004 wasprimarily attributable to the additional costs in 2004 related to the inventorywrite-off and the increase in sales in 2005 of Embosphere Microspheres in theUnited States, which provide our highest profit margins. Offsetting theseimprovements were costs associated with the initial production of ourHepaSphere Microsphere product, which we introduced commercially in 2005, andthe decrease in licensing revenue.

*Expense Overview*

| ** **                          | ** ** | **For the Years Ended December 31,** | ** ** | **Increase/  (Decrease)** | ** ** | **Increase/  (Decrease)** | ** ** |    |
|-------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|---------|
| **(in thousands)**             | ** ** | ** **                                                    | ** ** | **2005**                  | ** ** | **2004**                  | ** ** | **($)** | ** ** | **(%)** | ** ** |   |
| Research and development            |       |                                                          | $          | 2,359                     |       |                      |       | $       | 2,113 |   |   |   | $ | 246 |   |   |   | 12 | % |   |
| Sales                               |       |                                                          | 5,807      |                      |       |                      | 5,271      |    |   |   | 536 |   |   |   | 10 | % |   |
| Marketing                           |       |                                                          | 2,458      |                      |       |                      | 2,279      |    |   |   | 179 |   |   |   | 8 | % |   |
| General, administrative  and patent |       |                                                          | 4,219      |                      |       |                      | 4,154      |    |   |   | 65 |   |   |   | 2 | % |   |
| Litigation costs                    |       |                                                          | —     |                      |       |                      | 874        |    |   |   | (874 | ) |   |   | — |   |   |
| Total operating expenses            |       |                                                          | $          | 14,843                    |       |                      |       | $       | 14,691 |   |   |   | $ | 152 |   |   |   |   |   |   |
|                                     |            |                                                               |            |                           |            |                           |            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*Research and DevelopmentExpense.**  *Total  research and development expense in 2005increased 12% as we increased spending by approximately $325,000 in support ofour latest product, HepaSphere Microspheres, that we introduced commercially inthe European Union in 2005, and our product candidates, MR Microspheres and ournext-generation delivery systems, which increased spending by approximately$60,000 to differentiate Embosphere Microspheres from competitive products.Offsetting these increases in 2005 were lower overhead costs achieved by theconsolidation of space in our facility in Rockland, Massachusetts at the end ofthe first quarter of 2005.

*Sales Expense.**  *Sales expense for 2005 increased10%. The primary reason for the increase was the higher sales levels andimproved performance resulting in higher incentive compensation for our salespersonnel.

*Marketing Expense.**  *Marketing expense for 2005increased 8% from 2004. The increase was primarily due to increased spending onmarketing programs, including local advertising to support the growth inembolic sales in the United States.

*General,Administrative and Patent Expense.**  *General, administrative and patentexpenses for 2005 increased $65,000, or 2% from 2004. The increase wasprimarily due to higher patent maintenance costs of approximately $170,000;higher legal costs related to the governance of our French subsidiary andemployment issues of approximately $110,000, higher compensation costs forgeneral and administrative personnel of approximately $175,000 and an increasein investor relations activities of approximately $135,000. Offsetting theseincreases were costs related to the 2004 executive management transition, whichdid not occur in 2005.

*LitigationCosts.**  *In December 2004, we paid damages ina lawsuit brought by Terumo Europe N.V. against our French subsidiary,BioSphere Medical S.A. Terumo alleged that it suffered damages from apurported termination of the distribution contract by BioSphereMedical S.A. BioSphere Medical S.A. and Terumo Europe entered into adistribution agreement in January 2002 pursuant to which Terumo Europebecame the exclusive distributor of Embosphere Microsphere and EmboGoldMicrosphere products in certain countries of Europe. The Commercial Court ofPontoise, France, determined that while both parties had ceased to performtheir obligations under the agreement, we had not terminated the agreement inaccordance with its terms. Accordingly, BioSphere Medical S.A. wasrequired to pay Terumo $784,000 in damages for breach of contract in December 2004.The $874,000 charge recorded in the fourth quarter of 2004 includes $90,000 ofrelated accounts receivable written off in addition to the settlement payment.

*InterestIncome, Net.**  *Forthe year ended December 31, 2005, interest income, net of interestexpense, increased to $210,000 as compared to $76,000 in 2004. The increase in2005 as compared to 2004 was due primarily to increases in the averagedaily-invested cash balances and interest rates on available investment gradeassets.

*ForeignExchange Losses, Net.**  *Theforeign exchange losses during the year ended December 31, 2005 totaledapproximately $444,000 compared to the foreign exchange gains realized ofapproximately $389,000 in the comparable period of 2004. These changes wereprimarily the result of fluctuation of the U.S. dollar as compared to the Euroand a decrease in Euro denominated receivables.

*Income Tax Provision.**  *The 2005 income tax benefit of$93,000 primarily represents the realization of income tax benefits, as werecovered a portion of the 2001 taxes paid in France. In the first quarter of2005, we determined that a portion of the benefit reversed in 2004 would berealized. The 2004 income tax provision of $117,000 primarily represents thereversal of income tax benefits recorded during 2002, as we initiallydetermined in the fourth quarter of 2004 that we would not recover a portion ofthe 2001 taxes paid.

50

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***Liquidity and Capital Resources***

As of December 31, 2006, we had $22.12 million ofcash, cash equivalents and marketable securities, an increase of $13.35 millionfrom $8.77 million at December 31, 2005. This increase was primarily theresult of the net proceeds from our private placement of common stock in February 2006and by proceeds from stock option exercises by former employees offset by our2006 operating losses and changes in working capital. We have historicallyfunded our operations from the net proceeds provided by public and privateequity offerings, net revenues, bank financing, and equipment financing leasesand, to a lesser extent, the exercise of stock options.

The net cash used in operating activities was $704,000and includes a net loss of $2.32 million and $473,000 in working capitalchanges. Accounts receivable increased $437,000 on higher sales offset by athree-day improvement in days sales outstanding, which decreased to 58 daysfrom 61 days at December 31, 2005.

During 2006, we spent $464,000 to purchasemanufacturing equipment to produce our new delivery system and QuadraSphereMicrosphere products and to purchase other equipment to support our sales andmarketing expansion and to support our existing infrastructure.

Net cash provided byfinancing activities was $14.32 million during 2006, which included $13.50million of net proceeds from our private placement of 2,075,000 shares ofcommon stock in February 2006 and $952,000 from employee equity incentiveplans, including the exercise of stock options and from purchases under ourEmployee Stock Purchase Plan, offset by scheduled principal payments, such asthose on existing lease arrangements.

***Borrowing Arrangements***

At December 31, 2006, we had a credit facilitywith a bank under which we may borrow up to $3.00 million. We may use amountsborrowed under the agreement for general working capital and corporatepurposes, subject to limitations defined in the agreement. This agreementexpires in June 2007.

There were no borrowingsoutstanding under this agreement as of December 31, 2006. Each available30-, 60-, 90- or 180-day advance will bear interest ata per annum rate, at our option, equal to either (i) a variable rate asdetermined by the bank or (ii) a rate equal to the corresponding 30-,60-, 90- or 180-day LIBOR rate (5.33% as of December 31,2006) plus a LIBOR advance rate spread as determined by certain current workingcapital balances at the time of the advance. In connection with the creditfacility, we entered into a security agreement pursuant to which we havepledged to the bank all of our U.S. assets, excluding our equity ownership ofBioSphere Medical SA, a wholly owned subsidiary, as collateral.

***Other Contractual Obligations***

As of December 31, 2006, we are party to twooperating leases for our facilities in Rockland, Massachusetts and Roissy,France. The Roissy, France operating lease expires in May 2010. On February 24,2006, we amended the lease for the office and laboratory facility that wecurrently occupy in Rockland, Massachusetts. Pursuant to that amendment, theleased premises has been increased to a total area of approximately 13,000square feet at a monthly cost of $19,500 per month, and the term of the leaseis extended from March 31, 2007 to February 28, 2009. In addition tothe capital lease agreement we entered into in September 2005, we areparty to several other non-cancelable capital lease agreements with variousequipment-financing companies, related to the acquisition of certainmanufacturing and computer equipment during 2002 and 2004. The equipment leaseshave initial terms of 36 to 60 months with interest rates of 4.6% to 8.7%.Equipment leased under these arrangements serves as pledged capital withrespect to each capital lease agreement.

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Futurecash payments, including interest, under contractual obligations in effect asof December 31, 2006, are as follows:

| ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total**      | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|-----------------|------------|------------|------------|------------|------------|------------|------------|----------------|------------|
| ** **                     | ** ** | **Years**  | ** ** | ** ** | ** ** | **Contractual** | ** ** |
| **(in thousands)**        | ** ** | ** ** | ** ** | **2007**   | ** ** | **2008**        | ** ** | **2009**   | ** ** | **2010**   | ** ** | **2011**   | ** ** | **Thereafter** | ** ** | **Obligations** | ** ** |
| Operating leases               |       | $          | 696        |       | $          | 649             |       | $          | 402        |       | $          | 151        |       |           | $          | — |   |   |   | $ | — |   |   |   | $ | 1,898 |   |   |
| Capital leases                 |       | 62         |       | 29         |       | 10              |       | 8          |       |       | —     |       |       |           | —     |   |   |   | 109 |   |   |
| Other contractual  obligations |       | 73         |       | 90         |       | 20              |       | 20         |       |       | 20         |       |       |           | 35         |   |   |   | 258 |   |   |
| Total                          |       | $          | 831        |       | $          | 768             |       | $          | 432        |       | $          | 179        |       |           | $          | 20 |   |   |   | $ | 35 |   |   |   | $ | 2,265 |   |   |
|                                |            |            |            |            |            |                 |            |            |            |            |            |            |            |                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We believe that the $22.12 million in cash, cashequivalents and marketable securities that we have as of December 31, 2006, together with anticipatedproceeds from sales of our microspheres, delivery systems and other productswill be sufficient to fund our operating and capital requirements, as currentlyplanned through at least 2007. In the longer term, we expect to fund ouroperations and sustain capital requirements through a combination of expectedproceeds from product sales and capital equipment financing. However, our cashrequirements may vary materially from those now planned due to a number offactors, including, without limitation, our failure to achieve expected revenueamounts, costs associated with changes in our UFE marketing programs,anticipated research and development expenses, the scope and results ofpre-clinical and clinical testing, changes in the focus and direction of ourresearch and development programs, competitive and technological advances, thetiming and results of FDA regulatory review and the market’s acceptance of anyapproved products, including our Embosphere Microspheres for UFE and ourHepaSphere Microspheres and QuadraSphere Microsphere products.

We may incur additionalcosts, including costs related to ongoing research and development activities,pre-clinical studies, clinical trials, the expansion of our manufacturing,laboratory and administrative functions, and costs relating to further marketdevelopment and commercialization efforts. We may also need additional fundsfor such activities and for possible strategic acquisitions of synergisticbusinesses, products and/or technologies. These additional funds may besubstantial and raised from time to time through additional public or privatesales of equity, through borrowings, or through other financings. There are noassurances that we will be able to obtain any additional funding that may berequired, or that any such funding will be on acceptable terms.

***Related Party Transactions***

We did not have anyrelated party transactions during 2006.

***Off-Balance Sheet Arrangements***

We do not have anymaterial off-balance sheet arrangements.

***Inflation***

We believe that theeffects of inflation generally do not have a material adverse impact on ouroperations or financial condition.

52

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***New AccountingPronouncements***

In June 2006,the Financial Accounting Standards Board, or the FASB, issued FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement No. 109”, or Interpretation. TheInterpretation clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with FASBStatement No. 109, *Accounting forIncome Taxes.* The Interpretation prescribes a recognition thresholdand measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.This Interpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition. The Interpretation is effective for fiscal years beginning after December 15,2006. We have not completed our evaluation of the Interpretation, but do notcurrently believe that adoption will have a material impact on our results ofoperations, financial position or cash flows.

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements”, or SFAS 157. SFAS 157 defines fair value,establishes a framework for measuring fair value under generally acceptedaccounting principles in the United States, or GAAP, and expands disclosuresabout fair value measurements. SFAS 157 applies under other accountingpronouncements that require or permit fair value measurements, the FASB havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, SFAS 157 does not require anynew fair value measurements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears, with earlier adoption permitted. The provisions of SFAS 157 shouldbe applied prospectively as of the beginning of the fiscal year in which it isinitially applied, with limited exceptions. We do not believe the adoption ofSFAS 157 will have a material impact on our results of operations, financialposition or cash flows.

**Item 7A.**                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

***Derivative Financial Instruments, Other FinancialInstruments, and Derivative Commodity Instruments***

As of December 31,2006, we did not participate in any derivative financial instruments or otherfinancial and commodity instruments. However, in the future, we may considercertain financing instruments, including foreign currency forward contracts, oralternative instruments, which may be considered derivative in nature.

***Primary Market Risk Exposures***

Our primary market risk exposure is in the area offoreign currency exchange rate risk. We are exposed to currency exchange ratefluctuations related to our operations in France. Operations in France aredenominated in the Euro, and as of December 31, 2006, approximately Euro1.45 million, or $1.91 million, remained outstanding within the inter-companytrade accounts. We have not engaged in formal currency hedging activities todate, but do have a limited natural hedge in that both our revenues and expensesin France are primarily denominated in the Euro. We also attempt to minimizeexchange rate risk by converting non-U.S. currency to U.S. dollars as often aspracticable. We generally view our investment in foreign subsidiaries operatingunder a functional currency (the Euro) other than our reporting currency (theU.S. dollar) as long term. Our investment in foreign subsidiaries is sensitiveto fluctuations in foreign currency exchange rates. The effect of a change inforeign exchange rates on our net investment in foreign subsidiaries isreflected in the “Other accumulated comprehensive loss” component ofstockholders’ equity. Because our foreign currency exchange rate risk is notmaterial, no quantitative tabular disclosure has been provided.

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The primary objectiveof our investment activities is to preserve principal while at the same timemaximizing the income we receive from our investments without significantlyincreasing risk. Some of the securities that we invest in may have market risk.This means that an increase in prevailing interest rates may cause theprincipal amount of the investment to decrease. To minimize this risk in thefuture, we maintain our portfolio of cash equivalents and short-terminvestments in a variety of securities, including commercial paper, investmentgrade asset-backed corporate securities, money market funds and government andnon-government debt securities. Due to the conservative nature of ourinvestments, the relatively short duration of their maturities, our ability toconvert some or all of our long-term investments to less interestrate-sensitive holdings and our general intent to hold most securities untilmaturity, we believe interest rate risk is mitigated. A hypothetical 100 basispoint increase or decrease in interest rates would not have a material impacton the fair value of our short term investments as of December 31, 2006. As of December 31,2006, approximately 71% of the $13.21 million classified, as available-for-salemarketable securities will mature within one year.

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**BioSphere Medical, Inc.**INDEX

|                                                                                                                                                  | ** ** | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm                                                                                         |       | 56       |
| Consolidated Balance Sheets as of  December 31, 2006 and 2005                                                                               |       | 57       |
| Consolidated Statements of  Operations for the Years Ended December 31, 2006, 2005 and 2004.                                                |       | 58       |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income (Loss) for the Years Ended  December 31, 2006, 2005 and 2004 |       | 59       |
| Consolidated Statements of  Cash Flows for the Years Ended December 31, 2006, 2005, and 2004                                                |       | 60       |
| Notes  to Consolidated Financial Statements                                                                                                      |       | 61       |

 

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**Item 8.**                        FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**Reportof Independent Registered Public Accounting Firm**

To the Board of Directors and Stockholders ofBioSphere Medical, Inc.:

We have audited the accompanying consolidated balancesheets of BioSphere Medical, Inc. as of December 31, 2006 and 2005,and the related consolidated statements of operations, stockholders’ equity andcomprehensive income (loss), and cash flows for each of the three years in theperiod ended December 31, 2006. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged to perform an audit of the Company’s internalcontrol over financial reporting. Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purposes of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of BioSphere Medical, Inc. at December 31, 2006 and 2005,and the consolidated results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2006, in conformity withU.S. generally accepted accounting principles.

Asdiscussed in Note 2 to the consolidated financial statements, effective January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),“Share-Based Payment” using the modified prospective transition method.
|                       | /s/  Ernst & Young LLP |   |
|-----------------------|-------------------------------------------|--------|
| Boston, Massachusetts |                                      |   |
| March 20, 2007   |                                      |   |

 

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**BIOSPHERE MEDICAL, INC. CONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands except share data)**                                                                                                                                                                                                                    | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current Assets:                                                                                                                                                                                                                                                             |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                   |       | $                     | 8,913      |   | $ | 8,774 |   |
| Marketable securities                                                                                                                                                                                                                                                       |       | 13,206                |       | — |   |
| Account receivable, net of allowance for doubtful  accounts of $218 and $233 as of December 31, 2006 and 2005, respectively                                                                                                                                            |       | 4,082                 |       | 3,521 |   |
| Inventories                                                                                                                                                                                                                                                                 |       | 2,830                 |       | 2,435 |   |
| Prepaid and other current assets                                                                                                                                                                                                                                            |       | 612                   |       | 407 |   |
| Total current assets                                                                                                                                                                                                                                                        |       | 29,643                |       | 15,137 |   |
| Property and  equipment, net                                                                                                                                                                                                                                                |       | 929                   |       | 858 |   |
| Goodwill                                                                                                                                                                                                                                                                    |       | 1,443                 |       | 1,443 |   |
| Other assets                                                                                                                                                                                                                                                                |       | 64                    |       | 57 |   |
| Total Assets                                                                                                                                                                                                                                                                |       | $                     | 32,079     |   | $ | 17,495 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current Liabilities:                                                                                                                                                                                                                                                        |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                                                                                                            |       | $                     | 1,366      |   | $ | 1,146 |   |
| Accrued compensation                                                                                                                                                                                                                                                        |       | 1,935                 |       | 1,830 |   |
| Other accrued liabilities                                                                                                                                                                                                                                                   |       | 1,483                 |       | 1,203 |   |
| Current portion of capital lease obligations and  long-term debt                                                                                                                                                                                                            |       | 57                    |       | 127 |   |
| Current portion of deferred licensing revenue                                                                                                                                                                                                                               |       | 83                    |       | — |   |
| Total current liabilities                                                                                                                                                                                                                                                   |       | 4,924                 |       | 4,306 |   |
| Long-term debt  and capital lease obligations                                                                                                                                                                                                                               |       | 44                    |       | 101 |   |
| Long-term portion  of deferred licensing revenue                                                                                                                                                                                                                            |       | 146                   |       | — |   |
| Total Liabilities                                                                                                                                                                                                                                                           |       | 5,114                 |       | 4,407 |   |
| Commitments and  contingencies (Note 9 and 16)                                                                                                                                                                                                                              |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                                                                                                                  |       |                  |       |   |   |
| Preferred stock;  $.01 par value; 1,000,000 shares authorized:                                                                                                                                                                                                              |       |                  |       |   |   |
| 6% series A convertible preferred stock, 12,000  authorized shares, 8,950 and 8,434 shares issued and outstanding, as of  December 31, 2006 and 2005, respectively (aggregate liquidation  preference including accrued dividends of $9,083 at December 31, 2006) |       | 7,970                 |       | 7,449 |   |
| Common stock; $.01 par value; 50,000,000 shares  authorized; 17,957,964 and 15,006,005 shares issued and outstanding as of  December 31, 2006 and 2005, respectively                                                                                                   |       | 180                   |       | 150 |   |
| Additional  paid-in capital                                                                                                                                                                                                                                                 |       | 100,275               |       | 84,471 |   |
| Deferred compensation                                                                                                                                                                                                                                                       |       | —                |       | (41 | ) |
| Accumulated  deficit                                                                                                                                                                                                                                                        |       | (81,648               | )          | (78,799 | ) |
| Accumulated other  comprehensive income (loss)                                                                                                                                                                                                                              |       | 188                   |       | (142 | ) |
| Total stockholders’ equity                                                                                                                                                                                                                                             |       | 26,965                |       | 13,088 |   |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                                                                                                            |       | $                     | 32,079     |   | $ | 17,495 |   |
|                                                                                                                                                                                                                                                                             |            |                       |            |  |  |  |  |  |  |

 

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

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**BIOSPHERE MEDICAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                                        | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands except per share data)** | ** ** | ** **                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                         |       |                                                          |       |   |   |   |   |
| Product sales                                                     |       | $                                                             | 22,787     |   | $ | 18,484 |   | $ | 14,058 |   |
| Licensing revenues                                                |       | 104                                                           |       | — |   | 100 |   |
| Total revenues                                                    |       | 22,891                                                        |       | 18,484 |   | 14,158 |   |
| Costs and expenses:                                               |       |                                                          |       |   |   |   |   |
| Costs of product sales                                            |       | 6,958                                                         |       | 6,303 |   | 6,646 |   |
| Research and development                                          |       | 2,290                                                         |       | 2,359 |   | 2,113 |   |
| Sales                                                             |       | 7,583                                                         |       | 5,807 |   | 5,271 |   |
| Marketing                                                         |       | 3,666                                                         |       | 2,458 |   | 2,279 |   |
| General, administrative and patent                                |       | 5,561                                                         |       | 4,219 |   | 4,154 |   |
| Litigation costs                                                  |       | —                                                        |       | — |   | 874 |   |
| Total costs and expenses                                          |       | 26,058                                                        |       | 21,146 |   | 21,337 |   |
| Loss from  operations                                             |       | (3,167                                                        | )          | (2,662 | ) | (7,179 | ) |
| Interest income                                                   |       | 938                                                           |       | 225 |   | 92 |   |
| Interest expense                                                  |       | (15                                                           | )          | (15 | ) | (16 | ) |
| Foreign exchange  (loss) gains, net                               |       | (102                                                          | )          | (444 | ) | 389 |   |
| Other income  (expense), net                                      |       | 22                                                            |       | 2 |   | (10 | ) |
| Loss before income tax benefit (provision)                        |       | (2,324                                                        | )          | (2,894 | ) | (6,724 | ) |
| Income tax  benefit (provision)                                   |       | —                                                        |       | 93 |   | (117 | ) |
| Net loss                                                          |       | (2,324                                                        | )          | (2,801 | ) | (6,841 | ) |
| Preferred stock  dividends                                        |       | (525                                                          | )          | (495 | ) | (68 | ) |
| Net loss applicable to common stockholders                        |       | $                                                             | (2,849     | ) | $ | (3,296 | ) | $ | (6,909 | ) |
| Net loss per common  share applicable to common stockholders      |       |                                                          |       |   |   |   |   |
| Basic and diluted                                                 |       | $                                                             | (0.17      | ) | $ | (0.22 | ) | $ | (0.49 | ) |
| Weighted average number  of common shares outstanding             |       |                                                          |       |   |   |   |   |
| Basic and diluted                                                 |       | 17,027                                                        |       | 14,653 |   | 14,152 |   |
|                                                                   |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

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

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**BIOSPHERE MEDICAL,INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOME (LOSS)**

| ** **                                                                | ** ** | **Preferred** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Deferred** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’** | ** ** |
|---------------------------------------------------------------------------|------------|---------------|------------|-----------------------|------------|-------------------------|------------|--------------|------------|-----------------|------------|---------------------------------------|------------|-------------------------------|------------|
| **(in thousands)**                                                   | ** ** | ** **    | ** ** | **Stock**             | ** ** | **Shares**              | ** ** | **Amount**   | ** ** | **Capital**     | ** ** | **Compensation**                      | ** ** | **Deficit**                   | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** |
| **Balance  at December 31, 2003**                                    |       |          | $          | —                |       |                    | 13,841     |         |       | $               | 138        |                                  |       |                          | $          | 81,952 |   |   |   | $ | — |   |   |   | $ | (68,594 | ) |   |   | $ | 28 |   |   |   | $ | 13,524 |   |   |
| Comprehensive  loss:                                                      |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                  |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | (6,841 | ) |   |   | — |   |   |   | (6,841 | ) |   |
| Unrealized loss on  marketable securities                            |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | (6 | ) |   |   | (6 | ) |   |
| Translation  adjustment                                                   |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | (210 | ) |   |   | (210 | ) |   |
| Total  Comprehensive loss                                                 |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (7,057 | ) |   |
| Issuance of  convertible preferred stock and warrants           |       |          | 6,945      |                  |       | —                  |       |         | —     |            |       |                                  | 846        |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 7,791 |   |   |
| Dividends on  convertible preferred stock                                 |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | (68 | ) |   |   | — |   |   |   | (68 | ) |   |
| Issuance of common  stock under employee benefit and incentive plans |       |          | —     |                  |       | 453                     |       |         | 5          |            |       |                                  | 640        |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 645 |   |   |
| **Balance  at December 31, 2004**                                    |       |          | 6,945      |                  |       | 14,294                  |       |         | 143        |            |       |                                  | 83,438     |                          |       |   | — |   |   |   | (75,503 | ) |   |   | (188 | ) |   |   | 14,835 |   |   |
| Comprehensive  loss:                                                      |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                  |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | (2,801 | ) |   |   | — |   |   |   | (2,801 | ) |   |
| Unrealized gain on  marketable securities                            |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | 7 |   |   |   | 7 |   |   |
| Translation  adjustment                                                   |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | 39 |   |   |   | 39 |   |   |
| Total  Comprehensive loss                                                 |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (2,755 | ) |   |
| Issuance costs of  convertible preferred stock and warrants     |       |          | (59        | )                     |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (59 | ) |   |
| Dividends on  convertible preferred stock                                 |       |          | 563        |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | (495 | ) |   |   | — |   |   |   | 68 |   |   |
| Issuance of common  stock under employee benefit and incentive plans |       |          | —     |                  |       | 697                     |       |         | 7          |            |       |                                  | 974        |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 981 |   |   |
| Issuance of  restricted stock                                             |       |          | —     |                  |       | 15                      |       |         | —     |            |       |                                  | 59         |                          |       |   | (59 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of  stock based compensation                                 |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | 18 |   |   |   | — |   |   |   | — |   |   |   | 18 |   |   |
| **Balance  at December 31, 2005**                                    |       |          | 7,449      |                  |       | 15,006                  |       |         | 150        |            |       |                                  | 84,471     |                          |       |   | (41 | ) |   |   | (78,799 | ) |   |   | (142 | ) |   |   | 13,088 |   |   |
| Comprehensive  loss:                                                      |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                  |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  |       |                          |       |   |   |   |   |   | (2,324 | ) |   |   |   |   |   |   | (2,324 | ) |   |
| Unrealized loss on  marketable securities                            |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   | (4 | ) |   |   | (4 | ) |   |
| Translation adjustment                                                    |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   | 334 |   |   |   | 334 |   |   |
| Total  Comprehensive loss                                                 |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (1,994 | ) |   |
| Dividends on  convertible preferred stock                                 |       |          | 525        |                  |       | —                  |       |         | —     |            |       |                                  |       |                          |       |   |   |   |   |   | (525 | ) |   |   |   |   |   |   | — |   |   |
| Dividends paid in  cash in lieu of partial shares                         |       |          | (4         | )                     |       | —                  |       |         | —     |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (4 | ) |   |
| Issuance of common  stock                                                 |       |          |       |                  |       | 2,075                   |       |         | 21         |            |       |                                  | 13,477     |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 13,498 |   |   |
| Issuance of common  stock under employee benefit and incentive plans |       |          | —     |                  |       | 462                     |       |         | 5          |            |       |                                  | 943        |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 948 |   |   |
| Issuance of  restricted stock                                             |       |          | —     |                  |       | 415                     |       |         | 4          |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 4 |   |   |
| Reclassification  of deferred compensation upon adoption of SFAS 123R     |       |          |       |                  |       |                    |       |         |       |            |       |                                  | (41        | )                             |       |   | 41 |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Non-cash  stock-based compensation                                        |       |          |       |                  |       |                    |       |         |       |            |       |                                  | 1,425      |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,425 |   |   |
| **Balance  at December 31, 2006**                                    |       |          | $          | 7,970                 |       |                    | 17,958     |         |       | $               | 180        |                                  |       |                          | $          | 100,275 |   |   |   | $ | — |   |   |   | $ | (81,648 | ) |   |   | $ | 188 |   |   |   | $ | 26,965 |   |   |
|                                                                           |            |               |            |                       |            |                         |            |              |            |                 |            |                                       |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

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**BIOSPHEREMEDICAL, INC.**CONSOLIDATED STATEMENTS OF CASH FLOWS

| ** **                                                                           | ** ** | **For the Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**                                                              | ** ** | ** **                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                               |       |                                                          |       |   |   |   |   |
| Net loss                                                                             |       | $                                                             | (2,324     | ) | $ | (2,801 | ) | $ | (6,841 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:         |       |                                                          |       |   |   |   |   |
| (Recovery of) Provision for doubtful accounts                                        |       | (8                                                            | )          | 66 |   | 80 |   |
| Write down for inventory obsolescence                                                |       | 231                                                           |       | 54 |   | 1,384 |   |
| Depreciation                                                                         |       | 445                                                           |       | 509 |   | 625 |   |
| Realized loss on available-for-sale investments                                      |       | —                                                        |       | 5 |   | 4 |   |
| Stock-based compensation                                                             |       | 1,425                                                         |       | 18 |   | — |   |
| Changes in  operating assets and liabilities:                                        |       |                                                          |       |   |   |   |   |
| Accounts receivable                                                                  |       | (437                                                          | )          | (725 | ) | (510 | ) |
| Inventories                                                                          |       | (449                                                          | )          | 593 |   | (938 | ) |
| Prepaid and other current assets                                                     |       | (169                                                          | )          | (213 | ) | 129 |   |
| Accounts payable                                                                     |       | 144                                                           |       | 149 |   | 212 |   |
| Accrued compensation                                                                 |       | 39                                                            |       | (3 | ) | 799 |   |
| Other accrued expenses                                                               |       | 399                                                           |       | 89 |   | (182 | ) |
| Net cash used in operating activities                                                |       | (704                                                          | )          | (2,259 | ) | (5,238 | ) |
| Cash flows from  investing activities:                                               |       |                                                          |       |   |   |   |   |
| Purchase of property and equipment                                                   |       | (464                                                          | )          | (325 | ) | (200 | ) |
| Purchase of marketable securities                                                    |       | (16,575                                                       | )          | — |   | (255 | ) |
| Proceeds from the sale and maturity of marketable  securities                        |       | 3,364                                                         |       | 764 |   | 5,016 |   |
| Net cash (used in) provided by investing activities                                  |       | (13,675                                                       | )          | 439 |   | 4,561 |   |
| Cash flows from  financing activities:                                               |       |                                                          |       |   |   |   |   |
| Proceeds from issuance of convertible preferred  stock and warrants, net        |       | —                                                        |       | (59 | ) | 7,791 |   |
| Proceeds from issuance of common stock, net                                     |       | 13,498                                                        |       | — |   | — |   |
| Proceeds from issuance of common stock under  employee benefit   and incentive plans |       | 952                                                           |       | 981 |   | 645 |   |
| Proceeds from capital lease obligations                                              |       | —                                                        |       | 43 |   | 210 |   |
| Payment of cash dividends in lieu of partial shares                                  |       | (4                                                            | )          | — |   | — |   |
| Principal payments under long-term debt and capital  lease   obligations             |       | (124                                                          | )          | (163 | ) | (185 | ) |
| Net cash provided by financing activities                                            |       | 14,322                                                        |       | 802 |   | 8,461 |   |
| Effect of exchange rate changes on cash and cash  equivalents                        |       | 196                                                           |       | 332 |   | (367 | ) |
| Net increase (decrease) in cash and cash equivalents                                 |       | 139                                                           |       | (686 | ) | 7,417 |   |
| Cash and cash equivalents at beginning of year                                       |       | 8,774                                                         |       | 9,460 |   | 2,043 |   |
| Cash and cash  equivalents at end of year                                            |       | $                                                             | 8,913      |   | $ | 8,774 |   | $ | 9,460 |   |
|                                                                                      |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

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

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**BIOSPHEREMEDICAL, INC.**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

**1.**                 Natureof the Business

BioSphere Medical, Inc. (the “Company”) wasincorporated in Delaware in December 1993. The Company is focused onapplying its proprietary Embosphere® Microspheres and other ancillary embolotherapyproducts for use in treating uterine fibroids, hypervascularized tumors andarteriovenous malformations. The Company’s wholly owned subsidiary, BioSphereMedical S.A. (“BMSA”), a French société anonyme, holds the license to theembolotherapy technology that is the main focus of the Company’s business.

The Company believes thatits existing working capital as of December 31, 2006, together withanticipated proceeds from sales of microspheres, delivery systems and otherproducts will be sufficient to fund operating and capital requirements, ascurrently planned through at least 2007. In the longer term, the Companyexpects to fund its operations and sustain capital requirements through acombination of expected proceeds from product sales and capital equipmentfinancing. However, cash requirements may vary materially from those nowplanned due to a number of factors, including the Company’s failure to achieveexpected revenue amounts, costs associated with changes in its uterine fibroidembolization (“UFE”) marketing programs, unanticipated research and developmentexpenses, the scope and results of pre-clinical and clinical testing, changesin the focus and direction of research and development programs, competitiveand technological advances, the timing and results of regulatory review at theUnited States Food and Drug Administration (“FDA”) or comparable regulatoryagencies in other countries and the market’s acceptance of any approvedproducts, including Embosphere Microspheres for UFE, HepaSphere Microspheresand QuadraSphere Microspheres.

**2.**                 Summaryof Significant Accounting Policies

***Principles of Consolidation***

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries BMSA, BioSphere Medical Japan, Inc. and BSMDVentures, Inc. All intercompany balances and transactions have beeneliminated in consolidation.

***Translation of Foreign Currencies***

The functional currency ofeach of the Company’s foreign subsidiaries is their local currency. The assetsand liabilities of the Company’s foreign subsidiaries are translated into U.S.dollars using the exchange rates in effect as of each balance sheet date.Revenue and expense items are translated into U.S. dollars at averageexchange rates prevailing during each reporting period. Resulting translationadjustments are recorded in the cumulative translation adjustment account instockholders’ equity. Aggregate foreign exchange transaction gains and lossesresulting from Euro to U.S. dollar foreign currency fluctuations onEuro-denominated intercompany trade accounts are included in the accompanyingstatement of operations.

***Use of Estimates***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the following: (1) the reported amounts of assetsand liabilities, (2) the disclosure of contingent assets and liabilitiesat 

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the dateof the financial statements, and (3) the reported amounts of revenues andexpenses during the reporting periods. Actual results could differ from thoseestimates.

***Cash, Cash Equivalents and Marketable Securities***

The Company considers allhighly liquid investments with an original maturity of ninety days or less, asof the date of purchase, to be cash equivalents. As of December 31, 2006and 2005, approximately $8.39 million and $8.36 million respectively, of cashand cash equivalents held by financial institutions in the United Statesexceeded Federal Deposit Insurance Corporation insured amounts.

***Concentration of Credit Risk and Off-Balance SheetRisk***

The Company has no material concentrations of creditrisk, nor is it a party to any financial instruments with material off-balancesheet risk. Financial instruments that potentially subject the Company toconcentration of credit risk consist primarily of cash, cash equivalents,marketable securities and trade accounts receivable. The estimated fair valueof the Company’s financial instruments approximates their carrying value.Concentrations of credit risk with respect to trade accounts receivable arelimited due to the large number of customers and their dispersion across manygeographic areas. No single customer accounted for greater than 10% of theoutstanding receivables on December 31, 2006 or 2005, and no singlecustomer accounted for greater than 10% of revenues in 2006, 2005 or 2004.

The Company places itscash, cash equivalents and marketable securities with high credit qualityfinancial institutions. In accordance with the Company’s investment policy,surplus cash is invested in investment grade corporate and U.S. government debtas well as certain asset-backed securities. At December 31, 2006, allmarketable securities were classified as available-for-sale, since the Companyhad the intent to use such securities to satisfy current liabilities as needed.Available-for-sale marketable securities are carried at their fair value withunrealized gains and losses included in accumulated other comprehensive income(loss) in the accompanying balance sheet.

***Accounts Receivable and Allowance for DoubtfulAccounts***

Trade accounts receivableare recorded at the invoiced amount and do not bear interest. The allowance fordoubtful accounts is the Company’s best estimate of the amount of probablecredit losses in its existing accounts receivable. The Company determines theallowance based on the credit worthiness of customers, age of receivables andon historical write-off experience and future expectations by location. TheCompany reviews its allowance for doubtful accounts monthly. Account balancesare charged off against the allowance when the Company feels it is probable thereceivable will not be recovered. The Company does not have anyoff-balance-sheet credit exposure related to its customers.

***Property and Equipment***

Propertyand equipment are stated at cost. The Company provides for depreciation basedupon expected useful lives using the straight-line method over the followingestimated useful lives:

| Office equipment                        |   | 3-5 years                                           |
|-----------------------------------------|--------|-----------------------------------------------------|
| Laboratory and  manufacturing equipment |   | 3-5 years                                           |
| Leasehold improvements                  |   | Shorter of lease term or estimated useful life |

 

Maintenance and repairsare charged to expense as incurred. Upon retirement or sale, the cost ofdisposed assets and the related accumulated depreciation are removed from theaccounts and any resulting gain or loss is credited or charged to the statementof operations.

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***Goodwill and Other Assets***

Goodwill represents the difference between thepurchase price and the fair value of the tangible and identifiable intangibleassets acquired net of liabilities assumed when accounted for in accordancewith the purchase method of accounting. Between February 1999 and November 2001,the Company recorded goodwill upon the periodic step-acquisitions of BMSA.

The Company performsannual impairment reviews of its goodwill or whenever events or changes incircumstances indicate that the carrying value of the assets may not berecoverable. Goodwill was derived from the step acquisition of BMSA, theconsolidated subsidiary that holds the license to the embolotherapy platformdevice that is the main focus of the Company’s business. In performing thereview, the Company utilizes the two-step approach prescribed under the FinancialAccounting Standards Board, or FASB, Statement No. 142, Goodwill and OtherIntangible Assets. The first step requires a comparison of the carrying valueof the reporting units, as defined, to the fair value of these units. If the carryingvalue of a reporting unit exceeds its fair value, the Company will perform thesecond step of comparing the implied fair value of the reporting unit’sgoodwill to its carrying value. For purposes of performing the Goodwillimpairment review, management considers itself to be one reporting unit. Basedupon the Company’s review, the Company has not recorded any impairment charges.

***Impairment of Long-Lived Assets***

The Company periodicallyevaluates the potential impairment of its long-lived assets in accordance with Statementof Financial Accounting Standards, or SFAS, SFAS 144, “Accounting for theImpairment or Disposal of Long-lived Assets,” to determine whether events orchanges in circumstances may indicate that the carrying amount of a recordedasset may not be recoverable. Based on management’s assessment as of December 31,2006, the Company has determined that no impairment of long-lived assetsexists.

***Revenue Recognition***

The Company applies the revenue recognition guidelinessummarized in Staff Accounting Bulletin, or SAB, No. 104, “RevenueRecognition.” The Company recognizes revenue when products are shipped and thecustomer or distributor takes ownership and assumes risk of loss, collection ofthe relevant receivable is reasonably assured, persuasive evidence of anarrangement exists (a valid purchase order from an approved customer), thesales price is fixed or determinable, payment is not contingent on resale andthe Company does not have any continuing obligations to ensure resale. The Companyestablishes reserves for potential sales returns and evaluates the adequacy ofthose reserves based upon realized experience and expectations. Any significantchange in product satisfaction and any resulting credit returns could have amaterial adverse impact on the Company’s revenues and operating results for theperiod or periods in which such returns materialize. Shipping and handlingcosts are included in costs of product sales.

In September 2006, the Company entered into anagreement to license certain patent technologies to a third party in exchangefor an upfront lump-sum payment of $250,000 and an additional 4% royalty onfuture net sales of the licensed products. Under the agreement, the third partyis required to pay a minimum royalty of $1.00 million over the first threeyears of the agreement. The Company will recognize both the lump-sum paymentand the minimum royalties over the estimated useful life of the patent. TheCompany recognized approximately $104,000 as licensing revenue during the yearending December 31, 2006.

In June 2004, theCompany entered into an exclusive five-month development agreement with a thirdparty for the use of Embosphere Microspheres for gastroesophegal reflexdisease. In exchange for this development agreement, the Company received apayment of $100,000. The Company recognized $100,000 as licensing revenue overthe life of the contract, which concluded in November 2004.

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***Research and Development***

Research and developmentcosts include payroll, building costs, administrative expenses, and third partycosts related to developing new products, making technological improvements toexisting products and production methods are expensed in the period incurred.Preclinical testing of product candidates and clinical trials and productvalidation costs associated with recently released products are also includedin research and development expenses.

***Deferred Income Taxes***

The Company uses the assetand liability accounting method whereby deferred tax assets and liabilities arerecognized based on temporary differences between the financial statements andtax bases of assets and liabilities using current statutory tax rates. Avaluation allowance against net deferred tax assets is recorded if, based onthe available evidence, it is more likely than not that some or all of thedeferred tax assets will not be realized. Management evaluates, on a quarterlybasis, the ability to recover the deferred tax assets and the level of thevaluation allowance. Due to the size of the net operating loss carry forward inrelation to the Company’s history of unprofitable operations, the Company hasnot recognized any of its net deferred tax assets. However, future improvementsin operational performance could result in the increased certainty of the abilityto apply deferred tax assets against taxable income, which could, in turn,result in a significant impact on the value of the Company’s deferred taxassets and reported operating results.

***Comprehensive Income (Loss)***

Othercomprehensive income (loss) includes certain changes in equity that areexcluded from net loss, specifically, the effects of foreign currencytranslation adjustments and unrealized gains and losses on available-for-salemarketable securities, which are reflected separately in stockholders’ equityin accumulated other comprehensive income (loss). The components of accumulatedother comprehensive income (loss) are as follows:

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                              | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Foreign exchange  currency translation               |       | $                     | 192        |   | $ | (142 | ) |
| Unrealized losses  on investments                    |       | (4                    | )          | — |   |
| Total accumulated  other comprehensive income/(loss) |       | $                     | 188        |   | $ | (142 | ) |
|                                                      |            |                       |            |  |  |  |  |  |  |

 

***Net Loss Per Share***

Basicnet loss per share is calculated based on the weighted average number of commonshares outstanding during the period. Diluted net loss per share incorporatesthe dilutive effect of common stock equivalent options, warrants and otherconvertible securities. Shares used to compute dilutive net loss per shareexclude the following common share equivalents as their inclusion would have anantidilutive effect.

| ** **                                                 | ** ** | **For the years ended December 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**                                    | ** ** | ** **                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Shares issuable  upon exercise of stock options            |       |                                                          | 2,627      |   |   |   | 2,623 |   |   |   | 3,054 |   |   |
| Shares issuable  upon conversion of convertible securities |       |                                                          | 2,271      |   |   |   | 2,140 |   |   |   | 2,017 |   |   |
| Shares issuable  upon exercise of outstanding warrants     |       |                                                          | 400        |   |   |   | 400 |   |   |   | 563 |   |   |
| Unvested  restricted stock awards                          |       |                                                          | 430        |   |   |   | 15 |   |   |   | — |   |   |
|                                                       |       |                                                          | 5,728      |   |   |   | 5,178 |   |   |   | 5,634 |   |   |
|                                                            |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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***Stock Options***

The Company adopted the provisions of Statement ofFinancial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”),beginning January 1, 2006, using the modified prospective transitionmethod. This statement requires the Company to measure the cost of employeeservices in exchange for an award of equity instruments based on the grant-datefair value of the award and to recognize cost over the requisite serviceperiod. Under the modified prospective transition method, the Company has notadjusted its financial statements for periods prior to the date of adoption forthe change in accounting. However, the Company will recognize compensationexpense for (a) all share-based payments granted after the effective dateand (b) all awards granted to employees prior to the effective date thatremain unvested on the effective date. The Company recognizes compensationexpense on fixed awards with pro rata vesting on a straight-line basis over theawards vesting period.

Prior to January 1, 2006, the Company used theintrinsic value method to account for stock-based employee compensation underAccounting Principles Board Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” and, therefore, the Company did notrecognize compensation expense in association with employee options granted ator above the market price of the Company’s common stock at the date of grant.

As a result of adopting SFAS 123R, stock-basedcompensation charges during the year ended December 31, 2006 increased byapproximately $1.28 million. Net loss applicable to common stockholders for theyear ended December 31, 2006 increased as compared to the same periods in2005 by $0.07 per basic and diluted share.

At December 31, 2006, there was $3.15 million and$579,000 of unrecognized compensation cost, net of estimated forfeitures,related to non-vested options and restricted stock awards, respectively, whichthe Company expects to recognize over weighted-average periods of 3.70 yearsand 3.24 years, respectively. However,the amount of stock compensation expense recognized in any future period cannotbe predicted at this time because it will depend on levels of share-basedpayments granted in the future. The adoption of SFAS 123R did not require anycumulative adjustments to the Company’s financial statements.

Thefollowing table presents the stock-based compensation expense for the yearended December 31, 2006:

| **(in thousands)**             | ** ** | ** ** | ** ** | **For the Year Ended  December 31,  2006** | ** ** |
|-------------------------------------|------------|------------|------------|----------------------------------------------------------------|------------|
| Cost of product  sales              |       |       | $          | 195                                                            |       |   |
| Research and  development           |       |       | 72         |                                                           |       |
| Sales                               |       |       | 346        |                                                           |       |
| Marketing                           |       |       | 18         |                                                           |       |
| General,  administrative and patent |       |       | 794        |                                                           |       |
|                                |       |       | $          | 1,425                                                          |       |   |

 

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Thefair value of options granted during the year ended December 31, 2006,2005 and 2004 are estimated on the date of the grant using the Black-Scholesoption-pricing model with the following weighted average assumptions:

| ** **                              | ** ** | **For the Years   Ended December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| Options granted  (in thousands)         |       | 620                                                             |       | 483 |   | 1,101 |   |
| Weighted average  exercise price        |       | $                                                               | 7.01       |   | $ | 4.49 |   | $ | 2.89 |   |
| Weighted average  grant date fair value |       | $                                                               | 5.21       |   | $ | 3.19 |   | $ | 2.09 |   |
| Assumptions:                            |       |                                                            |       |   |   |   |   |
| Dividend yield                          |       | 0                                                               | %          | 0 | % | 0 | % |
| Expected  volatility                    |       | 83                                                              | %          | 84 | % | 93 | % |
| Risk-free  interest rate                |       | 4.85                                                            | %          | 3.77 | % | 3.63 | % |
| Expected term (years)                   |       | 6.25                                                            |       | 5.71 |   | 5.09 |   |

 

Historical Company information was the primary basisfor the expected volatility and the expected term assumptions. Based on theanalysis of the historical forfeitures, the Company utilized an estimatedforfeiture rate of 13% for the year ended December 31, 2006. Prior to January 1,2006, forfeitures were recorded on an actual basis.

Thefollowing table presents a reconciliation of reported net loss and per share information to proforma net loss and per share information that would have been reported if thefair value method had been used to account for stock-based employeecompensation for all periods prior to January 1, 2006:

| ** **                                                            | ** ** | **For the Years Ended  December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | ** **                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss  applicable to common stockholders                           |       |                                                      |       |   |   |
| As reported                                                           |       | $                                                         | (3,296     | ) | $ | (6,909 | ) |
| Pro forma compensation expense                                        |       | (872                                                      | )          | (894 | ) |
| Pro forma net loss                                                    |       | $                                                         | (4,168     | ) | $ | (7,803 | ) |
| Basic and diluted  loss per share                                     |       |                                                      |       |   |   |
| As reported                                                           |       | $                                                         | (0.22      | ) | $ | (0.49 | ) |
| Pro forma                                                             |       | $                                                         | (0.28      | ) | $ | (0.55 | ) |
|                                                                       |            |                                                           |            |  |  |  |  |  |  |

 

***Reclassifications***

Certain reclassificationshave been made to prior year’s consolidated financial statements to conform tothe current year presentation. In connection with preparation of theaccompanying consolidated financial statements, the Company concluded that itwas appropriate to classify local advertising campaigns initiated by the salesforce as marketing expenses. Previously, such advertising costs were classifiedas selling expenses. This revision in classification does not affect totaloperating costs and expenses.

***New Accounting Pronouncements***

In June 2006, the FASB issued FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation ofFASB Statement No. 109”, or Interpretation. The Interpretation clarifiesthe accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, *Accounting for Income Taxes.* TheInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. This Interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure and 

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transition. TheInterpretation is effective for fiscal years beginning after December 15,2006. The Company has not completed its evaluation of the Interpretation, butdoes not currently believe that adoption will have a material impact on itsresults of operations, financial position or cash flows.

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements”, or SFAS 157. SFAS 157 defines fair value,establishes a framework for measuring fair value under generally acceptedaccounting principles in the United States, or GAAP, and expands disclosuresabout fair value measurements. SFAS 157 applies under other accountingpronouncements that require or permit fair value measurements, the FASB havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, SFAS 157 does not require anynew fair value measurements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears, with earlier adoption permitted. The provisions of SFAS 157 shouldbe applied prospectively as of the beginning of the fiscal year in which it isinitially applied, with limited exceptions. The Company does not believe theadoption of SFAS 157 will have a material impact on its results ofoperations, financial position or cash flows.

**3.**                 Goodwill

Goodwill, comprisedentirely of the unamortized purchase price paid in excess of the net BMSAassets acquired, equaled $1.44 million as of December 31, 2006 and 2005.

**4.**                 MarketableSecurities

All current fixed maturity securities are classifiedas “available-for-sale” and are reported at fair value. The Company hasdetermined its investment securities are available to support currentoperations and, accordingly, has classified such marketable securities ascurrent assets without regard for contractual maturities. The unrealized gainsor losses on these securities are included in accumulated other comprehensiveincome as a separate component of stockholders’ equity unless the decline invalue is deemed to be other-than-temporary, in which case securities arewritten down to fair value and the loss is charged to income. The Companyevaluates its investment securities for other-than-temporary declines based onquantitative and qualitative factors.

TheCompany’s available-for-sale marketable securities, including accrued interestreceivable, as of December 31, 2006 are as follows:

| **(in thousands)**            | ** ** | ** ** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains/  (losses)** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------|------------|------------|------------|---------------------|------------|----------------------------------|------------|----------------------------|------------|
| United States  Treasury securities |       |       | $          | 2,014               |       |                             |       | $                          | (13        | ) |   |   | $ | 2,001 |   |   |
| Corporate  obligations             |       |       | 6,465      |                |       |                             | 8          |                       |       |   | 6,473 |   |   |
| Bank obligations                   |       |       | 4,599      |                |       |                             | 1          |                       |       |   | 4,600 |   |   |
| Mortgage-backed  obligations       |       |       | 132        |                |       |                             | —     |                       |       |   | 132 |   |   |
| Total marketable  securities       |       |       | $          | 13,210              |       |                             |       | $                          | (4         | ) |   |   | $ | 13,206 |   |   |

 

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The Company’s cash and cash equivalents as of December 31,2005 were comprised of cash and money market funds.

As of December 31,2006, the contractual maturities of marketable securities are as follows:

| **(in thousands)**              | ** ** | ** ** | ** ** | **Estimated Fair  Market Value** | ** ** |
|--------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| **Due within  one year:**            | ** ** |       | ** ** | ** **                                 |       |
| United States  Treasury securities   |       |       | $          | 2,001                                      | ** ** |   |
| Corporate  obligations               |       |       | 2,655      | ** **                                 |       |
| Bank obligations                     |       |       | 4,600      | ** **                                 |       |
| Mortgage-backed  obligations         |       |       | 132        | ** **                                 |       |
| **Due  between one and five years:** | ** ** |       | ** ** | ** **                                 |       |
| Corporate  obligations               |       |       | 3,818      | ** **                                 |       |
| Total                                |       |       | $          | 13,206                                     | ** ** |   |

 

No material realized gainsor losses on the Company’s marketable securities were recognized during theyears ended December 31, 2006, 2005 and 2004.

**5.**                 Inventories

Inventoriesare stated at the lower of cost (first-in, first-out) or market and consist ofthe following as of:

| ** **              | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-----------------------|------------|
| **(in thousands)** | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Finished goods          |       | $                     | 1,793      |   | $ | 1,348 |   |
| Work in progress        |       | 793                   |       | 878 |   |
| Raw material            |       | 244                   |       | 209 |   |
| Total inventory         |       | $                     | 2,830      |   | $ | 2,435 |   |
|                         |            |                       |            |  |  |  |  |  |  |

 

**6.**                 Propertyand Equipment

Propertyand equipment consists of the following:

| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                      | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Office equipment                             |       | $                     | 1,080      |   | $ | 976 |   |
| Laboratory and  manufacturing equipment |       | 2,608                 |       | 2,166 |   |
| Leasehold  improvements                      |       | 211                   |       | 189 |   |
| Total property and equipment                 |       | 3,899                 |       | 3,331 |   |
| Less: accumulated  depreciation              |       | (2,970                | )          | (2,473 | ) |
| Net property and  equipment                  |       | $                     | 929        |   | $ | 858 |   |
|                                              |            |                       |            |  |  |  |  |  |  |

 

Property and equipment under capital lease agreements,net of accumulated depreciation, which are included in the table above, atDecember 31, 2006 and 2005, were $87,000 and $210,000, respectively.

Depreciation expense,including amortization on capital leases, was $445,000, $509,000 and $625,000for the years ended December 31, 2006, 2005 and 2004, respectively.

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**7.**                 AccruedCompensation

Accruedcompensation consists of the following:

| ** **                                            | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                               | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Accrued payroll,  vacation and incentive compensation |       | $                     | 1,840      |   | $ | 1,559 |   |
| Accrued severance                                     |       | —                |       | 14 |   |
| Accrued  relocation                                   |       | 95                    |       | 257 |   |
|                                                  |       | $                     | 1,935      |   | $ | 1,830 |   |
|                                                       |            |                       |            |  |  |  |  |  |  |

 

At December 31, 2006and December 31, 2005, there was $95,000 and $257,000, respectively,remaining of costs accrued to relocate two new executives, who were hiredduring 2004.

**8.**                 AccruedExpenses

Accruedexpenses consist of the following:

| ** **              | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-----------------------|------------|
| **(in thousands)** | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Accrued royalties       |       | $                     | 1,016      |   | $ | 702 |   |
| Accrued other           |       | 467                   |       | 501 |   |
|                    |       | $                     | 1,483      |   | $ | 1,203 |   |
|                         |            |                       |            |  |  |  |  |  |  |

 

**9.**                 Debtand Lease Obligations

Debtconsists of the following:

| ** **                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                             | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Capital lease  obligations                          |       | $                     | 101        |   | $ | 228 |   |
| Less: current  portion                              |       | (57                   | )          | (127 | ) |
| Total long-term  debt and capital lease obligations |       | $                     | 44         |   | $ | 101 |   |
|                                                     |            |                       |            |  |  |  |  |  |  |

 

The Company currently has a credit facility with abank under which it may borrow up to $3.00 million for general workingcapital and corporate purposes. The credit facility expires in June 2007.There were no borrowings outstanding under this agreement as of December 31,2006 or 2005. Each available 30-, 60-, 90- or 180- dayadvance will bear interest at a per annum rate, at the Company’s option, equalto either (i) a variable rate as determined by the bank or (ii) arate equal to the corresponding 30-, 60-, 90- or 180-dayLIBOR rate (5.33% as of December 31, 2006) plus a LIBOR advance ratespread as determined by certain current working capital balances at the time ofthe advance. In connection with the credit facility, the Company entered into asecurity agreement pursuant to which the Company has pledged to the bank all ofthe Company’s U.S. assets, excluding our equity ownership of our subsidiariesincluding BMSA, as collateral. Letters of credit issued in the ordinary courseof business totaled $448,000 as of December 31, 2006, and werecollateralized by the Company’s credit facility noted above.

The Company leases approximately 13,000 square feet ofoffice and laboratory space at its Rockland, Massachusetts facility under anoperating lease expiring in February 2009 for approximately $234,000 peryear, exclusive of periodic operating and maintenance expenses. BMSA leasesapproximately 18,000 square feet of manufacturing and office space in Roissy,France through May 2010 for approximately €230,000per year (approximately $300,000 as of December 31, 2006). The Companyalso has several operating leases covering certain pieces of manufacturing andoffice equipment through 2010.

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During 2005 and 2004, the Company entered into severalcapital lease agreements in connection with the acquisition of certainmanufacturing, computer and communication equipment. The leases have initialterms of 36 to 60 months with interest rates of 4.6% to 8.7%. All equipmentleased under these agreements serves as pledged capital.

Futureminimum lease payments under non-cancelable operating leases and capital leasesin effect as of December 31, 2006, are as follows:

| **(in thousands)**                              | ** ** | ** ** | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------|------------|---------------------|------------|
| 2007                                                 |       |       | $          | 696                   |       |                |       | $ | 62 |   |   |
| 2008                                                 |       |       | 649        |                  |       |                | 29         |   |   |
| 2009                                                 |       |       | 402        |                  |       |                | 10         |   |   |
| 2010                                                 |       |       | 151        |                  |       |                | 8          |   |   |
| Thereafter                                           |       |       | —     |                  |       |                | —     |   |   |
| Total lease  commitments                             |       |       | $          | 1,898                 |       |                |       | 109 |   |   |
| Less amount  representing interest                   |       |       |       |                  |       |                | (8         | ) |   |
| Present value of net  minimum capital lease payments |       |       |       |                  |       |                | $          | 101 |   |   |

 

Total facility rentalexpense for the years ended December 31, 2006, 2005 and 2004 wasapproximately $540,000, $431,000 and $509,000, respectively.

**10.**          IncomeTaxes

As of December 31,2006, the Company had federal net operating loss (“NOL”) carry forwards ofapproximately $71.71 million, which will expire through the year 2026, stateNOL carry forwards of approximately $37.04 million, which will expire throughthe year 2011, and foreign NOL carry forwards of approximately $4.01 million,which do not expire. The difference between the federal and state NOL carry forwardsand the deferred tax asset related to NOL carry forwards is attributable to thetax deduction for stock option exercises during the year ended December 31,2006, which totaled $2.21 million. As of December 31, 2006, the Companyhas $187,000 of research and development credit carry forwards to offset futureincome taxes, which will expire through the year 2018. The components of theCompany’s net deferred tax asset at December 31, 2006 and 2005 are asfollows:

| ** **                          | ** ** | **December31,** | ** ** |
|-------------------------------------|------------|-----------------|------------|
| **(in thousands)**             | ** ** | ** **      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Assets derived  from the following: |       |            |       |   |   |
| NOL carry forwards                  |       | $               | 26,981     |   | $ | 26,890 |   |
| Tax credit carry forwards           |       | 186             |       | 187 |   |
| Other                               |       | 374             |       | 171 |   |
| Subtotal                            |       | 27,541          |       | 27,248 |   |
| Valuation allowance                 |       | (27,541         | )          | (27,248 | ) |
| Net deferred tax asset              |       | $               | —     |   | $ | — |   |
|                                     |            |                 |            |  |  |  |  |  |  |

 

As discussed in Note 2, the Company adopted SFAS 123Reffective January 1, 2006 for stock-based compensation plans. Generally,tax return deductions are allowable on such arrangements but may arise indifferent amounts and periods from compensation costs recognized on financialstatements. Pursuant to SFAS 123R, if the tax return deduction for an awardexceeds the cumulative compensation cost recognized on the financialstatements, any excess tax benefit shall be recognized as additionalpaid-in-capital when the deduction reduces taxes payable. Prior to adoption,the Company recognized deferred tax assets, along with an offsetting valuationallowance, for net operating loss carry forwards that included deductions for 

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excess tax benefits fromstock-based compensation. The net tax amount of unrealized excess tax benefitsas of December 31, 2006, included and disclosed as a deferred tax asset,is approximately $7.64 million.

The Company has established a full valuation allowanceagainst its deferred tax assets as of December 31, 2006 as it considersthe realizable value of any tax benefit against future taxable income to beuncertain. The change in the valuation allowance from December 31, 2005 toDecember 31, 2006 is a result of the increase in NOL carry forwards fromthe inclusion of the current period loss offset by a decrease in state NOL carryforwards due to carry forward limitations.

The 2005 income tax benefit of $93,000 primarilyrepresents the realization of income tax benefits, as a portion of the 2001taxes paid in France were recovered.

For the years ended December 31, 2006, 2005, and2004, the increase in the valuation allowance relating to losses not resultingin a current period tax benefit is the primary difference between the incometax provision (benefit) recorded by the Company and the amount of the incometax benefit would be at statutory income tax rates.

Thecomponents of the Company’s pre-tax income (loss) by tax jurisdiction, net ofany intercompany transactions, are as follows:

| ** **              | ** ** | **For the years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States           |       | $                                                             | (2,815     | ) | $ | (3,100 | ) | $ | (4,996 | ) |
| France                  |       | 491                                                           |       | 206 |   | (1,728 | ) |
| **Pretax  loss**        |       | $                                                             | (2,324     | ) | $ | (2,894 | ) | $ | (6,724 | ) |
|                         |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

**11.**          SegmentInformation

TheCompany develops microspheres and other ancillary embolotherapy products foruse in the treatment of uterine fibroids, hypervascularized tumors andarteriovenous malformations. The Company operates exclusively in the medicaldevice business, which the Company considers as one business segment pursuantto SFAS No. 131, “Disclosures About Segments of an Enterprise and RelatedInformation”. Financial information by geographic area, attributed to countriesaccording to the location of customers and equipment, is as follows:

| ** **                     | ** ** | **For the years ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**        | ** ** | ** **                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenues:**                  |       |                                                          |       |   |   |   |   |
| United States                  |       | $                                                             | 16,458     |   | $ | 12,663 |   | $ | 9,080 |   |
| France                         |       | 3,516                                                         |       | 3,382 |   | 2,883 |   |
| Other European Union countries |       | 1,855                                                         |       | 1,658 |   | 1,408 |   |
| Other foreign countries        |       | 1,062                                                         |       | 781 |   | 787 |   |
| Total revenues                 |       | $                                                             | 22,891     |   | $ | 18,484 |   | $ | 14,158 |   |
| **Long- lived assets:**        |       |                                                          |       |   |   |   |   |
| United States                  |       | $                                                             | 385        |   | $ | 297 |   | $ | 425 |   |
| France                         |       | 544                                                           |       | 561 |   | 709 |   |
| Total long- lived  assets      |       | $                                                             | 929        |   | $ | 858 |   | $ | 1,134 |   |
|                                |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

**12.**          Stockholders’Equity

***Common Stock***

On February 22, 2006,the Company sold 2,075,000 shares of common stock at a price per share of $7.00to several investors in a private placement. Upon payment of all offering expenses,the Company received net proceeds of approximately $13.50 million. The commonstock was issued in reliance upon the 

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exemptionsfrom registration under Section 4(2) of the Securities Act of 1933,as amended, and Regulation D promulgated thereunder, relative to sales by anissuer not involving any public offering. The proceeds are being used to fundcurrent operations.

***Preferred Stock***

Under the certificate ofincorporation of the Company, the Board of Directors has the authority to issueup to 1,000,000 shares of $0.01 par value preferred stock from time to time inone or more series with such preferences terms and rights as the Board ofDirectors may determine without further action by the stockholders of theCompany. Accordingly, the Board of Directors has the power to establish theprovisions, if any, relating to dividends, voting rights, redemption rates,liquidation preferences and conversion rights for any series of preferred stockissued in the future.

***6% Series AConvertible Preferred Stock***

In November 2004, theCompany completed a private placement of $8.00 million of its series Aconvertible preferred stock (“series A preferred stock”) and warrants topurchase common stock with Sepracor Inc. and affiliates of Cerberus CapitalManagement, L.P., two existing investors. These investors purchased a total of8,000 shares of series A preferred stock, which are initially convertible into2,000,000 shares of common stock based upon a conversion price of $4.00 pershare. In addition, The Company has the right to convert the series A preferredstock into common stock, or redeem it, under specified circumstances. Theseries A preferred stock has a 6% dividend, which is payable quarterly ineither cash or additional shares of series A preferred stock, at the Company’selection. Additionally, the investors were issued warrants to purchase anaggregate of 400,000 shares of common stock. These warrants expire five yearsfrom the date of issuance and have an initial exercise price of $4.00 pershare. These warrants were assigned a value of $850,000 using the Black-Scholesoption-pricing model. Through December 31, 2006, the Company issued 950shares of series A preferred stock for payment of series A preferred stockdividends.

**13.**          StockPlans

***Stock Option Plans***

As of December 31,2006, the Company has granted options and/or restricted stock awards under thefollowing four stock-based compensation plans: (i) the 2006 StockIncentive Plan (the “2006 Plan”), which was adopted by the Company’s Board ofDirectors on March 9, 2006 and was approved by the Company’s stockholderson May 10, 2006 and which authorizes the issuance of up to an aggregate of2,000,000 shares of common stock to officers, directors, advisors, consultantsand employees of the Company; (ii) the 1997 Stock Option Plan (the “1997Plan”), which expires in March 2007 and is intended to be replaced by the2006 Plan, (iii) the 1994 Stock Option Plan (the “1994 Plan”), whichexpired in January 2004 and, accordingly, has no shares available forfuture grant and (iv) the 1994 Director Option Plan (the “Director Plan”),which expired in January 2000 and, accordingly, has no shares availablefor future grant. The Company’s 2006 Plan, 1997 Plan and 1994 Plan each providefor the grant of Incentive Stock Options (“ISOs”) to officers and employees andNon-Statutory Stock Options (“NSOs”) to officers, directors, advisors,consultants and employees of the Company. Options granted under such plansgenerally become exercisable in five equal annual installments beginning on thefirst anniversary of the date of the grant and have a maximum term of ten yearsfrom the date of grant. The Company’s Director Plan provided for the grant ofNSOs to directors of the Company who are not officers or employees of theCompany or any subsidiary of the Company. Options granted under the DirectorPlan vest in either two or five equal installments beginning on the firstanniversary of the date of the grant depending on the nature of the grant andhave a maximum term of ten years from the date of grant. At December 31,2006 there were 1,575,000 and 20,000 shares available for future grantunder 2006 Plan and 1997 Plan, respectively.

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The 2006 Plan and 1997 Plan also provide for the grantof restricted stock awards to officers, directors, advisors, consultants andemployees of the Company. Generally, the restricted stock awards are subject toa right of repurchase by the Company if service is terminated prior tospecified dates and/or if specified performance conditions are not met, whichright of repurchase lapses over time. Ownership of restricted stock cannot betransferred, except under specified circumstances, until the foregoing repurchaserestrictions have lapsed. In connection with restricted stock grants, theCompany records compensation expense based on the fair value of the shares atthe time of grant. This stock compensation is amortized on a straight-linebasis over the vesting periods.

On June 1, 2006, the Board of Directors awardedan aggregate of 400,000 shares of restricted common stock to the Company’sexecutive officers under the 2006 Plan. The shares of restricted common stockare subject to a right of repurchase by the Company, which lapses on June 1,2010, subject to the achievement by the Company of specified stockholderreturns on its common stock. If on June 1, 2010, the four-year cumulativetotal stockholder return on the Company’s common stock is equal in dollar amountto the four-year cumulative total return for the NASDAQ Medical Equipment Index(“NASDAQ Index”), 25% of the restricted stock award will vest and no longer besubject to the repurchase option. An additional 1.6304% of the restricted stockaward will vest and become free of the repurchase option for each onepercentage that the four-year cumulative total stockholder return on theCompany’s common stock exceeds the four-year cumulative total return for theNASDAQ Index. The aggregate intrinsic value of the 400,000 shares of theCompany’s common stock underlying the restricted stock awards was $2.40million, based on the closing price of the Company’s common stock on the NASDAQNational Market on the date of grant. The Company utilized a Monte-Carlo simulationto estimate a range of possible future stock prices over the four-year periodfor the Company’s common stock and the NASDAQ Index to estimate the number ofrestricted shares that may vest based upon such simulation. Using theMonte-Carlo simulation method, the Company calculated an aggregate compensationcost of $580,000 at the time of the grant. The Company is recognizing thiscompensation cost over the four-year service period whether or not the marketcondition is actually satisfied. However, in the event one or more of theparticipants voluntarily terminates before the end of the four year period,some amounts of the charge will be reversed. In the event that a qualifyingchange in the control of the Company occurs prior to June 1, 2010, theCompany’s repurchase option will fully lapse, and the Company will thenrecognize a compensation change equal to the full $2.40 million intrinsic valueless any previously recognized compensation expense.

Pursuant to the Company’s 2000 Employee Stock PurchasePlan, the Company may issue and sell to its eligible employees up to anaggregate of 100,000 shares of common stock at a purchase price equal to 85% ofthe lower of the fair market value on the first or last day of each six-monthoffering period. Eligible employees may elect to have up to a maximum of 10% oftheir regular compensation withheld through payroll deductions to pay thepurchase price of the shares at the end of the offering period, subject tolimitations specified in the plan.

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Changesin outstanding stock options for the year ended December 31, 2006, were asfollows:

| **(in thousands, except exercise price and term)** | ** ** | ** ** | ** ** | **Number  of Stock  Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|------------------------------------|------------|-------------------------------------------|------------|
| Outstanding at  December 31, 2003                                           |       |       | 2,921      |                               |       |                                      | $          | 3.85 |   |   |
| Granted                                                                          |       |       | 1,101      |                               |       |                                      | $          | 2.89 |   |   |
| Exercised                                                                        |       |       | (450       | )                                  |       |                                      | $          | 1.40 |   |   |
| Forfeited and expired                                                            |       |       | (518       | )                                  |       |                                      | $          | 5.39 |   |   |
| Outstanding at  December 31, 2004                                           |       |       | 3,054      |                               |       |                                      | $          | 3.57 |   |   |
| Granted                                                                          |       |       | 483        |                               |       |                                      | $          | 4.49 |   |   |
| Exercised                                                                        |       |       | (705       | )                                  |       |                                      | $          | 1.47 |   |   |
| Forfeited and expired                                                            |       |       | (209       | )                                  |       |                                      | $          | 6.41 |   |   |
| Outstanding at  December 31, 2005                                           |       |       | 2,623      |                               |       |                                      | $          | 4.07 |   |   |
| Granted                                                                          |       |       | 620        |                               |       |                                      | $          | 7.01 |   |   |
| Exercised                                                                        |       |       | (440       | )                                  |       |                                      | $          | 1.88 |   |   |
| Forfeited and expired                                                            |       |       | (176       | )                                  |       |                                      | $          | 5.54 |   |   |
| Outstanding at  December 31, 2006                                           |       |       | 2,627      |                               |       |                                      | $          | 5.04 |   |   |
| Exercisable at December 31, 2006                                            |       |       | 1,081      |                               |       |                                      | $          | 5.56 |   |   |
| Vested or  expected to vest at December 31, 2006                            |       |       | 2,085      |                               |       |                                      | $          | 5.15 |   |   |

 

The weighted average remaining contractual life inyears of stock options outstanding, exercisable and vested or expected to vestat December 31, 2006, was 6.69, 4.68 and 6.32 years, respectively.

Changesin non-vested restricted stock awards for the year ended December 31,2006, were as follows:

| **(in thousands, except fair value)** | ** ** | ** ** | ** ** | **Number of  Restricted Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|-------------------------------------------------------------|------------|
| Non-vested at  December 31, 2004                     |       |       | —     |                                       |       |                                                        | —     |   |   |
| Awarded                                                   |       |       | 15         |                                       |       |                                                        | $          | 3.90 |   |   |
| Non-vested at  December 31, 2005                     |       |       | 15         |                                       |       |                                                        | $          | 3.90 |   |   |
| Awarded                                                   |       |       | 415        |                                       |       |                                                        | $          | 1.65 |   |   |
| Non-vested at  December 31, 2006                     |       |       | 430        |                                       |       |                                                        | $          | 1.73 |   |   |

 

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The aggregate intrinsicvalue of restricted shares outstanding at December 31, 2006 is $2.87million.

Thefollowing table summarizes information about the range of exercise prices forstock options under the four plans, outstanding and exercisable as of December 31,2006:

| ** **                                                           | ** **   | ** **   | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                  | ** ** |
|----------------------------------------------------------------------|--------------|--------------|------------|------------------------------|------------|-----------------------------------------------|------------|
| **Range of Exercise Prices**                          | ** **   | ** **   | ** ** | **Number  Outstanding**      | ** ** | **Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| **(in thousands except per share amounts)** | ** **   | ** **   | ** ** | ** **                   | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $0.81                                                                |  – |   $2.31 |       |                         | 34         |                                          |       |   | 2.54 |   |   |   | $ | 1.64 |   |   |   | $ | 169 |   |   |   | 34 |   |   |   | $ | 1.65 |   |   |   | $ | 169 |   |   |
| $2.55                                                                |  – |   $2.55 |       |                         | 600        |                                          |       |   | 7.84 |   |   |   | $ | 2.55 |   |   |   | $ | 2,478 |   |   |   | 200 |   |   |   | $ | 2.55 |   |   |   | $ | 826 |   |   |
| $2.70                                                                |  – |   $3.29 |       |                         | 315        |                                          |       |   | 5.67 |   |   |   | $ | 3.14 |   |   |   | $ | 1,115 |   |   |   | 193 |   |   |   | $ | 3.16 |   |   |   | $ | 686 |   |   |
| $3.31                                                                |  – |   $3.91 |       |                         | 242        |                                          |       |   | 7.88 |   |   |   | $ | 3.40 |   |   |   | $ | 794 |   |   |   | 99 |   |   |   | $ | 3.52 |   |   |   | $ | 314 |   |   |
| $4.25                                                                |  – |   $4.25 |       |                         | 280        |                                          |       |   | 0.84 |   |   |   | $ | 4.25 |   |   |   | $ | 680 |   |   |   | 280 |   |   |   | $ | 4.25 |   |   |   | $ | 680 |   |   |
| $4.49                                                                |  – |   $4.49 |       |                         | 377        |                                          |       |   | 8.26 |   |   |   | $ | 4.49 |   |   |   | $ | 826 |   |   |   | 53 |   |   |   | $ | 4.49 |   |   |   | $ | 116 |   |   |
| $4.98                                                                |  – |   $7.01 |       |                         | 166        |                                          |       |   | 7.33 |   |   |   | $ | 6.31 |   |   |   | $ | 84 |   |   |   | 24 |   |   |   | $ | 5.95 |   |   |   | $ | 16 |   |   |
| $7.08                                                                |  – |   $7.08 |       |                         | 267        |                                          |       |   | 9.19 |   |   |   | $ | 7.08 |   |   |   | $ | — |   |   |   | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| $7.15                                                                |  – | $16.72       |       |                         | 266        |                                          |       |   | 6.82 |   |   |   | $ | 8.81 |   |   |   | $ | — |   |   |   | 118 |   |   |   | $ | 10.60 |   |   |   | $ | — |   |   |
| $17.25                                                               |  – | $27.25       |       |                         | 80         |                                          |       |   | 3.28 |   |   |   | $ | 20.90 |   |   |   | $ | — |   |   |   | 80 |   |   |   | $ | 20.90 |   |   |   | $ | — |   |   |
| $0.81                                                                |  – | $27.25       |       |                         | 2,627      |                                          |       |   | 6.69 |   |   |   | $ | 5.04 |   |   |   | $ | 6,146 |   |   |   | 1,081 |   |   |   | $ | 5.56 |   |   |   | $ | 2,807 |   |   |
|                                                                      |              |              |            |                              |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The aggregate intrinsicvalue of options outstanding at December 31, 2006 of $6.15 million iscalculated as the difference between the exercise price of the underlyingoptions and the market price of the Company’s common stock for the 1,937,550shares that had exercise prices that were lower than the $6.68 closing marketprice of the Company’s common stock at December 31, 2006. The aggregateintrinsic value of options vested or expected to vest at December 31, 2006is $4.95 million. The total intrinsic value of options exercised was $2.30million, $2.56 million and $981,000 during the years ended December 31,2006, 2005 and 2004, respectively, determined as of the date of exercise.

***Employee Stock Purchase Plan***

Under the 2000 EmployeeStock Purchase Plan (the “2000 ESPP”), an aggregate of 100,000 shares of commonstock may be purchased by employees at 85% of the fair market value on thefirst or last day of each six-month offering period, whichever is lower. Duringeach offering period, the maximum number of shares that may be purchased by aparticipating employee is determined on the first day of the offering periodand is equal to the number of shares of common stock determined by dividing$12,500 by the last reported sale price of the common stock on the NASDAQNational Market on the first day of the offering. An eligible employee may electto have up to a maximum of 10% deducted through payroll deductions from his orher regular salary. During 2006, 2005 and 2004, respectively, 21,801, 7,836 and9,307 shares of the Company’s common stock were issued under the 2000 ESPP.During the year ended December 31, 2006 the Company recognized $43,000 ofequity compensation related to the issuance of shares under the 2006 ESPP.

**14.**          EmployeeSavings Plan

The Company has a 401(k) savingsplan for all domestic employees pursuant to which eligible employees mayvoluntarily contribute up to $15,000 subject to statutory limitations. Inaddition, the Company matches in cash 50% of the first $3,000 contributed byemployees up to a $1,500 maximum per employee per year. Employer cash matchingcontributions amounted to approximately $43,000, $36,000, and $38,000 for theyears ended December 31, 2006, 2005 and 2004, respectively.

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**15.**          Valuationand Qualifying Accounts

TheCompany monitors the creditworthiness of its trade customers based uponhistorical payment experience. The allowance for doubtful accounts activity forthe years ended December 31, 2006, 2005 and 2004 is as follows:

| **(in thousands)**            | ** ** | ** ** | ** ** | **Balance,  Beginning  of Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions** | ** ** | **Balance,  End of  Period** | ** ** |
|------------------------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------------------------|------------|----------------|------------|-----------------------------------|------------|
| Year ended December 31,  2006 |       |       | $          | 233                                     |       |                                          |       | $              | (8         | )                                 |       |   | $ | (7 | ) |   |   | $ | 218 |   |   |
| Year ended  December 31, 2005 |       |       | $          | 184                                     |       |                                          |       | $              | 66         |                              |       |   | $ | (17 | ) |   |   | $ | 233 |   |   |
| Year ended  December 31, 2004 |       |       | $          | 180                                     |       |                                          |       | $              | 80         |                              |       |   | $ | (76 | ) |   |   | $ | 184 |   |   |

 

**16.**          Contingencies

On August 17, 2005, alawsuit commenced in the Circuit Court, Twenty-Second Judicial Circuit,St. Louis, Missouri captioned *Brett Pingel by nextfriend Dawn LaRose vs. BioSphere Medical, Inc., Bruce Kirke Bieneman,M.D., St. Louis University Hospital, John Stith, M.D. and St. Louis University*.The lawsuit alleges, among other things, that a patient suffered permanentbilateral blindness as a result of the use of the Company’s EmbosphereMicrospheres or the negligence of the healthcare providers or both factorscombined. All defendants have denied the allegations against them. Plaintiffsseek compensatory and punitive damages. The Company carries product liabilityinsurance and this case is currently being defended by the Company’s insurerunder reservation of rights with respect to the claim of punitive damages, forwhich an exclusion from coverage exists. The Company has filed an answer tothis lawsuit in which it has denied the claims being made. The Company intendsto defend against the claims vigorously. However, the Company cannot give anyassurance that it will prevail and it is currently unable to predict thefinancial impact, of this product liability litigation.

**17.**          QuarterlyFinancial Data (Unaudited)

Thefollowing is a summary of quarterly financial results:

| ** **                                                           | ** ** | **First**  | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(in thousands except per share amounts)** | ** ** | ** ** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Net revenues                                                         |       |       |       |        |       |        |       |        |       |   |   |   |   |
| 2006                                                                 |       | $          | 5,269      |        | $          | 5,637       |       |        | $          | 5,644 |   |   |   | $ | 6,341 |   |   |
| 2005                                                                 |       | 4,429      |       | 4,489       |       |        | 4,412      |        |       |   | 5,154 |   |   |
| Gross profit                                                         |       |       |       |        |       |        |       |        |       |   |   |   |   |
| 2006                                                                 |       | 3,578      |       | 3,968       |       |        | 3,936      |        |       |   | 4,451 |   |   |
| 2005                                                                 |       | 2,888      |       | 2,990       |       |        | 2,866      |        |       |   | 3,437 |   |   |
| Net loss applicable to common stockholders                           |       |       |       |        |       |        |       |        |       |   |   |   |   |
| 2006                                                                 |       | (901       | )          | (1,115      | )          |        | (500       | )           |       |   | (333 | ) |   |
| 2005                                                                 |       | (1,346     | )          | (1,159      | )          |        | (519       | )           |       |   | (272 | ) |   |
| Basic and diluted net loss per share                                 |       |       |       |        |       |        |       |        |       |   |   |   |   |
| 2006                                                                 |       | $          | (0.06      | )           | $          | (0.06       | )          |        | $          | (0.03 | ) |   |   | $ | (0.02 | ) |   |
| 2005                                                                 |       | (0.09      | )          | (0.08       | )          |        | (0.04      | )           |       |   | (0.02 | ) |   |
|                                                                      |            |            |            |             |            |             |            |             |            |  |  |  |  |  |  |  |  |  |  |

 

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**Item 9.**                        CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**Item 9A.**                CONTROLSAND PROCEDURES

Our management, with the participation of the Company’schief executive officer and chief financial officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures as of December 31,2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms. Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure.Management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and management necessarily applies its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of December 31,2006, the Company’s chief executive officer and chief financial officerconcluded that, as of such date, the Company’s disclosure controls andprocedures were effective at the reasonable assurance level.

No change in our internalcontrol over financial reporting occurred during the fiscal quarter ended December 31,2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Item 9B.**               OTHERINFORMATION

None.

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**PART III**

**Item 10.**                 DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

**Directors andExecutive Officers**

Information regarding our directors will be includedin the definitive proxy statement for the 2007 Annual Meeting of Stockholdersunder “Nominees for Director” and is herein incorporated by reference.

Information regarding ourexecutive officers is included in Part I, Item 4, under the heading “EXECUTIVEOFFICERS.”

**Audit Committee**

We have aseparately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) ofthe Exchange Act. Additional information regarding the Audit Committee will beincluded in the definitive proxy statement for the 2007 Annual Meeting ofStockholders under “Board and Committee Meetings” and “Report of the AuditCommittee” and is herein incorporated by reference.

**Audit CommitteeFinancial Expert**

The Board of Directors hasdetermined that William M. Cousins, Jr. and John H. MacKinnon are each an “auditcommittee financial expert” as defined by Item 401(h) of Regulation S-K ofthe Exchange Act and has determined that they are independent within themeaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Information regarding Section 16(a) BeneficialOwnership Reporting Compliance will be included in the definitive proxystatement for the 2007 Annual Meeting of Stockholders under “Section 16(a) BeneficialOwnership Reporting Compliance” and is herein incorporated by reference.

**Code of Ethics**

We have adopted a code ofbusiness conduct and ethics that applies to our directors, officers (includingour principal executive officer, principal financial officer, principalaccounting officer or controller, or persons performing similar functions) as wellas our employees, a copy of which is listed as an exhibit to this annual reporton Form 10-K. A copy of our code of ethics is also available on theCompany’s website at *www.biospheremed.com*.

**Item 11.**                 EXECUTIVECOMPENSATION

The response to this itemwill be included in the definitive proxy statement for the 2007 Annual Meetingof Stockholders under “Compensation of Executive Officers” and is hereinincorporated by reference.

**Item 12.**                 SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The response to this itemwill be included in the definitive proxy statement for the 2007 Annual Meetingof Stockholders under “Stock Ownership of Certain Beneficial Owners andManagement” and “Equity Compensation Plan Information” and is hereinincorporated by reference.

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**Item 13.**                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The response to this itemwill be included in the definitive proxy statement for the 2007 Annual Meetingof Stockholders under “Certain Relationships and Related Transactions” and isherein incorporated by reference.

**Item 14.**                 PRINCIPALACCOUNTANT FEES AND SERVICES

The response to this itemwill be included in the definitive proxy statement for the 2007 Annual Meetingof Stockholders under “Report of the Audit Committee” and “IndependentAccountants, Fees and Other Matters” and is herein incorporated by reference.

**PART IV**

**Item 15.**                 EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(a) (1)                 Thefollowing consolidated financial statements of BioSphere Medical, Inc. andsubsidiaries are filed as part of this Form 10-K:
| Statement                                                                                                                                          | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| Report of  Independent Registered Public Accounting Firm                                                                                           |
| Consolidated  Balance Sheets—December 31, 2006 and 2005                                                                                  |
| Consolidated  Statements of Operations—Years ended December 31, 2006, 2005 and 2004                                                      |
| Consolidated Statements  of Stockholders’ Equity and Comprehensive Income (Loss)—Years  ended December 31, 2006, 2005 and 2004 |
| Consolidated  Statements of Cash Flows—Years ended December 31, 2006, 2005 and 2004                                                      |
| Notes to  Consolidated Financial Statements                                                                                                        |

 

(a) (2)                 Allschedules are omitted because they are not applicable or the requiredinformation is shown in the Financial Statements or notes thereto.

(a) (3)                 Exhibitsincluded or incorporated herein:

See Exhibit Index

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**Exhibit Index**

| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                             |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Certificate of Incorporation, as amended, of the  Company. (Incorporated herein by reference to the Company’s Registration  Statement on Form S-8. (File No. 333-83639)).                                                                                                                                                                                    |
| 3.2              |       | By-Laws of the Company (Incorporated herein by  reference to the Company’s Registration Statement on Form S-8.  (File No. 333-05621)).                                                                                                                                                                                                                       |
| 4.1              |       | Specimen Certificate for shares of common stock,  $.01 par value, of the Company. (Incorporated herein by reference to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 1999 (File No. 000-23678)).                                                                                                                           |
| 4.2              |       | Certificate of Designations, Preferences and Rights  of Series A Preferred Stock of BioSphere Medical, Inc.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on November 15, 2004 (File No. 000-23678)).                                                                                                 |
| 4.3              |       | Amendment No. 1 to Certificate of Designation,  Preferences and Rights of Series A Preferred Stock of BioSphere  Medical, Inc. (Incorporated herein by reference to the Company’s Current  Report on Form 8-K filed on May 23, 2005 (File No. 000-23678)).                                                                               |
| 4.4*             |       | Certificate of Amendment  of Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                  |
| 10.1(1)          |       | 1994 Director Option Plan. (Incorporated herein by  reference to the Company’s Registration Statement on Form S-1, as  amended (File No. 33-75212)).                                                                                                                                                                                                         |
| 10.2(1)          |       | 1994 Stock Option Plan. (Incorporated herein by  reference to the Company’s Registration Statement on Form S-1, as  amended (File No. 33-75212)).                                                                                                                                                                                                            |
| 10.3(1)          |       | 1997 Stock Incentive Plan. (Incorporated herein by  reference to the Company’s Quarterly Report on Form 10-Q for the  quarter ended June 30, 1997 (File No. 000-23678)).                                                                                                                                                                                |
| 10.4(1)          |       | Form of Nonstatutory Stock Option Agreement  granted under 1994 Stock Option Plan. (Incorporated herein by reference to  the Company’s Form 10-K for the year ended December 31, 2004  (File No. 000-23678)).                                                                                                                                      |
| 10.5(1)          |       | Form of Incentive Stock Option Agreement  granted under 1997 Stock Incentive Plan. (Incorporated herein by reference to  the Company’s Form 10-K for the year ended December 31, 2004  (File No. 000-23678)).                                                                                                                                      |
| 10.6(1)          |       | Form of Nonstatutory Stock Option Agreement  granted under 1997 Stock Incentive Plan. (Incorporated herein by reference to  the Company’s Form 10-K for the year ended December 31, 2004 (File  No. 000-23678)).                                                                                                                                   |
| 10.7(1)          |       | Form of Restricted Stock Agreement granted  under 1997 Stock Incentive Plan. (Incorporated herein by reference to the  Company’s Form 10-K for the year ended December 31, 2004  (File No. 000-23678)).                                                                                                                                            |
| 10.8             |       | Form of Technology Transfer and License  Agreement dated as of January 1, 1994 between the Company and Sepracor  Inc. (Incorporated herein by reference to the Company’s Registration  Statement on Form S-1, as amended (File No. 33-75212)).                                                                                                     |
| 10.9             |       | Share Purchase Agreement by and between Marie-Paule  Leroy-Landercy and the Company dated December 31, 1998. (Incorporated  herein by reference to the Company’s Annual Report on Form 10-K  for the year ended December 31, 1999 (File No. 000-23678)).                                                                                           |
| 10.10+           |       | Joint Ownership Contract between the Company and  L’Assistance Publique Hopitaux de Paris dated January 5, 1998, together  with amendment dated February 10, 2001 (translated from French).  (Incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 1999 (File  No. 000-23678)). |

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| 10.11    |   | Rider No. 2 dated June 20, 2000 to the  Joint Ownership Contract between the Company and L’Assistance Publique  Hopitaux de Paris dated January 5, 1998. (Incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2001 (File No. 000-23678)).                                                              |
|----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.12+   |   | Exclusive License Agreement between  Dr. Shin-ichi Hori and the Company dated May 8, 2000. (Incorporated  herein by reference to the Company’s Annual Report on Form 10-K  for the year ended December 31, 2001 (File No. 000-23678)).                                                                                                                                      |
| 10.13+   |   | Exclusive License and Know-How Agreement  No. L99037 by and between Le Centre National de la Recherche  Scientifique, L’Universite Louis Pasteur Strasbourg and the Company dated  July 15, 1999 (translated from French). (Incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the year  ended December 31, 1999 (File No. 000-23678)). |
| 10.14    |   | Lease Agreement dated January 7, 2000 by and  between 1050 Hingham Street Realty Trust and the Company. (Incorporated  herein by reference to the Company’s Annual Report on Form 10-K  for the year ended December 31, 1999 (File No. 000-23678)).                                                                                                                              |
| 10.15    |   | First Amendment to Lease Agreement dated  June 27, 2000 by and between 1050 Hingham Street Realty Trust and the  Company. (Incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2000 (File  No. 000-23678)).                                                                                                            |
| 10.16    |   | Lease Agreement dated October 19, 2000 by and  between BioSphere Medical S.A. and Salamandre S.A (translated from French to  English). (Incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2000 (File  No. 000-23678)).                                                                                               |
| 10.17    |   | Credit Agreement between the Company and Brown  Brothers Harriman & Co. dated May 17, 2002. (Incorporated  herein by reference to the Company’s Quarterly Report on Form 10-Q  for the quarter ended June 30, 2002 (File No. 000-23678)).                                                                                                                               |
| 10.18    |   | Security Agreement between the Company and Brown  Brothers Harriman & Co. dated May 17, 2002. (Incorporated  herein by reference to the Company’s Quarterly Report on Form 10-Q  for the quarter ended June 30, 2002 (File No. 000-23678)).                                                                                                                             |
| 10.19    |   | Second Modification, dated as of June 30, 2004,  to the Credit Agreement and Promissory Note by and between the Company and  Brown Brothers Harriman & Co. dated May 17 2002. (Incorporated  herein by reference to the Company’s Quarterly Report on Form 10-Q  for the quarter ended September 30, 2004 (File No. 000-23678)).                                   |
| 10.20    |   | Third Modification, dated as of June 29, 2005,  to the Credit Agreement and Promissory Note by and between the Company and  Brown Brothers Harriman & Co. dated May 17 2002. (Incorporated  herein by reference to the Company’s Current Report on Form 8-K  filed on July 5, 2005 (File No. 000-23678)).                                                          |
| 10.21(1) |   | Letter Agreement between BioSphere  Medical, Inc. and Gary M. Saxton, dated November 18, 2004.  (Incorporated herein by reference to the Company’s Form 10-K for  the year ended December 31, 2004 (File No. 000-23678)).                                                                                                                                                   |
| 10.22(1) |   | Employment Agreement between BioSphere  Medical, Inc. and Richard J. Faleschini, dated November 2, 2004.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on November 8, 2004 (File No. 000-23678)).                                                                                                                                   |
| 10.23(1) |   | Executive Retention Agreement between BioSphere  Medical, Inc. and Richard J. Faleschini, dated November 2, 2004.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on November 8, 2004 (File No. 000-23678)).                                                                                                                          |

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| 10.24    |   | Securities Purchase Agreement, dated as of  November 10, 2004, by and among BioSphere Medical, Inc. and the  investors named therein. (Incorporated herein by reference to the Company’s  Current Report on Form 8-K filed on November 15, 2004 (File  No. 000-23678)).                                                    |
|----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25    |   | Investor Rights Agreement, dated as of  November 10, 2004, by and among BioSphere Medical, Inc. and the  investors named therein. (Incorporated herein by reference the Company’s  Current Report on Form 8-K filed on November 15, 2004 (File  No. 000-23678)).                                                           |
| 10.26    |   | Warrant No. 2004-1, dated as of  November 10, 2004, issued to Cerberus Partners, L.P. (Incorporated  herein by reference to the Company’s Current Report on Form 8-K  filed on November 15, 2004 (File No. 000-23678)).                                                                                                    |
| 10.27    |   | Warrant No. 2004-2, dated as of  November 10, 2004, issued to Sepracor Inc. (Incorporated herein by  reference to the Company’s Current Report on Form 8-K filed on  November 15, 2004 (File No. 000-23678)).                                                                                                              |
| 10.28    |   | Restrictive Covenants Agreement, dated as of  December 23, 2004, by and among BioSphere Medical, Inc., Cerberus  Partners, L.P. and Sepracor Inc. (Incorporated herein by reference to the  Company’s Current Report on Form 8-K filed on December 30,  2004 (File No. 000-23678)).                                        |
| 10.29    |   | Amendment No. 1 to Warrant No. 2004-1,  dated December 23, 2004, issued to Cerberus Partners, L.P. (Incorporated  herein by reference to the Company’s Current Report on Form 8-K  filed on December 30, 2004 (File No. 000-23678)).                                                                                  |
| 10.30    |   | Amendment No. 1 to Warrant No. 2004-2,  dated December 23, 2004, issued to Sepracor Inc. (Incorporated herein by  reference to the Company’s Current Report on Form 8-K filed on  December 30, 2004 (File No. 000-23678)).                                                                                            |
| 10.31    |   | Second Amendment to Lease between BioSphere  Medical, Inc. and Thomas J. Teuten and John H. Spurr, Jr., Trustees  of 1050 Hingham Street Realty Trust, dated January 24, 2005.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on January 27, 2005 (File No. 000-23678)).       |
| 10.32    |   | Third Amendment to Lease between BioSphere  Medical, Inc. and Thomas J. Teuten and John H. Spurr, Jr.,  Trustees of 1050 Hingham Street Realty Trust, dated February 24, 2006.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on February 28, 2006 (File No. 000-23678)). |
| 10.33(1) |   | Compensation Program for Non-Employee Directors of  BioSphere Medical, Inc. (Incorporated herein by reference to the  Company’s Current Report on Form 8-K filed on August 9, 2006  (File No. 000-23678)).                                                                                                                      |
| 10.34(1) |   | Letter Agreement between BioSphere  Medical, Inc. and Martin J. Joyce, dated June 14, 2005.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on June 17, 2005 (File No. 000-23678)).                                                                                                  |
| 10.35(1) |   | Letter Agreement between BioSphere  Medical, Inc. and Peter C. Sutcliffe, dated June 14, 2005.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on June 17, 2005 (File No. 000-23678)).                                                                                               |
| 10.36    |   | Securities Purchase Agreement, dated as of  February 17, 2006, by and among BioSphere Medical, Inc. and the  investors named therein. (Incorporated herein by reference to the Company’s  Current Report on Form 8-K filed on February 21, 2006 (File  No. 000-23678)).                                                    |
| 10.37    |   | Registration Rights Agreement, dated as of  February 17, 2006, by and among BioSphere Medical, Inc. and the  investors named therein. (Incorporated herein by reference to the Company’s  Current Report on Form 8-K filed on February 21, 2006 (File  No. 000-23678)).                                                    |

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| 10.38 |   | BioSphere Medical, Inc. 2006 Stock Incentive  Plan (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on May 16, 2006).                                                                          |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.39 |   | Form on Incentive Stock Option Agreement  Granted Under BioSphere Medical, Inc. 2006 Stock Incentive Plan  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on May 16, 2006).             |
| 10.40 |   | Form of Nonstatutory Stock Option Agreement  Granted Under BioSphere Medical, Inc. 2006 Incentive Plan (Incorporated  herein by reference to the Company’s Current Report on Form 8-K  filed on May 16, 2006).                |
| 10.41 |   | Form of Restricted Stock Agreement Granted  Under BioSphere Medical, Inc. 2006 Stock Incentive Plan (Incorporated  herein by reference to the Company’s Current Report on Form 8-K  filed on May 16, 2006).                   |
| 10.42 |   | Amendment No. 1 to 2006 Stock Incentive Plan.  (Incorporated herein by reference to the Company’s Current Report on  Form 8-K filed on August 9, 2006 (File No. 000-23678)).                                                  |
| 14.1  |   | Code of Business Conduct and Ethics of the Company.  (Incorporated herein by reference to the Company’s Form 10-K for  the year ended December 31, 2003 (File No. 000-23678)).                                                     |
| 21.1  |   | Subsidiaries of the Company. (Incorporated herein by  reference to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2000 (File No. 000-23678)).                                                           |
| 23.1* |   | Consent of Ernst & Young LLP.                                                                                                                                                                                                                 |
| 31.1* |   | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002, dated March 26, 2007. |
| 31.2* |   | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002, dated March 27, 2007. |
| 32.1* |   | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002, dated March 26,  2007.                                                         |
| 32.2* |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002, dated March 27,  2007.                                                         |

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(1)          Management contract orcompensatory plan or arrangement filed as an exhibit to this Form 10-Kpursuant to Items 14(a) and 14(c) of Form 10-K.

+                Confidentialtreatment requested as to certain portions.

*                    Filedherewith.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                                       | BIOSPHERE MEDICAL, Inc. |
|---------------------------------------|------------------------------|
|                                  | By:                          | /s/  RICHARD J. FALESCHINI |
| ** **                            | ** **                   | **Richard  J. Faleschini** |
| ** **                            | *** ***                 | ***President  and Chief Executive Officer*** |
| Date:  March 26,  2007 |                         |   |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has been signedbelow by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.
|                                       | **Signature** | ** **                                       | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|---------------------------------------|---------------|--------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ RICHARD J. FALESCHINI             |          | Director,  President and Chief Executive Officer |       | March 26,  2007 |
| **Richard J. Faleschini**             |          | (Principal Executive  Officer)                   |       |                 |
| /s/ MARTIN J. JOYCE                   |          | Vice President  and Chief Financial Officer      |       | March 27,  2007 |
| **Martin J. Joyce**                   |          | (Principal Financial and  Accounting Officer)    |       |                 |
| /s/ TIMOTHY J. BARBERICH              |          | Director                                         |       | March 23,  2007 |
| **Timothy J. Barberich**              |          |                                             |       |                 |
| /s/ WILLIAM M. COUSINS, JR.           |          | Director                                         |       | March 27,  2007 |
| **William M. Cousins, Jr.**      |          |                                             |       |                 |
| /s/ MARIAN L. HEARD                   |          | Director                                         |       | March 27,  2007 |
| **Marian L. Heard**                   | ** **    | ** **                                       | ** ** | ** **           |
| /s/ ALEXANDER M. KLIBANOV, Ph.D. |          | Director                                         |       | March 27,  2007 |
| **Alexander M. Klibanov, Ph.D.**      |          |                                             |       |                 |
| /s/ JOHN H. MACKINNON                 |          | Director                                         |       | March 27,  2007 |
| **John H. MacKinnon, CPA**            |          |                                             |       |                 |
| /s/ RICCARDO PIGLIUCCI                |          | Director                                         |       | March 27,  2007 |
| **Riccardo Pigliucci**                |          |                                             |       |                 |
| /s/ DAVID P. SOUTHWELL                |          | Director and  Chairman of the Board              |       | March 27,  2007 |
| **David P. Southwell**                |          |                                             |       |                 |

 

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