**UNITED STATESSECURITIES 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,  2005** |
| **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) ofthe Act:

**None**

Securities registered pursuant to Section 12(g) ofthe Act:

**common stock, $.01 parvalue**

(Title of class)

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 or Section 15(d) ofthe Act. Yes  o    No  x

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the 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 accelerated  filer  o    Accelerated  filer  o    Non-accelerated  filer  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, 2005, was $35,249,000based on the closing price of the common stock as reported by the NASDAQNational Market as of such date.

The Registrant had 17,231,505 shares of common stockoutstanding as of March 1, 2006.

**Documentsincorporated by reference:**

Portionsof the Registrant’s Definitive Proxy Statement for the 2006 Annual Meeting ofStockholders of the Registrant are incorporated by reference into Part IIIof this Form 10-K.

 

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**PART I**

*This annual report on Form 10-K containsforward-looking statements that involve risks, uncertainties and assumptionsthat, if they never materialize or prove incorrect, could cause the results ofBioSphereMedical, Inc. to differ materially from those expressed orimplied by such forward-looking statements. All statements other thanstatements of historical fact are statements that could be deemedforward-looking statements, including any projections of revenues, expenses,earnings or losses from operations, or other financial items; any statements ofthe plans, strategies and objectives of management for future operations; anystatements concerning product research, development and commercializationtimelines and expectations regarding market acceptance and market penetrationfor our products; any statements of expectation or belief; and any statementsof assumptions underlying any of the foregoing. The risks, uncertainties andassumptions referred to above include risks that are described in “Risk Factors”and elsewhere in this annual report and that are otherwise described from timeto time in our Securities and Exchange Commission reports filed after thisreport.*

*The forward-looking statements included in this annualreport represent our estimates as of the date of this annual report. Wespecifically disclaim any obligation to update these forward-looking statementsin the future. These forward-looking statements should not be relied upon asrepresenting our estimates or views as of any date subsequent to the date ofthis annual report.*

**Item 1.**                        BUSINESS

**OVERVIEW**

We are focused on applyingour proprietary microsphere technology to medical applications usingembolotherapy techniques. Embolotherapy is the process of obstructing a bloodvessel or organ by the insertion or lodgment of particles or other materials.Embolotherapy works by occluding blood vessels, either to arrest or preventhemorrhaging to devitalize a structure or organ by depleting its blood supply.Our core technologies consist of patented bioengineered polymers, which arechemical compounds that we create through the application to medical science ofengineering principles, and manufacturing methods. These core technologies areused to produce miniature spherical embolic particles with uniquely beneficialproperties 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 thetreatment of symptomatic uterine fibroids, which are noncancerous tumorsgrowing within or on the wall of the uterus, using a procedure called uterinefibroid embolization, or UFE. UFE is a minimally invasive procedure in whichmicrospheres are injected through a microcatheter into the blood vessels thatsupply the uterus. Blood flow guides these particles into the network ofvessels that preferentially flow toward the fibroids, thereby blocking theblood supply to the fibroids, but not the surrounding healthy tissue. Mostpatients with uterine fibroids are not initially symptomatic and remainuntreated until the patient experiences symptoms such as abnormal bleeding,increased urinary frequency, pain, pelvic discomfort or fertility difficulties.Our products are gaining acceptance in this procedure, as well as in a numberof other new and established medical treatments, including the use ofmicrospheres in the treatment of primary liver cancer. Our strategy is to growour embolotherapy business worldwide through increases in UFE and primary livercancer embolization procedures, by increasing the awareness and availability ofthese procedures. 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 embolicproducts, Embosphere® Microspheres and EmboGold® Microspheres, have a number of beneficialproperties that we believe make them well suited for embolotherapy procedures.Because of their uniform, spherical shape and soft, slippery surface, ourparticles are easy to inject through small catheters, resulting in a more evendistribution within the vessel network. We provide these products in precisesizes, so they can be selected to target occlusion of specific sized vessels toproduce predictable results and optimize therapeutic benefit.

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In November 2002, wereceived 510(k) clearance from the Food and Drug Administration, or FDA,to market our Embosphere Microspheres for UFE. Third-party clinical data andpublications support the safety, efficacy, cost-effectiveness and long-termdurability of the UFE procedure. We believe that the medical community acceptsUFE as an effective option for most patients who are on drug therapy or areconsidering undergoing a hysterectomy for treatment of their uterine fibroids.For these reasons, we believe the number of UFE procedures will increase at anaccelerating rate. We were the first company to gain regulatory clearance tomarket a product for UFE in the United States. During 2005, we focused ongrowing our Embosphere Microsphere business through the development ofphysician referral networks and patient awareness programs. We continue toexpand our sales and marketing organization to maintain our leadership positionin the field of UFE.

We also believe thatgrowth opportunities exist in the use of other embolotherapy procedures,notably in the treatment of primary liver cancer. In May 2000, we obtaineda worldwide exclusive royalty-bearing license to HepaSphereTM Microspheres from Dr. ShinichiHori. HepaSphere Microspheres have different properties than EmbosphereMicrospheres and EmboGold Microspheres. Specifically, HepaSphere Microsphereshave an ability to absorb fluids and expand to 4 times their dry state in vivowhile maintaining  their spherical form.HepaSphere Microspheres occlude with a high degree of conformity to the vesselwall. Additionally, HepaSphere Microspheres have an ability to locally delivera chemotherapeutic agent when used in the treatment of liver tumors. We have CEmark approval to market our HepaSphere Microspheres in the European Union forthe treatment of liver cancer and are in early stage commercial introductionwith limited 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. HepaSphere Microspheres are currently underclinical evaluation in Japan and we have also had limited sales of this productin Japan under private import restrictions. We intend to seek regulatoryapproval of the HepaSphere Microspheres in Japan, but do not expect that suchapproval will be granted, if at all, in the near term. On March 13, 2006,we announced that we have 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 is in turn 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. We are not aware of any adverse eventsresulting from the defects in the paper packaging. Sales of HepaSphere Microspheresoutside of the United States are expected to resume once a new packaging designis produced and validated.

In September 2005, wesubmitted a 510(k) application to the FDA seeking United States marketingclearance for our QuadraSphereTM Micropheres product candidate for the treatmentof hypervascularized tumors and peripheral arteriovenous malformations. OurQuadraSphere Microspheres are identical in all respects to our HepaSphereMicrospheres, which are marketed outside of the United States.

In addition, we expect toseek FDA clearance to release our next generation infusion catheter andGuidewire, and MR-Embosphere Microspheres, microspheres visible under magneticresonance imaging.We filed for marketing approval of our Embosphere Microspheresin the People’s Republic of China and in Korea and we expect market release in2006.

We believe that ourmicrosphere technologies may have several non-embolotherapy applications,including tissue bulking, and are exploring the use of our microspheres in thetreatment of gastroesophageal reflux disease and for use in cosmeticdermatology. As a result of these efforts, we filed a number of patentapplications, and have issued U.S. patents, related to the application of ourtechnologies in these non-embolotherapy applications. Although our currentfocus is on embolotherapy markets, and significant additional research in theseareas would be required, we believe that these non-embolotherapy 

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applicationsmay provide us with development and commercialization opportunities throughinternal 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®, Embosphere®, EmboGold®, EmboCath®, Segway®, SequitorTM, QuadraSphereTM, and ask4UFETMare trademarks of BioSphere Medical, Inc. Other trademarks appearing inthis annual report are the property of their respective holders.

**INDUSTRY OVERVIEW**

**Embolotherapy Markets**

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 uterine fibroid embolization and embolization for the treatment ofcertain cancers, in particular liver cancer. Moreover, we believe that anincreasing number of affected patients are seeking alternative treatments withembolotherapy due to their desire for less invasive treatment options thanthose presented by non-embolotherapy procedures.

**Uterine Fibroids**

Untilrecently, women suffering from uterine fibroids have had few treatment options.These existing treatment options include the following:

·                    **Hysterectomy.  **Hysterectomy is asurgical procedure to remove the uterus. While hysterectomy has a relativelylow complication rate, it requires a hospital stay of several days, a recoveryperiod of up to six to eight weeks, and results in loss of fertility.Furthermore, hysterectomies have been tied to adverse psychological effects,sexual and urinary dysfunction, as well as the onset of early menopause. Inaddition, for many women who have their ovaries removed during hysterectomy,this treatment means extended hormone replacement therapy.

·                    **Myomectomy.  **Myomectomy is thesurgical removal of the uterine fibroids without removal of the uterus. It isusually performed on women who wish to preserve their fertility. Only fibroidsthat can be easily accessed and excised are candidates for removal with this technique.Because some fibroids are difficult to identify while others are difficult toremove, 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.”  **Drugtherapies include non-steroidal anti-inflammatory drugs, oral contraceptivepills, progestational agents and gonadotropin-releasing hormone agonists. Womenwith less severe symptoms who elect against drug therapy and those 

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seeking to conceivehave few satisfactory options. In these circumstances, physicians usuallymonitor symptoms and will administer therapy only if the condition worsens.

·                    **Other treatments.**   Other treatmentsfor uterine fibroids include high intensity focused ultrasound and global endometrialablation. High-intensity focused ultrasound is a method of deliveringultrasonic energy to a discrete, distant point with resultant heat and tissuedestruction, but without causing a significant temperature increase or cellularinjury to tissue lying in the path of the ultrasound beam. Global endometrialablation describes the minimally invasive application of energy to destroy theentire endometrial lining in women who are experiencing severe menstrualbleeding and who have completed their childbearing.

**Liver Cancer**

Liver cancer is one of themost prevalent forms of cancer worldwide. There are several types of livercancer.

Primary liver cancer istypically diagnosed at a state that is too advanced to cure surgically. Primaryliver cancer refers to cancer that begins within the liver itself. Chronichepatitis B and chronic hepatitis C, inflammations of the liverassociated with the hepatitis virus, are contributing factors to thedevelopment of primary liver cancer. For the 80% of patients who are notsurgical candidates in the United States who fall into this category, existingtreatment options are primarily designed to improve quality of life rather thancure the underlying disease. Metastatic liver cancer occurs when cancer beginsin another part of the body, such as the colon, and then migrates, or spreads,to the liver. In the United States, metastatic liver cancer is more prominentthan primary liver cancer. However, the rate of primary liver cancer, where thecancer originates in the liver, is expected to increase dramatically in theUnited States due to increased incidences of hepatitis C, a key risk factor forprimary liver cancer. There is a high incidence of primary liver cancer outsideof the United States, particularly in Asia, due to the high rates of thehepatitis B and C viruses outside of the United States.

Numerous studies andmedical publications indicate that embolotherapy has been used for at least 20years to treat liver cancer. For example, particle embolization is commonly usedin Japan to manage liver cancer patients. In the United States, embolicparticles are commonly injected with chemotherapeutic agents to control andlimit distribution of the chemotherapy agents, thereby increasing thetherapeutic exposure at the target area. Recently, a new, targeted approach totreating liver cancer, using radioactive particles, has become available. Theseparticles, which are similar to our Embosphere Microspheres, are delivered in atargeted fashion through catheters placed in the feeding vessels near the tumorsite.

A number of other, lessinvasive technologies are either in use or in development to treat inoperableprimary liver cancer. Selective tumor ablation, using needle-like devicescontaining thermal energy or chemicals that are placed directly through theskin and into the tumor, can be used. However, application of this technique ispractically limited to those with adequate liver function and relatively smalltumors.

**Non-EmbolotherapyApplications**

Although our current focusis to develop our embolotherapy business, we believe there may be applicationsfor our core technology in non-embolotherapy applications, particularly asbulking agents to replace or supplement tissue support. Bulking agents arematerials, injected into body sites, used to provide extra physical supportwhere normal anatomic support is not present. These applications include gastroesophageal reflux disease and cosmetic dermatology.

We have developed a numberof technologies related to non-embolotherapy applications that have resulted innumerous patent applications. Although we are currently focusing our resourcesand efforts on the embolotherapy business and significant additional researchin these areas would be required, we believe that these non-embolotherapyapplications may provide us with development and commercializationopportunities.

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**PRODUCTS**

Our innovative microspheretechnology evolved out of approximately 15 years of research and development ofpolymer formulations used in the field of biological separations and drugpurification.

The following table summarizes information about ourprincipal products and products under research and development.

**Principal Products**

| **PRODUCT**                  | ** ** | **CLEARED FOR THE FOLLOWING  INTENDED USES**                             | ** ** | **GEOGRAPHIC  APPROVALS**                                                                                                                |
|------------------------------|------------|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|
| Embosphere Microspheres |       | Uterine fibroids,  hypervascularized tumors and other arteriovenous malformations       |       | United States, Canada,  European Union, Argentina, Brazil, Colombia, Costa Rica, Panama, Peru,  Uruguay, Hong Kong, Taiwan and Australia |
| EmboGold Microspheres        |       | Hypervascularized  tumors (other than uterine fibroids) and arteriovenous malformations |       | United States,  Canada, European Union, Argentina, Brazil, Colombia, Costa Rica, Panama,  Peru, Uruguay, Hong Kong, Taiwan and Australia |
| 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                                                  |
| HepaSphere Microspheres |       | Liver cancer

                                                                     |       | European Union  and clinical evaluation in Japan                                                                                         |

 

**Products underResearch and Development**

| **PRODUCT**                                            | ** ** | **POTENTIAL MARKETS**                                                             | ** ** | **DEVELOPMENT  STATUS**                      |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|----------------------------------------------|
|                                                   |       |                                                                              |       |                                         |
| QuadraSphere Microspheres                              |       | Hypervascularized tumors and arteriovenous  malformations                         |       | 510(k) application submitted to the FDA |
| MR—(magnetic resonance) - Embosphere Microspheres |       | Uterine fibroids,  hypervascularized tumors and other arteriovenous malformations |       | Preclinical research—animal  studies    |
| EmboCath Plus Infusion  Microcatheter             |       | Peripheral embolization  procedures                                               |       | Preclinical research—animal  studies    |
| Sequitor Steerable Guidewire                           |       | Peripheral embolization  procedures                                               |       | Preclinical research—animal  studies    |

 

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**EmbosphereMicrospheres**

Our EmbosphereMicrospheres and EmboGold Microspheres products are intended for use inembolotherapy to block or control the blood supply to certain tumors and othervascular malformations. In November 2002, following successful completionof our clinical studies, we received regulatory clearance in the United Statesfrom the FDA for use of our Embosphere Microspheres in treating uterinefibroids. In April 2000, we received 510(k) marketing clearance fromthe FDA of our Embosphere Microspheres for hypervascularized tumors andarteriovenous malformations.

We believe that UFE willbecome the principal application for our microsphere products. The majority ofour revenues are currently derived from the sale of our Embosphere Microspheresfor UFE. Uterine fibroid embolization is a minimally invasive procedure,performed principally by interventional radiologists, in which microspheres areinjected through a small catheter into the blood vessels that supply theuterus. Blood flow guides these particles into the network of vessels thatpreferentially flow toward the fibroids, thereby preferentially blocking theblood supply to the fibroids, but not to the surrounding healthy tissue. Thegoal of the uterine fibroid embolization procedure is to eliminate the flow ofblood to the uterine fibroids, thereby causing fibroid shrinkage andalleviating related symptoms, while preserving normal uterine and ovarianfunction.

We believe thatembolotherapy is a significantly more attractive alternative for treatment ofuterine fibroids, particularly when compared to the invasiveness of suchsurgical procedures as hysterectomy or myomectomy, or even when compared 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 uterinefibroid embolization on continued fertility or fetal development has not beenstudied extensively, and our 510(k) clearance does not include women whointend future pregnancy, we believe that uterine fibroid embolization has thepotential to preserve the fertility of at least some of the patients that wouldotherwise be lost through hysterectomy or may be compromised by the use ofcurrent therapies or technologies, and to reduce or eliminate the risk ofrecurrence of the uterine fibroid tumor and the complications associated withmyomectomy. Most uterine fibroid embolization procedures can be performed inless than one hour, while the patient is sedated, but awake. The patient oftenstays overnight in the hospital to manage any discomfort and/or pain associatedwith the procedure and typically returns to everyday activities in severaldays. In contrast, hysterectomy patients undergo general anesthesia, stay inthe hospital for two to three days, and have a recovery period lasting up tosix to eight weeks.

We believe EmbosphereMicrospheres are also being used in other disease areas and procedures,including liver cancer and arteriovenous malformations, although we arecurrently devoting most of our internal efforts to marketing and selling thisproduct for UFE.

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 

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be of particular concernduring uterine fibroid embolization as it can disrupt the flow of blood, whichclinicians rely on during embolization to direct the microspheres to the vesseltargeted 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 ourEmbosphere Microspheres are an appropriate agent for permanent vesselocclusion.

·       **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 Microspheres are currently available in sixsizes, from 40 to 1,200 microns. They are designed to precisely fit the bloodvessels, resulting in targeted and controlled occlusion. They can be used withour accessory catheter products or with any other commercially availablecatheter and delivery systems.

**EmboGoldMicrospheres**

Our EmboGold Microspheres product was launched in theUnited States in September 2001 after receiving FDA clearance fortreatment of hypervascularized tumors and arteriovenous malformations. In March 2002,we received CE mark approval in the European Union. This product enhancementadds color to the microspheres for improved visibility during preparation andinjection. We do not have FDA clearance to market our EmboGold Microspheres foruse in the treatment of uterine fibroids, and have determined not to seek suchapproval at this time. We made this decision because of reports that a smallnumber of patients treated with UFE using EmboGold Microspheres, which webelieve constitutes approximately 2% of the total number of patients receivingthe UFE procedure using EmboGold Microspheres, reported a delayed onset of painand/or rash.

**HepaSphereMicrospheres**

HepaSphere Microspheres are marketed in the EuropeanUnion and have been sold in limited quantities under private importrestrictions in Japan, where it is in clinical evaluation for the treatment ofprimary liver cancer. We intend to seek regulatory approval of the HepaSphereMicroSpheres in Japan, but we do not expect regulatory approval to marketHepaSphere Microspheres in Japan in the near term. On March 13, 2006, weannounced that we have 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 is in turn 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. We are not aware of any adverse eventsresulting from the defects in the paper packaging. Sales of HepaSphereMicrospheres outside of the United States are expected to resume once a newpackaging design is produced and validated.

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The product attributes ofHepaSphere 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 vivo—64 timesits 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

·       theability to carry a chemotherapeutic agent.

Like treatment of uterinefibroids, targeted liver embolotherapy is intended to starve the liver tumorwithout damaging the surrounding tissue or causing any adverse side effects onother parts of the body, such as those associated with chemotherapy andradiation. In May 2000, we obtained a worldwide exclusive royalty-bearinglicense to HepaSphere Microsphere from Dr. Shinichi Hori.

**Delivery Systems**

During 2002, we introduced our EmboCath InfusionCatheter and our Segway Guidewire, which are products used to deliverembolization material into the target area. These delivery system devices areintended for peripheral embolization procedures, which are procedures in partsof the body other than the head, heart or vascular system. We are seeking tofurther develop this pipeline with new delivery products and productenhancements.

In November 2001, we received FDA clearance tomarket our EmboCath Infusion Catheter. The EmboCath Infusion Catheter is amicrocatheter that is designed to be used to inject embolization material inthe pelvic and abdominal region and has properties that we believe optimize theunique design of our hydrophilic and compressible microspheres, including thelargest inside diameter available on the market in this size range, a speciallydesigned hub to enable easy transfer of embolic agents from the syringe throughthe catheter, a hydrophilic coating and variable stiffness shaft to enableresponsive yet supple handling.

In 2002, we introduced ourSegway Guidewire, designed specifically for use with our EmboCath InfusionCatheter. The unique, proprietary design offers advanced features developed foruse in cardiology applications. Guidewires are used in most intravascularcatheter procedures to establish a support structure to aid placement of thecatheter.

**QuadraSphere Microspheres**

Our absorbing andexpanding QuadraSphere Microsphere product under development is identical inall respects to HepaSphere Microspheres, which are marketed outside of the United States. InSeptember 2005, we submitted a 510(k) application to the FDA seekingUnited States marketing clearance for our QuadraSphere Microspheres productcandidate for the treatment of hypervascularized tumors and peripheralarteriovenous malformations.

**MR-(magnetic resonance visible sphere)—Embosphere Microspheres**

Our MR-Embosphere Microsphere product underdevelopment is intended to enhance our Embosphere Microspheres with featuresthat make the microspheres visible under magnetic resonance imaging, or MRI.Non-invasive detection of microspheres may be useful to enable image-guidedtherapy as well as to optimize patient care. This product candidate iscurrently in the preclinical research stage.

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**EmboCathPlus Infusion Microcatheter and Sequitor Steerable Guidewire**

Our current deliverysystem product candidates under development include the EmboCath Plus InfusionMicrocatheter and the Sequitor Steerable Guidewire. With these productcandidates, we intend to build on the advantages of our first generationembolic delivery system, adding enhanced tracking, torque response and coatingtechnology to the product lines. These product candidates are beingspecifically designed to be used together to optimize flexibility for use inUFE and liver procedures. Each of these product candidates is currently in thepre-clinical research stage.

**Other Nonstrategic 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 a portion of our revenues in 2005 and 2004from these nonstrategic products, we do not expect these products to be asignificant component of our future sales.

**MARKETING AND SALES**

We currently market our embolotherapy and deliverysystems products through direct sales efforts in the United States and througha combination of direct sales and distributors in Europe, Asia, Canada, theMiddle East, Africa, South America and other parts of the world.

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 2005.

**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, 2005, 2004, and 2003, research and development expenseswere $2.36 million, $2.11 million and $2.34 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 alchol, 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 states 

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targetedby us. Currently, the primary products with which our microspheres compete forsome of our applications are spherical PVA, sold by Boston ScientificCorporation, Biocompatibles and Terumo, gel foam, sold by Pfizer, andnon-spherical PVA, sold by Boston Scientific, Angiodynamics and Cook. Many ofour 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 PVA product and anext-generation 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 high degree of ease of use,targeted delivery, durable vessel occlusion, and therefore satisfactory shortand long-term clinical outcomes, when compared to our competitors.

**GOVERNMENT REGULATION**

*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 development, clinical testing, manufacture, packaging, labeling, storage,distribution and promotion of medical devices. Before a new device that wedevelop can be introduced into the market, we must obtain marketing clearancethrough a 510(k) notification or approval through a premarket approvalapplication.

*Changesin Approved Devices.*   We must obtain new FDA 510(k) clearanceor premarket approval when there is a major change or modification in theintended use of a legally marketed device or a change or modification,including product enhancements, to a legally marketed device that couldsignificantly affect its safety or effectiveness.

*CurrentGood Manufacturing Practices and Reporting.**  *The Federal Food, Drug, andCosmetic Act requires us to comply with Current Good Manufacturing Practicesand the Quality Systems Regulation. We must comply with various quality controlrequirements pertaining to all aspects of our product design and manufacturingprocess, including requirements for packaging, labeling and record keeping,including complaint files. The FDA enforces these requirements through periodicinspections of medical device manufacturing facilities. In addition, themedical device reporting regulation requires us to inform the FDA wheneverinformation reasonably suggests that one of our devices may have caused orcontributed to death or serious injury, or when one of our devicesmalfunctions, if the device would be likely to cause or contribute to a deathor a serious injury in the event the malfunction recurred. We believe that we,and all of our contract manufacturers, are in compliance with applicableCurrent Good Manufacturing Practices and the Quality Systems regulations andwith 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, claims that are outsidethe labeling either approved or cleared by the FDA may 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 

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Federal Food, Drug, andCosmetic Act may be refused admission and a notice of detention and hearing maybe 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. To obtain this certificate from theFDA, the device manufacturer must certify to the FDA that the product has beengranted clearance or approval in the United States and that the manufacturingfacilities are in compliance with Good Manufacturing Practices regulations atthe time of the last FDA inspection.

*Finesand Penalties for Noncompliance.**  *Failure to comply with applicableFDA regulatory requirements could result in, among other things, premarketclearance or approval withdrawal, injunctions, product withdrawals, voluntaryor mandatory 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 are also in effect in many countries outside of the United States.These range from comprehensive device approval requirements for some or all ofour medical device products to simpler requests for product data orcertification. The number and scope of these requirements are increasing. Salesof medical devices in the European Union are subject to the European MedicalDevice Directive. This directive contains requirements for quality system andproduct performance guidelines with which all manufacturers must comply. Theseguidelines contain quality system guidelines and preproduction product designverification that closely resemble current FDA requirements. In February 2006,we obtained ISO 13485:2003 Quality Management Systems Requirements forRegulatory Purposes certification showing that our French manufacturingprocedures and facilities comply 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 are subjectto various federal, state, local and foreign laws and regulations relating tothe protection of the environment, as well as health and safety. In the courseof our business, we are involved in the handling, storage and disposal oflimited amounts of certain chemicals. The laws and regulations applicable toour operations include provisions that regulate the discharge of materials intothe environment. Usually these environmental laws and regulations impose “strictliability,” rendering a person liable without regard to negligence or fault onthe part of such person. Such environmental laws and regulations may expose usto liability for the conduct of, or conditions caused by, others, or for actsthat were in compliance with all applicable laws at the time the acts wereperformed. We have not been required to expend material amounts in connectionwith our efforts to comply with environmental requirements or that compliancewith such requirements will have a material adverse effect upon our capital expenditures,results of operations or competitive position. Failure to comply withapplicable environmental and related laws could have a material adverse effecton our business. In addition, because the requirements imposed by such laws andregulations are frequently changed, we are unable to predict the cost ofcompliance with such requirements in the future, or the effect of such laws onour capital expenditures, results of 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, 

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in exchange for or toinduce either the referral of an individual for, or the furnishing, arrangingfor or recommending a good or service for which payment may be made in whole orpart under a federal healthcare program such as Medicare or Medicaid. Thedefinition of remuneration has been broadly interpreted to include anything ofvalue, 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 reimbursedin whole or in part under federal healthcare programs, the statute has beenviolated. The law contains a few statutory exceptions, including payments tobona fide employees, certain discounts and certain payments to group purchasingorganizations. Violations can result in significant penalties, imprisonment andexclusion from Medicare, Medicaid and other federal healthcare programs.Exclusion of a manufacturer would preclude any federal healthcare program frompaying for its products. In addition, some enforcement officials have arguedthat kickback arrangements can provide the basis for an action under theFederal False Claims Act, which is discussed 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 of1991. 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.**  *HIPAAand the rules promulgated thereunder require certain entities, referred toas covered entities, to comply with established standards, including standardsregarding the privacy and security of protected health information, or PHI.HIPAA further requires that covered entities enter into agreements meetingcertain regulatory requirements with their business associates, as such term isdefined by HIPAA, which, among other things, obligate the business associatesto safeguard the covered entity’s PHI against improper use and disclosure.While not directly regulated by HIPAA, a business associate may facesignificant contractual liability pursuant to such an agreement if the businessassociates breaches the agreement or causes the covered entity to fail to complywith HIPAA. In the course of our business operations, we have entered intoseveral business associate agreements with certain of our customers that arealso covered entities. Pursuant to the terms of these business associateagreements, we have agreed, among other things, not to use or further disclosethe covered entity’s PHI except as permitted or required by the agreements oras required by law, to use reasonable safeguards to prevent prohibiteddisclosure of such PHI and to report to the covered entity any unauthorizeduses or disclosures of such PHI. Accordingly, we incur compliance related costsin meeting HIPAA-related obligations under business associates agreements towhich we are a party. Moreover, if we fail to meet our contractual obligationsunder such agreements, we may incur significant liability.

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 the commercialsale of any products that incorporate technology covered by the patents. We mayonly sublicense these exclusive rights under the agreement with the priorwritten consent of AP-HP, which consent cannot be unreasonably withheld. Therights granted under the contract are for an initial period, which ends on September 16,2009, and are renewable by mutual agreement between the parties. The agreementcan be terminated on three months’ notice by either party if the other partydoes not perform one or more of its obligations under the agreement and failsto cure its nonperformance during the notice period. These jointly-ownedU.S.and foreign counterpart patents will expire in 2014 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 these patents, ifissued, may not provide us with sufficient protection against competitors.Further, we may 

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be required to obtainadditional licenses concerning the Japanese patent application and anylicenses, if obtained, may not be on terms that are acceptable to us.

In addition to those listed above, we have a number ofUnited States and foreign patents and pending applications related to our microspheretechnology and uses thereof. For example, we have at least four U.S. and twoforeign patents, and five U.S. and ten foreign counterpart pending applicationsrelated to microspheres and uses thereof for tissue bulking, tissueconstruction, dermal augmentation, and the treatment of gastroesophageal refluxdisease, or GERD, and urinary incontinence. The issued U.S. and foreigncounterpart patents expire at various dates between 2019 and 2020. We also haveat least three U.S. and four foreign counterpart pending applications relatedto microspheres and uses thereof for drug delivery and gene therapy. Additionally,we have at least one patent and one pending application in each of the UnitedStates and Europe related to PVA microspheres useful for embolization andmethods thereof. The U.S. and European PVA patents expire in 2019. Other U.S.and foreign counterpart patent applications have also issued or are currentlypending. The subjects of these patents and applications include new materialsfor embolization, new methods of using our materials for embolization and otherapplications, as well as new uses of our materials outside of embolization.

The subjects of these patents and applications includenew materials for embolization, new methods of using our materials forembolization and other applications, as well as new uses of our materialsoutside of embolization.

We currently ownthe following U.S. trademarks:

·       BioSphere®

·       Embosphere®

·       EmboGold®

·       EmboCath®

·       Segway®

·       Pinstripe®

·       SequitorTM

·       QuadraSphereTM

·       ask4UFETM

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.

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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 to protectall of our rights. If we enforce our patents against third parties, they maychallenge the validity or enforceability of our patents. We cannot predictwhether we will be successful in enforcing our patents or defending theirvalidity 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 successfully challenged,invalidated, circumvented or rendered unenforceable so that our patent rightsmay not create an effective competitive barrier. Moreover, the laws of someforeign countries may not protect our proprietary rights to the same extent, asdo the laws of the United States. There can be no assurance that any patentsissued to us will provide a legal basis for establishing an exclusive marketfor our products or provide us with any competitive advantages, or that thepatents of others will not have an adverse effect on our ability to do businessor to continue to use our technologies freely. In view of these factors, thevalue 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 Kingdomand Italy. On January 13, 2005, we were notified of a Notice ofOppositions filed by Biocompatibles UK Limited on December 23, 2004 againstthis European patent. We have filed a response to the Notice of Opposition andan auxiliary claim set on August 11, 2005. We will continue defending ourEuropean PVA patent in this proceeding. While we are not able to predict theoutcome of this proceeding, it will not impact our ability to sell ourEmbosphere Microsphere products, which are 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 

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technology.Therefore, the measures we are taking to protect our proprietary technology maynot be adequate.

**EMPLOYEES**

As of December 31, 2005, we employed 69 persons.Of these employees, seven are primarily engaged in research, development andclinical activities, 22 are engaged in manufacturing, 30 are engaged in salesand marketing, and the remainder are engaged in finance and administration. Ofthese 69 persons, 34 are located in the United States and 35 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.**                RISKFACTORS

*Investing in our common stock involves a high degreeof risk. The risks described below are not the only ones facing our company. Additionalrisks not presently known to us or that we deem immaterial may also impair ourbusiness operations. Any of the following risks could materially adverselyaffect our business, operating results and financial condition and could resultin a complete loss of your investment.*

**Risks Relating to Our Future Profitability, OurFinancial Results and Need For Financing**

**Becausewe have a history of losses and our future profitability is uncertain, ourcommon stock is a speculative investment.**

We have incurred operating losses since our inceptionand, as of December 31, 2005, had an accumulated deficit of approximately$78.80 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 corporate purposes.We expect to continue to incur operating losses in 2006, as we continue ourresearch, development and commercialization efforts.

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.

**Wewill continue to need additional funds, and if additional capital is not available,we may have to limit, scale back or cease our operations.**

We believe that our existing cash and other workingcapital (including the proceeds from our recent sale of securities in February 2006),together with anticipated proceeds from sales of our products will be sufficient to fund our operating andcapital requirements, as currently planned through 2007.

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

•     produce and manufacture ourproducts;

•     support our sales andmarketing efforts for our Embosphere Microsphere products for UFE and otherindications, as well as our other products for sale;

•     support our research anddevelopment activities; and

•     fund our general andadministrative 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, in 

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particular from the use ofour Embosphere Microspheres for UFE; changes in our UFE regulatory andmarketing programs; anticipated research and development efforts; cost and timeinvolved in preclinical and clinical testing; costs resulting from changes inthe focus and direction of our research and development programs; competitiveadvances that make it harder for us to market and sell our products; the timingand cost of FDA regulatory review; and the market’s acceptance of any approvedproducts.

We also expect to incur additional costs related toongoing research and development activities, preclinical studies, clinicaltrials, the expansion of our manufacturing, laboratory and administrativefunctions, 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.

**Ifoperating results fluctuate significantly from quarter to quarter, then ourstock price may decline.**

Our operating results could fluctuate significantlyfrom quarter to quarter. These fluctuations may be due to a number of factors,including:

the timing andvolume of customer orders for our products;

•     procedure cancellations;

•     introduction or announcementof competitive products;

•     regulatory approvals;

•     product recalls;

•     turnover in our direct salesforce;

•     timing and amount ofexpenses;

•     reductions in orders by ourdistributors;

•     effectiveness of newmarketing and sales program;

•     changes in management;

•     negative publicy; and

•     general economic conditions.

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

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 to Our Industry, Business and Strategy**

**If wedo not achieve widespread market acceptance of our microsphere products, ourbusiness prospects will be seriously harmed.**

Our microspheres are based on new technologies andtherapeutic approaches. In the United States, we began selling our microsphereproduct in the first half of 2000. In November 2002, we received FDAclearance to market our Embosphere Microspheres in the United States for specificuse in the embolization of uterine fibroids. Our success will depend uponincreasing acceptance by the medical community, patients and third-party payersthat our Embosphere Microspheres and other products are medically therapeuticand cost effective. Our embolotherapy techniques are administered byinterventional 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 achievedwidespread acceptance primarily because obstetrics and gynecology physiciansmay elect to offer and provide other forms of treatment to their patients withuterine fibroids that do not require a referral to another specialist, such asan interventional radiologist. The majority of our revenues are from the saleof our EmboSphere Microsheres 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 publicityassociated with any adverse medical effects attributed to embolizationtreatments generally, or our products specifically, may create the marketperception that our products are unsafe. For example, patients commonlyexperience a day or two of post-procedure abdominal pain or cramping. Otherinfrequently occurring complications may include allergic reactions, rashes,early onset of menopause, infertility and infection that may, in some cases,require a hysterectomy. We are also aware that a small number of the patientpopulation, which we believe constitutes approximately 2% of those receivingthe UFE procedure using EmboGold Microspheres, reported a delayed onset of rashand/or pain.

**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 are designed to permanently occludetargeted blood vessels. There is some risk that some or all of the microspheresused in a medical procedure may travel in the blood system to sites other thanthe intended surgical site and occlude, or block, other blood vessels,resulting in the potential for significant adverse health effects on thepatient or, in a worst case, even death. Moreover, to use our microspherescorrectly for a particular medical procedure, trained physicians must selectand use the proper size and quantity. A physician’s selection and use of thewrong size or quantity of our microspheres could potentially have significantadverse health effects on the patient, including death. It is necessary for usto educate physicians about the selection and use of the proper size andquantity of microspheres in patient therapy. In addition, there is only limiteddata concerning the long-term health effects on persons receiving embolotherapyusing our microspheres. For example, the effect of UFE on continued fertilityhas 

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not yet been specificallystudied, and our FDA clearance for Embosphere Microspheres currently does notinclude women who desire future pregnancy.

If we are not able to successfully educate physiciansto properly use our product, or if the market determines or concludes that anyof our products are not safe or effective for any reason, we may be exposed toproduct liability claims, product recalls, fines or other penalties or enforcementactions by regulatory agencies and associated adverse publicity. For example,in September 2005, we were named as a defendant in a product liabilitylawsuit in which the defendant, a minor child, claims that he was renderedblind in both eyes as a result of the use of our Embosphere Microsphere productduring a nasal angiofibroma embolization. See “We may be exposed to productliability claims, and if we are unable to obtain or maintain adequate productliability insurance, then we may have to pay significant monetary damages in asuccessful product liability claim against us.” While we have product liabilityinsurance, we may not be able to maintain such insurance at favorable rates, orat all, and any successful judgments against us could exceed our coverage. Inaddition, we have provided to our customers a satisfaction guarantee thatrequires us to accept the return of any inventory and credit the entire amountof the original order if a properly trained customer is not satisfied with theperformance of our microspheres 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, weannounced that we had 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 is in turn packaged inside a paper pouch. Wedetermined that a defect in the paper pouch may compromise the sterility of theoutside of the vial. If the sterility of the outside of the vial is notmaintained, there is the risk that a physician’s hands can become contaminatedwhen handling the vial. Although we are not aware of any adverse eventsresulting from the defects in the paper packaging, our voluntary recall of thisproduct could result in reputational harm or a perception that the product isnot safe, either of which could adversely affect market acceptance of ourmicrosphere 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, 2005were derived from the sale of Embosphere Microspheres for use in UFE. Althoughwe believe that EmboGold Microspheres accounted for a significant portion ofrevenue, we currently do not intend to seek 510(k) clearance for use ofEmboGold Microspheres in UFE. Because we do not intend to seek510(k) clearance of EmboGold Microspheres, we believe that our futureproduct revenues are substantially dependent on our ability to achievewidespread acceptance of the use of Embosphere Microspheres for the treatmentof UFE, and if we do not achieve increased widespread acceptance, our product revenues,profitability and success will be adversely affected. We are continuing tomarket EmboGold Microspheres for use in hypervascularized tumors (other thanuterine fibroids) and arteriovenous malformations. If we cease to marketEmboGold Microspheres for any reason, we could incur substantial costs to writeoff and replace existing inventories. As of December 31, 2005, we hadEmboGold inventory with a carrying value of $228,000, including in-processinventory of $144,000 and finished goods syringes of $84,000. We currentlybelieve no provision for the write-off or replacement of EmboGold Microspheresinventory is required in the accompanying financial statements.

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**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 with gynecologists, obstetricians,interventional  radiologists and otherhealthcare providers are critical to our continued growth. We believe thatthese relationships are based on the quality of our products, our long-standingcommitment to embolotherapy treatments, our marketing efforts and our presenceat medical society and trade association meetings. Any actual or perceiveddiminution in our reputation or the quality of our products, or our failure orinability to maintain these other efforts could damage our currentrelationships, or prevent us from forming new relationships, with healthcareprofessionals and cause our growth to be limited and 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 in obtainingthe 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 weexperience delays, difficulties or unanticipated costs in establishing thesales, distribution and marketing capabilities necessary to successfullycommercialize our products, we will have difficulty maintaining and increasingour sales.**

We are continuingto develop 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. We currently have a sales force of 18 persons locatedprincipally in the United States. Competition for skilled salespersons in themedical device industry is intense, and we may not be able to provide adequateincentive to maintain our sales force or to attract new sales personnel or toestablish and maintain favorable distribution and marketing collaborations withother companies to promote our products. We have only limited sales andmarketing experience both in the United States and internationally and may notbe successful in developing and implementing our strategy. Among other things,we need to:

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

·       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 45 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 such distributionagreements. For example, our subsidiary, BioSphere Medical S.A., or BSMA, endedits distribution agreement with Terumo N.V. in 2002 in part because of Terumo’sfailure to achieve sales forecasts agreed upon by the parties. As a result ofsubsequent litigation in December 2004, BSMA was 

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requiredto pay Terumo approximately $784,000 in damages arising from such terminationand incurred additional legal and administrative expenses incident to the legalproceeding. We and any of our third-party collaborators must also market ourproducts in compliance with federal, state and local laws relating to theproviding of incentives and inducements. Violation of these laws can result insubstantial penalties. If we are unable to successfully motivate and expand ourmarketing and sales force and further develop our sales and marketingcapabilities, or if our distributors fail to promote our products, we will havedifficulty maintaining and increasing our sales.

**Wemay be required to expend significant resources for research, development,testing and regulatory approval of our products under development, and theseproducts 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-Embosphere Microspheres, EmboCath Plus Infusion Microcatheter andSequitor Steerable Guidewire, are still in the early stages of research anddevelopment. Our products may not provide greater benefits than currenttreatments or products, or alternative treatments or products underdevelopment. All of our products under development will require significantadditional research, development, engineering, preclinical and/or clinicaltesting, regulatory approval and a commitment of significant additionalresources prior to their commercialization. Our potential products may not:

•     be developed successfully;

**•****    **beproven safe and effective in clinical trials;

•     offer therapeutic or otherimprovements over current treatments and products;

•     meet applicable regulatorystandards or receive regulatory approvals;

•     be capable of production incommercial quantities at acceptable costs; or

•     besuccessfully marketed.

**If wedo not develop and introduce new products, we may not achieve additionalrevenue opportunities.**

We derived approximately13% of our revenues for the period ended December 31, 2005 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 years ended December 31,2005 and 2004 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 total number of patients receivingthe procedure, reported a delayed onset of rash and/or pain. Accordingly, weneed to develop and introduce new applications for our embolotherapy technologyand pursue opportunities for microsphere technology in other medicalapplications. Any such new application for our embolotherapy technology ormicrosphere technology will be subject to a number of risks inherent in thedevelopment and commercialization of a medical device product, includinguncertainties with respect to the successful completion of clinical trials, ourability to achieve and maintain, and our willingness to seek, requiredregulatory approvals and our ability to successfully commercialize, market andsell these new applications assuming FDA approval is achieved. If, as a resultof these or other risks, we are not successful in developing new applicationsand products, we will not achieve new revenue opportunities.

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**Wemay be exposed to product liability claims, and if we are unable to obtain ormaintain adequate product liability insurance, then we may have to paysignificant monetary damages in a successful product liability claim againstus.**

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,among other things, that a patient suffered permanent bilateral blindness as aresult of the use of our Embosphere Microspheres in a juvenile nasalangiofibroma embolization. Plaintiffs seek compensatory and punitive damages.Although we currently maintain product liability insurance coverage for ourproducts, including the Embosphere Microsphere product that is the subject ofthe Pingel claim, our existing insurance and any additional insurance we maysubsequently obtain may not provide us with adequate coverage against allpotential claims. For example, although our product liability insurer hasagreed to vigorously defend us with regards to all of the counts set forthagainst us in the Pingel Claim, the insurer has advised us in writing that any verdictagainst us for punitive damages is specifically excluded from coverage. Theinsurer has also advised us that it does not waive any other defenses tocoverage that may apply.

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.

**Wehave instituted a voluntary recall of our HepaSphere Microspheres product inthe European Union and Japan, which may result in decreased market acceptanceof this product and reputational harm, as well as hindering our ability togenerate revenue from sales of the product.**

On March 13, 2006, weannounced that we have instituted a voluntary recall of our HepaSphereMicrospheres in Europe and Japan to correct a packaging defect that weidentified while conducting aging studies routinely performed on all of ourproduct packaging. We received CE mark approval to sell HepaSphere Microspheresin the European Union in 2004 and commercial launch began in late 2005. We alsohave had limited sales of HepaSphere Microspheres in Japan under private importrestrictions.  HepaSphere Microspheresare contained in a prefilled vial that is in turn 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 and result in decreased sales. In addition, we mayencounter unanticipated 

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delaysand expenses relating to correcting the packaging defect, which could adverselyaffect our operating results.

**If weare not able to compete effectively, we may experience decreased demand for ourproducts, which may result in price reductions.**

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 thanwe do. As a result, they may develop products quicker 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 another specialist.

**If wefail to maintain, or in some instances obtain, an adequate level ofreimbursement for our products by third-party payers, there may be nocommercially 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 embolization procedures. These third-party payers attemptto contain or reduce the costs of healthcare by challenging the prices thatcompanies such as ours charge for medical products. In some foreign countries,particularly the countries of the European Union where our microsphere productsare currently marketed and sold, the pricing of medical devices is subject togovernmental control, and the prices charged for our products have in someinstances 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 localjurisdictions and other countries. While these initiatives have in many casesrelated 

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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 wedo not retain our senior management, other key employees, scientificcollaborators and advisors, we may not be able to successfully implement ourbusiness strategy.**

The loss of key members ofour management team could harm us. We have recently experienced significantchanges in management. In late 2004, Richard Faleschini, our president andchief executive officer, Gary M. Saxton, our executive vice president and chiefoperating officer, and Martin Joyce, our executive vice president and chieffinancial officer, joined our company. Our former president and chief executiveofficer only served as our president and chief executive officer forapproximately 27 months; our former vice president of U.S. sales andmarketing served as our vice president of U.S. sales for approximately 34months; and our former vice president of research and development served for approximatelyfive years. Our success is substantially dependent on our ability  to retain members of our senior managementand other key employees. We do not carry key man life insurance on any of ourexecutive officers or other personnel.

**If wemake any acquisitions, we will incur a variety of costs and may neversuccessfully 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, serviceor product. 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 contingent liabilitiesin connection with any future acquisitions.

**Becausekey stockholders beneficially own a significant amount of our common stock,they may be able to exert control over us.**

As of March 1,2006, Sepracor Inc., or Sepracor, and funds affiliated with Cerberus CapitalManagement, L.P., or Cerberus, beneficially owned approximately 23% and 14% ofour outstanding common stock, respectively, including shares of common stockissuable upon the exercise of warrants and series A preferred stock held bythese stockholders. Moreover, two of our directors are executive officers ofSepracor and we have granted board observation rights to Cerberus. Accordingly,Sepracor and Cerberus may have significant influence over corporate actionsrequiring stockholder approval, such as the election of directors, amendment ofour charter documents and the approval of merger or significant asset saletransactions. In addition, the shares of our series A preferred stock held bySepracor and Cerberus entitled them to certain voting rights in accordance withthe terms 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:

•     amending our charter orbylaws in a manner that adversely affects the holders of series A preferredstock;

•     authorizing or issuing anyequity security that is senior to or pari passu with the series A preferred stock;and

•     declaring or paying anydividends on, or redeeming or repurchasing any shares of, our capital stock,subject to customary exceptions.

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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.

**Theholders of shares of our series A preferred stock have rights that couldadversely 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 enterinto an acquisition or business combination in which we sell all orsubstantially all of our assets or if there occurs a change of control of amajority of our common stock outstanding prior to such transaction, the holdersof our series A preferred stock will have the right to receive, before anydistributions or payments to the holders of our common stock, an amount in cashequal to their initial purchase price, $8,000,000, plus an amount equal to anyaccrued but unpaid dividends, and will then participate with the holders of thecommon stock on a pro rata basis with respect to the distribution of anyremaining assets. The existence of this right may make it difficult for us toraise capital in financing transactions with third parties and will also resultin holders of our common stock receiving less distributions or payments upon achange of control or asset sale than they would be entitled to receive if nopreferential payments were required to be made to holders of our series Apreferred stock.

**Risks Relating to Regulatory Matters**

**If wedo not obtain and maintain the regulatory approvals or clearances required tomarket and sell our products, then our business may be unsuccessful and themarket price of our stock may decline.**

We are subject to regulation by government agencies inthe United States and abroad with respect to the manufacture, packaging,labeling, advertising, promotion, distribution and sale of our products. Forexample, our products are subject to approval or clearance by the FDA prior tocommercial marketing in the United States. Similar regulations exist in mostmajor foreign markets, including the European Union, Latin America and Asia.The process of obtaining necessary regulatory approvals and clearances will betime-consuming and expensive for us. If we do not receive required regulatoryapproval or clearance to market our products, or if any approvals or clearanceswe have received are revoked or terminated, we may not be able to develop andcommercialize our products and become profitable, and the value of our commonstock may decline.

We are also subject tonumerous foreign regulatory requirements governing the conduct of clinicaltrials, manufacturing and 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 outsidethe United States. Many foreign regulatory authorities, including those inmajor markets such as Japan and China, have different approval procedures thanthose required by the FDA and may impose additional testing requirements forour medical device candidates.

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**Ifthe FDA or other regulatory agencies place restrictions on, or imposeadditional approval requirements with respect to, products we are thenmarketing, we may incur substantial additional costs and experience delays ordifficulties in continuing to market and sell these products.**

Even if the FDA grants us clearance with respect tomarketing any product, it may place substantial restrictions on the indicationsfor which we may market the product, which could result in lower revenues. Themarketing claims we are permitted to make in labeling or advertising regardingour microspheres are limited to those consistent with any FDA clearance orapproval. For example, because our EmboGold Microspheres are not cleared foruse in UFE, we may not promote them for this use.

We may in the future makemodifications to our microspheres or their labeling which we determine do notnecessitate the filing of a new 510(k) notification. However, if the FDAdoes not agree with our determination, it will require us to make additional510(k) filings for the modification, and we may be prohibited frommarketing the modified product or the new claims until we obtain FDA clearance.Similarly, if we obtain premarket approval, we may not be able to make productor labeling changes until we get further FDA approval.

**Evenif we obtain the necessary FDA clearances or approvals, if we or our suppliersfail to comply with ongoing regulatory requirements our products could besubject to restrictions or withdrawal from the market.**

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 or seizure 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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**Wemay be subject, directly or indirectly, to federal and state healthcare fraudand abuse laws and regulations and, if we are unable to fully comply with suchlaws, 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 or 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 to Our Intellectual Property**

**If weare unable to obtain patent protection for our products, their competitivevalue 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 ourtechnologies to varying degrees, and these rights may not prevent others fromdesigning products similar to or otherwise competitive with our EmbosphereMicrospheres and other products we commercialize. To the extent that ourcompetitors are able to design products competitive with ours, we mayexperience less market penetration with our products and, consequently, we mayhave decreased revenues.

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 published approximately18 months after their earliest priority date. Consequently, the United StatesPatent and Trademark Office could initiate interference proceedings involvingour owned or licensed U.S. patent applications or issued patents. Further,there is a substantial backlog of patent applications at the United StatesPatent and Trademark Office, and the approval or rejection of patentapplications 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 webecome involved in expensive patent litigation or other proceedings to enforceor defend our patent rights, we could incur substantial costs and expenses orsubstantial liability for damages or be required to stop our productdevelopment and commercialization efforts.**

On January 13, 2005, we were notified of aproceeding brought before the European Patent Office on December 23, 2004by Biocompatibles UK Limited challenging the patentability of the claims in ourgranted European Patent 1128816, which relates to certain PVA microspheres,their use in embolization and methods of manufacture related to such PVAmicrospheres. We are defending our European PVA patent in this proceeding. Whilewe are not able to predict the outcome of this patent opposition proceeding, itwill not impact our ability to sell our Embosphere Microsphere products.

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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 property litigationis costly, and, even if we prevail, could divert management attention andresources 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.

**Ifany of our licenses to use third-party technologies in our products areterminated, we may be unable to develop, market or sell our products.**

We are dependent on variouslicense agreements relating to each of our current and proposed products thatgive us rights under intellectual property rights of third parties. Inparticular, we have an agreement with L’Assistance Publique-Hopitaux De Paris,pursuant to which L’Assistance Publique-Hopitaux De Paris has granted usexclusive rights to use two jointly owned patents relating to EmbosphereMicrospheres. We also have an agreement with Dr. Shinichi Hori pursuant towhich we have an exclusive royalty-bearing license to Japanese patent rightsfor our HepaSphere Microsphere product. We also have an agreement withArchimmed SARL pursuant to which we have an exclusive royalty-bearing licenseto patent rights for our MR-Embosphere 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 to the Production and Supply of OurProducts**

**If weexperience manufacturing delays or interruptions in production, then we mayexperience customer dissatisfaction and our reputation 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 engagedRadius Medical Technologies, Inc. to supply our guidewire product andConcert Medical to supply and package our catheter product. Either we or anythird-party manufacturer would likely experience significant delays orcessation in producing our products if a labor strike, natural disaster, localor regional conflict or other supply disruption were to occur. If we are unableto 

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manufacture and packageour products at our facility in France, we may be required to enter intoarrangements with one or more alternative contract manufacturing companies.

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.

**Becausewe rely on a limited number of suppliers, we may experience difficulty inmeeting our customers’ demands for our products in a timely manner or withinbudget.**

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

•     the possibility that one ormore of our suppliers could terminate their services at any time withoutpenalty;

•     the potential inability ofour suppliers to obtain required components;

•     the potential delays andexpenses of seeking alternative sources of supply;

•     reduced control over pricing,quality and timely delivery due to difficulties in switching to alternativesuppliers; and

•     the possibility that one ormore of our suppliers could fail to be compliant with Quality SystemRegulations, 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 to Our Foreign Operations**

**If weare unable to meet the operational, legal and financial challenges that weencounter in our international operations, we may not be able to grow ourbusiness.**

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, 2005 

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and2004, approximately 27% and 30%, respectively, of our revenues were derivedfrom sales of our microspheres and other products in the European Union. We areincreasingly subject to a number of challenges that specifically relate to ourinternational business activities. Our international operations may not besuccessful if we are unable to meet and overcome these challenges, which wouldlimit the growth of our business. These challenges include:

•     failure of local laws toprovide the same degree of protection against infringement of our intellectualproperty;

•     protectionist laws andbusiness practices that favor local competitors, which could slow our growth ininternational 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;

•     complex reimbursementproedures;

•     potentially longer salescycles to sell products, which could slow our revenue growth from internationalsales; and

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

**Becausewe translate foreign currency from international sales into U.S. dollars andare required to make foreign currency payments, we may incur losses due tofluctuations in foreign currency exchange rates.**

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 notcurrently engage in foreign exchange hedging transactions to manage our foreigncurrency exposure.

**Risk Relating to Our Stock Price**

**Becausethe market price of our stock is highly volatile, investments in our stockcould rapidly lose their value and we may incur significant costs from classaction litigation.**

The market price of our stock is highly volatile. FromJanuary 1, 2004 through March 1, 2006, the price of our common stockhas ranged from a low of $2.12 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 8,000 square feet of corporate offices andlaboratory space pursuant to a seven-year lease expiring in March 2007 ata cost of $13,000 per month. On February 24, 2006, we entered into anamendment to this lease pursuant to which we increased the leased premises to atotal area of approximately 13,000 square feet at a monthly cost of $19,500 permonth, and the term of the lease is extended through February 28, 2009. OurRoissy, France facility includes approximately 18,000 square feet of office,laboratory and manufacturing space and is leased through May 2010 at acost of  $20,000 per month.

At our facility in France, we produce our EmbosphereMicrospheres and some ancillary disposable devices. Embosphere Microsphereproduction includes the synthesis of raw materials and third-party manufacturedintermediary compounds. Currently, the final product packaging of our SegwayGuidewires, EmboCath Catheters and certain other ancillary products sold inEurope is performed by independent contract manufacturers under FDA GoodManufacturing Practices.

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 in ajuvenile nasal angiofibroma embolization or the negligence of the health careproviders or both factors combined. All defendants have denied the allegationsagainst them. Plaintiffs seek compensatory and punitive damages. We carryproduct liability insurance and this case is currently being defended by ourinsurer under reservation of rights with respect to the claim of punitivedamages, for which an exclusion from coverage exists. We have filed an answerto this lawsuit in which we have denied the claims being made. We believe thatthis lawsuit is without merit and that we have viable defenses to theallegations in the complaint. Accordingly, we intend to defend against theclaims vigorously.  However, we cannotgive any assurance that we will prevail and we are currently unable to predictthe impact, financial or otherwise, of this product liability litigation.

**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, 2005.

**EXECUTIVE OFFICERS**

Asof  March 1, 2006, our executiveofficers, their respective ages and their positions are as follows:

| **Name**               | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                                                   | ** ** |
|------------------------|------------|------------|------------|---------|------------|--------------------------------------------------------------------------------|------------|
| Richard J.  Faleschini |       |       | 59         |    |       | President  and Chief Executive Officer                                         |       |
| Gary M. Saxton         |       |       | 45         |    |       | Executive Vice President  and Chief Operating Officer                |       |
| Martin J. Joyce        |       |       | 52         |    |       | Executive  Vice President and Chief Financial Officer |       |
| Peter C. Sutcliffe     |       |       | 56         |    |       | Vice President,  Manufacturing                                                 |       |

 

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*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 tophysicians specializing in the treatment of urological and gynecologicaldisorders. From 1999 to 2003, Mr. Faleschini was Vice President ofMarketing and Sales for American Medical Systems Holdings, Inc. From 1995to 1999, he held executive marketing and general management positions atMedtronic, a medical technology company, with responsibilities in severalsectors of their cardiac rhythm management, cardiac surgery, and interventionalvascular businesses. His previous experience also includes executive marketingand sales management responsibilities at Cordis 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, Boston, Massachusetts.

*MartinJ. Joyce*has served as our Executive Vice President and ChiefFinancial Officer since January 16, 2006. He served as our Chief FinancialOfficer and Vice President from September 2004 to January 2006. From2000 to 2004, Mr. Joyce served as Managing Partner of Stratex Group LLC, aprovider of biopharmaceutical executive services to early-stage companies andventure investors. From 1996 to 2000, Mr. Joyce was North American ChiefFinancial Officer for Serono Inc. a biotechnology company. Prior to serving asNorth American Chief Financial Officer, Mr. Joyce held a variety of seniorlevel positions within Serono, in finance, sales, marketing and manufacturing. Mr. Joycewas previously employed at Millipore and Bose Corporations focusing onstrategic planning, product rationalization and return on investment analysis. Mr. Joycereceived a B.S. in finance from Northeastern University and an M.B.A. fromSuffolk University, Boston, Massachusetts.

*Peter C.Sutcliffe* has served as our Vice President, Manufacturingsince October 2002. From 2001 to 2002, Mr. Sutcliffe served as theVice President for North American Manufacturing for Whatman, Plc., a lifescience filtration company. From 1996 to 2001, he was the Chief OperatingOfficer for HemaSure Inc., a manufacturer and supplier of blood filters.From 1982 to 1996, Mr. Sutcliffe held the position of Vice President ofManufacturing for Corning Costar Company, a life science products company.Prior to Costar, he held manufacturing management positions with MilliporeCorporation, a high technology bioscience company. Mr. Sutcliffe holds aB.S. in biology from the University of Richmond in Virginia and an M.B.A. fromSul 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 National Marketunder the symbol “BSMD”. On March 1, 2006, the last reported sale price ofour common stock on the NASDAQ National Market was $7.47 and there wereapproximately 140 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 as reported on the NASDAQ National Market for the last two fiscalyears.

| ** **     | ** ** | **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          |   |

 

| ** **     | ** ** | **2004** | ** ** |
|----------------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 5.70       |   | $ | 3.00 |   |
| Second Quarter |       | $        | 5.30       |   | $ | 2.50 |   |
| Third Quarter  |       | $        | 4.00       |   | $ | 2.12 |   |
| Fourth Quarter |       | $        | 4.00       |   | $ | 2.27 |   |

 

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

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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,**                              | ** ** | ** **   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------------------------------------------------------|------------|--------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **(in thousands, except per share amounts)**   | ** ** | ** **   | ** ** |
| **Statement of Operations Data:**                                       |       |         |       |     |       |     |       |     |       |     |       |
| Revenues:                                                               |       |         |       |     |       |     |       |     |       |     |       |
| Product sales                                                           |       | $18,484      |       | $        | 14,058     |     | $          | 12,803   |       | $        | 12,152     |     | $          | 8,752 |   |
| License fees and collaboration revenues                                 |       | —       |       | 100      |       | —   |       | —   |       | 250      |       |
| Total revenues                                                          |       | 18,484       |       | 14,158   |       | 12,803   |       | 12,152   |       | 9,002    |       |
| Costs and expenses:                                                     |       |         |       |     |       |     |       |     |       |     |       |
| Costs of product sales                                                  |       | 6,303        |       | 6,646    |       | 5,558    |       | 3,261    |       | 2,356    |       |
| Research and development                                                |       | 2,359        |       | 2,113    |       | 2,344    |       | 3,714    |       | 4,427    |       |
| Sales                                                                   |       | 6,185        |       | 5,322    |       | 5,892    |       | 5,035    |       | 6,137    |       |
| Marketing                                                               |       | 2,080        |       | 2,228    |       | 3,670    |       | 3,024    |       | 3,305    |       |
| General, administrative and patent                                      |       | 4,219        |       | 4,154    |       | 3,359    |       | 4,263    |       | 3,725    |       |
| Litigation costs                                                        |       | —       |       | 874      |       | —   |       | —   |       | —   |       |
| Total costs and expenses                                                |       | 21,146       |       | 21,337   |       | 20,823   |       | 19,297   |       | 19,950   |       |
| Loss from operations                                                    |       | (2,662       | )          | (7,179   | )          | (8,020   | )          | (7,145   | )          | (10,948  | )          |
| Other income (expense):                                                 |       |         |       |     |       |     |       |     |       |     |       |
| Interest income                                                         |       | 225          |       | 92       |       | 135      |       | 398      |       | 794      |       |
| Interest expense                                                        |       | (15          | )          | (16      | )          | (27      | )          | (29      | )          | (31      | )          |
| Other                                                                   |       | (442         | )          | 379      |       | 583      |       | 214      |       | (72      | )          |
| Loss before income taxes                                                |       | (2,894       | )          | (6,724   | )          | (7,329   | )          | (6,562   | )          | (10,257  | )          |
| Income tax benefit (provision)                                          |       | 93           |       | (117     | )          | (23      | )          | 181      |       | (88      | )          |
| Net loss                                                                |       | (2,801       | )          | (6,841   | )          | (7,352   | )          | (6,381   | )          | (10,345  | )          |
| Preferred stock dividends                                               |       | (495         | )          | (68      | )          | —   |       | —   |       | —   |       |
| Net loss applicable to common stockholders                              |       | $(3,296      | )          | $        | (6,909     | )        | $          | (7,352   | )          | $        | (6,381     | )        | $          | (10,345 | ) |
| Basic and diluted net loss per share applicable to  common stockholders |       | $ (0.22 | )          | $        | (0.49      | )        | $          | (0.55    | )          | $        | (0.49      | )        | $          | (0.89 | ) |
| Basic and diluted  weighted average number of common shares outstanding |       | 14,653       |       | 14,152   |       | 13,462   |       | 12,988   |       | 11,642   |       |
|                                                                         |            |              |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| **As of  December 31,**                                 | ** ** | ** **                                                                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **(in thousands)**                                      | ** ** | ** **                                                                                       | ** ** |
| **Balance Sheet Data:**                                      |       |                                                                                             |       |     |       |     |       |     |       |     |       |
| Cash, cash equivalents and marketable securities             |       | $ 8,774               |       | $        | 10,222     |     | $          | 7,575    |       | $        | 14,738     |     | $          | 23,119 |   |
| Working capital                                              |       | 10,832                                                                                           |       | 12,391   |       | 10,704   |       | 17,008   |       | 22,789   |       |
| Total assets                                                 |       | 17,495                                                                                           |       | 19,391   |       | 17,002   |       | 23,928   |       | 29,984   |       |
| Long-term debt and minority interest acquisition  obligation |       | 101                                                                                              |       | 192      |       | 171      |       | 270      |       | 303      |       |
| Stockholders’  equity                                   |       | 13,089                                                                                           |       | 14,836   |       | 13,525   |       | 20,259   |       | 25,873   |       |
|                                                              |            |                                                                                                  |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |

 

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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 andmarket products for medical applications using embolotherapy techniques. Embolotherapyis the therapeutic introduction of various substances into the circulation toocclude blood vessels, either to arrest or prevent hemorrhaging or todevitalize a structure or organ by occluding its blood supply. Our core technologies consist ofpatented bioengineered polymers, which are chemical compounds that we createthrough the application to medical science of engineering principles andmanufacturing methods. These core technologies are used to produce miniaturespherical beads with unique properties for a variety of applications. Typically, a procedure is performed by aninterventional radiologist who injects Embosphere 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.

In 2005, we generated revenues primarily from productsales of our Embosphere Microspheres in North America and the European Union.We also generated revenues from product sales in other geographic territories,including the Middle East, Africa, South America, and Asia. Product revenuesalso include the sale of accessory embolotherapy devices such as our EmboCathInfusion Catheter and our Segway Guidewire, as well as our othernon-embolotherapy products, including barium delivery kits, and other ancillarymedical devices soldexclusively in Europe. We currently derive a majority of our revenues inthe United States and the European Union from the sale of EmbosphereMicrospheres for use in the treatment of uterine fibroids using UFE.

Our principal focus is on growing our EmbosphereMicrosphere and accessory embolotherapy device business worldwide, specificallyfor the UFE procedure, which we believe will be a key driver to our success.Our marketing strategy is to promote the UFE procedure for patients sufferingwith uterine fibroids through our ask4UFETM awareness and education program andalso to specifically promote our Embosphere Microspheres as the treatment ofchoice for the UFE procedure. Our success will depend upon the continuedacceptance by the medical community, patients and third-party payers of the UFEprocedure, and our Embosphere Microspheres product and our other products, assafe, medically therapeutic and cost effective.

We have experienced operating losses in each fiscalperiod since our inception. As of December 31, 2005, we had approximately$8.77 million in cash and cash equivalents and an accumulated deficit ofapproximately $78.80 million. Most of our expenditures to date have been forsales and marketing activities, general and administrative expenses andresearch and development activities. We expect to incur operating losses in2006 as we execute our business plan, including continuing to establish salesand marketing capabilities and conducting research and development activities.

On March 13, 2006, weannounced that we have instituted a voluntary recall of our HepaSphereMicrospheres in Europe and Japan to correct a packaging defect that weidentified while conducting aging studies routinely performed on all of ourproduct packaging. HepaSphere Microspheres are contained in a prefilled vialthat is in turn packaged inside a paper pouch. We determined that a defect inthe paper 

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pouchmay compromise the sterility of the outside of the vial. If the sterility ofthe outside of the vial is not maintained, there is the risk that a physician’shands can become contaminated when handling the vial. We are not aware of anyadverse events resulting from the defects in the paper packaging. Sales ofHepaSphere Microspheres outside of the United States are expected to resumeonce a new packaging design is produced and validated.

***Research and Development***

Thefollowing table identifies each of the programs for which we have incurredresearch and development expenses in the years ended December 31, 2005,2004 and 2003 and the current development phase of each.

| **Product / Product Candidate **                 | ** ** | ** **                                                                                                                                                                                                                                            | ** ** | **Development  Status** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|
| Embosphere Microspheres                               |       | Approved for UFE,  hypervascularized tumors and other arteriovenous malformations in the United  States, Canada, European Union, Argentina, Brazil, Colombia, Costa Rica,  Panama, Peru, Uruguay, Hong Kong, Taiwan and Australia                     |
| EmboGold Microspheres                                 |       | Approved for  hypervascularized tumors (other than uterine fibroids) and arteriovenous  malformations in the United States, Canada, European Union, Argentina,  Brazil, Colombia, Costa Rica, Panama, Peru, Uruguay, Hong Kong, Taiwan and  Australia |
| EmboCath Infusion  Catheter                           |       | Approved for  peripheral embolization procedures including UFE and liver embolization in  the United States, Canada, European Union, Argentina, Brazil, Costa Rica,  Panama and China                                                                 |
| Segway Guidewire                                      |       | Approved for  peripheral embolization procedures including UFE and liver embolization in  the United States, Canada, European Union, Argentina, Brazil, Costa Rica,  Panama and China                                                                 |
| HepaSphere Microspheres                               |       | CE Mark approval  obtained in the European Union; clinical evaluation in Japan                                                                                                                                                                        |
| QuadraSphere  Microspheres                            |       | 510(k) application  submitted to the FDA                                                                                                                                                                                                         |
| MR (magnetic resonance)—Embosphere  Microspheres |       | Preclinical  research—animal studies                                                                                                                                                                                                             |
| EmboCath Plus Infusion  Microcatheter                 |       | Preclinical  research—animal studies                                                                                                                                                                                                             |
| Sequitor Steerable Guidewire                          |       | Preclinical research—animal  studies                                                                                                                                                                                                             |

 

Research anddevelopment expenses relate primarily to:

·       researchto identify and evaluate new and innovative embolotherapy products based on ourplatform microsphere technology;

·       pre-clinicaltesting and clinical trials of product candidates;

·       developmentrelated to improving manufacturing processes; and

·       productand production facilities validation processes under FDA Current GoodManufacturing Practices.

Total research and development expenses were $2.36million, $2.11 million and $2.34 million for the years ended December 31,2005, 2004 and 2003, respectively, representing approximately 11%, 10% and 

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11% of our total costs andexpenses for the years ended December 31, 2005, 2004 and 2003,respectively. Our research and development functions typically work on a numberof projects concurrently. In addition, except for clinical expenses, asubstantial amount of fixed research and development costs such as salary andsalary-related benefits, rent, equipment depreciation, utilities, insurance andmaintenance are shared among various programs. Accordingly, we have not historicallytracked specific costs for each of our research and development projects.

There is a risk that any medical device developmentprogram may not produce revenue. Moreover, because of uncertainties inherent inmedical device development, including those factors described above under “RiskFactors” we may not be able to successfully develop and commercialize theproduct candidates included in the table above.

We have obtained CEmark approval in the European Union for our HepaSphere Microspheres, which are also inclinical evaluation in Japan. We have exclusive worldwide rights to theHepaSphere Microspheres technology under a license from Dr. Shinichi Hori,subject only to Dr. Hori’s right to conduct clinical trials on our behalfin Japan, treat patients at Rinku Medical Center and Osaka Medical Center inJapan and engage in research at Osaka University. We have submitted a 510(k) application to the FDA seeking UnitedStates marketing clearance for our QuadraSphere Microspheres product candidatefor the treatment of hypervascularized tumors and peripheral arteriovenousmalformations. Our QuadraSphere Microspheres are identical in all respects toour HepaSphere Microspheres, which are marketed outside of the United States.Weare also conducting preclinical research of our MR-Embosphere Microspheresproduct candidate for use in the treatment of uterine fibroids and liver cancerand of our EmboCath Plus Infusion Microcatheters and Sequitor SteerableGuidewires product candidates. The successful development of these early-stageproduct candidates is highly uncertain. We cannot reasonably estimate or knowthe nature, timing and estimated costs of the efforts necessary to complete thedevelopment of, or the period in which material net cash inflows are expectedto commence from, any of our product candidates due to the numerous risks anduncertainties associated with developing medical devices, including theuncertainty of:

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

·       futureclinical trials results;

·       thecost and timing of regulatory approvals;

·       thecost and timing of establishing sales, marketing and distribution capabilities;

·       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.

Any failure to completethe development of our product candidates in a timely manner could have amaterial adverse effect on our operations, financial position and liquidity. Adiscussion of the risks and uncertainties associated with completing our projectson schedule, or at all, and some consequences of failing to do so are set forthin “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 

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generallyaccepted in the United States. The preparation of these financial statementsrequires us****to make estimates andjudgments that affect the reported amounts of assets and liabilities, revenuesand expenses, and related disclosure at the date of our financial statements.The significant accounting policies which we believe are most critical ingaining an understanding of our financial statements include policies andjudgments relating to revenue recognition, accounts receivable, inventories anddeferred taxes. Actual results could differ materially from these estimates.Our significant accounting policies are summarized in note B of the notes toour consolidated financial statements. The significant accounting policieswhich we believe are the most critical to gaining a full understanding of andevaluating our reported financial results include the following:

*Revenue Recognition*

We comply with the revenue recognition guidelines summarizedin Staff Accounting Bulletin, or SAB, No. 104, “Revenue Recognition.” Werecognize revenue when products are shipped and the customer takes ownershipand assumes risk of loss, collection of the relevant receivable is reasonablyassured, persuasive evidence of an arrangement exists (a valid purchase orderfrom an approved customer), and the sales price is fixed or determinable.Revenue from licensing agreements is recognized ratably over the period of therelated agreement. We establish reserves for potential sales returns andevaluate the adequacy of those reserves based upon realized experience. Underour current policy, only those products on a customer’s initial order qualifyfor product satisfaction-related credit returns. To date, returns related toproduct satisfaction have been immaterial. While such returns have historicallybeen within our expectations and the provisions established, we cannotguarantee that we will continue to experience the same return rates that wehave in the past. Any significant change in product satisfaction and anyresulting credit returns could have a material adverse impact on our operatingresults for the period or periods in which such returns materialize.

In June 2004 weentered into an exclusive five-month development agreement with a third partyfor the use of Embosphere Microspheres for GERD. In exchange for thisagreement, we received a payment of $100,000. Based upon the application of ourrevenue recognition policies and all related judgments and estimates, werecognized $100,000 as licensing revenue over the life of the contract, whichconcluded in November 2004.

*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 liquidityand profitability of our customer base.

*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 such 

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determination.Although we make every effort to ensure the accuracy of our production processand forecasts of future product demand, any significant unanticipated changesin production yield or product demand could have a significant impact on thevalue of our inventory and our reported operating results.

***Results ofOperations***

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

*Revenue and Margin Overview*

| ** **              | ** ** | **For the Years Ended December 31,** | ** ** | **Inc./**                                                                                                                  | ** ** | **Inc./**                                                                                                                        | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **          2005         ** | ** ** | **          2004          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| 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 $4.33 million or 31% in 2005 as compared to 2004 primarily due to thefollowing:

·       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 Microsphere salesvolumes in France, Germany and the United Kingdom. In April 2005, we begana 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 did not renew in2005.

*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 due to manufacturing processimprovements, and product replacements resulting from shelf life limitations thatwe recorded during 2004 and did not occur in 2005.

The gross margin improvement of 13% as a percentage ofrevenues for 2005 as compared to 2004 was primarily attributable to theadditional costs in 2004 related to the inventory write-off and the increase insales in 2005 of Embosphere Microspheres in the United States, which provideour highest profit margins. Offsetting these improvements were costs associatedwith the initial production of our HepaSphere Microsphere product, which weintroduced commercially in 2005, and the decrease in licensing revenue.

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

·       revenuegrowth;

·       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,** | ** **                                                                                       | **Inc./**                                                                                                                        | ** ** | **Inc./**                                                                                                                        | ** ** |
|-----------------------------|------------|---------------------------------------------------------------|--------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)**     | ** ** | ** **                                                    | ** **                                                                                       | **          2005          ** | ** ** | **          2004          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| Research and  development   |       |                                                          | $ 2,359               |                                                                                                                             |       |                                                                                                                             | $          | 2,113 |   |   | $ | 246 |   |   | 12 | % |   |
| Sales                       |       |                                                          | 6,185                                                                                            |                                                                                                                             |       |                                                                                                                             | 5,322      |   |   | 863 |   |   | 16 | % |   |
| Marketing                   |       |                                                          | 2,080                                                                                            |                                                                                                                             |       |                                                                                                                             | 2,228      |   |   | (148 | ) |   | -7 | % |   |
| General and  administrative |       |                                                          | 4,219                                                                                            |                                                                                                                             |       |                                                                                                                             | 4,154      |   |   | 65 |   |   | 2 | % |   |
| Litigation costs            |       |                                                          | —                                                                                           |                                                                                                                             |       |                                                                                                                             | 874        |   |   | (874 | ) |   | — |   |   |
| Total operating expenses    |       |                                                          | $14,843                    |                                                                                                                             |       |                                                                                                                             | $          | 14,691 |   |   | $ | 152 |   |   |   |   |   |
|                             |            |                                                               |                                                                                                  |                                                                                                                                  |            |                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Researchand Development Expense.**  *Total  researchand development expense in 2005 increased $246,000 or 12% as we increasedspending by approximately $325,000 in support of our latest product, HepaSphereMicrospheres, that we introduced commercially in Europe in 2005, and ourproduct candidates, MR-Embosphere Microspheres and our next-generation deliverysystems, which increased spending by approximately $60,000 to differentiateEmbosphere Microspheres from competitive products. Offsetting these increasesin 2005 were lower overhead costs achieved by the consolidation of space in ourfacility in Rockland, Massachusetts, at the end of the first quarter of 2005. Weexpect future spending for research and development to increase as we seek toprovide further clinical research for our existing and future products.

*SalesExpense.**  *Salesexpense for 2005 increased $863,000 or 16%. The primary reason for the increasewas the higher revenue sales levels and improved performance resulting inhigher incentive compensation for our sales personnel.

*MarketingExpense.**  *Marketingexpense for 2005 decreased $148,000 or 7% from 2004. The decrease was primarilydue to the timing of spending on marketing programs over the course of 2005 ascompared to 2004. In 2004, such expenses included marketing support of anarticle on UFE in *The Wall Street Journal* and othermedia coverage, including a segment in the television program *20/20*. These expenses did not recur at comparable levels in2005.

*Generaland 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 BioSphere Medical S.A.BioSphere Medical S.A. and Terumo Europe entered into a distributionagreement in January 2002 pursuant to which Terumo Europe became theexclusive distributor of EmboSphere Microsphere and EmboGold Microsphereproducts in certain countries of Europe. The Commercial Court of Pontoise,France, determined that while both parties had ceased to perform theirobligations 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 inDecember 2004. The $874,000 charge recorded in the fourth quarter of 2004includes $90,000 of related accounts receivable written off in addition to thesettlement payment.

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*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 Gains, Net.**  *Foreignexchange gains and losses primarily resulted from Euro to U.S. dollar foreigncurrency fluctuations on Euro-denominated intercompany trade accounts. 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.

***Years Ended December 31, 2004 and 2003***

*Revenue and MarginOverview*

| ** **              | ** ** | **For the Years Ended December 31,** | ** ** | **Inc./**                                                                                                                        | ** ** | **Inc./**                                                                                                                        | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **          2004          ** | ** ** | **          2003          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| Total revenues          |       |                                                          | $          | 14,158                                                                                                                           |       |                                                                                                                             |       | $ | 12,803 |   |   |   | $ | 1,355 |   |   |   | 11 | % |   |
| Costs of product  sales |       |                                                          | 6,646      |                                                                                                                             |       |                                                                                                                             | 5,558      |   |   |   | 1,088 |   |   |   | 20 | % |   |
| Gross margin            |       |                                                          | $          | 7,512                                                                                                                            |       |                                                                                                                             |       | $ | 7,245 |   |   |   | $ | 267 |   |   |   | 4 | % |   |
| Gross margin %          |       |                                                          | 53         | %                                                                                                                                |       |                                                                                                                             | 57         | % |   |   | -4 | % |   |   |   |   |   |
|                         |            |                                                               |            |                                                                                                                                  |            |                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Revenues.*   The$1.36 million or 11% increase in revenue in 2004 as compared to 2003 wasprimarily due to the following:

·       revenuesfrom microspheres and delivery systems in the United States grew approximately$385,000 due to increasing market acceptance, which we believe is being fueledby increased adoption within the interventional radiologists community,increased awareness among fibroid patents due to media attention and increasingsupport of gynecologists;

·       revenuesfrom microspheres and delivery systems in Europe increased approximately$210,000 due to increased market acceptance of our microspheres and deliverysystems;

·       revenuesfrom microspheres and delivery systems in the rest of the world increasedapproximately $180,000 due to our renewed focus on these geographical areasduring 2004 and to our obtaining approvals to sell our EmboCath Catheter andSegway Guidewire products in Canada and several other Latin American countries;

·       wederived $100,000 of licensing revenue from a five-month agreement for thedevelopment of Embosphere Microspheres for use in the prevention of GERD, whichconcluded in the fourth quarter of 2004; and

·       finally,the strengthening of the Euro against the U.S. dollar in 2004 accounted forapproximately $420,000 of the increase.

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*Cost of Product Sales.**  *The $1.09 million or 20% increasein cost of product sales in 2004 as compared to 2003 was primarily due to thefollowing factors:

·       werecorded a write-off of approximately $913,000 for in process EmboGoldMicrosphere and Embosphere Microspheres inventory related to inventory producedprior to the implementation of an improved manufacturing process in ourfacility in France; and

·       werecognized approximately $223,000 in costs of product sales related to productreplacement of EmboGold Microsphere and Embosphere syringes. This replacementwas due to shelf life limitations of the saline solution contained within thesyringes.

The gross margin decreaseof $267,000 or 4% as a percent of revenues was primarily attributable to theadditional costs related to the write-off of in-process inventory and expensesassociated with the product replaced as a result of the shelf limitationsdiscussed above, offset by increased manufacturing efficiencies, net of foreigncurrency translation adjustments.

*Expense Overview*

| ** **                          | ** ** | **For the Years Ended December 31,** | ** ** | **Inc./**                                                                                                                        | ** ** | **Inc./**                                                                                                                        | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)**             | ** ** | ** **                                                    | ** ** | **          2004          ** | ** ** | **          2003          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| Research and  development           |       |                                                          | $          | 2,113                                                                                                                            |       |                                                                                                                             |       | $ | 2,344 |   |   | $ | (231 | ) |   | -10 | % |   |
| Sales                               |       |                                                          | 5,322      |                                                                                                                             |       |                                                                                                                             | 5,892      |   |   | (570 | ) |   | -10 | % |   |
| Marketing                           |       |                                                          | 2,228      |                                                                                                                             |       |                                                                                                                             | 3,670      |   |   | (1,442 | ) |   | -39 | % |   |
| General,  administrative and patent |       |                                                          | 4,154      |                                                                                                                             |       |                                                                                                                             | 3,359      |   |   | 795 |   |   | 24 | % |   |
| Litigation costs                    |       |                                                          | 874        |                                                                                                                             |       |                                                                                                                             | —     |   |   | 874 |   |   | — |   |   |
| Total operating expenses            |       |                                                          | $          | 14,691                                                                                                                           |       |                                                                                                                             |       | $ | 15,265 |   |   | $ | (574 | ) |   |   |   |   |
|                                     |            |                                                               |            |                                                                                                                                  |            |                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Researchand Development Expense.**  *The $231,000 or 10% decrease in research anddevelopment expenses in 2004 as compared to 2003 was primarily due to a reduction in headcount, which decreasedcompensation-related expenses by approximately $230,000, after the completionof development related projects in 2003, offset by $50,000 of higher costs inFrance due to the stronger Euro and an increase in activity on a joint projectin France.

*SalesExpense.**  *The$570,000 or 10% decrease in sales expense in 2004 as compared to 2003 was dueto the elimination of our 2004 national sales meeting, which decreased expenseby approximately $200,000, and other savings on personnel costs, includingtravel and incentive compensation, which decreased expense by approximately$550,000 as selling costs were realigned with realized sales levels in thefirst half of 2004. Offsetting these decreases were severance and hiring costsin the fourth quarter of 2004, which totaled approximately $400,000, resultingfrom the departures and addition of certain senior management.

*MarketingExpense.**  *The$1.44 million or 39% decrease in marketing expense in 2004 as compared to 2003was primarily due to the reduction in expenses related to awareness andeducation programs associated with promoting the UFE procedure through our ask4UFEcampaign as well as a reduction in expenses relating to the promotion ofEmbosphere Microspheres, which decreased expenses by approximately $1.1million. Additional cost savings in 2004 came from reduced overall headcount,which decreased expenses by approximately $200,000, and from our decision tolimit our head count presence at key trade shows as we sought to keep salesrepresentatives focused on their key accounts in the field, which decreasedexpenses by approximately $250,000.

*General,Administrative and Patent Expenses.**  *The $795,000 or 24% increase ingeneral and administrative expenses in 2004 as compared to 2003 was primarilydue to the executive transition and severance expenses incurred in the fourthquarter of 2004 in connection with the departure and hiring of certainexecutives of the Company.

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*LitigationCosts.**  *In December 2004, we paid damages ina lawsuit brought by Terumo Europe N.V. against our French subsidiary,BioSphere Medical S.A. as described in the previous section.

*InterestIncome, Net.**  *Interestincome, net of interest expense, is generally incurred in relation to capitalleases. For the year ended December 31, 2004, interest income, net ofinterest expense, was $76,000 as compared to $108,000 in 2003, a decrease of 30%.The decrease in 2004 as compared to 2003 was due primarily to decreases in theaverage daily-invested cash balances and interest rates on available investmentgrade assets.

*ForeignExchange Gains, Net.**  *Foreignexchange gains and losses primarily resulted from realized Euro to U.S. dollarforeign currency fluctuations on Euro denominated intercompany trade accounts.The foreign exchange gains realized during 2004 totaled approximately $389,000as compared to gains of approximately $555,000 realized during 2003. The$166,000 decrease was primarily due to higher average intercompany tradereceivables, which are denominated in Euros, offset by a decrease in the ratethat the Euro strengthened against the dollar during 2004 as compared to 2003.

*Income Tax Provision.**  *The 2004 income tax provision of$117,000 primarily represents the reversal of income tax benefits recordedduring 2002 as we determined in the fourth quarter of 2004 that a portion ofthe 2001 taxes paid would not be recovered.The 2003 income tax provisionrepresents minimum corporate taxes due in both France and in the United States.

***Liquidity and Capital Resources***

As of December 31, 2005, we had $8.77 million ofcash and cash equivalents, a decrease of $1.45 million from $10.22 million at December 31,2004. This decrease was primarily the result of our 2005 operating loss offsetby proceeds from stock option exercises by former employees and Euro to U.S.dollar foreign exchange rate changes. We have historically funded ouroperations from the net proceeds provided by public and private equityofferings, net revenues, bank financing, equipment financing leases and, to alesser extent, the exercise of stock options.

The net cash used in operating activities includes anet loss of $2.80 million adjusted for $110,000 in working capital changes. Accountsreceivable increased $725,000 on higher sales offset by a two-day improvementin days sales outstanding, which decreased to 61 days from 63 days at December 31,2004.

During 2005, we spent $185,000 to purchasemanufacturing equipment at our facility in Roissy, France to produce ourmichrosphere products, including $75,000 specifically to produce HepaSphereMicrospheres, and we spent an additional $140,000 to purchase other equipmentto support our existing infrastructure.

Net cash provided by financing activities was $802,000during 2005, which included $981,000 from employee equity incentive plans and$43,000 from equipment financing offset by scheduled principal payments, suchas those on existing lease arrangements, and additional costs associated withour private placement of series A preferred stock in the fourth quarter of2004.

On February 22, 2006,we sold 2,075,000 shares of the common stock at a price per share of $7.00 toseveral investors in a private placement. We received net proceeds ofapproximately $13.40 million.

***Borrowing Arrangements***

In September 2005, we entered into a five-yearcapital lease agreement for the purchase of communication equipment at ourfacility in Rockland, Massachusetts. The amount of the lease is $43,000,payable over 60 months, at an effective annual interest rate of 8.65%. As of December 31,2005 there was $41,000 outstanding under this capital lease agreement.

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We currently have a creditfacility with a bank under which we may borrow up to $3.0 million for generalworking capital and corporate purposes, subject to limitations defined in theagreement. The credit facility was to expire in June 2005, and in that monthwe entered into an agreement to extend the credit facility for an additionaltwo years. There were no borrowings outstanding under this agreement as ofDecember 31, 2005. Each available 30-, 60-, 90- or 180-dayadvance will bear interest at a per annum rate, at our option, equal to either(i) a variable rate as determined by the bank or (ii) a rate equal tothe corresponding 30-, 60-, 90- or 180-day LIBOR rate(4.4% as of December 31, 2005) plus a LIBOR advance rate spread asdetermined by certain current working capital balances at the time of theadvance. In connection with the credit facility, we entered into a securityagreement pursuant to which we have pledged to the bank all of our U.S. assets,excluding our equity ownership of our subsidiaries, as collateral.

***Other Contractual Obligations***

As of December 31, 2005, we are party to twooperating leases for our facilities in Rockland, Massachusetts and Roissy,France. The Roissy, France operating lease expires in May 2010. OnFebruary 24, 2006, we amended the lease for the office and laboratoryfacility we currently occupy in Rockland, Massachusetts. Pursuant to thatamendment, the leased premises has been increased to a total area ofapproximately 13,000 square feet at a monthly cost of $19,500 per month, andthe term of the lease is extended from March 31, 2007 to February 28,2009. In addition to the capital lease agreement we entered into inSeptember 2005, we are party to several other non-cancelable capital leaseagreements with various equipment-financing companies, related to theacquisition of certain manufacturing and computer equipment during 2002 and2004. The equipment leases have initial terms of 36 to 60 months with interestrates of 4.6% to 8.5%. Equipment leased under these arrangements serves aspledged capital with respect to each capital lease agreement.

Futurecash payments, including interest, under contractual obligations in effect asof December 31, 2005, are as follows:

| ** **                     | ** ** | **Period** | ** ** | ** ** | ** ** | **Total  Contractual** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|------------------------|------------|
| **(in thousands)**        | ** ** | ** ** | ** ** | **2006**   | ** ** | **2007**               | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Obligations** | ** ** |
| Operating Leases               |       | $          | 507        |       | $          | 344                    |       | $ | 242 |   | $ | 206 |   | $ | 87 |   |   | $ | — |   |   |   | $ | 1,386 |   |   |
| Capital Leases                 |       | 137        |       | 62         |       | 29                     |       | 11 |   | 8 |   |   | — |   |   |   | 247 |   |   |
| Other Contractual  Obligations |       | 104        |       | 28         |       | 20                     |       | 20 |   | 20 |   |   | 55 |   |   |   | 247 |   |   |
| Total                          |       | $          | 748        |       | $          | 434                    |       | $ | 291 |   | $ | 237 |   | $ | 115 |   |   | $ | 55 |   |   |   | $ | 1,880 |   |   |
|                                |            |            |            |            |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We believe that the approximate $8.77 million in cashand cash equivalents  that we have as ofDecember 31, 2005, together with anticipated proceeds from sales of ourmicrospheres, delivery systems and other products, together with the netproceeds of approximately $13.40 million from our placement of 2,075,000 sharesof common stock, which was completed on February 22, 2006, will besufficient to fund our operating and capital requirements, as currently plannedthrough 2007. In the longer term, we expect to fund our operations and sustaincapital requirements through a combination of expected proceeds from productsales and capital equipment financing. However, our cash requirements may varymaterially from those now planned due to a number of factors, including,without limitation, our failure to achieve expected revenue amounts, costsassociated with changes in our UFE marketing programs, anticipated research anddevelopment expenses, the scope and results of pre-clinical and clinicaltesting, changes in the focus and direction of our research and developmentprograms, competitive and technological advances, the timing and results of FDAregulatory review and the market’s acceptance of any approved products, includingour Embosphere Microspheres for UFE and HepaSphere Microspheres.

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 

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functions,as well as costs relating to further market development and commercializationefforts. We may also need additional funds for such activities and for possiblestrategic acquisitions of synergistic businesses, products and/or technologies.These additional funds may be substantial and raised from time to time throughadditional public or private sales of equity, through borrowings, or throughother financings. There are no assurances that we will be able to obtain anyadditional funding that may be required, or that any such funding will be onacceptable terms.

***Related Party Transactions***

We did not have anyrelated party transactions during 2005.

***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.

***New Accounting Pronouncements***

In December 2004, the Financial AccountingStandards Board, or FASB, issued Statement of Financial Accounting Standards,or SFAS, No. 123 (revised 2004), “Share-Based Payment” which, as revised,we refer to as SFAS 123R. SFAS 123R addresses the accounting for transactionsin which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS 123R supersedes Accounting PrinciplesBoard No. 25, or APB 25, and requires that such transactions be accountedfor using a fair value-based method. SFAS 123R requires companies to recognizean expense for compensation cost related to share-based payment arrangements,including stock options and employee stock purchase plans. In April 2005,the SEC announced the adoption of a new rule that amends the compliancedates for SFAS 123R. The SEC’s new rule requires companies to implementSFAS 123R at the beginning of the next fiscal year that begins after June 15,2005. Accordingly, we adopted SFAS 123R as of January 1, 2006. We expectto use the modified-prospective transition method and will not restate priorperiods for the adoption of SFAS 123R.

As permitted by SFAS No. 123, we currentlyaccount for share-based payments to employees using APB 25’s intrinsic valuemethod and, as such, generally recognize no compensation cost for employeestock options. Accordingly, the adoption of SFAS 123R fair value methodwill have a significant impact on our results of operations, although it willhave no impact on our overall financial position and cash position. The impactof adoption of SFAS 123R cannot be quantified at this time because it willdepend on the level of share-based payments granted in the future, expectedvolatilities and expected useful lives, among other factors, present at thegrant date. However, based on our current assumptions we expect the adoption ofSFAS 123R to increase our compensation costs by approximately $1.30million in 2006.

In November 2004, theFASB issued SFAS No. 151, “Inventory Costs—an amendment of AccountingResearch Bulletin, or ARB, No. 43, Chapter 4”, or SFAS 151. SFAS 151 isthe result of a broader effort by the FASB to improve the comparability ofcross-border financial reporting by working with the International AccountingStandards Board, or IASB, toward development of a single set of high qualityaccounting standards. The FASB and the IASB noted that ARB No. 43, Chapter4 and International Accounting Standard No. 2, “Inventories,” or IAS 2,require that abnormal amounts of idle freight, handling costs, and wastedmaterials be recognized as period costs; however, the FASB and the IASB notedthat differences in the wording of the two standards could lead to inconsistentapplication of those 

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similarrequirements. The FASB concluded that clarifying the existing requirements inARB No. 43 by adopting language similar to that used in IAS No. 2 isconsistent with its goals of improving financial reporting in the United Statesand promoting convergence of accounting standards internationally. Adoption ofSFAS 151 is required for fiscal years beginning after June 15, 2005. Theprovisions of SFAS 151 will be applied prospectively. We are currently inthe process of evaluating the impact of SFAS 151, but do not expect itwill have a material impact on our results of operations and financialposition.

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

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

As of December 31,2005, 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, 2005, approximately Euro870,000, or $1.03 million, remained outstanding within the inter-company tradeaccounts. Accordingly, a hypothetical 10 percent increase in Euro to U.S.dollar conversion rates would result in an approximate $103,000 foreigncurrency market-to-market change in the fair value of our inter-company tradeaccount balance as of December 31, 2005. We have not engaged in formalcurrency hedging activities to date, but do have a limited natural hedge inthat our revenues and expenses in France are primarily denominated in the Euro.We also attempt to minimize exchange rate risk by converting non-U.S. currency toU.S. dollars as often as practicable. We generally view our investment inforeign subsidiaries operating under a functional currency (the Euro) otherthan our reporting currency (the U.S. dollar) as long term. Our investment inforeign subsidiaries is sensitive to fluctuations in foreign currency exchangerates. The effect of a change in foreign exchange rates on our net investmentin foreign subsidiaries is reflected in the “Other accumulated comprehensiveloss” component of stockholders’ equity. Because our foreign currency exchangerate risk is not material, no quantitative tabular disclosure has beenprovided.

The primary objective of our investment activities isto preserve principal while at the same time maximizing the income we receivefrom our investments without significantly increasing risk. We maintain ourportfolio of cash equivalents and short-term investments in money market funds.Due to the conservative nature of our investments, we believe interest raterisk is mitigated.

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**Item8.**                        FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Stockholders of BioSphere Medical, Inc. and subsidiaries:

We have audited theaccompanying consolidated balance sheets of BioSphere Medical, Inc. andsubsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations, stockholders’ equity and comprehensiveincome (loss), and cash flows for each of the three years in the period ended December 31,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. We were not engaged to perform an audit of the Company’sinternal control over financial reporting. Our audit included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposesof expressing an opinion on the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidatedfinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of BioSphere Medical, Inc.and subsidiaries at December 31, 2005 and 2004, and the consolidatedresults of operations, stockholders’ equity and comprehensive income (loss),and cash flows for each of the three years in the period ended December 31,2005 in conformity with U.S. generally accepted accounting principles.

|                                                                                                                  | /s/  ERNST & YOUNG LLP |   |
|------------------------------------------------------------------------------------------------------------------|-------------------------------------------|--------|
| Boston, Massachusetts  January 27, 2006, except for Note Q,  as to which the date is February 24, 2006 |

 

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**BIOSPHERE MEDICAL,INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands except share data)**                                                                                                                                                                                                                         | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                  |       |                  |       |   |   |   |   |
| Current Assets:                                                                                                                                                                                                                                                             |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                   |       |                  | $          | 8,774 |   |   | $ | 9,460 |   |
| Marketable securities                                                                                                                                                                                                                                                       |       |                  | —     |   |   | 762 |   |
| Account receivable, net of allowance for doubtful  accounts of $233 and $184 as of December 31, 2005 and 2004, respectively                                                                                                                                            |       |                  | 3,521      |   |   | 2,999 |   |
| Inventories                                                                                                                                                                                                                                                                 |       |                  | 2,435      |   |   | 3,311 |   |
| Prepaid and other current assets                                                                                                                                                                                                                                            |       |                  | 407        |   |   | 222 |   |
| Total current assets                                                                                                                                                                                                                                                        |       |                  | 15,137     |   |   | 16,754 |   |
| Property and  equipment, net                                                                                                                                                                                                                                                |       |                  | 858        |   |   | 1,134 |   |
| Goodwill                                                                                                                                                                                                                                                                    |       |                  | 1,443      |   |   | 1,443 |   |
| Other assets                                                                                                                                                                                                                                                                |       |                  | 57         |   |   | 60 |   |
| Total Assets                                                                                                                                                                                                                                                                |       |                  | $          | 17,495 |   |   | $ | 19,391 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                               |       |                  |       |   |   |   |   |
| Current Liabilities:                                                                                                                                                                                                                                                        |       |                  |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                                            |       |                  | $          | 1,146 |   |   | $ | 1,084 |   |
| Accrued compensation                                                                                                                                                                                                                                                        |       |                  | 1,830      |   |   | 1,880 |   |
| Other current accrued liabilities                                                                                                                                                                                                                                           |       |                  | 1,202      |   |   | 1,224 |   |
| Current portion of capital lease obligations and  long-term debt                                                                                                                                                                                                            |       |                  | 127        |   |   | 175 |   |
| Total current liabilities                                                                                                                                                                                                                                                   |       |                  | 4,305      |   |   | 4,363 |   |
| Long-term debt  and capital lease obligations                                                                                                                                                                                                                               |       |                  | 101        |   |   | 192 |   |
| Total Liabilities                                                                                                                                                                                                                                                           |       |                  | 4,406      |   |   | 4,555 |   |
| Commitments and  contingencies (Note I and P)                                                                                                                                                                                                                               |       |                  |       |   |   |   |   |
| Stockholders’ equity:                                                                                                                                                                                                                                                  |       |                  |       |   |   |   |   |
| Preferred stock;  $.01 par value; 1,000,000 shares authorized:                                                                                                                                                                                                              |       |                  |       |   |   |   |   |
| 6% series A convertible preferred stock, 12,000  authorized shares, 8,434 and 8,000 shares issued and outstanding, as of December 31,  2005 and 2004, respectively (aggregate liquidation preference including  accrued dividends of $8,560 at December 31, 2005) |       |                  | 7,449      |   |   | 6,945 |   |
| Common stock; $.01 par value; 25,000,000 shares  authorized; 15,006,005 and 14,294,032 shares issued and outstanding as of December 31,  2005 and 2004, respectively                                                                                                   |       |                  | 150        |   |   | 143 |   |
| Additional  paid-in capital                                                                                                                                                                                                                                                 |       |                  | 84,471     |   |   | 83,438 |   |
| Deferred  compensation                                                                                                                                                                                                                                                      |       |                  | (41        | ) |   | — |   |
| Accumulated deficit                                                                                                                                                                                                                                                         |       |                  | (78,798    | ) |   | (75,502 | ) |
| Accumulated other  comprehensive loss                                                                                                                                                                                                                                       |       |                  | (142       | ) |   | (188 | ) |
| Total stockholders’ equity                                                                                                                                                                                                                                             |       |                  | 13,089     |   |   | 14,836 |   |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                                                                                                            |       |                  | $          | 17,495 |   |   | $ | 19,391 |   |
|                                                                                                                                                                                                                                                                             |            |                       |            |  |  |  |  |  |  |  |  |

 

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

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**BIOSPHERE MEDICAL, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                                   | ** ** | **For the Years Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands except per share data)** | ** ** | ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                    |       |                                                          |       |   |   |   |   |
| Product sales                                                |       | $                                                             | 18,484     |   | $ | 14,058 |   | $ | 12,803 |   |
| Licensing revenues                                           |       | —                                                        |       | 100 |   | — |   |
| Total revenues                                               |       | 18,484                                                        |       | 14,158 |   | 12,803 |   |
| Costs and  expenses:                                         |       |                                                          |       |   |   |   |   |
| Costs of product sales                                       |       | 6,303                                                         |       | 6,646 |   | 5,558 |   |
| Research and development                                     |       | 2,359                                                         |       | 2,113 |   | 2,344 |   |
| Sales                                                        |       | 6,185                                                         |       | 5,322 |   | 5,892 |   |
| Marketing                                                    |       | 2,080                                                         |       | 2,228 |   | 3,670 |   |
| General, administrative and patent                           |       | 4,219                                                         |       | 4,154 |   | 3,359 |   |
| Litigation costs                                             |       | —                                                        |       | 874 |   | — |   |
| Total costs and expenses                                     |       | 21,146                                                        |       | 21,337 |   | 20,823 |   |
| Loss from operations                                         |       | (2,662                                                        | )          | (7,179 | ) | (8,020 | ) |
| Interest income                                              |       | 225                                                           |       | 92 |   | 135 |   |
| Interest expense                                             |       | (15                                                           | )          | (16 | ) | (27 | ) |
| Foreign exchange  (loss)/gains, net                          |       | (444                                                          | )          | 389 |   | 555 |   |
| Other income/  (expense), net                                |       | 2                                                             |       | (10 | ) | 28 |   |
| Loss before income taxes                                     |       | (2,894                                                        | )          | (6,724 | ) | (7,329 | ) |
| Income tax  benefit/ (provision)                             |       | 93                                                            |       | (117 | ) | (23 | ) |
| Net loss                                                     |       | (2,801                                                        | )          | (6,841 | ) | (7,352 | ) |
| Preferred stock  dividends                                   |       | (495                                                          | )          | (68 | ) | — |   |
| Net loss applicable to common stockholders                   |       | $                                                             | (3,296     | ) | $ | (6,909 | ) | $ | (7,352 | ) |
| Net loss per common  share applicable to common stockholders |       |                                                          |       |   |   |   |   |
| Basic and diluted                                            |       | $                                                             | (0.22      | ) | $ | (0.49 | ) | $ | (0.55 | ) |
| Weighted average number of  common shares outstanding        |       |                                                          |       |   |   |   |   |
| Basic and diluted                                            |       | 14,653                                                        |       | 14,152 |   | 13,462 |   |
|                                                              |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

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

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**BIOSPHERE MEDICAL,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS 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, 2002**                                     |       |          | $          | —                |       |                    | 13,226     |         |       | $               | 132        |                                  |       |                          | $          | 81,169 |   |   |   | $ | — |   |   |   | $ | (61,241 | ) |   |   | $ | 199 |   |   |   | $ | 20,259 |   |   |
| Comprehensive loss:                                                       |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                  |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | (7,352 | ) |   |   | — |   |   |   | (7,352 | ) |   |
| Unrealized loss on marketable securities                             |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | (22 | ) |   |   | (22 | ) |   |
| Translation adjustment                                                    |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | (149 | ) |   |   | (149 | ) |   |
| Total Comprehensive loss                                                  |       |          |       |                  |       |                    |       |         |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (7,523 | ) |   |
| Issuance of common stock under employee benefit  and incentive plans |       |          | —     |                  |       | 615                     |       |         | 6          |            |       |                                  | 744        |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 750 |   |   |
| Stock-based compensation to non-employees                            |       |          | —     |                  |       | —                  |       |         | —     |            |       |                                  | 39         |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 39 |   |   |
| **Balance at December 31, 2003**                                     |       |          | —     |                  |       | 13,841                  |       |         | 138        |            |       |                                  | 81,952     |                          |       |   | — |   |   |   | (68,593 | ) |   |   | 28 |   |   |   | 13,525 |   |   |
| 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     |                          |       |   | — |   |   |   | (75,502 | ) |   |   | (188 | ) |   |   | 14,836 |   |   |
| 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 | ) |   |   | $ | (78,798 | ) |   |   | $ | (142 | ) |   |   | $ | 13,089 |   |   |
|                                                                           |            |               |            |                       |            |                         |            |              |            |                 |            |                                       |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

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**BIOSPHEREMEDICAL, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**                                                             | ** ** | ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows from  operating activities:                                              |       |                                                          |       |   |   |   |   |
| Net loss                                                                            |       | $                                                             | (2,801     | ) | $ | (6,841 | ) | $ | (7,352 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:        |       |                                                          |       |   |   |   |   |
| Provision for doubtful accounts                                                     |       | 66                                                            |       | 80 |   | 59 |   |
| Provision for inventory obsolescence                                                |       | 54                                                            |       | 1,384 |   | 593 |   |
| Depreciation                                                                        |       | 509                                                           |       | 625 |   | 658 |   |
| Realized (gain) loss on available-for-sale investments                              |       | 5                                                             |       | 4 |   | (15 | ) |
| Non-cash stock-based compensation                                                   |       | 18                                                            |       | — |   | 39 |   |
| Changes in  operating assets and liabilities:                                       |       |                                                          |       |   |   |   |   |
| Accounts receivable                                                                 |       | (725                                                          | )          | (510 | ) | (364 | ) |
| Inventories                                                                         |       | 593                                                           |       | (938 | ) | (640 | ) |
| Prepaid and other current assets                                                    |       | (213                                                          | )          | 129 |   | 384 |   |
| Accounts payable                                                                    |       | 149                                                           |       | 212 |   | (115 | ) |
| Accrued compensation                                                                |       | (3                                                            | )          | 799 |   | (216 | ) |
| Other accrued expenses                                                              |       | 89                                                            |       | (182 | ) | (59 | ) |
| Net cash used in operating activities                                               |       | (2,259                                                        | )          | (5,238 | ) | (7,028 | ) |
| Cash flows from  investing activities:                                              |       |                                                          |       |   |   |   |   |
| Purchase of property and equipment                                                  |       | (325                                                          | )          | (200 | ) | (273 | ) |
| Purchase of marketable securities                                                   |       | —                                                        |       | (255 | ) | (11,841 | ) |
| Proceeds from the maturity of marketable securities                                 |       | 764                                                           |       | 5,016 |   | 16,926 |   |
| Net cash provided by investing activities                                           |       | 439                                                           |       | 4,561 |   | 4,812 |   |
| Cash flows from  financing activities:                                              |       |                                                          |       |   |   |   |   |
| Proceeds from issuance of convertible preferred  stock and warrants, net  |       | (59                                                           | )          | 7,791 |   | — |   |
| Proceeds from issuance of common stock under  employee benefit and incentive plans  |       | 981                                                           |       | 645 |   | 750 |   |
| Proceeds from capital lease obligations                                             |       | 43                                                            |       | 210 |   | — |   |
| Principal payments under long-term debt and capital  lease obligations              |       | (163                                                          | )          | (185 | ) | (140 | ) |
| Net cash provided by financing activities                                           |       | 802                                                           |       | 8,461 |   | 610 |   |
| Effect of exchange rate changes on cash and cash  equivalents                       |       | 332                                                           |       | (367 | ) | (463 | ) |
| Net (decrease)/increase in cash and cash equivalents                                |       | (686                                                          | )          | 7,417 |   | (2,069 | ) |
| Cash and cash equivalents at beginning of year                                      |       | 9,460                                                         |       | 2,043 |   | 4,112 |   |
| Cash and cash  equivalents at end of year                                           |       | $                                                             | 8,774      |   | $ | 9,460 |   | $ | 2,043 |   |
|                                                                                |       |                                                          |       |   |   |   |   |
|                                                                                     |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

 

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

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**BIOSPHERE MEDICAL,INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**A—Nature of 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, 2005, together withanticipated proceeds from sales of microspheres, delivery systems and otherproducts, together with the proceeds from our placement of 2,075,000 shares ofcommon stock, which was completed on February 22, 2006 (see Note Q) willbe sufficient to fund operating and capital requirements, as currently plannedthrough 2007. In the longer term the Company expects to fund its operations andsustaining capital requirements through a combination of expected proceeds fromproduct sales and capital equipment financing. However, cash requirements mayvary materially from those now planned due to a number of factors, including,without limitation, the Company’s failure to achieve expected revenue amounts,costs associated with changes in its uterine fibroid embolization (“UFE”)marketing programs, anticipated research and development expenses, the scopeand results of pre-clinical and clinical testing, changes in the focus anddirection of research and development programs, competitive and technologicaladvances, the timing and results of regulatory review at the United States Foodand Drug Administration (“FDA”) or comparable regulatory agencies in othercountries and the market’s acceptance of any approved products, includingEmbosphere Microspheres for UFE and HepaSphere Microspheres.

**B—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 average exchangerates prevailing during each reporting period. Resulting translationadjustments are recorded in the cumulative translation adjustment account instockholders’ equity. Aggregate foreign exchange transaction gains and lossesare included in the accompanying statement of operations for all periodspresented.

***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. In accordance with the Company’sinvestment policy, surplus cash is invested in investment grade corporate andU.S. government debt as well as certain asset-backed securities. At December 31,2004, all marketable securities were classified as available for sale, sincethe Company had the intent to use such securities to satisfy currentliabilities as needed. Available-for-sale marketable securities are carried attheir fair value with unrealized gains and losses included in accumulated othercomprehensive income (loss) in the accompanying balance sheet.

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

The Company has nomaterial concentrations of credit risk, nor is it a party to any financialinstruments with material off-balance sheet risk. Financial instruments thatpotentially subject the Company to concentration of credit risk consistprimarily of cash, cash equivalents, marketable securities, trade accountsreceivable, accounts payable and long-term debt obligations. The estimated fairvalue of the Company’s financial instruments approximates their carrying value.The Company places its cash, cash equivalents and marketable securities withhigh credit quality financial institutions. Concentrations of credit risk withrespect to trade accounts receivable are limited due to the large number ofcustomers and their dispersion across many geographic areas. No single customeraccounted for greater than 10% of the outstanding receivables on December 31,2005 or 2004, and no single customer accounted for greater than 10% of revenuesin 2005, 2004 or 2003.

***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 age of receivables and on historical write-off experience bylocation. The Company reviews its allowance for doubtful accounts monthly. Pastdue balances over 90 days and over a specified amount are reviewed individuallyfor collectibility. Account balances are charged off against the allowance whenthe Company feels it is probable the receivable will not be recovered. TheCompany does not have any off-balance-sheet credit exposure related to itscustomers.

***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 intangiblenet assets acquired when accounted for in accordance with the purchase methodof accounting. Between February 1999 and November 2001, the Companyrecorded goodwill upon the periodic step-acquisitions of BMSA.

The Company performsannual impairment reviews of its goodwill. Goodwill was derived from the stepacquisition of BMSA, the consolidated subsidiary that holds the license to theembolotherapy platform device that is the main focus of the Company’s business.Accordingly, impairment measurements are based upon the discounted cash flowsof BMSA statutory profitability and anticipated worldwide sales of the Company’smicrospheres. Based upon the Company’s review, the Company has not recorded anyimpairment charges.

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

The Company periodicallyevaluates the potential impairment of its long-lived assets in accordance withSFAS 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” todetermine whether events or changes in circumstances may indicate that thecarrying amount of a recorded asset may not be recoverable. Based on management’sassessment as of December 31, 2005, the Company has determined that noimpairment of long-lived assets exists.

***Revenue Recognition***

The Company complies with the revenue recognitionguidelines summarized in Staff Accounting Bulletin (SAB) No. 104, “RevenueRecognition.” The Company recognizes revenue when products are shipped and thecustomer takes ownership and assumes risk of loss, collection of the relevantreceivable is reasonably assured, persuasive evidence of an arrangement exists(a valid purchase order from an approved customer), and the sales price isfixed or determinable. Revenue from licensing agreements is recognized ratablyover the period of the related agreement. The Company establishes reserves forpotential sales returns and evaluates, the adequacy of those reserves basedupon realized experience. Under the Company’s current policy, only thoseproducts on a customer’s initial order qualify for product satisfaction-relatedcredit returns. To date, returns related to product satisfaction have beenminimal and immaterial. While such returns have historically been within theCompany’s expectations and the provisions established, the Company cannotguarantee that it will continue to experience the same return rates that it hasin the past. Any significant change in product satisfaction and any resultingcredit returns could have a material adverse impact on the Company’s operatingresults for the period or periods in which such returns materialize. Shippingand handling costs are included in costs of product sales.

In June 2004, theCompany entered into an exclusive five-month development agreement with a thirdparty for the use of Embosphere Microspheres for gastroesophegal reflexdisease, or GERD. In exchange for this agreement, the Company received apayment of $100,000. Based upon the application of the revenue recognitionpolicies and all related judgments and estimates, the Company recognized$100,000 as licensing revenue over the life of the contract, which concluded inNovember 2004.

***Research and Development***

Research and developmentcosts, including product validation costs under FDA Good ManufacturingPractices, are expensed in the period incurred.

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***Deferred 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 theability to apply deferred tax assets against taxable income, which could, inturn, result in a significant impact on the value of the Company’s deferred taxassets and reported operating results.

***Comprehensive Income/(Loss)***

Comprehensiveincome/(loss) is comprised of net loss and other comprehensive income/(loss).Other comprehensive 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 salesecurities, which are reflected separately in stockholders’ equity inaccumulated other comprehensive income/(loss). The components of accumulatedother comprehensive income/(loss) are as follows:

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                              | ** ** | ** **            | ** ** | **2005** | ** ** | ** 2004 ** | ** ** |
| Foreign exchange  currency translation               |       | $                     | (142       | ) |   | $ | (181 | ) |   |
| Unrealized  gains/(losses) on investments            |       | —                |       |   | (7 | ) |   |
| Total accumulated  other comprehensive income/(loss) |       | $                     | (142       | ) |   | $ | (188 | ) |   |
|                                                      |            |                       |            |  |  |  |  |  |  |  |  |

 

***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 common share equivalents as their inclusion would have an antidilutiveeffect.

| ** **                                                 | ** ** | **For the years ended December 31,** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**                                    | ** ** | ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Shares issuable  upon exercise of stock options            |       |     2,624                                      |       |     3,054 |   |     2,924 |   |
| Shares issuable  upon conversion of convertible securities |       | 2,140                                                         |       | 2,017 |   | — |   |
| Shares issuable  upon exercise of outstanding warrants     |       | 400                                                           |       | 563 |   | 163 |   |
| Unvested  restricted stock awards                          |       | 15                                                            |       | — |   | — |   |
|                                                       |       |     5,179                                      |       |     5,634 |   |     3,087 |   |
|                                                            |            |                                                               |            |  |  |  |  |  |  |

 

***Stock Options***

The Company applies the principles of AccountingPrinciples Board Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” and related interpretations inaccounting for its stock incentive plans. Under APB No. 25, compensationexpense is measured as the difference, if any, between the option exerciseprice and the fair value of the Company’s common stock at the date of grant.The Company has historically granted options to employees and directors atexercise prices equal to the fair value of the Company’s 

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common stock. Accordingly,no compensation expense has been recognized for its employee stock-basedcompensation plans.

SFAS No. 123,“*Accounting for Stock-Based Compensation*”,as amended, establishes a fair value based approach for valuing stock options.The Company follows the disclosure-only alternative afforded by SFAS No. 123.Had compensation expense for stock options issued to employees and directorsbeen determined based on the estimated fair value at the grant dates ascalculated in accordance with SFAS No. 123, the Company’s reported netloss and basic and diluted net loss per common share for the years ended December 31,2005, 2004 and 2003 would have been adjusted to the pro forma amounts indicatedbelow:

| ** **                                                            | ** ** | **For the years ended December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | ** **                                                    | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** |
| Net loss  applicable to common stockholders                           |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                           |       |                                                          | $          | (3,296 | ) |   |   | $ | (6,909 | ) |   |   | $ | (7,352 | ) |   |
| Pro forma compensation expense                                        |       |                                                          | (872       | ) |   |   | (894 | ) |   |   | (1,617 | ) |   |
| Pro forma net loss                                                    |       |                                                          | $          | (4,168 | ) |   |   | $ | (7,803 | ) |   |   | $ | (8,969 | ) |   |
| Basic and diluted  loss per share                                     |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                           |       |                                                          | $          | (0.22 | ) |   |   | $ | (0.49 | ) |   |   | $ | (0.55 | ) |   |
| Pro forma                                                             |       |                                                          | $          | (0.28 | ) |   |   | $ | (0.55 | ) |   |   | $ | (0.67 | ) |   |
|                                                                       |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaverage estimated fair value of options granted during fiscal years 2005, 2004and 2003 was $3.20, $2.09, and $3.20, respectively, and was estimated using theBlack-Scholes option-pricing model using the following weighted-averageassumptions:

| ** **               | ** ** | **2005**       | ** ** | **2004**       | ** ** | **2003**       | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| Dividend yield           |       | None           |       | None           |       | None           |       |
| Volatility               |       | 84             | %          | 93             | %          | 111            | %          |
| Risk-free  interest rate |       | 3.73–4.37 | %          | 2.80–3.81 | %          | 3.35–3.70 | %          |
| Expected life (years)    |       | 6              |       | 5              |       | 5              |       |

 

***Stock-Based Compensation to Non-Employees***

The Company accounts forstock-based compensation to non-employees using the fair value methodprescribed by SFAS No. 123. As a result of stock options issued tonon-employee medical board advisors, the Company recognized $39,000 innon-employee compensation expense during the year ended December 31, 2003.The fair value of the non-employee stock options was derived from theBlack-Scholes option-pricing model.

***Reclassifications***

Certain reclassificationshave been made to prior year’s consolidated financial statements to conform tothe current year presentation.

***New Accounting Pronouncements***

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (as revised, “SFAS 123R”). SFAS 123R addresses the accounting fortransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise, or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS 123R supersedes APB 25 and requiresthat such transactions be accounted for using a fair-value based method. SFAS123R requires companies to recognize an expense for compensation cost relatedto share-based payment arrangements, including 

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stock option and employeestock purchase plans. In April 2005, the Securities and ExchangeCommission (“SEC”) announced the adoption of a new rule that amends thecompliance dates for SFAS 123R. The new rule of the SEC requires companiesto implement SFAS 123R at the beginning of the next fiscal year that beginsafter June 15, 2005. Accordingly, the Company adopted SFAS 123R as of January 1,2006. The Company expects to use the modified-prospective transition method andwill not restate prior periods for the adoption of SFAS 123R.

As permitted by Statement of Financial AccountingStandards No. 123 (“SFAS 123”), the Company currently accounts forshare-based payments to employees using APB 25’s intrinsic value method and, assuch,  generally recognizes nocompensation cost for employee stock options. Accordingly, the adoption ofSFAS 123R fair value method will have a significant impact on theCompany’s result of operations, although it will have no impact on its overallfinancial position and cash position. The impact of adoption of SFAS 123Rcannot be quantified at this time because it will depend on the level ofshare-based payments granted in the future, expected volatilities and expecteduseful lives, among other factors, present at the grant date. However, based onthe Company’s current assumptions the adoption of SFAS 123R is expected toincrease compensation costs by approximately $1.30 million in 2006.

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs—an amendment of Accounting Research Bulletin (“ARB”) No. 43,Chapter 4” (“SFAS 151”). SFAS 151 is the result of a broader effort by the FASBto improve the comparability of cross-border financial reporting by workingwith the International Accounting Standards Board (“IASB”) toward developmentof a single set of high quality accounting standards. The FASB and the IASBnoted that both ARB No. 43, Chapter 4 and International AccountingStandard (“IAS”) No. 2, “Inventories,” require that abnormal amounts ofidle freight, handling costs, and wasted materials be recognized as periodcosts; however, the FASB and the IASB noted that differences in the wording ofthe two standards could lead to inconsistent application of those similarrequirements. The FASB concluded that clarifying the existing requirements inARB No. 43 by adopting language similar to that used in IAS No. 2 isconsistent with its goals of improving financial reporting in the United Statesand promoting convergence of accounting standards internationally. Adoption ofSFAS 151 is required for fiscal years beginning after June 15, 2005;accordingly, the Company will adopt SFAS 151 as of January 1, 2006. Theprovisions of SFAS 151 will be applied prospectively. The Company is currentlyin the process of evaluating the impact of SFAS 151, but does not believe itwill have a material impact on the results of operations and financial positionof the Company.

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**C—Goodwill**

Goodwill, comprisedentirely of the unamortized purchase price paid in excess of the net BMSAassets acquired, equaled $1.44 million as of December 31, 2005 and 2004.

**D—Marketable Securities**

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

TheCompany’s cash, cash equivalents and marketable securities as of December 31,2004 are as follows:

| **(in thousands)**                               | ** ** | ** ** | ** ** | **Maturity** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains/  (losses)** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------------|------------|------------|------------|--------------|------------|---------------------|------------|----------------------------------|------------|----------------------------|------------|
| Cash and money  market funds                          |       |       | N/A        |         |       |                | $          | 8,515                            |       |                       |       | $ | — |   |   |   | $ | 8,515 |   |   |
| Corporate  obligations                                |       |       | <1  yr. |         |       |                | 1,185      |                             |       |                       | —     |   |   |   | 1,185 |   |   |
| Asset backed  securities                              |       |       | 1-5  yrs.  |         |       |                | 529        |                             |       |                       | (7         | ) |   |   | 522 |   |   |
| Total                                                 |       |       |       |         |       |                | 10,229     |                             |       |                       | (7         | ) |   |   | 10,222 |   |   |
| Less amounts  classified as cash and cash equivalents |       |       |       |         |       |                | (9,460     | )                                |       |                       | —     |   |   |   | (9,460 | ) |   |
| Total marketable  securities                          |       |       |       |         |       |                | $          | 769                              |       |                       |       | $ | (7 | ) |   |   | $ | 762 |   |   |

 

No material realized gainsor losses on the Company’s marketable securities were recognized during theyears ended December 31, 2005, 2004 and 2003.

**E—Inventories**

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

| ** **              | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-----------------------|------------|
| **(in thousands)** | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Finished goods          |       | $                     | 1,348      |   | $ | 1,450 |   |
| Work in progress        |       | 878                   |       | 1,393 |   |
| Raw material            |       | 209                   |       | 468 |   |
| Total inventory         |       | $                     | 2,435      |   | $ | 3,311 |   |
|                         |            |                       |            |  |  |  |  |  |  |

 

Included in inventory isan excess and obsolete product valuation allowance of $117,000 and $321,000 asof December 31, 2005 and 2004, respectively.

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**F—Property and Equipment**

Propertyand equipment consists of the following:

| ** **                                   | ** ** | **December 31,**        | ** ** |
|----------------------------------------------|------------|------------------------------|------------|
| **(in thousands)**                      | ** ** | ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Office equipment                             |       |  $   976 |       | $ | 1,221 |   |
| Laboratory and  manufacturing equipment |       | 2,166                        |       | 2,276 |   |
| Leasehold  improvements                      |       | 189                          |       | 344 |   |
| Total property and equipment                 |       | 3,331                        |       | 3,841 |   |
| Less: accumulated  depreciation              |       | (2,473                       | )          | (2,707 | ) |
| Net property and equipment    |       | $                            | 858        |   | $ | 1,134 |   |
|                                              |            |                              |            |  |  |  |  |  |  |

 

Propertyand equipment under capital lease agreements, which are included in the tableabove, consist of the following:

| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                      | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Office equipment                             |       | $                     | 101        |   | $ | 84 |   |
| Laboratory and  manufacturing equipment |       | 553                   |       | 638 |   |
| Total property and equipment                 |       | 654                   |       | 722 |   |
| Less: accumulated  depreciation              |       | (444                  | )          | (389 | ) |
| Net property and  equipment                  |       | $                     | 210        |   | $ | 333 |   |
|                                              |            |                       |            |  |  |  |  |  |  |

 

Depreciation expense,including amortization on capital leases, was $509,000, $625,000 and $658,000for the years ended December 31, 2005, 2004 and 2003, respectively.

**G—Accrued Compensation**

Accruedcompensation consists of the following:

| ** **                                            | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                               | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Accrued payroll,  vacation and incentive compensation |       | $                     | 1,559      |   | $ | 998 |   |
| Accrued severance                                     |       | 14                    |       | 549 |   |
| Accrued  relocation                                   |       | 257                   |       | 333 |   |
|                                                  |       | $                     | 1,830      |   | $ | 1,880 |   |
|                                                       |            |                       |            |  |  |  |  |  |  |

 

In the fourth quarter of2004, we recorded a $589,000 charge for severance costs related to the terminationof two former executives. The amount accrued at December 31, 2005represents the remaining severance that was paid out in January 2006. Inaddition, at December 31, 2005, there was $257,000 remaining of costsaccrued to relocate two new executives, who were hired during 2004.

**H—Accrued Expenses**

Accruedexpenses consist of the following:

| ** **              | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-----------------------|------------|
| **(in thousands)** | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Accrued royalties       |       | $                     | 702        |   | $ | 613 |   |
| Accrued other           |       | 500                   |       | 611 |   |
|                    |       | $                     | 1,202      |   | $ | 1,224 |   |
|                         |            |                       |            |  |  |  |  |  |  |

 

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**I—Debt and Lease Obligations**

Debtconsists of the following:

| ** **                                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                                             | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Capital lease  obligations                                          |       | $                     | 228        |   | $ | 355 |   |
| Euro term loan  payable to a bank secured by the net assets of BMSA |       | —                |       | 12 |   |
| Less: current  portion                                              |       | (127                  | )          | (175 | ) |
| Total long-term  debt and capital lease obligations                 |       | $                     | 101        |   | $ | 192 |   |
|                                                                     |            |                       |            |  |  |  |  |  |  |

 

The Company currently has a credit facility with abank under which it may borrow up to $3.0 million for general working capitaland corporate purposes, subject to limitations defined in the agreement. Thecredit facility expires in June 2007. There were no borrowings outstandingunder this agreement as of December 31, 2005 or 2004. Each available 30-,60-, 90- or 180- day advance will bear interest at a perannum rate, at the Company’s option, equal to either (i) a variable rateas determined by the bank or (ii) a rate equal to the corresponding 30-,60-, 90- or 180-day LIBOR rate (4.4% as of December 31,2005) plus a LIBOR advance rate spread as determined by certain current workingcapital balances at the time of the advance. In connection with the creditfacility, the Company entered into a security agreement pursuant to which theCompany has pledged to the bank all of the Company’s U.S. assets, excluding ourequity ownership of our subsidiaries including BMSA, as collateral. Letters ofcredit issued in the ordinary course of business totaled $453,000 as of December 31,2005, and were collateralized by the Company’s credit facility noted above.

The Company leases approximately 8,000 square feet ofoffice and lab space at its Rockland, Massachusetts facility under an operatinglease expiring in March 2007 for approximately $156,000 per year,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 €171,000per year (approximately $205,000 as of December 31, 2005). The Companyalso has several operating leases covering certain pieces of manufacturing andoffice equipment through 2010.

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, 2005, are as follows:

| **(in thousands)**                             | ** ** | ** ** | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|-----------------------------------------------------|------------|------------|------------|-----------------------|------------|---------------------|------------|
| 2006                                                |       |       | $          | 507                   |       |                |       | $ | 137 |   |   |
| 2007                                                |       |       | 344        |                  |       |                | 62         |   |   |
| 2008                                                |       |       | 242        |                  |       |                | 29         |   |   |
| 2009                                                |       |       | 206        |                  |       |                | 11         |   |   |
| 2010                                                |       |       | 87         |                  |       |                | 8          |   |   |
| Thereafter                                          |       |       | —     |                  |       |                | —     |   |   |
| Total lease commitments                             |       |       | $          | 1,386                 |       |                |       | 247 |   |   |
| Less amount representing  interest                  |       |       |       |                  |       |                | (19        | ) |   |
| Present value of net minimum capital lease payments |       |       |       |                  |       |                | $          | 228 |   |   |

 

The above table does not include the effect of theCompany’s amendment to the operating lease for the facility located inRockland, Massachusetts, which was completed on February 24, 2006 (SeeNote Q).

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Total facility rental expense for the years ended December 31,2005, 2004 and 2003 was approximately $431,000, $509,000 and $467,000,respectively.

**J—Income Taxes**

As ofDecember 31, 2005, the Company had federal net operating loss (“NOL”)carry forwards of approximately $67.50 million, which will expire through theyear 2025, state NOL carry forwards of approximately $42.56 million, which willexpire through the year 2010, and foreign NOL carry forwards of approximately$3.70 million, which do not expire. As of December 31, 2005, the Companyhas $189,000 of research and development credit carry forwards to offset futureincome taxes, which will expire through the year 2017. The components of theCompany’s net deferred tax asset at December 31, 2005 and 2004 are asfollows:

| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| **(in thousands)**             | ** ** | ** **            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Assets derived from the  following: |       |                  |       |   |   |
| NOL carry forwards                  |       | $                     | 26,890     |   | $ | 26,230 |   |
| Tax credit carry forwards           |       | 187                   |       | 161 |   |
| Other                               |       | 171                   |       | 398 |   |
| Subtotal                            |       | 27,248                |       | 26,789 |   |
| Valuation allowance                 |       | (27,248               | )          | (26,789 | ) |
| Net deferred tax asset              |       | $                     | —     |   | $ | — |   |
|                                     |            |                       |            |  |  |  |  |  |  |

 

The Company has established a full valuation allowanceagainst its deferred tax assets as of December 31, 2005 as it considersthe realizable value of any tax benefit against future taxable income to beuncertain. The change in the valuation allowance from December 31, 2004 toDecember 31, 2005 is a result of the increase in NOL carry forwards anddeferred compensation.

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.

The 2004 income tax provision of $117,000 primarilyrepresents the reversal of income tax benefits recorded during 2002 asmanagement determined in the fourth quarter of 2004 that a portion of the 2001taxes paid would not be recovered. For the years ended December 31, 2005,2004, and 2003, the increase in the valuation allowance relating to losses notresulting in a current period tax benefit is the primary difference between theincome tax provision (benefit) recorded by the Company and what the income taxbenefit would be at statutory income tax rates.

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Thecomponents of the Company’s pre-tax loss by tax jurisdiction, net of anyintercompany transactions, are as follows:

| ** **              | ** ** | **For the years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| United States           |       | $                                                             | (3,100     | ) | $ | (4,996 | ) | $ | (4,729 | ) |
| France                  |       | 206                                                           |       | (1,728 | ) | (2,600 | ) |
| **Pretax  loss**        |       | $                                                             | (2,894     | ) | $ | (6,724 | ) | $ | (7,329 | ) |
|                         |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

**K—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. Financialinformation by geographic area, attributed to countries according to thelocation of customers and equipment, is as follows:

| ** **                     | ** ** | **For the years ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**        | ** ** | ** **                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues:**                  |       |                                                          |       |   |   |   |   |
| United States                  |       | $                                                             | 12,663     |   | $ | 9,080 |   | $ | 8,595 |   |
| France                         |       | 3,382                                                         |       | 2,883 |   | 2,579 |   |
| Other European Union countries |       | 1,658                                                         |       | 1,408 |   | 1,102 |   |
| Other foreign countries        |       | 781                                                           |       | 787 |   | 527 |   |
| Total revenues                 |       | $                                                             | 18,484     |   | $ | 14,158 |   | $ | 12,803 |   |
| **Long- lived assets:**        |       |                                                          |       |   |   |   |   |
| United States                  |       | $                                                             | 297        |   | $ | 425 |   | $ | 616 |   |
| France                         |       | 561                                                           |       | 709 |   | 881 |   |
| Total long- lived  assets      |       | $                                                             | 858        |   | $ | 1,134 |   | $ | 1,497 |   |
|                                |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

**L—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 

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assigneda value of $850,000 using the Black-Scholes option-pricing model. Through December 31,2005, the Company issued 560 shares of series A preferred stock for payment ofseries A preferred stock dividends.

**M—Stock Plans**

***Stock Option Plans***

The Company’s 1997 Stock Option Plan, as amended (the “1997Plan”), provides for the grant of both Incentive Stock Options (“ISOs”) andNon-Statutory Stock Options (“NSOs”) to officers, directors, advisors,consultants and employees of the Company. A total of 5.0 million shares havebeen approved for issuance under the 1997 Plan and as of December 31,2005, approximately 457,000 shares were available for issuance. Optionsgenerally become exercisable in five equal annual installments beginning on thefirst anniversary of the date of grant and have a maximum term of ten yearsfrom the date of grant.

The 1994 Stock Option Plan (the “1994 Plan”) providedfor the grant of ISOs and NSOs to officers, directors, advisors and keyemployees of the Company. The exercise price for ISOs must be at least equal tothe fair market value of the Company’s common stock on the date of grant andthe exercise price of NSOs must be at least equal to 50% of the fair marketvalue of the Company’s common stock on the date of grant. Options generallybecome exercisable in five equal annual installments beginning on the firstanniversary of the date of grant and have a maximum term of ten years from thedate of grant. The 1994 Plan expired in January 2004, and as of December 31,2005, no shares were available for issuance.

The 1994 Director Option Plan (the “Director Plan”),as amended, provided for the granting of NSOs to directors of the Company whoare not officers or employees of the Company or of any subsidiary of theCompany. A total of 300,000 shares of common stock were reserved for issuanceunder the Director Plan subject to adjustments as provided therein. Theexercise price per share will equal the fair market value of a share of Company’scommon stock on the date the option is granted. Options granted under theDirector Plan will vest in either two or five equal installments beginning onthe first anniversary of the date of the grant depending on the nature of thegrant and have a maximum term of ten years from the date of grant. The DirectorPlan expired in January 2000, and as of December 31, 2005, no shareswere available for issuance.

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Thefollowing table summarizes all stock option activity under the three stockoption plans for the three years ended December 31, 2005:

| ** **                                                  | ** ** | **Options issued under the Plans** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **(in thousands, except option price)** | ** ** | ** **                                             | ** ** | **Shares** | ** ** | **Average  Price Per Share** | ** ** |
| Outstanding at  December 31, 2002                      |       |                                                   | 3,767      |   |   |   | $ | 3.66 |   |   |
| Granted                                                     |       |                                                   | 20         |   |   |   | 3.99 |   |   |
| Exercised                                                   |       |                                                   | (609       | ) |   |   | 1.19 |   |   |
| Forfeited                                                   |       |                                                   | (257       | ) |   |   | 7.34 |   |   |
| Outstanding at  December 31, 2003                      |       |                                                   | 2,921      |   |   |   | 3.85 |   |   |
| Granted                                                     |       |                                                   | 1,101      |   |   |   | 2.89 |   |   |
| Exercised                                                   |       |                                                   | (450       | ) |   |   | 1.40 |   |   |
| Forfeited                                                   |       |                                                   | (518       | ) |   |   | 5.39 |   |   |
| Outstanding at  December 31, 2004                      |       |                                                   | 3,054      |   |   |   | 3.57 |   |   |
| Granted                                                     |       |                                                   | 483        |   |   |   | 4.49 |   |   |
| Exercised                                                   |       |                                                   | (705       | ) |   |   | 1.47 |   |   |
| Forfeited                                                   |       |                                                   | (209       | ) |   |   | 6.41 |   |   |
| Outstanding at  December 31, 2005                      |       |                                                   | 2,623      |   |   |   | $ | 4.07 |   |   |
| Exercisable at December 31, 2005                       |       |                                                   | 1,239      |   |   |   | $ | 4.70 |   |   |
| Exercisable at December 31, 2004                       |       |                                                   | 1,741      |   |   |   | $ | 3.69 |   |   |
| Exercisable at  December 31, 2003                      |       |                                                   | 1,904      |   |   |   | $ | 3.28 |   |   |
|                                                             |            |                                                        |            |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information about the range of exercise prices forstock options under the three plans, outstanding and exercisable as of December 31,2005:

| ** **                                                           | ** ** | ** ** | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                  | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|-----------------------------------------------|------------|
| **Range of Exercise Prices**                          | ** ** | ** ** | ** ** | **Number  Outstanding**      | ** ** | **Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| **(in thousands except per share amounts)** | ** ** | ** ** | ** ** | ** **                   | ** ** |
| $0.81                                                                | –     | $2.00      |            |                         | 390        |                                          |       | 2.49 |   |   |   | $1.50 |   |   | 390 |   |   |   $1.50 |   |   |
| $2.31                                                                | –     | $2.31      |            |                         | 15         |                                          |       | 3.94 |   |   |   | $2.31 |   |   | 15 |   |   | $2.31 |   |   |
| $2.55                                                                | –     | $2.55      |            |                         | 600        |                                          |       | 8.84 |   |   |   | $2.55 |   |   | 100 |   |   | $2.55 |   |   |
| $2.70                                                                | –     | $3.29      |            |                         | 405        |                                          |       | 7.26 |   |   |   | $3.14 |   |   | 176 |   |   | $3.16 |   |   |
| $3.31                                                                | –     | $4.25      |            |                         | 549        |                                          |       | 5.37 |   |   |   | $3.85 |   |   | 354 |   |   | $4.12 |   |   |
| $4.49                                                                | –     | $4.49      |            |                         | 393        |                                          |       | 9.45 |   |   |   | $4.49 |   |   | — |   |   | — |   |   |
| $4.98                                                                | –     | $27.25     |            |                         | 271        |                                          |       | 5.57 |   |   |   | $12.52 |   |   | 204 |   |   | $14.40 |   |   |
| $0.81                                                                | –     | $27.25     |            |                         | 2,623      |                                          |       | 6.65 |   |   |   | $4.07 |   |   | 1,239 |   |   | $4.70 |   |   |
|                                                                      |            |            |            |                              |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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***Employee StockPurchase Plans***

Under the 2000 Employee Stock Purchase Plan (the “2000ESPP”), an aggregate of 50,000 shares of common stock may be purchased byemployees at 85% of the fair market value on the first or last day of eachsix-month offering period, whichever is lower. During each offering period, themaximum number of shares which may be purchased by a participating employee isdetermined on the first day of the offering period and is equal to the numberof shares of common stock determined by dividing $12,500 by the last reportedsale price of the common stock on the NASDAQ National Market on the first dayof the offering. An eligible employee may elect to have up to a maximum of 10%deducted through payroll deductions from his or her regular salary. During2005, 2004 and 2003, respectively, 7,836, 9,207 and 11,834 shares of theCompany’s common stock were issued under the 2000 ESPP.

**N—EmployeesSavings Plan**

The Company has a 401(k) savings plan for alldomestic employees pursuant to which eligible employees may voluntarilycontribute up to $14,000 subject to statutory limitations. In addition, theCompany matches in cash 50% of the first $3,000 contributed by employees up toa $1,500 maximum per employee per year. Employer cash matching contributionsamounted to approximately $36,000, $38,000, and $49,000 for the years ended December 31,2005, 2004 and 2003, respectively.

**O—Valuationand Qualifying Accounts**

The Company monitors thecredit worthiness of its trade customers based upon historical paymentexperience. A rollforward of the allowance for doubtful accounts for the yearsended December 31, 2005, 2004 and 2003 is as follows:

| **(in thousands)**            | ** ** | ** ** | ** ** | **Balance,  Beginning  of Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions** | ** ** | **Balance,  End of  Period** | ** ** |
|------------------------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------------------------|------------|----------------|------------|-----------------------------------|------------|
| Year ended December 31,  2005 |       |       | $          | 184                                     |       |                                          |       | $              | 66         |                              |       |   | $ | (17 | ) |   |   | $ | 233 |   |   |
| Year ended December 31,  2004 |       |       | $          | 180                                     |       |                                          |       | $              | 80         |                              |       |   | $ | (76 | ) |   |   | $ | 184 |   |   |
| Year ended December 31,  2003 |       |       | $          | 117                                     |       |                                          |       | $              | 71         |                              |       |   | $ | (8 | ) |   |   | $ | 180 |   |   |

 

**P—Contingencies**

On August 17, 2005, alawsuit commenced in the Circuit Court, Twenty-Second Judicial Circuit,St. Louis, Missouri captioned *BrettPingel by next friend Dawn LaRose vs. BioSphere Medical, Inc., Bruce KirkeBieneman, M.D., St. Louis University Hospital, John Stith, M.D. and St. LouisUniversity.*The lawsuit alleges, among other things, that a patientsuffered permanent bilateral blindness as a result of the use of the Company’sEmbosphere Microspheres in a juvenile nasal angiofibroma embolization or thenegligence of the healthcare providers or both factors combined. All defendantshave denied the allegations against them. Plaintiffs seek compensatory andpunitive damages. The Company carries product liability insurance and this caseis currently being defended by the Company’s insurer under reservation ofrights with respect to the claim of punitive damages, for which an exclusionfrom coverage exists. The Company has filed an answer to this lawsuit in whichit has denied the claims being made. The Company believes that this lawsuit iswithout merit and that it has viable defenses to the allegations in thecomplaint. Accordingly, the Company intends to defend against the claimsvigorously.  However, the Company cannotgive any assurance that it will prevail and it is currently unable to predictthe impact, financial or otherwise, of this product liability litigation.

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**Q—Subsequent Events**

On February 22, 2006, the Company sold 2,075,000shares of the Company’s common stock at a per share price of $7.00 to severalinvestors in a private placement. Net proceeds to the Company wereapproximately $13.40 million.

On February 24, 2006,the Company amended the lease for the Rockland, Massachusetts facilityincreasing the total area of leased space to approximately 13,000 square feetat a monthly cost of $19,500 per month, and extending the term of the leasethrough February 28, 2009.

**R—Quarterly Financial Data (Unaudited)**

The following is a summaryof quarterly financial results:

| ** **                                                           | ** ** | ** ** | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(in thousands except per share amounts)** | ** ** | ** ** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Net revenues                                                         |       |       |       |        |       |        |       |        |       |
| 2005                                                                 |       | $          | 4,429      |        | $          | 4,489       |       | $           | 4,412      |        | $          | 5,154 |   |
| 2004                                                                 |       | 3,180      |       | 3,226       |       | 3,473       |       | 4,279       |       |
| Gross profit                                                         |       |       |       |        |       |        |       |        |       |
| 2005                                                                 |       | 2,888      |       | 2,990       |       | 2,866       |       | 3,437       |       |
| 2004                                                                 |       | 1,618      |       | 938         |       | 2,312       |       | 2,644       |       |
| Net loss applicable to common stockholders                           |       |       |       |        |       |        |       |        |       |
| 2005                                                                 |       | (1,346     | )          | (1,159      | )          | (519        | )          | (272        | )          |
| 2004(1)                                                              |       | (1,556     | )          | (2,243      | )          | (1,148      | )          | (1,962      | )          |
| Basic and diluted net loss per share                                 |       |       |       |        |       |        |       |        |       |
| 2005                                                                 |       | $          | (0.09      | )           | $          | (0.08       | )          | $           | (0.04      | )           | $          | (0.02 | ) |
| 2004                                                                 |       | (0.11      | )          | (0.16       | )          | (0.08       | )          | (0.14       | )          |

----

(1)—Included in the fourthquarter of 2004 is an $874,000 litigation charge related to the termination ofa distribution agreement with Terumo Europe.

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

None.

**Item 9A.**                CONTROLSAND PROCEDURES

Our management, with theparticipation of the Company’s chief executive officer and chief financialofficer, evaluated the effectiveness of the Company’s disclosure controls andprocedures as of December 31, 2005. The term “disclosure controls andprocedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, 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 31,2005, 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 internal control over financialreporting occurred during the fiscal quarter ended December 31, 2005 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

**Item9B.**               OTHER INFORMATION

None.

 

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**PART III**

**Item 10.**                 DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

**Directors and Executive Officers**

Information regarding our directors will be includedin the definitive proxy statement for the 2006 Annual Meeting of Stockholdersunder “Nominees for Director” and is herein incorporated by reference.

Information regarding ourofficers 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 2006 Annual Meeting ofStockholders under “Board and Committee Meetings” and “Report of the Audit Committee”and is herein incorporated by reference.

**Audit Committee Financial 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 2006 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) aswell as our employees, a copy of which is listed as an exhibit to this annualreport on Form 10-K. A copy of our code of ethics is also availableon the Company’s website at *www.biospheremed.com*.

**Item 11.**                 EXECUTIVECOMPENSATION

The response to this itemwill be included in the definitive proxy statement for the 2006 Annual Meetingof Stockholders under “Compensation of Executive Officers” and is hereinincorporated by reference.

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

The response to this itemwill be included in the definitive proxy statement for the 2006 Annual Meetingof Stockholders under “Stock Ownership of Certain Beneficial Owners andManagement” and “Equity Compensation Plan Information” and is herein incorporatedby reference.

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**Item 13.**                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The response to this itemwill be included in the definitive proxy statement for the 2006 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 2006 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, 2005 and 2004                                                                                  |
| Consolidated Statements  of Operations—Years ended December 31, 2005, 2004 and 2003                                                      |
| Consolidated Statements  of Stockholders’ Equity and Comprehensive Income (Loss)—Years ended December 31,  2005, 2004 and 2003 |
| Consolidated Statements  of Cash Flows—Years ended December 31, 2005, 2004 and 2003                                                      |
| 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)   Exhibits included 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)).                                                                              |
| 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) |   | Executive Retention  Agreement between BioSphere Medical, Inc. and Alain Massot, dated March 25,  2004. (Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2004 (File No. 000-23678)).                                                                                                                       |
| 10.22(1) |   | Employment Agreement  between BioSphere Medical, Inc. and Alain Massot, dated March 25,  2004. (Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2004 (File No. 000-23678)).                                                                                                                                |
| 10.23(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)).                                                                                                                                                   |

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| 10.24(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)).                                                                                  |
|----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25(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)).                                                                         |
| 10.26    |   | 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)).                                                    |
| 10.27    |   | 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)).                                                           |
| 10.28    |   | 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)).                                                                                                    |
| 10.29    |   | 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)).                                                                                                              |
| 10.30    |   | 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)).                                        |
| 10.31    |   | 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)).                                                                                  |
| 10.32    |   | 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)).                                                                                            |
| 10.33    |   | 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)).       |
| 10.34    |   | 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)). |
| 10.35(1) |   | Severance Agreement and  General Release between BioSphere Medical, Inc. and Thomas Keenan, dated  January 21, 2005. (Incorporated herein by reference to the Company’s  Current Report on Form 8-K filed on January 27, 2005 (File No. 000-23678)).                                                                       |
| 10.36(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 (File No. 000-23678)).                                                                                                                                                    |
| 10.37(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)).                                                                                            |

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| 10.38(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)).                                      |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.39    |   | 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)). |
| 10.40    |   | 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)). |
| 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 21, 2006.                                                |
| 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 21, 2006.                                                |
| 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 21,  2006.                                                                                                        |
| 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 21,  2006.                                                                                                        |

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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 21, 2006 |                          |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

|                                        | **Signature** | ** **                                       | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|----------------------------------------|---------------|--------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ RICHARD  J. FALESCHINI             |          | Director,  President and Chief Executive Officer |       | March 21,  2006 |
| **Richard J. Faleschini**              |          | (Principal Executive  Officer)                   |       |                 |
| /s/ MARTIN  J. JOYCE                   |          | Vice President  and Chief Financial Officer      |       | March 21,  2006 |
| **Martin J. Joyce**                    |          | (Principal Financial and  Accounting Officer)    |       |                 |
| /s/ TIMOTHY  J. BARBERICH              |          | Director                                         |       | March 21,  2006 |
| **Timothy J. Barberich**               |          |                                             |       |                 |
| /s/ WILLIAM  M. COUSINS, JR.           |          | Director                                         |       | March 21,  2006 |
| **William M. Cousins, Jr.**       |          |                                             |       |                 |
| /s/ ALEXANDER  M. KLIBANOV, Ph.D. |          | Director                                         |       | March 21,  2006 |
| **Alexander M. Klibanov, Ph.D.**       |          |                                             |       |                 |
| /s/ JOHN  H. MACKINNON                 |          | Director                                         |       | March 21,  2006 |
| **John H. MacKinnon, CPA**             |          |                                             |       |                 |
| /s/ RICCARDO  PIGLIUCCI                |          | Director                                         |       | March 21,  2006 |
| **Riccardo Pigliucci**                 |          |                                             |       |                 |
| /s/ DAVID  P. SOUTHWELL                |          | Director and  Chairman of the Board              |       | March 21,  2006 |
| **David  P. Southwell**                |          |                                             |       |                 |

 

 

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