**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-K

**FOR ANNUAL AND TRANSITION REPORTS PURSUANT TOSECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**x    ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934**

**Forthe fiscal year ended: December 31, 2004**

**or**

**o    TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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  or Organization) | (I.R.S. Employer  Identification No.) |

 

**1050 Hingham St.,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 markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.   Yes  x    No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  o    No  x

The aggregate market valueof voting common stock held by non-affiliates of the registrant on June 30,2004 was $22,431,000 based on the closing price of the common stock as reportedby the Nasdaq National Market as of such date.

The Registrant had14,425,421 shares of common stock outstanding as of March 15, 2005.

**Documentsincorporated by reference:**

Portions of theRegistrant’s Definitive Proxy Statement for the 2005 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 reporton Form 10-K contains forward-looking statements that involve risks,uncertainties and assumptions that, if they never materialize or proveincorrect, could cause the results of BioSphere to differ materially from thoseexpressed or implied by such forward-looking statements. All statements otherthan statements 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 “Business—FactorsThat May Affect Future Results” and elsewhere in this annual report andthat are otherwise described from time to time in our Securities and ExchangeCommission reports filed after this report.*

*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

We are focused on applying our proprietary microspheretechnology to medical applications using embolotherapy techniques.Embolotherapy is the process of obstructing a blood vessel or organ by theinsertion or lodgment of particles or other materials. Embolotherapy works byreducing blood flow to targeted areas of the body. Our core technologiesconsist of patented bio-engineered polymers, which are chemical compounds thatwe create through the application to medical science of engineering principles,and manufacturing methods. These core technologies are used to produceminiature spherical beads with uniquely beneficial properties for a variety ofmedical applications. Byselectively blocking the target tissue’s blood supply, the deprived tissue willeither become destroyed or devitalized, resulting in therapeutic benefit.

Our principal focus is the treatment of symptomaticuterine fibroids, which are non-cancerous tumors growing within or on the wallof the uterus, using a procedure called uterine fibroid embolization, or UFE.UFE is a minimally invasive procedure in which microspheres are injectedthrough a small catheter into the blood vessels that supply the uterus. Bloodflow guides these particles into the network of vessels that preferentiallyflow toward the fibroids, thereby blocking the blood supply to the fibroids,but not the surrounding healthy tissue. Most patients with uterine fibroids arenot initially symptomatic and remain untreated until the patient experiencessymptoms such as abnormal bleeding, increased urinary frequency, pain, swellingor fertility difficulties. Our products are continuing to gain acceptance inthis rapidly emerging procedure, as well as in a number of other new andestablished medical treatments. Our strategy is twofold. First, we are seekingto grow the embolotherapy business worldwide, specifically the UFE procedure,by increasing the awareness and availability of this procedure. Second, we willseek to maintain our current technology leadership by introducing new productsand product improvements, through both internally developed and externallyacquired technologies, that improve and broaden the use of embolotherapytechniques.

Our initial products, 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 a varietyof precise sizes, so they can be selected to target occlusion of specific sizedvessels to produce predictable results.

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In November 2002, we received 510(k) clearancefrom the Food and Drug Administration, or FDA, to market our EmbosphereMicrospheres for UFE. Significant third-party clinical data and publicationssupport the safety and effectiveness of the UFE procedure. We believe that agrowing part of the medical community perceives UFE to be a reasonablealternative for most patients who now consider or undergo hysterectomy fortreatment of their fibroids. For these reasons, we believe the number of UFEprocedures has the potential to increase at an accelerating rate. We were thefirst company to gain regulatory clearance to market a product for UFE in theUnited States. During 2004, we continued to focus on seeking to grow ourEmbosphere Microsphere business through media relations activities, as well asreferral physician and patient awareness programs. We continue to develop oursales and marketing organization to maintain our leadership position in thefield of UFE.

We also believe that growth opportunities exist in theuse of other embolotherapy procedures, notably in the treatment of livercancer. We obtained CE approval mark for our Hepasphere SAPTMMicrospheres forthe treatment of liver cancer in the third quarter of 2004 and expect to begincommercializing this product in the European Union in 2005. CE mark approvaldenotes conformity with European standards for safety and allows certifieddevices to be placed in the market in European Union countries. We continue toconduct and support research on the safety and effectiveness of our productcandidates in other indications. Specifically, we are currently engaged inpreclinical research on the development of temporary or dissolving embolics andthe use of our microsphere technology for the targeted delivery of radiationtherapy. We have also sought to develop new and improved technologies. Forexample, in 2002 we introduced our EmboCath® Infusion Catheter andour Segway® Guidewire, the first products in our microspheredelivery system product line.

We believe that our microsphere technologies haveseveral non-embolotherapy applications, such as tissue bulking, repair andregeneration. For example, we have explored the use of our microspheres in thetreatment of stress urinary incontinence, gastroesophageal reflux disease,urinary reflux and certain dermal defects. As a result of these efforts, wefiled a number of patent applications related to the application of ourtechnologies in these areas. Although our current focus is on embolotherapymarkets and significant additional research in these areas would be required,we believe that these non-embolotherapy applications may provide us withdevelopment and commercialization opportunities through internal efforts orthird party licensing, collaboration or similar opportunities.

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 the contextotherwise requires, references in this annual report on Form 10-K to “BioSphere,”“we,” and “our” refer to BioSphere Medical, Inc. and our subsidiaries.

We maintain a website with the address www.biospheremed.com.We are not including the information contained in our website as part of, orincorporating it by reference into, this annual report on Form 10-K. Wemake our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and all amendments to those reports availablefree of charge on our website as soon as reasonably practicable after weelectronically file this material with, or furnish this material to, the U.S.Securities and Exchange Commission.

BioSphere®, Embosphere®,EmboGold®, EmboCath®, Segway®, Hepasphere SAPTM,TempRXTM, RadiosphereTM, and ASK4UFETM are trademarks of BioSphere Medical, Inc.Other trademarks appearing in this annual report are the property of theirrespective holders.

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**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, and 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**

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

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

·       **Myomectomy.  **Myomectomy is the surgical removal of theuterine fibroids without removal of the uterus. It is usually performed onwomen who wish to preserve their fertility. Only fibroids that can be easilyaccessed and excised are candidates for removal with this technique. Becausesome fibroids are difficult to identify while others are difficult to remove,there is a relatively high symptom recurrence rate, between 10% and 30%, aftermyomectomy. Partly for this reason and because only a small percentage ofgynecologists are trained to perform this procedure, relatively fewmyomectomies are performed compared to the number of eligible patients.

·       **Drug Therapy and “Watchful Waiting.”  **Drug therapiesinclude non-steroidal anti-inflammatory drugs, oral contraceptive pills,progestational agents and gonadotropin-releasing hormone agonists. Women withless severe symptoms who elect against drug therapy and those seeking toconceive have few satisfactory options. In these circumstances, physiciansusually monitor symptoms and will administer therapy only if the conditionworsens.

·       **Other treatments.**   Other treatments for benign uterineconditions 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 menorrhagia andwho have completed their childbearing.

**Liver Cancer**

Liver cancer is one of the most prevalent forms ofcancer worldwide. There are several types of liver cancer. Metastatic livercancer occurs when cancer begins in another part of the body, such as thecolon, and then migrates, or spreads, to the liver. Primary liver cancer refersto cancer that begins within the liver itself. Hepatitis B andhepatitis C, inflammations of the liver caused by the hepatitis virus, arecontributing factors to the development of primary liver cancer. In the U.S.,metastatic liver cancer is more prominent than primary liver cancer. However,the rate of primary liver cancer, where the cancer originates in the 

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liver, is expected toincrease dramatically in the U.S. due to increased incidences of hepatitis C, akey risk factor for primary liver cancer. There is a high incidence of primaryliver cancer outside of the U.S., particularly in Asia, due to the high ratesof the hepatitis B and C viruses outside of the U.S.

Primary liver cancer is typically diagnosed at a statethat is too advanced for surgical cure. For the 75 percent of patients, who arenot surgical candidates in the U.S. who fall into this category, existingtreatment options are primarily designed to improve quality of life rather thancure the underlying disease. Many conventional forms of cancer therapy, such assystemic chemotherapy or external beam radiation, do not show significanteffectiveness for most primary liver cancer patients.

Numerous studies and medical publications indicatethat embolotherapy has been used for decades to treat liver cancer. Forexample, particle embolization is commonly used in Japan to manage liver cancerpatients. In the United States, embolic particles are commonly injected withchemotherapeutic agents to control and limit distribution of the chemotherapyagents, thereby increasing the therapeutic exposure at the target area.Recently, a new, targeted approach to treating liver cancer, using radioactiveparticles, has become available. These particles, which are similar to ourEmbosphere Microspheres, are delivered in a targeted fashion, through cathetersplaced in the feeding vessels near the tumor site.

A number of other, less invasive technologies areeither in use or in development to treat inoperable primary liver cancer.Selective tumor ablation, using needle-like devices containing thermal energyor chemicals that are placed directly through the skin and into the tumor, canbe used. However, application of this technique is practically limited to thosewith adequate liver function and relatively small tumors.

We are seeking to developembolotherapy technologies that we believe will offer significant advantagesover the products currently available to treat both primary and metastatic****liver cancer.

**Non-Embolotherapy Applications**

Although our current focus is to develop ourembolotherapy business, we believe there may be applications for our coretechnology in non-embolotherapy applications, particularly as bulking agents toreplace or supplement tissue support. Bulking agents are materials, injectedinto body sites, used to provide extra physical support where normal anatomicsupport is not present. These applications include: stress urinaryincontinence, gastro esophageal reflux disease, urinary reflux in infants andcertain skin conditions.

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 applications mayprovide us with development and commercialization opportunities.

**OUR BUSINESS STRATEGY**

Our goal is to be aglobal leader in embolotherapy. Elements of our strategy to accomplish thisgoal include:

·       **Leverage our FDA clearance to help grow UFE procedures in the UnitedStates and around the world.  **We are seeking to grow theembolotherapy business worldwide, specifically the UFE procedure, by increasingawareness of the availability and benefits of this procedure. We achievedsuccessful regulatory clearance in the United States for use of our EmbosphereMicrosphere product in UFE in late 2002. We have developed a multi-elementsales and marketing campaign and are seeking to improve awareness of UFE toprospective patients and referring physicians in the United States.

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·       **Maintain our technology leadership.  **We are seeking tomaintain our current technology leadership by introducing new products andproduct improvements, through both internally developed and externally acquiredtechnologies, that improve and broaden the use of embolotherapy techniques. Wehave an established track record of introducing new innovations to theembolotherapy market. We introduced our first commercial microsphere in Europein 1997 and in the United States in 2000; the first colorized microsphere, ourEmboGold Microspheres product, in 2001; the first sterilized vial in 2001; andthe first pre-filled sterilized syringe in 2001. In 2002, we became the firstcompany with a product that is FDA cleared in the United States for use in UFE.Additionally, in 2002 we introduced two new accessory embolotherapy productsdesigned specifically to deliver our products and other embolic particles. In2004, we obtained CE mark in the European Union for our Hepasphere SAP Microspheres.We are also seeking to develop a product pipeline of new products and productimprovements.

**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 summarizesinformation about our principal products and products under research anddevelopment.

**Principal Products**
| **PRODUCT**                                 | ** ** | **CLEARED FOR THE FOLLOWING  INTENDED USES**                 | ** ** | **GEOGRAPHIC APPROVALS**                                                                                       |
|---------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|
| Embosphere® Microspheres          |       | Uterine fibroids,  hypervascularized tumors and arteriovenous malformations |       | United States, Canada,  European Union, Argentina, Brazil, Costa Rica, Hong Kong, Korea, Taiwan and  Australia |
| EmboGold® Microspheres                 |       | Hypervascularized  tumors and arteriovenous malformations                   |       | United States,  Canada, European Union, Argentina, Brazil, Costa Rica, Hong Kong, Korea,  Taiwan and Australia |
| Hepasphere SAPTM Microspheres |       | Liver cancer                                                                |       | European Union                                                                                                 |
| EmboCath® Infusion  Catheter           |       | Peripheral  embolization procedures                                         |       | United States,  Canada, European Union, Argentina, Brazil, Costa Rica and Hong Kong                            |
| Segway® Guidewire                      |       | Peripheral  embolization procedures                                         |       | United States,  Canada, European Union, Argentina, Brazil, Costa Rica and Hong Kong                            |

 

**Productsunder Research and Development**
| **PRODUCT**                    | ** ** | **POTENTIAL MARKETS** | ** ** | **DEVELOPMENT STATUS**                    |
|--------------------------------|------------|-----------------------|------------|-------------------------------------------|
| TempRxTM Microspheres      |       | Trauma, hemorrhage    |       | Preclinical Research—Animal  Studies |
| RadiosphereTM Microspheres |       | Cancer                |       | Feasibility                               |

 

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**Embosphere Microspheres**

Our Embosphere Microspheres and EmboGold Microspheresproducts, are intended for use in embolotherapy to block or control the bloodsupply to certain tumors and other vascular malformations. In November 2002,following successful completion of our clinical studies, we received regulatoryclearance in the United States from the FDA for use of our Embosphere Microspheresin treating uterine fibroids. In April 2000, we received 510(k) marketingclearance from the FDA of our Embosphere Microspheres for hypervascularizedtumors and arteriovenous malformations.

We believe that UFE will become the principalapplication for our microsphere products. The majority of our revenues in theUnited States is currently derived from the sale of our Embosphere Microspheresfor UFE. Uterine fibroid embolization is a minimally invasive procedure,performed by interventional radiologists, in which microspheres are injectedthrough a small catheter into the blood vessels that supply the uterus. Bloodflow guides these particles into the network of vessels that preferentiallyflow toward the fibroids, thereby preferentially blocking the blood supply tothe fibroids, but not to the surrounding healthy tissue. The goal of theuterine fibroid embolization procedure is to eliminate the flow of blood to theuterine fibroids, thereby causing fibroid shrinkage and alleviating relatedsymptoms, while preserving normal uterine and ovarian function.

We believe that embolotherapy is a significantly moreattractive alternative for treatment of uterine fibroids, particularly whencompared to the invasiveness of such surgical procedures as hysterectomy ormyomectomy, or even when compared to hormone therapy and “watchful waiting.”Current therapies can have significant adverse side effects, including loss offertility, lengthy recovery periods, high costs, discomfort and risk ofrecurrence of fibroids.

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

We believe Embosphere Microspheres are also being usedin other disease areas and procedures, including liver cancer and arteriovenousmalformations, although we are devoting substantially all of our internalefforts to marketing and selling this product 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 know as microcatheters.Many clinicians prefer using microcatheters during embolization, since such cathetersminimize the frequency of artery or vessel spasm during the procedure. Vesselspasm can be of particular concern during uterine fibroid embolization as itcan disrupt the flow of blood, 

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

·       **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.

·       **Non-biodegradability.**   Our microspheres are composed of asynthetic three-component polymer that is compatible with the human body. Thispolymer is insoluble and non-biodegradable. 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 non-targeted vessels.

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

**EmboGold® Microspheres**

Our EmboGold Microspheresproduct was launched in the United States in September 2001 afterreceiving FDA clearance for treatment of hypervascularized tumors andarteriovenous malformations. In March 2002, we received CE mark approvalin the European Union. This product enhancement adds color to the microspheresfor improved visibility during preparation and injection. We do not have FDAclearance to market our EmboGold Microspheres for use in the treatment ofuterine fibroids, and have determined not to seek such approval at this time. Wemade this decision because of reports that a small number of patients treatedwith UFE using EmboGold Microspheres, which we believe constitute approximately2% of the total number of patients receiving the procedure, reported a delayedonset of pain and/or rash.

**Hepasphere SAPTM Microspheres**

Hepasphere SAPMicrospheres are CE marked in the European Union and Hepasphere SAPMicrospheres are currently in clinical evaluation in Japan. This product sharessome features with our Embosphere Microspheres, which also are used for thetreatment of liver cancer and, in addition, they expand in size. Like treatmentof uterine fibroids, targeted liver embolotherapy is intended to starve theliver tumor without damaging the surrounding tissue or causing any adverse sideeffects on other parts of the body, such as those associated with chemotherapyand radiation. In September 1999, we obtained a worldwide exclusivelicense to Hepasphere SAP Microsphere from Dr. Shinichi Hori.

**Delivery Systems**

During 2002, we introduced our EmboCath InfusionCatheter and our Segway Guidewire, which are our first products in our deliverysystem line. We are seeking to further develop this pipeline with new deliveryproducts and product enhancements.

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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 in thepelvic 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.

**TempRxTM Microspheres**

We believe that anopportunity exists for temporary or resorbing embolic materials, which areembolic particles that degrade or dissolve after some period of time.Currently, embolic materials are frequently used to temporarily treat internalbleeding from trauma or specific disease, and we believe that this could be asuitable application for temporary embolics. We believe that there is also agrowing interest to use temporary or dissolving embolics in many currentembolization applications, including liver and fibroid embolization. We arecurrently conducting preclinical research on our TempRx Microspheres astemporary embolics.

**RadiosphereTM Microspheres**

We are currentlyconducting feasibility studies on our Radiosphere Microspheres, through whichwe are seeking to adapt our microsphere technology in order to createradioactive compounds for targeted delivery of radiation therapy. We believethat the targeting of radiation doses through the body’s blood vessels is apotentially superior method to external radiation treatment modalities becauseit offers a conceptually optimal way of uniformly dosing the tissue that ismost actively proliferating while, at the same time, minimizing dosage tonon-targeted areas. We also believe our technology may offer significantbenefits to physicians and patients compared with first generation productsrecently introduced.

**Other Non-Strategic 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 significant portion of our revenues in 2004and 2003 from these non-strategic products, we do not expect these products tobe a significant 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. We have a worldwide team ofmedical advisors that conduct research, perform clinical studies and publishscientific papers relating to our business areas.

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**RESEARCH AND DEVELOPMENT**

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, 2004, 2003, and 2002, research and development expenseswere $2.39 million, $2.58 million and $3.97 million, respectively.

**COMPETITION**

We encounter, and expectto continue to encounter, competition in the sale of our current and futureembolotherapy and delivery system products. The primary competitiveembolotherapy product has been polyvinyl alcohol, or PVA, a product introducedinto the market more than 20 years ago. Our principal competitors in both thefields of embolotherapy and the delivery systems used in the UFE procedure areAngiodynamics Incorporated, Biocompatibles, Ltd., Boston ScientificCorporation, Cook Incorporated, Cordis Corporation, a Johnson and JohnsonCompany, Pfizer, Inc. and Terumo Corporation, as well as companies sellingor developing non-embolotherapy solutions for the disease states targeted byus. Currently, the primary products with which our microspheres compete forsome of our applications are spherical polyvinyl alcohol, sold by BostonScientific Corporation, Biocompatibles and Terumo, gel foam, sold by Pfizer,and non-spherical polyvinyl alcohol, sold by 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 embolizationcontrol, 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**

*FDA Regulation.  *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 thereunder, the FDA regulates thedevelopment, 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.

*Changes in Approved Devices*.   Wemust obtain new FDA 510(k) clearance or pre-market approval when there isa major change or modification in the intended use of a legally marketed deviceor a change or modification, including product enhancements, to a legallymarketed device that could significantly affect its safety or effectiveness.

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*Good Manufacturing Practices andReporting.  *The Federal Food, Drug, and Cosmetic Actrequires us to comply with Good Manufacturing Practices or Quality Systemsregulations. We must comply with various quality control requirementspertaining to all aspects of our product design and manufacturing process,including requirements for packaging, labeling and record keeping, includingcomplaint files. The FDA enforces these requirements through periodic inspectionsof medical device manufacturing facilities. In addition, the medical devicereporting regulation obligates us to inform the FDA whenever informationreasonably suggests that one of our devices may have caused or contributed todeath or serious injury, or when one of our devices malfunctions, if the devicewould be likely to cause or contribute to a death or a serious injury in theevent the malfunction recurred. We believe we, and all of our contractmanufacturers, are in compliance with applicable Good Manufacturing Practicesand Quality Systems regulations and with medical device reporting requirements.

*Labeling and Advertising*.   Labelingand promotional activities are also subject to scrutiny by the FDA. Among otherthings, labeling is violative of the law if it is false or misleading in anyrespect or it fails to contain adequate directions for use. Moreover, claimsthat are outside the labeling either approved or cleared by the FDA may violatethe Federal Food, 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.

*Import Requirements.  *Toimport a device, the importer must file an entry notice and bond with the U.S.Customs Service pending an FDA decision on the product’s admissibility. Alldevices are subject to FDA examination before release from Customs. Any articlethat appears to be in violation of the Federal Food, Drug, and Cosmetic Act maybe refused admission and a notice of detention and hearing may be issued.

*Export Requirements*.   Productsfor export from Europe and from the United States are subject to foreigncountries’ import requirements and the FDA’s or European regulating bodies’exporting requirements. In addition to the import requirements of foreigncountries, we must also comply with the United States laws governing the exportof products regulated by the FDA. However, foreign countries often require,among other things, an FDA certificate for products for export. To obtain thiscertificate, the device manufacturer must certify to the FDA that the producthas been granted clearance or approval in the United States and that themanufacturing facilities are in compliance with Good Manufacturing Practicesregulations at the time of the last FDA inspection.

*Fines and Penalties forNoncompliance.  *Failure to comply with applicable FDAregulatory 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.

Medical device laws are also in effect in manycountries outside of the United States. These range from comprehensive deviceapproval requirements for some or all of our medical device products to simplerrequests for product data or certification. The number and scope of theserequirements are increasing. Sales of medical devices in the European Union aresubject to the European Medical Device Directive. This directive containsrequirements for quality system and product performance guidelines with whichall manufacturers must comply. These guidelines contain quality systemguidelines and preproduction product design verification that closely resemblecurrent FDA requirements. In 1997, we obtained ISO 9002 international qualitysystems registration, a certification showing that our manufacturing proceduresand facilities comply with standards for quality assurance and manufacturing 

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process control. Ourcompliance with this registration has been confirmed since 1997 in semi-annualsurveillance audits.

Failure to materially comply with applicable federal,state and foreign medical device laws and regulations would likely have amaterial adverse effect on our business. In addition, federal, state andforeign regulations regarding the manufacture and sale of medical devices aresubject to future changes.

We are subject to variousfederal, state, local and foreign laws and regulations relating to theprotection of the environment, as well as health and safety. In the course ofour business, we are involved in the handling, storage and disposal of limitedamounts of certain chemicals. The laws and regulations applicable to ouroperations include provisions that regulate the discharge of materials into theenvironment. 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 capitalexpenditures, results of operations or competitive position. Failure to complywith applicable environmental and related laws could have a material adverseeffect on our business. In addition, because the requirements imposed by suchlaws and regulations are frequently changed, we are unable to predict the costof compliance with such requirements in the future, or the effect of such lawson our capital expenditures, results of operations or competitive position.

**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 patents that wejointly own with AP-HP relating to Embosphere Microspheres. We are required topay to AP-HP a royalty on the commercial sale of any products that incorporatetechnology covered by the patents. We may only sublicense these exclusiverights under the agreement with the prior written consent of AP-HP, whichconsent cannot be unreasonably withheld. The rights granted under the contractare for an initial period, which ends on September 16, 2009, and arerenewable by mutual agreement between the parties. The agreement can beterminated on three months’ notice by either party if the other party does notperform one or more of its obligations under the agreement and fails to cureits nonperformance during the notice period. These jointly-owned patents willexpire in 2014.

In 1999, we entered into an agreement with Dr. ShinichiHori, pursuant to which we have an exclusive royalty-bearing license toJapanese patent rights for our Hepasphere SAP Microsphere product. These patentrights expire in 2012. We are prosecuting patent applications that includeimprovements of this inventor’s technology. However, present applications maynot issue as patents, and these patents, if issued, may not provide us withsufficient protection against competitors. Further, we may be required toobtain additional licenses concerning the Japanese patent application and anylicenses, if obtained, may not be on terms that are acceptable to us.

In 2003, we received a United States patent that isdirected to methods and kits for dermal augmentation and tissue bulking usingmicrospheres, which expires in 2019. In early 2004, we received a 

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U.S. patent directed to amethod of embolization using polyvinyl alcohol microspheres; this patentexpires in 2019.

In 2002, we received a United States patent that isdirected to the treatment of urinary incontinence using microparticles, whichexpires in 2019.

In 2002 and 2004, two additional United States patentswere awarded to us, directed to microspheres capable of swelling and methodsfor their use in dermal augmentation, both of which expire in 2020.

We have numerous United States patent applicationscurrently pending. Almost all of these applications have corresponding Europeanand other foreign applications pending. The subjects of the patents include newmaterials for embolization, new methods of using our materials for embolizationand other applications, as well as new uses of our materials outside ofembolization.

We currently ownthe following U.S. trademarks:

·       BioSphere®

·       Embosphere®

·       EmboGold®

·       EmboCath®

·       Segway®

·       HepasphereSAPTM

·       TempRXTM

·       RadiosphereTM

·       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.

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

In addition, the laws governing patent issuance andthe scope of patent coverage continue to evolve, particularly in life sciences,and the patent rights we possess, or are pursuing, generally cover ourtechnologies to varying degrees. As a result, we cannot ensure that patentswill issue from any of our patent applications or from applications licensed tous, or that any of our issued patents will offer meaningful protection. Inaddition, our issued patents or patents licensed to us may be successfullychallenged, invalidated, circumvented or rendered unenforceable so that ourpatent rights may not create an effective 

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competitive barrier.Moreover, the laws of some foreign countries may not protect our proprietaryrights to the same extent, as do the laws of the United States. There can be noassurance that any patents issued to us will provide a legal basis forestablishing an exclusive market for our products or provide us with anycompetitive advantages, or that the patents of others will not have an adverseeffect on our ability to do business or to continue to use our technologiesfreely. In view of these factors, the value of our intellectual propertyposition is uncertain.

On January 13, 2005, an Opposition proceeding wasbrought by Biocompatibles UK Limited against our granted European Patent1128816 relating to polyvinyl alcohol microspheres useful for embolization andmethods thereof. We intend to file a response to the Opponent’s Brief prior tothe deadline of June 1, 2005. We have validated this European patent inGermany, Spain, France, United Kingdom and Italy. While we are not able topredict the outcome of this proceeding, it will not impact our ability to sellour Embosphere products.

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 corresponding patentsand copyrights arising from their work for us. However, it is possible thatthese agreements may be breached, invalidated or rendered unenforceable, and,if so, our trade secrets could be disclosed to others, including ourcompetitors, and there may not be an adequate corrective remedy available.Despite the measures we have taken to protect our intellectual property,parties to our agreements may breach the confidentiality provisions in ourcontracts or infringe or misappropriate our patents, copyrights, trademarks,trade secrets and other proprietary rights. In addition, third parties mayindependently discover or invent competitive technologies, or reverse engineerour trade secrets or other technology. Therefore, the measures we are taking toprotect our proprietary technology may not be adequate.

**EMPLOYEES**

As of December 31, 2004, we employed 69 persons.Of these employees, nine are primarily engaged in research, development andclinical activities, 22 are engaged in manufacturing, 28 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 2.**                        PROPERTIES

We currently lease office and manufacturing facilitiesin Rockland, Massachusetts, and Roissy, France. Our Rockland, Massachusettsoffice includes approximately 13,000 square feet of corporate offices andlaboratory space pursuant to a five-year lease expiring in March 2005 at acost of $23,000 per month. 

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On January 24, 2005,we entered into an amendment to this lease pursuant to which the leasedpremises is decreased to a total area of approximately 7,797 square feet at amonthly cost of $13,000 per month, and the term of the lease is extendedthrough March 31, 2007.  Our Roissy,France facility includes approximately 18,000 square feet of office, laboratoryand manufacturing space and is leased through May 2010 at a cost of  $22,000 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 as recently amended, and as existing inRoissy, France are suitable to meet our current requirements and that suitableadditional or substitute space will be available to us on commerciallyreasonable terms, if needed in the future.

**Item 3.**                        LEGALPROCEEDINGS

We are not a party to anymaterial legal proceedings.

**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, 2004.

**EXECUTIVE OFFICERS**

As ofMarch 25, 2005, our executive officers, their respective ages and theirpositions are as follows:
| **Name**              | ** ** | ** ** | ** ** | **Age**                                                             | ** ** | **Position** |
|-----------------------|------------|------------|------------|---------------------------------------------------------------------|------------|--------------|
| Richard J. Faleschini |       | 58         |       | President and Chief  Executive Officer                              |
| Martin J. Joyce       |       | 50         |       | Vice President and Chief Financial Officer |
| Gary M. Saxton        |       | 44         |       | Senior Vice President  and General Manager           |
| Peter C. Sutcliffe    |       | 55         |       | Vice President, Manufacturing                                       |

 

*Richard J. Faleschini* has served as 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.

*Martin Joyce*hasserved as Chief Financial Officer Vice President since September 2004.From 2000 to 2004, Mr. Joyce served as Managing Partner of Stratex GroupLLC, a provider of biopharmaceutical executive services to early-stagecompanies and venture investors. From 1996 to 2000, Mr. Joyce was NorthAmerican Chief Financial Officer for Serono Inc. a biotechnology company. Priorto serving as North American Chief Financial Officer, Mr. Joyce held avariety of senior level positions within Serono, in finance, sales, marketingand manufacturing. Mr. Joyce’s earlier years were spent at Millipore andBose 

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Corporations focusing onstrategic planning, product rationalization and return on investment analysis.Mr. Joyce received a B.S. in finance from Northeastern University and anM.B.A. from Suffolk University, Boston, Massachusetts.

*Gary Saxton*hasserved as Vice President Marketing and Sales since November 2004. From2001 to 2004, Mr. Saxton was a strategy consultant in the medical deviceindustry. From 1999 to 2001, he was the Vice President of Sales and Marketingat Symphonix Devices, Inc. and the Vice President of Marketing atCardioGenesis Corporation, both publicly traded medical device companies. Mr. Saxtonalso previously held several marketing and strategy positions within Medtronic, Inc.,both in the U.S. 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.

*Peter C. Sutcliffe*has served as Vice President, Manufacturing since October 2002. From 2001to 2002, Mr. Sutcliffe served as the Vice President for North AmericanManufacturing for Whatman, Plc., a life science filtration company. From 1996to 2001, he was the Chief Operating Officer for HemaSure, Inc., amanufacturer and supplier of blood filters. From 1982 to 1996, Mr. Sutcliffeheld the position of Vice President of Manufacturing for Corning CostarCompany, a life science products company. Prior to Costar, he heldmanufacturing management positions with Millipore, a high technology biosciencecompany. Mr. Sutcliffe holds a B.S. in biology from the University ofRichmond in Virginia and an M.B.A. from Sul Ross State University of Texas,Fort Bliss, Texas.

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**PART II**

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

Our common stock trades on the NASDAQ National Marketunder the symbol “BSMD”. On March 15, 2005, the last reported sale priceof our common stock on the NASDAQ National Market was $3.80 and there wereapproximately 105 stockholders of record and approximately 2,526 beneficialowners of our common stock.

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.
| ** **     | ** ** | **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 |   |

 
| ** **     | ** ** | **2003** | ** ** |
|----------------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 6.75       |   | $ | 3.50 |   |
| Second Quarter |       | $        | 6.20       |   | $ | 4.15 |   |
| Third Quarter  |       | $        | 6.33       |   | $ | 2.80 |   |
| Fourth Quarter |       | $        | 4.45       |   | $ | 2.70 |   |

 

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

The following selectedconsolidated financial data should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andour financial statements and related notes to those statements and otherfinancial information included elsewhere in this annual report on Form 10-K.Historical results are not necessarily indicative of future results.
| **Year Ended December 31,**                              | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **(in thousands, except per share amounts)**   | ** ** | ** ** | ** ** |
| **Statement of Operations Data:**                                       |       |       |       |     |       |     |       |     |       |     |       |
| Revenues:                                                               |       |       |       |     |       |     |       |     |       |     |       |
| Product sales                                                           |       | $          | 14,058     |     | $          | 12,803   |       | $        | 12,152     |     | $          | 8,752    |       | $ | 3,961 |   |
| License fees and collaboration revenues                                 |       | 100        |       | —   |       | —   |       | 250      |       | —   |       |
| Total revenues                                                          |       | 14,158     |       | 12,803   |       | 12,152   |       | 9,002    |       | 3,961    |       |
| Costs and expenses:                                                     |       |       |       |     |       |     |       |     |       |     |       |
| Costs of product sales                                                  |       | 6,646      |       | 5,558    |       | 3,261    |       | 2,356    |       | 1,461    |       |
| Research and development                                                |       | 2,393      |       | 2,577    |       | 3,971    |       | 4,755    |       | 2,517    |       |
| Sales                                                                   |       | 4,923      |       | 5,427    |       | 5,035    |       | 6,137    |       | 2,247    |       |
| Marketing                                                               |       | 2,627      |       | 4,135    |       | 3,024    |       | 3,305    |       | 3,299    |       |
| General and administrative                                              |       | 3,874      |       | 3,126    |       | 4,006    |       | 3,397    |       | 3,562    |       |
| Litigation costs                                                        |       | 874        |       | —   |       | —   |       | —   |       | —   |       |
| Total costs and expenses                                                |       | 21,337     |       | 20,823   |       | 19,297   |       | 19,950   |       | 13,086   |       |
| Loss from operations                                                    |       | (7,179     | )          | (8,020   | )          | (7,145   | )          | (10,948  | )          | (9,125   | )          |
| Other income (expense):                                                 |       |       |       |     |       |     |       |     |       |     |       |
| Interest income                                                         |       | 92         |       | 135      |       | 398      |       | 794      |       | 715      |       |
| Interest expense                                                        |       | (16        | )          | (27      | )          | (29      | )          | (31      | )          | (54      | )          |
| Other                                                                   |       | 379        |       | 583      |       | 214      |       | (72      | )          | 17       |       |
| Loss before income taxes                                                |       | (6,724     | )          | (7,329   | )          | (6,562   | )          | (10,257  | )          | (8,447   | )          |
| Income tax benefit (provision)                                          |       | (117       | )          | (23      | )          | 181      |       | (88      | )          | —   |       |
| Net loss                                                                |       | (6,841     | )          | (7,352   | )          | (6,381   | )          | (10,345  | )          | (8,447   | )          |
| Preferred stock dividends                                               |       | (68        | )          | —   |       | —   |       | —   |       | —   |       |
| Net loss applicable to common stockholders                              |       | $          | (6,909     | )        | $          | (7,352   | )          | $        | (6,381     | )        | $          | (10,345  | )          | $ | (8,447 | ) |
| Basic and diluted net loss per share applicable to  common stockholders |       | $          | (0.49      | )        | $          | (0.55    | )          | $        | (0.49      | )        | $          | (0.89    | )          | $ | (0.87 | ) |
| Basic and diluted  weighted average number of common shares outstanding |       | 14,152     |       | 13,462   |       | 12,988   |       | 11,642   |       | 9,700    |       |

 
| **Balance Sheet Data as of December 31,** | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **(in thousands)**                                                 | ** ** | ** ** | ** ** |
| Cash, cash equivalents and marketable securities                        |       | $          | 10,222     |     | $          | 7,575    |       | $        | 14,738     |     | $          | 23,119   |       | $ | 15,276 |   |
| Working capital                                                         |       | 12,391     |       | 10,704   |       | 17,008   |       | 22,789   |       | 14,136   |       |
| Total assets                                                            |       | 19,391     |       | 17,002   |       | 23,928   |       | 29,984   |       | 19,306   |       |
| Long-term debt and minority interest acquisition  obligation            |       | 192        |       | 171      |       | 270      |       | 303      |       | 575      |       |
| Stockholders’  equity                                              |       | 14,836     |       | 13,525   |       | 20,259   |       | 25,873   |       | 15,686   |       |
|                                                                         |            |            |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

 

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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 “Business-FactorsThat May Affect Future Results” for a discussion of important factors thatcould cause actual results to differ materially from the results described in orimplied by the forward-looking statements contained in the following discussionand analysis**.***

***Overview***

We develop, manufacture andmarket products for medical applications using embolotherapy techniques. Embolotherapyis the process of obstructing a blood vessel or organ by the insertion orlodgment of particles or other materials. Embolotherapy works by reducing blood flow to targeted areas of thebody. Our core technologies consist of patented bio-engineered polymers,which are chemical compounds that we create through the application to medicalscience of engineering principles, and manufacturing methods. These coretechnologies are used to produce miniature spherical beads with uniqueproperties for a variety of applications. Typically,a procedure is performed by an interventional radiologist who injects particlesthrough a catheter into the blood vessels that feed these target areas. Byselectively blocking the target tissue’s blood supply, the deprived tissue willeither become destroyed or devitalized, resulting in therapeutic benefit.

In 2004, we generated revenues primarily from productsales of our Embosphere Microspheres and EmboGold Microspheres in NorthAmerica. We also generate revenues from product sales in the European Union andother geographic territories including the Middle East, Africa, South America,and Asia. Product revenues also include the sale of accessory embolotherapydevices such as our EmboCath Catheter and our Segway Guidewire, as well as ourother non-embolotherapy products, including barium, a substance used to enhancex-rays of the gastrointestinal system and other gastrointestinal medicaltesting, and other ancillary medical devices sold exclusively in Europe. Wecurrently derive a majority of our revenues in the United States from the saleof Embosphere MicroSpheres and EmboGold Microspheres for use in the treatmentof uterine fibroids. We do not have FDA clearance to market our EmboGoldMicrospheres for use in the treatment of uterine fibroids, and we determined in2003 not to seek such approval at this time. We made this decision because ofreports that a small number of the patients treated with UFE using EmboGoldMicrospheres, which we believe constitute approximately 2% of the total numberof patients receiving the procedure, reported a delayed onset of pain and/orrash.

Our principal focus is on growing our EmbosphereMicrosphere and accessory embolotherapy device business worldwide, specificallythe UFE procedure, which we believe will be a key driver to our success. Ourmarketing strategy is to promote UFE through our ASK4UFE awareness andeducation program and also to specifically promote our Embosphere Microspheresas the treatment of choice for UFE. 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 other products as safe,medically therapeutic and cost effective.

In the third quarter of 2004 we obtained CE markapproval in Europe for our Hepasphere SAP Microsphere product for theembolization of liver tumors. We intend to commence marketing of our HepasphereSAP Microsphere for this application in 2005.

In the fourth quarter of 2004, Richard J. Faleschinijoined us as President and Chief Executive Officer and Gary M. Saxton joined us as Vice President,Marketing and Sales.

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We recorded a non-routine charge of $874,000 in thefourth quarter of 2004 related to the payment of damages by BioSphere MedicalS.A., our wholly-owned French subsidiary, in satisfaction of a judgment made infavor of Terumo Europe N.V. by the Commercial Court of Pointoise, France in acontract dispute.

In the fourth quarter of2004, we completed a private placement of $8.00 million of series Aconvertible preferred stock and warrants to purchase common stock with SepracorInc. and affiliates of Cerberus Capital Management, L.P., both of which areexisting investors of the Company.

We have experiencedoperating losses in each fiscal period since our inception. As of December 31,2004, we had approximately $10.22 million in cash, cash equivalents andmarketable securities and an accumulated deficit of approximately $75.50million. Most of our expenditures to date have been for sales and marketingactivities, general and administrative expenses and research and developmentactivities. We expect to experience continued operating losses until at leastthe fourth quarter of 2005 as we execute our business plan, includingcontinuing to establish sales and marketing capabilities and conductingresearch and development activities.

***Research and Development***

Thefollowing table identifies each of the programs for which we have incurredresearch and development expenses in the years ended December 31, 2004,2003 and 2002 and the current development phase of each.
| **Product /  Product Candidate**   | ** ** | ** **                                                                                                                                                                                                     | ** ** | **Development Status** |
|------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|
| Embosphere®  Microspheres     |       | Approved for uterine  fibroids, hypervascularized tumors and arteriovenous malformations in the  United States, Canada, European Union, Argentina, Brazil, Costa Rica, Hong  Kong, Korea, Taiwan and Australia |
| EmboGold®  Microspheres       |       | Approved for  hypervascularized tumors and arteriovenous malformations in the United  States, Canada, European Union, Argentina, Brazil, Costa Rica, Hong Kong,  Korea, Taiwan and Australia                   |
| EmboCath®  Infusion Catheter  |       | Approved for  peripheral embolization procedures in the United States, Canada, European  Union, Argentina, Brazil, Costa Rica and Hong Kong                                                                    |
| Segway®  Guidewire            |       | Approved for  peripheral embolization procedures in the United States, Canada, European  Union, Argentina, Brazil, Costa Rica and Hong Kong                                                                    |
| Hepasphere SAPTM  Microspheres |       | CE Mark obtained  in the European Union; Clinical evaluation in Japan                                                                                                                                          |
| TempRxTM Microspheres          |       | Preclinical  Research—Animal Studies                                                                                                                                                                      |
| RadiosphereTM Microspheres     |       | Feasibility                                                                                                                                                                                                    |

 

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 Good ManufacturingPractices.

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Total research and development expenses were $2.39million, $2.58 million and $3.97 million for the years ended December 31,2004, 2003 and 2002, respectively, representing approximately 11%, 12% and 21%of our total costs and expenses for the years ended December 31, 2004,2003 and 2002, respectively. Our research and development functions typicallywork on a number of projects concurrently. In addition, except for clinicalexpenses, a substantial amount of fixed research and development costs such assalary and salary-related benefits, rent, equipment depreciation, utilities,insurance and maintenance are shared among various programs. Accordingly, wehave not historically tracked specific costs for each of our research anddevelopment projects.

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 “Business—RiskFactors That May Affect Results,” we may not be able to successfullydevelop and commercialize the product candidates included in the table above.

As described in thetable above, we recently have obtained CE mark approval for our Hepasphere SAPMicrospheres, which are also in clinical evaluation in Japan. We have exclusiveworldwide rights to the Hepasphere SAP Microspheres technology under a licensefrom Dr. Shinichi Hori, subject only to Dr. Hori’s right to conductclinical trials on our behalf in Japan, treat patients at Rinku Medical Centerand Osaka Medical Center in Japan and engage in research at Osaka University.Our TempRx Microspheres and Radiosphere Microspheres product developmentinitiatives are in preclinical and feasibility evaluation. The successfuldevelopment of these early-stage product candidates is highly uncertain. Wecannot reasonably estimate or know the nature, timing and estimated costs ofthe efforts necessary to complete the development of, or the period in whichmaterial net cash inflows are expected to commence from, any of our productcandidates due to the numerous risks and uncertainties associated withdeveloping medical devices, including the uncertainty 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 ourprojects on schedule, or at all, and some consequences of failing to do so, areset forth in “Management’s discussion and analysis of financial condition—FactorsThat May Affect Future Results.”

***Critical Accounting Policies***

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us****to make estimates and judgments that affect the reportedamounts of assets and liabilities, revenues and expenses, 

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andrelated disclosure at the date of our financial statements. The significantaccounting policies which we believe are most critical in gaining anunderstanding of our financial statements include policies and judgmentsrelating to revenue recognition, accounts receivable, inventories and deferredtaxes. Actual results could differ materially from these estimates. Oursignificant accounting policies are summarized in note B of the notes to ourconsolidated financial statements. The significant accounting policies which webelieve are the most critical to gaining a full understanding of and evaluatingour reported financial results include the following:

*Revenue Recognition*

We comply with the revenue recognition guidelinessummarized in Staff Accounting Bulletin (SAB) No. 101, “RevenueRecognition in Financial Statements,” as updated by SAB No. 104 “RevenueRecognition.” We recognize revenue when products are shipped and the customertakes ownership and assumes risk of loss, collection of the relevant receivableis probable, persuasive evidence of an arrangement exists (a valid purchaseorder from 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 and evaluatethe adequacy of those reserves based upon realized experience. Under ourcurrent policy, only those products on a customer’s initial order qualify forproduct satisfaction-related credit returns. To date, returns related toproduct satisfaction have been minimal and immaterial. While such returns havehistorically been within our expectations and the provisions established, wecannot guarantee that we will continue to experience the same return rates thatwe have 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 gastroesophegal reflex disease, orGERD. In exchange for this agreement, we received a payment of $100,000. Basedupon the application of our revenue recognition policies and all relatedjudgments and estimates, we recognized $100,000 as licensing revenue over thelife of the contract, which concluded 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 suchdetermination. Although we make every effort to ensure the accuracy of ourproduction process and 

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forecastsof future product demand, any significant unanticipated changes in productionyield or product demand could have a significant impact on the value of ourinventory and our reported operating results.

***Results of Operations***

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

*Revenue and Margin Overview*
| ** **              | ** ** | **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 ofgastroesophageal reflex disease; or GERD, which concluded in the fourth quarterof 2004; and

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

As a result of our strategic focus on UFE and otherembolotherapy applications using our microsphere products, we expect that salesof Embosphere Microspheres and our ancillary embolotherapy delivery systemswill increase in 2005 as compared to 2004.

*Cost ofProduct Sales.  *The $1.09 million or 20% increase incost 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 decrease of $267,000 or 4% as apercent of revenues was primarily attributable to the additional costs relatedto the write-off of in process inventory and expenses associated with the 

23

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product replaced as aresults of the shelf limitations discussed above, offset by increasedmanufacturing efficiencies, net of foreign currency translation adjustments.

We expect that futuregross margin will be highly correlated with the following factors:

·       revenuegrowth;

·       productionlevels;

·       foreignexchange rate movements;

·       sub-contractedmanufacturer and supplier agreement terms and conditions; and

·       future inventory reserverequirements.

*Expense Overview*
| ** **                  | ** ** | **For the Years Ended December 31,** | ** ** | **Inc./**                                                                                                                        | ** ** | **Inc./**                                                                                                                        | ** ** |
|-----------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)**     | ** ** | ** **                                                    | ** ** | **          2004          ** | ** ** | **          2003          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| Research and  development   |       |                                                          | $          | 2,393                                                                                                                            |       |                                                                                                                             |       | $ | 2,577 |   |   | $ | (184 | ) |   | -7 | % |   |
| Sales                       |       |                                                          | 4,923      |                                                                                                                             |       |                                                                                                                             | 5,427      |   |   | (504 | ) |   | -9 | % |   |
| Marketing                   |       |                                                          | 2,627      |                                                                                                                             |       |                                                                                                                             | 4,135      |   |   | (1,508 | ) |   | -36 | % |   |
| General and  administrative |       |                                                          | 3,874      |                                                                                                                             |       |                                                                                                                             | 3,126      |   |   | 748 |   |   | 24 | % |   |
| Litigation costs            |       |                                                          | 874        |                                                                                                                             |       |                                                                                                                             | —     |   |   | 874 |   |   | — |   |   |
| Total operating expenses    |       |                                                          | $          | 14,691                                                                                                                           |       |                                                                                                                             |       | $ | 15,265 |   |   | $ | (574 | ) |   |   |   |   |
|                             |            |                                                               |            |                                                                                                                                  |            |                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Research and Development Expense.  *The$184,000 or 7% decrease in research and development expenses in 2004 ascompared to 2003 was primarily due to wasa reduction in headcount, which decreased expenses by approximating $230,000,after the completion of development related projects in 2003, offset by $50,000of higher costs in France due to the stronger Euro and an increase in activityon a joint project in France.

*Sales Expense.  *The$504,000 or 9% decrease in sales expense in 2004 as compared to 2003 was due tothe elimination of our 2004 national sales meeting, which decreased expense byapproximately $200,000, and other savings on personnel costs, including traveland incentive compensation, which decreased expense by approximately $550,000as selling costs were realigned with realized sales levels in the first half of2004. Offsetting these decreases were severance and hiring costs in the fourthquarter of 2004, which totaled approximately $400,000, resulting from the departuresand addition of certain senior management.

*Marketing Expense.  *The$1.51 million or 36% 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 outASK4UFE campaign as well as a reduction in expenses relating to the promotionof Embosphere 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 and Administrative Expenses.  *The$748,000 or 24% increase in general and administrative expenses in 2004 ascompared to 2003 was primarily due to the executive transition and severanceexpenses incurred in the fourth quarter of 2004 in connection with thedeparture and hiring of certain executives of the Company.

*LitigationCosts.  *In December 2004, we paid damages in alawsuit brought by Terumo Europe N.V. against our French subsidiary, BioSphereMedical, S.A. Terumo alleged that it suffered damages from a purportedtermination of the distribution contract by BioSphere Medical, S.A. BioSphereMedical, S.A. 

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and Terumo Europe enteredinto a distribution agreement in January 2002 pursuant to which TerumoEurope became the exclusive distributor of EmboSphere Microsphere and EmboGoldMicrosphere products in certain countries of Europe. The Commercial Court ofPontoise, France, determined that while both parties had ceased to performtheir obligations under the agreement, our termination was not in accordancewith the provisions of the Agreement. Accordingly, BMSA was required to payTerumo $784,000 in damages for breach of contract in December 2004. The$874,000 charge recorded in the fourth quarter of 2004 includes $90,000 of relatedaccounts receivable written-off in addition to the settlement payment.

*Interest Income, 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 of30%. The decrease in 2004 as compared to 2003 was due primarily to decreases inthe average daily-invested cash balances and interest rates on availableinvestment grade assets.

*Foreign Exchange 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 $166,000decrease was primarily due to higher average intercompany trade receivables,which are denominated in Euros, offset by a decrease in the rate that the Eurostrengthened against the dollar during 2004 as compared to 2003.

*IncomeTax Provision.  *The 2004 income tax provision of$117,000 primarily represents the reversal of income tax benefits recordedduring 2002 as management determined in the fourth quarter of 2004 that aportion of the 2001 taxes paid would not be recovered.The 2003income tax provision represents minimum corporate taxes due in both France andin the United States. All other future tax benefits resulting from ouroperating losses have been reserved for in their entirety, as managementbelieves the ability to realize any benefit against future taxable income isuncertain.

***Years Ended December 31, 2003 and 2002***

*Revenue and Margin Overview*
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** | **Inc./**                                                                                                                        | ** ** | **Inc./**                                                                                                                        | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **          2003          ** | ** ** | **          2002          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| Total revenues          |       |                                                          | $          | 12,803                                                                                                                           |       |                                                                                                                             |       | $ | 12,152 |   |   | $ | 651 |   |   | 5 | % |   |
| Costs of product  sales |       |                                                          | 5,558      |                                                                                                                             |       |                                                                                                                             | 3,261      |   |   | 2,297 |   |   | 70 | % |   |
| Gross margin            |       |                                                          | $          | 7,245                                                                                                                            |       |                                                                                                                             |       | $ | 8,891 |   |   | $ | (1,646 | ) |   | -19 | % |   |
| Gross margin %          |       |                                                          | 57         | %                                                                                                                                |       |                                                                                                                             | 73         | % |   | -17 | % |   |   |   |   |
|                         |            |                                                               |            |                                                                                                                                  |            |                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Revenues.  *Ofthe $651,000, or 5%, increase in total revenues in 2003 as compared to 2002,$506,000 was due to the strengthening of the Euro against the U.S. dollar. Theremaining $144,000 increase was due to worldwide sales growth of our EmboCath Catheter and our Segway Guidewire,both of which were launched in the fourth quarter of 2002. The majorityof our revenues in 2003 was derived from the sale of Embosphere Microspheres,as a result of our strategic focus on UFE and other embolotherapy applicationsusing our microsphere products.

*Cost ofProduct Sales.  *The $2.30 million, or 70% increase incost of product sales in 2003 as compared to 2002 was primarily due to thefollowing factors:

·       ourmanufacturing overhead increased $600,000 in 2003 from the establishment of aU.S. manufacturing team that we expect will assist in improving the overallquality and efficiency of the manufacturing process and increase the capacityof our French manufacturing facility;

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·       theEuropean launch of Embosphere Microspheres in sterile syringe packages that aremanufactured through a sub-contractor agreement resulted in higher total unitcost, which contributed $500,000 to the increase;

·       weexperienced a foreign currency impact of $500,000 due to a stronger Euroagainst the U.S. dollar;

·       wereserved an additional $185,000 in 2003 as compared to 2002 for obsolescence ofspecific sizes of Embosphere Microspheres and EmboGold Microspheres that werehistorically slow moving;

·       welaunched our Segway Guidewire and EmboCath Catheter in the fourth quarter of2002, and we experienced $150,000 in additional cost of product sales in 2003in connection with a full year of sales volume; and

·       weincurred a one-time expense of $80,000 to streamline the delivery system supplychain, which is expected to result in future manufacturing cost savings.

Gross margin decreased to57% in 2003, a decline of 17% from gross margin in 2002, primarily due to theaddition of fixed costs of product sales as described above, net of foreigncurrency translation adjustments.

*Expense Overview*
| ** **                  | ** ** | **For the Years Ended December 31,** | ** ** | **Inc./**                                                                                                                        | ** ** | **Inc./**                                                                                                                        | ** ** |
|-----------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| **(in thousands)**     | ** ** | ** **                                                    | ** ** | **          2003          ** | ** ** | **          2002          ** | ** ** | **(Dec.) ($)** | ** ** | **(Dec.) (%)** | ** ** |
| Research and  development   |       |                                                          | $          | 2,577                                                                                                                            |       |                                                                                                                             |       | $ | 3,971 |   |   | $ | (1,394 | ) |   | -35 | % |   |
| Sales                       |       |                                                          | 5,427      |                                                                                                                             |       |                                                                                                                             | 5,035      |   |   | 392 |   |   | 8 | % |   |
| Marketing                   |       |                                                          | 4,135      |                                                                                                                             |       |                                                                                                                             | 3,024      |   |   | 1,111 |   |   | 37 | % |   |
| General and  administrative |       |                                                          | 3,126      |                                                                                                                             |       |                                                                                                                             | 4,006      |   |   | (880 | ) |   | -22 | % |   |
| Total operating expenses    |       |                                                          | $          | 15,265                                                                                                                           |       |                                                                                                                             |       | $ | 16,036 |   |   | $ | (771 | ) |   |   |   |   |
|                             |            |                                                               |            |                                                                                                                                  |            |                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Research and Development Expense.  *The$1.39 million or 35% decrease in research and development expense in 2003 ascompared to 2002 was primarily due to the completion of our pivotal Phase IIclinical trials in 2002 to support FDA-specific labeling clearance to use ourmicrosphere products in the treatment of uterine fibroids. Total clinical costswere $226,000 and $982,000 for the years ended December 31, 2003 and 2002,respectively. Also contributing to thedecrease in total research and development expenses in 2003 was a reduction incertain non-essential headcount after the completion of development relatedprojects in 2003. We estimate that during the years ended December 31,2003 and 2002, the majority of our research and development expenses wererelated to clinical trial costs, development and validation of our newembolotherapy products and packaging formats, development and validation of ourEmboCath Catheter and Segway Guidewire, as well as salary and related benefitexpenses and laboratory supplies related to our Radiosphere, TempRx andHepasphere SAP programs.

*Sales Expense.  *The$392,000 or 8% increase in sales expense in 2003 as compared to 2002 wasprimarily due to salary and salary-related benefits as a result of an increasein headcount in the U.S. sales force and to a lesser degree the stronger Euroagainst the U.S. dollar. Sales expense in 2002 included $38,000 of stock-basedcompensation to non-employees

 

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*Marketing Expense.  *The$1.11 million or 37% increase in marketing expense in 2003 as compared to 2002was primarily due to expenses relating to our UFE awareness and educationprograms. Marketing expense in 2003 also includes $39,000 of stock-basedcompensation to non-employees.

*General and Administrative Expenses.  *The$880,000 or 22% decrease in general and administrative expense in 2003 ascompared to 2002 was primarily due to the executive transition and severanceexpenses incurred in 2002 in connection with the departure of certain of ourexecutives, and the reduced executive bonus expense in 2003.

*Interest Income, Net.  *NetInterest income for the year ended December 31, 2003 was $108,000 comparedwith $369,000 in 2002. The decrease from 2002 to 2003 was due primarily todecreases in the average daily invested cash balances and interest rates onavailable investment grade assets. Interest expense for the year endedDecember 31, 2003 was relatively constant at $27,000 compared to $29,000for the year ended December 31, 2002.

*Foreign Exchange Gains, Net.  *Foreignexchange gains for the year ended December 31, 2003 increased to $555,000from $164,000 in 2002. The increase in 2003 due primarily to realizedEuro-to-U.S. dollar foreign currency exchange gains associated with ourintercompany trade accounts.

*IncomeTax Benefit (Provision).  *The 2003 income tax provisionrepresents minimum corporate taxes due in both France and in the United States.Income tax benefit recorded during 2002 represents recoverable prior year taxexpense. All other future tax benefits resulting from our operating losses havebeen reserved for in their entirety, as management believes the ability torealize any benefit against future taxable income is uncertain.

***Liquidity and Capital Resources***

As of December 31, 2004, we had $10.22 million ofcash, cash equivalents and marketable securities, an increase of $2.64 millionfrom $7.58 million at December 31, 2003. This increase was primarily theresult of our $8.00 million private placement of series A convertible preferredstock in November 2004, offset by operating losses and Euro to U.S. dollarforeign exchange rate changes. We have historically funded our operations fromthe net proceeds provided by public and private equity offerings, net revenues,bank financing, equipment financing leases and, to a lesser extent the exerciseof stock options.

The net cash used in operating activities includes anet loss of $6.84 million adjusted for $2.09 million in non-cash charges.Accounts receivable increased $510,000 on higher sales, as days sales outstandingremained consistent with 2003 at 63 days. Accrued compensation increased$799,000 as a result of costs associated with the senior management transition,which occurred in the fourth quarter of 2004 and will be paid out in 2005. Asof December 31, 2004, we had $12.39 million in working capital. Cash usedin operations is expected to decrease during 2005 as anticipated increases inproduct sales are expected to partially offset our operational and productdevelopment expenditures.

In 2004 we spent $200,000 to purchase manufacturingequipment at our facility in Roissy, France and other equipment to support ourexisting infrastructure. We anticipate that the level of capital expendituresover the next 12 months will increase as we configure our Roissy, Francefacility to produce Hepasphere SAP Microspheres in 2005.

Net cash provided by financing activities was $8.46million for the 12 months ended December 31, 2004, which included netproceeds of $7.79 million from our private placement of series A preferredstock and $645,000 from the exercise of common stock options and other employeeincentive plans. Additional financing totaling $210,000 in the form of capitalequipment leases was secured during 2004. If available on favorable terms, weexpect to finance future fixed asset acquisitions through leasing arrangements.

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On November 10, 2004,we completed a private placement of $8.00 million of our series A convertiblepreferred stock and warrants to purchase common stock with Sepracor Inc. andaffiliates of Cerberus Capital Management, L.P., two of our existing investors.These investors purchased a total of 8,000 shares of series A preferred stockwhich are initially convertible into 2,000,000 shares of common stock basedupon a conversion price of $4.00 per share. In addition, we have the right toconvert the series A preferred stock into common stock, or redeem it, underspecified circumstances. The series A preferred stock has a 6% dividend, whichis payable quarterly in either cash or additional shares of series A preferredstock, at our election. We also issued the investors 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 per share.These warrants have been assigned a value of $850,000 using the Black-Scholesoption-pricing model.

***Borrowing Arrangements***

On February 28, 2004, we entered into a four-yearcapital lease agreement for the purchase of manufacturing equipment at our facilityin Roissy, France. The amount of the lease is $165,000, payable over 48 months,at an effective annual interest rate of 4.64%. As of December 31, 2004there was $133,000 outstanding under this capital lease agreement.

On June 30, 2004, we entered into an agreement toextend the existing two-year credit facility with a bank originally enteredinto in May 2002. The amended agreement provides that the credit facilitywill contain all of the terms and conditions of our original credit facility,with the exceptions that the maximum amount under which we could borrow forgeneral working capital and corporate purposes, subject to limitations definedin the agreement, was reduced from $5.00 million to $3.00 million.

There were no borrowings outstanding under thisagreement as of December 31, 2004. Each available 30, 60, 90 or 180-dayadvance will bear interest at a per annum rate, at our option, equal to either (i) avariable rate as determined by the bank or (ii) a rate equal to thecorresponding 30, 60, 90 or 180-day LIBOR rate (2.42% as of December 31,2004) plus a LIBOR advance rate spread as determined by certain current workingcapital balances at the time of the advance. Our ability to borrow under thiscredit line is limited to eligible receivables as defined by the agreement andto the maintenance of certain levels of cash and cash equivalents of at leastone and one-half times the outstanding principal balance of the note. As of December 31,2004 there was approximately $1.30 million available to borrow under thiscredit facility. In connection with the credit facility, we entered into asecurity agreement pursuant to which we have pledged to the bank all of ourU.S. assets, excluding our equity ownership of BMSA, as collateral. As of December 31,2004, we were in compliance in all material respects with all credit facilitycovenants.

In March 2001, BMSAentered into a €152,450 ($208,000equivalent as of December 31, 2004) term loan with a French national bankthat is payable in Euros over four years and accrues interest at 5.4% perannum. The total loan balance outstanding as of December 31, 2004 wasapproximately $12,000.

***Other Contractual Obligations***

As of December 31, 2004, we are party to twooperating leases for the lease of our facilities in Rockland, Massachusetts andRoissy, France. The Roissy, France operating lease expires in May 2010. OnJanuary 24, 2005, we amended the lease for the office and laboratoryfacility we currently occupy in Rockland, Massachusetts. Pursuant to thisamendment, the leases premises is decreased to a total area of approximately7,797 square feet at a monthly cost of $13,000 per month, and the term of thelease is extended from March 31, 2005 to March 31, 2007. In additionto the capital lease agreement we entered into in February 2004, we areparty to several other non-cancelable capital lease agreements with variousequipment-financing companies, related to the acquisition of certainmanufacturing and computer equipment during 2002. The equipment leases haveinitial terms of 30 to 60 months with interest rates of 

28

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5.4% to 13.4%. Equipmentleased under these arrangements serves as pledged capital with respect to eachcapital lease agreement.

Futurecash payments, including interest, under contractual obligations in effect asof December 31, 2004, are as follows:
| ** **              | ** ** | **Period** | ** ** | ** ** | ** ** | **Total  Contractual** | ** ** |
|-------------------------|------------|------------|------------|------------|------------|------------------------|------------|
| **(in thousands)** | ** ** | ** ** | ** ** | **2005**   | ** ** | **2006**               | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Obligations** | ** ** |
| Operating Leases        |       | $          | 493        |       | $          | 470                    |       | $ | 314 |   | $ | 234 |   | $ | 234 |   |   | $ | 97 |   |   |   | $ | 1,842 |   |   |
| Capital Leases          |       | 176        |       | 159        |       | 51                     |       | 7 |   | — |   |   | — |   |   |   | 393 |   |   |
| Term Loans              |       | 12         |       | —     |       | —                 |       | — |   | — |   |   | — |   |   |   | 12 |   |   |
| Total                   |       | $          | 681        |       | $          | 629                    |       | $ | 365 |   | $ | 241 |   | $ | 234 |   |   | $ | 97 |   |   |   | $ | 2,247 |   |   |
|                         |            |            |            |            |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We believe that the approximate $10.22 million incash, cash equivalents and marketable securities that we have as of December 31,2004, together with anticipated proceeds from sales of our microspheres,delivery systems and other products will be sufficient to fund our operatingand capital requirements, as currently planned, into the fourth quarter of2006. In the longer term we expect to fund our operations and sustainingcapital requirements through a combination of expected proceeds from product salesand 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,including our Embosphere Microspheres for UFE and HepaSphere SAP 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 functions, as well as costs relating to furthermarket development and commercialization efforts. We may also need additionalfunds for such activities and for possible strategic acquisitions ofsynergistic businesses, products and/or technologies. These additional fundsmay be substantial and raised from time to time through additional public orprivate sales of equity, through borrowings, or through other financings. Thereare no assurances that we will be able to obtain any additional funding thatmay be required, or that any such funding will be on acceptable terms.

***Related Party Transactions***

On November 10, 2004, we entered into a SecuritiesPurchase Agreement with Sepracor Inc. and Cerberus Partners,L.P., pursuant to which we sold to each of Sepracor and Cerberus,respectively, (i) 4,000 shares of our series A convertible preferredstock, $0.01 par value per share, and (ii) warrants to purchase 200,000shares of our common stock, for aggregate gross proceeds to us of $8.00million.

Sepracor and Cerberus each are beneficial owners ofmore than five percent of our outstanding capital stock. Messrs. Barberichand Southwell, directors of our company, are the Chairman and Chief ExecutiveOfficer and the Chief Financial Officer, respectively, of Sepracor.

Pursuant to the terms ofthe Securities Purchase Agreement, we agreed to indemnify Sepracor andCerberus and specified related parties of each entity against damages withrespect to breaches of representations, warranties, covenants and agreementsmade by us under the Securities Purchase Agreement and related transactiondocuments.

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***Off-Balance Sheet Arrangements***

We do not have any materialoff-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 No. 123 (revised 2004), “Share-BasedPayment,” or SFAS 123R. SFAS 123R addresses the accounting for transactions inwhich 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 No. 25 andrequires that such transactions be accounted for using a fair-value basedmethod. SFAS 123R requires companies to recognize an expense for compensationcost related to share-based payment arrangements including stock options andemployee stock purchase plans. We are required to implement the proposedstandard no later than July 1, 2005. The cumulative effect of adoption,applied on a modified retrospective basis, would be measured and recognized on July 1,2005. We are currently evaluating option valuation methodologies andassumptions related to stock compensation plans.

As permitted by Statement 123, we currently accountfor share-based payments to employees using APB 25’s intrinsic value methodand, as such, generally recognize no compensation cost for employee stockoptions. Accordingly, the adoption of SFAS 123R fair value method will have asignificant impact on our result of operations, although it will have no impacton our overall financial position and cash position. The impact of adoption ofSFAS 123R cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had we adopted SFAS 123Rin prior periods, the impact of that standard would have approximated theimpact of Statement 123 as described in the disclosure of pro forma net lossper share as illustrated in the notes to the consolidated financial statements.

In December 2004, the FASB issued FASB StaffPosition 109-2, “Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004” (“FSP109-2”), in response to the American Jobs Creation Act of 2004 which was signedinto law in October, 2004 and which provides for a special one-time taxdeduction of 85% of certain foreign earnings that are repatriated (as defined).Based on our decision to reinvest rather than to repatriate current and prioryear’s unremitted foreign earnings, the application of FSP 109-2 did not affectincome tax expense in the period of enactment or any related disclosures.

In November 2004, theFASB issued SFAS No. 151, “Inventory Costs—an amendment of 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 ARB 43, Chapter 4 and IAS 2, “Inventories,” require that abnormalamounts of idle freight, handling costs, and wasted materials be recognized asperiod costs, however, the Boards noted that differences in the wording of thetwo standards could lead to inconsistent application of those similarrequirements. The FASB concluded that clarifying the existing requirements inARB 43 by adopting language similar to that used in IAS 2 is consistent withits goals of improving financial reporting in the United States and promotingconvergence of accounting standards internationally. Adoption of SFAS 151 isrequired for fiscal years beginning after June 15, 2005. The provisions ofSFAS 151 will be applied 

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prospectively.We are currently in the process of evaluating the impact that SFAS 151, but donot expect it will have a material impact on our results of operations andfinancial position.

**FACTORSTHAT MAY AFFECT FUTURE RESULTS**

**Risk Relating to Our Future Profitability**

**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, 2004, had an accumulated deficit of approximately$75.50 million. We have incurred net losses of $6.91 million,$7.35 million and $6.38 million for the years ended December 31,2004, 2003 and 2002, respectively. We expect to spend substantial funds tocontinue research and product testing, to maintain sales, marketing, qualitycontrol, regulatory, manufacturing and administrative capabilities and forother general corporate purposes. We expect to continue to incur operating lossesbeyond the fourth quarter of 2005, as we continue our commercializationefforts.

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.

**Risks Relating to Our Financial Results and Need ForFinancing**

**Wewill continue to need additional funds, and if additional capital is notavailable, we may have to limit, scale back or cease our operations.**

We believe that our existing cash and other workingcapital, together with the proceeds from the $8.00 million private placement wecompleted on November 10, 2004, together with anticipated proceeds fromsales of our products will be sufficient to fund our operating and capitalrequirements, as currently planned, into the fourth quarter of 2006.

Ourcurrently-planned operating and capital requirements primarily include the needfor working capital to:

·       produceand manufacture our products;

·       supportour sales and marketing efforts for our Embosphere Microspheres products forUFE and other indications as well as our other products for sale;

·       supportour research and development activities; and

·       fundour general and administrative costs and expenses.

However, our cash requirements may vary materiallyfrom those now planned due to a number of factors, including, withoutlimitation, the amount of revenues we generate from sales of our products, inparticular from the use of our Embosphere Microspheres for UFE, changes in ourUFE regulatory and marketing programs, anticipated research and developmentefforts, cost and time involved in pre-clinical and clinical testing, costsresulting from changes in the focus and direction of our research anddevelopment programs, competitive advances that make it harder for us to marketand sell our products, the timing and cost of FDA regulatory review and themarket’s acceptance of any approved products.

We also expect to incur additional costs related toongoing research and development activities, pre-clinical 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.

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If adequate funds are notavailable, we may be required to delay, scale back or eliminate some of ourresearch, development, sales and marketing initiatives, which would have amaterial adverse effect on our business, results of operations and ability toachieve 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 investment in 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 several factors,including the timing and volume of customer orders for our products, procedurecancellations, introduction or announcement of competitive products and generaleconomic conditions. Due to these fluctuations, our operating results in somequarters may not meet the expectations of our investors. In that case, ourstock price may decline.

In addition, a largeportion of our expenses, including expenses for facilities, equipment andpersonnel, are relatively fixed. Accordingly, if our revenues decline or do notgrow as much as we anticipate, we might not be able to improve our operatingmargins. Failure to achieve anticipated levels of revenues could thereforesignificantly harm our operating results for a particular fiscal period.

**Risks Relating to Our Industry, Business and Strategy**

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

Our microspheres are based on new technologies andtherapeutic approaches. In the United States, we began selling our microspheresproduct in the first half of 2000. In November 2002, we received FDAclearance to market our Embosphere Microspheres in the United States forspecific use in the embolization of uterine fibroids. Our success will dependupon increasing acceptance by the medical community, patients and third-partypayers that our Embosphere Microspheres and other products are medicallytherapeutic and cost-effective. Our embolotherapy techniques are administeredby interventional radiologists. To date we have not achieved widespread marketacceptance of our Embosphere Microspheres or other products. We believe that wehave not yet achieved widespread acceptance primarily because obstetrics andgynecology physicians may elect to offer and provide other forms of treatmentto their patients with uterine fibroids that do not require a referral toanother specialist, such as an interventional radiologist. Accordingly, ourfuture success will depend upon obstetrics and gynecology physicians referringpatients to interventional radiologists to receive treatment using ourEmbosphere Microspheres in lieu of, or in addition to, receiving other forms oftreatment that the obstetrics and gynecology physicians can otherwise providedirectly.

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 

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example,patients commonly experience a day or two of post-procedure abdominal pain orcramping. Other infrequently occurring complications may include allergicreactions, rashes, early onset of menopause, infertility and infection thatmay, in some cases, require a hysterectomy. We are also aware that a smallnumber of the patient population, which we believe constitute approximately 2%of those receiving the UFE procedure using EmboGold Microspheres, reported adelayed onset of pain and/or rash.

**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 occludeblood vessels. There is some risk that some or all of the microspheres used ina medical procedure may travel in the blood system to sites other than theintended surgical site and occlude, or block, other blood vessels, resulting inthe potential for significant adverse health effects on the patient or, in aworst case, even death. Moreover, to use our microspheres correctly for aparticular medical procedure, trained physicians must select and use the propersize and quantity. A physician’s selection and use of the wrong size orquantity of our microspheres could potentially have significant adverse healtheffects on the patient, including death. It is necessary for us to educatephysicians about the selection and use of the proper size and quantity ofmicrospheres in patient therapy. In addition, there is only limited dataconcerning the long-term health effects on persons receiving embolotherapyusing our microspheres. For example, the effect of uterine fibroid embolizationon continued fertility has not yet been specifically studied and our FDAclearance for Embosphere Microspheres currently does not include women whodesire future pregnancy.

If we are not able tosuccessfully educate physicians to properly use our product, or if the marketdetermines or concludes that any of our products are not safe or effective forany reason, we may be exposed to product liability claims, product recalls,fines or other penalties or enforcement actions by regulatory agencies andassociated adverse publicity. In addition, we have provided to our customers asatisfaction guarantee that requires us to accept the return of any inventoryand credit the entire amount of the original order if a properly trainedcustomer is not satisfied with the performance of either our microspheres, ourEmboCath catheter, or our Segway guidewire 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.

**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, 2004was derived from the sale of Embosphere Microspheres and EmboGold Microspheres,for use in UFE. Although we believe that EmboGold Microspheres accounted for asignificant portion of revenue, we currently do not intend to seek 510(k) clearancefor use of EmboGold Microspheres in UFE. Because we do not intend to seek 510(k) clearanceof EmboGold Microspheres, we believe that our future product revenues aresubstantially dependent on our ability to achieve awareness of the use ofEmbosphere Microspheres for the treatment of UFE, and if we do not achieveincreased awareness, our product revenues profitability and success will beadversely affected. If we cease to market EmboGold Microspheres for any reason,we could incur substantial costs to write off and replace existing inventories.As of December 31, 2004, we had EmboGold inventory with a carrying valueof $590,000, including in process inventory of $470,000 and finished goodssyringes of $120,000. We currently believe no 

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provisionfor the write off or replacement of EmboGold Microspheres inventory is requiredin the accompanying financial statements.

**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 continuing todevelop sales, distribution and marketing capabilities in the United States,the European Union, Asia and in South America. In 2003, we began a marketingstrategy to promote UFE awareness and the benefits of our product for thetreatment of uterine fibroids. It will be expensive and time-consuming for usto develop a global marketing and sales force. Moreover, we may choose, or findit necessary, to enter into strategic collaborations to sell, market anddistribute our products. We may not be able to provide adequate incentive to oursales force or to establish and maintain favorable distribution and marketingcollaborations with other companies to promote our products. We currently havedistribution agreements with approximately 50 third-party distributors. Anythird party with whom we have established a marketing and distributionrelationship may not devote sufficient time to the marketing and sales of ourproducts thereby exposing us to potential expenses in terminating suchdistribution agreements. For example, our subsidiary, BioSphere Medical S.A.,or BSMA, ended its distribution agreement with Terumo N.V. in 2002 in partbecause of Terumo’s failure to achieve sales forecasts agreed upon by theparties. As a result of subsequent litigation, BSMA was required to pay Terumoapproximately $784,000 in damages arising from such termination and incurredadditional legal and administrative expenses incident to the legal proceeding.We and any of our third-party collaborators must also market our products incompliance with federal, state and local laws relating to the providing ofincentives and inducements. Violation of these laws can result in substantialpenalties. If we are unable to successfully motivate and expand our marketingand sales force and further develop our sales and marketing capabilities, or ifour distributors fail to promote our products, we will have difficultymaintaining 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 arestill in the early stages of research and development. Our products may notprovide greater benefits than current treatments or products, or alternativetreatments or products under development. All of our products under developmentwill require significant additional research, development, pre-clinical and/orclinical testing, regulatory approval and a commitment of significantadditional resources prior to their commercialization. Our potential productsmay not:

·       bedeveloped successfully;

·       beproven safe and effective in clinical trials;

·       offertherapeutic or other improvements over current treatments and products;

·       meetapplicable regulatory standards or receive regulatory approvals;

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

·       be successfully marketed.

 

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

We derived approximately16% of our revenues for the period ended December 31, 2004 from the saleof non-strategic medical products that over time we expect will constitute aless significant portion of our revenues on an ongoing basis. Thesenon-strategic medical products include barium delivery kits sold by us in theEuropean Union, as well as other ancillary devices for hospital and physicianuse. In addition, we estimate that a significant portion of our revenues forthe year ended December 31, 2004 and 2003 was derived from the sale ofEmboGold Microspheres for UFE, an indication for which we do not have, and donot presently intend to seek clearance from the FDA to market. We made thedecision not to seek FDA clearance for our EmboGold Microsphere product becauseof reports that a small number of patients treated with UFE using EmboGoldMicrospheres, which we believe constitute approximately 2% of the total numberof patients receiving the procedure, reported a delayed onset of pain and/orrash. Accordingly, we need to develop and introduce new applications for ourembolotherapy technology and pursue opportunities for microsphere technology inother medical applications. Any such new application for our embotherapytechnology or microsphere technology will be subject to a number of risksinherent in the development and commercialization of a medical device product,including uncertainties with respect to the successful completion of clinicaltrails, our ability to achieve and maintain, and our willingness to seek,required regulatory approvals and our ability to successfully commercialize,market and sell these new applications assuming FDA approval is achieved. If,as a result of these or other risks, we are not successful in developing newapplications and products, we will not achieve new revenue opportunities.

**If we are unable toobtain or maintain adequate product liability insurance, then we may have topay significant monetary damages in a successful product liability claimagainst us.**

The development and saleof medical devices entails an inherent risk of product liability. For example,if we are not able to successfully educate physicians to properly use ourproducts, or if the market determines or concludes that any of our products arenot safe or effective for any reason, we may be exposed to product liabilityclaims. Although we currently maintain product liability insurance coverage forour products, our existing insurance and any additional insurance we maysubsequently obtain may not provide us with adequate coverage against allpotential claims. If we are exposed to product liability claims for which wehave insufficient insurance, we may be required to pay significant damages,which would prevent or delay our ability to commercialize our products andcould harm our business and results of operations.

**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 Microsphere 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 Johnson Company,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 

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indicated. Theavailability of these free or reduced priced samples has had, and may continue tohave, 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 polyvinyl alcohol, sold by Boston Scientific, Terumo andBiocompatibles and, gel foam, sold by Pfizer, and non-spherical polyvinylalcohol, sold by Angiodynamics, Boston Scientific and Cook. In addition, ourcompetitors may develop technologies that render our products obsolete orotherwise noncompetitive.

We may not be able toimprove our products or develop new products or technologies quickly enough tomaintain a competitive position in our market and continue to commerciallydevelop our business. Moreover, we may not be able to compete effectively, andcompetitive pressures may result in less demand for our products and impair ourability to become profitable.

**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 to pharmaceutical pricing, implementation of more sweeping healthcarereforms in significant markets may limit the price of, or the level at whichreimbursement is provided for, the Company’s products and may influence aphysician’s selection of products 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; changes in management could result in short-term disruptionto our business.**

The loss of key members ofour management team could harm us. We have recently experienced significantchanges in management. In November 2004, Richard Faleschini joined us asour president and chief executive officer and Gary M. Saxton joined us as vicepresident of marketing and sales, and in September 2004, Martin Joycejoined us as our chief financial officer. Our senior management team alsoincludes Jonathan R. McGrath, vice president, research and development. Our formerpresident and chief executive officer, Paul A. Looney, only served as ourpresident and chief executive officer for approximately 27 months and ourformer vice president of U.S. sales and marketing, Thomas Keenan, servedas our vice president of U.S. sales for approximately 34 months.Disruptions in our business could result in the near term as a result ofchanges in our management such as the departures of Messrs. Looney andKeenan, and the integration of our new management team into our company. Our successis substantially dependent on the ability, experience and performance of thesemembers of our senior management and other key employees. We currently haveemployment agreements with each of our executive officers, other than Mr. Saxton.These employment agreements are generally for a term of one year and aresubject to annual renewal. Either party has the right to terminate theagreement at any time for any reason or no reason on 60 days prior writtennotice, except that we can terminate Mr. Joyce’s 

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agreementwithin the first year without notice. We do not carry key man life insurance onany of our executive officers or other personnel. We also depend onapproximately 25 scientific collaborators and advisors, all of whom have othercommitments that may limit their availability to us. Because of their abilityand experience, if we lose one or more of these individuals, we may not be ableto successfully implement our business strategy.

**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 contingentliabilities in 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 thecompletion of our private placement on November 10, 2004, Sepracor Inc.and funds affiliated with Cerberus Capital Management, L.P. beneficially ownedapproximately 26.9% and 16.5% of our outstanding common stock, respectively,including shares of common stock issuable as of November 10, 2004 upon theexercise of warrants and series A preferred stock held by these stockholders.Moreover, two of our directors are executive officers of Sepracor and we havegranted board observation rights to Cerberus. Accordingly, Sepracor andCerberus may have significant influence over corporate actions requiringstockholder approval, such as the election of directors, amendment of ourcharter 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:

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

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

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

In addition, on December 23, 2004, we enteredinto a restrictive covenants agreement with Sepracor and Cerberus, pursuant towhich we agreed not to issue any shares of common stock upon conversion of theseries A preferred stock and/or upon exercise of the warrants held by thesestockholders to the extent that such conversion and/or exercise would result in(i) a change of control (within the meaning of the Nasdaq MarketplaceRules), or (ii) the aggregate issuance of more than 19.9% of our commonstock outstanding as of November 10, 2004. Pursuant to the terms of therestrictive covenants agreement, both Sepracor and Cerberus also agreed tolimit the number of shares of common stock each entity would vote, in respectof the shares of series A preferred stock held, on matters in which holders ofour series A preferred stock and our common stock vote as one class, to no morethan the quotient of (x) the aggregate purchase price paid by such entityfor its series A preferred shares divided by (y) the closing bid price ofthe common stock on the initial issuance date of the series A preferred stock.We also agreed with these 

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investors that we willsubmit to our stockholders for approval amendments to the certificate ofdesignations, preferences and rights of series A preferred stock we filed withthe secretary of state of the state of Delaware on November 9, 2004 toeffect the modifications to the terms of the series A preferred stock set forthin the restrictive covenants agreement. Sepracor and Cerberus have agreed tovote in favor of such amendments to the certificate of designations and havegranted an irrevocable proxy to appoint our chief executive officer and vicepresident of finance as attorney-in-fact and proxy to vote all of their sharesof common stock, other than the shares underlying the series A preferred stockand warrants, in favor of such amendments.

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 your interest in BioSpherein the event of future financing transactions. The holders of series Apreferred 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. If paid in stock, this dividend could also further dilute your ownershipinterest. In addition, the holders of our series A preferred stock have theright to participate in future capital raising transactions by BioSphere. Theexistence of this right may reduce our ability to establish terms with respectto, or enter 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 the marketprice of our stock may decline.**

We are subject toregulation by government agencies in the United States and abroad with respectto the manufacture, packaging, labeling, advertising, promotion, distributionand sale of our products. For example, our products are subject to approval orclearance by the FDA prior to commercial marketing in the United States.Similar regulations exist in most major foreign markets, including the EuropeanUnion, Latin America and Asia. The process of obtaining necessary regulatoryapprovals and clearances will be time-consuming and expensive for us. If we donot receive required regulatory approval or clearance to market our products,or if any approvals we have received are revoked or terminated, we may not beable to develop and commercialize our products and become profitable, and thevalue of our common stock may decline.

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

Even if the FDA grants usclearance with respect to marketing any product it may place substantialrestrictions on the indications for which we may market the product, whichcould result in lower revenues. The marketing claims we are permitted to makein labeling or advertising regarding our microspheres are limited to thoseconsistent with any FDA clearance or approval. For example, because ourEmboGold Microspheres are not cleared for use in UFE, we may not promote themfor this use.

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

Further, the FDA has classified our embolotherapydevice into Class III, which means that even though we have obtained clearanceunder Section 510(k) to market the device for certain indications,the FDA could in the future promulgate a regulation requiring that we submit apre-market approval as a “pre-amended” device of the device under Section 515of the Federal Food, Drug, and Cosmetic Act to allow it to remain on themarket. If the FDA were to issue such a regulation, we may experiencedifficulty in providing the FDA with sufficient data for pre-market approval ina timely fashion, if at all.

Our products will be subject to continuing FDArequirements relating to quality control, quality assurance, maintenance ofrecords and documentation, manufacturing, labeling and promotion of medicaldevices. We are also required to submit medical device reports to the FDA toreport device-related deaths or serious injuries, as well as malfunctions, therecurrence of which would be likely to cause or contribute to a death orserious injury. These reports are publicly available.

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 U.S. Many foreign regulatory authorities, including those in major marketssuch as Japan and China, have different approval procedures than those requiredby the FDA and may impose additional testing requirements for our medicaldevice candidates.

**If wefail to comply with regulatory laws and requirements, we will be subject toenforcement actions, which will affect our ability to market and sell ourproducts and may harm our reputation.**

If we fail tocomply with applicable federal, state or foreign laws or regulations, we couldbe subject to enforcement actions, which could affect our ability to develop,market and sell our products successfully and could harm our reputation andlead to less acceptance of our products by the market. These enforcementactions include:

·       productseizures;

·       voluntaryor mandatory recalls;

·       voluntaryor mandatory patient or physician notification;

·       withdrawalof product clearances or approvals;

·       withdrawalof investigational device exemption approval;

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·       restrictionson, or prohibitions against, marketing our products;

·       fines;

·       restrictionson importation or exportation of our products;

·       injunctions;and

·       civil and criminalpenalties.

**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 commercialized by us. 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 UnitedStates patent applications on file, since United States patent applicationsfiled before November 28, 2000 or for which no foreign patents will besought are secret until issued, and applications filed after November 28,2000 are published approximately 18 months after their earliest priority date.Consequently, the United States Patent and Trademark Office could initiateinterference proceedings involving our owned or licensed United States patentapplications or issued patents. Further, there is a substantial backlog ofpatent applications at the United States Patent and Trademark Office, and theapproval or rejection of patent applications may take several years.

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

**If 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, an Opposition proceeding wasbrought by Biocompatibles UK Limited against our granted European Patent1128816 relating to polyvinyl alcohol microspheres useful for embolization andmethods thereof. We intend to file a response to the Opponent’s Brief prior tothe deadline of June 1, 2005. While we are not able to predict the outcomeof this proceeding, it will not impact our ability to sell our Embosphereproducts.

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. 

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Furthermore, we may besued for infringing on the intellectual property rights of others. We may findit necessary, if threatened, to initiate a lawsuit seeking a declaration from acourt regarding the proprietary rights of others. Intellectual propertylitigation is costly, and, even if we prevail, could divert managementattention and resources away from our business.

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

**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 onvarious license agreements relating to each of our current and proposedproducts that give us rights under intellectual property rights of thirdparties. In particular, we have an agreement with L’AssistancePublique-Hopitaux De Paris, pursuant to which L’Assistance Publique-HopitauxDe Paris has granted us exclusive rights to use two jointly-owned patentsrelating to Embosphere Microspheres. We also have an agreement with Dr. ShinichiHori pursuant to which we have an exclusive royalty-bearing license to Japanesepatent rights for our Hepasphere SAP Microspheres product. Either of theseagreements can be terminated on short notice by the licensor if we default onour obligations under the license and fail to cure such default after notice isprovided. These licenses impose commercialization, sublicensing, royalty,insurance and other obligations on us. Our failure, or any third party’sfailure, to comply with the terms of any of these licenses could result in ourlosing our rights to the license, which could result in our being unable todevelop, manufacture or sell products which contain the licensed 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 U.S., we have engaged RadiusMedical Technologies, Inc. to supply our guidewire product and Accellentto supply and package our catheter product. Either we or any third-partymanufacturer would likely experience significant delays or cessation inproducing our products if a labor strike, natural disaster, local or regionalconflict or other supply disruption were to occur. If we are unable to manufactureand package our products at our facility in France, we may be required to enterinto arrangements with one or more alternative contract manufacturingcompanies. In addition, if we are required to depend on third-partymanufacturers, our profit margins may be lower, which will make it moredifficult for us to achieve profitability.

Medical devicemanufacturers must adhere to the FDA’s current Good Manufacturing Practicesregulations, which are enforced by the FDA through its facilities inspectionprogram. The manufacturers may not be able to comply or maintain compliancewith Good Manufacturing Practices regulations. If any third-party manufacturerswe engage fail to comply, their noncompliance could significantly delay our 

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receiptof new product premarket approvals or result in FDA enforcement action,including an embargo on imported devices. For a premarket approval device, ifwe change our manufacturing facility or switch to a third-party manufacturer,we will be required to submit a premarket approval application supplementbefore the change is implemented.

**Wehave initiated a program to replace syringes containing our microspheresproducts because of shelf life limitations on the saline solution containedwithin the syringes, and reserves we have taken may not be adequate.**

We have incurred costs inconnection with replacing syringes containing our microspheres products becauseof shelf life limitations of the saline solution contained within the syringes.We have informed our customers of these shelf life limitations, and haveadvised them to contact us regarding product replacement of their syringes. Webelieve that all syringes subject to this shelf life limitation have beenreplaced as of December 31, 2004. However, we may continue to incur coststo replace additional syringes that have not been identified as of December 31,2004. For the year ended December 31, 2004, we have recognized $223,000 incosts of product sales for product replacement as a result of shelf lifelimitations.

**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, from whom we purchase guidewires for our Segway Guidewire product, andAccellent, from whom we purchase catheters for our EmboCath Infusion Cathetersproduct. We generally do not have long-term agreements with any of oursuppliers. Our reliance on our suppliers exposes us to risks, including:

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

·       thepotential inability of our suppliers to obtain required components;

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

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

·       thepossibility that one or more of our suppliers could fail to satisfy any of theFDA’s required current Good Manufacturing Practices regulations.

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.

**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, 2004 and 2003,approximately 30% and 29%, respectively, of our revenues were derived fromsales of our microspheres and other products in the European Union. We areincreasingly subject to a number of challenges which specifically relate to ourinternational business activities. Our international operations 

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maynot be successful if we are unable to meet and overcome these challenges, whichwould limit the growth of our business. These challenges include:

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

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

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

·       potentially longer accountsreceivable payment cycles and difficulties in collecting accounts 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.During 2004 and 2003, the price of our common stock ranged from a high of $6.75to a low of $2.12. As a result of this volatility, investments in our stockcould rapidly lose their value. In addition, the stock market often experiencesextreme price and volume fluctuations, which affect the market price of manymedical device companies and which are often unrelated to the operatingperformance 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 7A.**                QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

As of December 31,2004, 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, 2004, approximately €4,000,000,or $5,500,000, 

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remained outstandingwithin the inter-company trade accounts. Accordingly, a hypothetical 10 percentincrease in Euro to U.S. Dollar conversion rates would result in an approximate$495,000 foreign currency market-to-market change in the fair value of ourinter-company trade account balance as of December 31, 2004. We have notengaged in formal currency hedging activities to date, but do have a limitednatural hedge in that our revenues and expenses in France are primarilydenominated in the Euro. We also attempt to minimize exchange rate risk byconverting non-U.S. currency to U.S. dollars as often as practicable. Wegenerally view our investment in foreign subsidiaries operating under afunctional currency (the Euro) other than our reporting currency (the U.S.Dollar) as long term. Our investment in foreign subsidiaries is sensitive tofluctuations in foreign currency exchange rates. The effect of a change inforeign exchange rates on our net investment in foreign subsidiaries isreflected in the “Other accumulated comprehensive loss” component ofstockholders’ equity. Because our foreign currency exchange rate risk is notmaterial, no quantitative tabular disclosure has been provided.

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. Some of thesecurities that we invest in may have market risk. This means that an increasein prevailing interest rates may cause the principal amount of the investmentto decrease. To minimize this risk in the future, we maintain our portfolio ofcash equivalents and short-term investments in a variety of securities,including commercial paper, investment grade asset-backed corporate securities,money market funds and government and non-government debt securities. Due tothe conservative nature of our investments, the relatively short duration oftheir maturities, our ability to convert some or all of our long-terminvestments to less interest rate-sensitive holdings and our general intent tohold most securities until maturity, we believe interest rate risk ismitigated. As of December 31, 2004, approximately 32% of the $762,000classified, as available-for-sale marketable securities will mature within oneyear.

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**Item 8.**                        FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

We have audited the accompanying consolidated balancesheets of BioSphere Medical, Inc. and subsidiaries as of December 31,2004 and 2003, and the related consolidated statements of operations,stockholders’ equity and comprehensive income (loss), and cash flows for eachof the three years in the period ended December 31, 2004. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

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

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofBioSphere Medical, Inc. and subsidiaries at December 31, 2004 and2003, and the consolidated results of operations, stockholders’ equity andcomprehensive income (loss), and cash flows for each of the three years in theperiod ended December 31, 2004 in conformity with U.S. generally acceptedaccounting principles.
|                       | /s/  ERNST & YOUNG LLP |   |
|-----------------------|-------------------------------------------|--------|
| January 27, 2005 |
| Boston, Massachusetts |

 

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**BIOSPHERE MEDICAL, INC.AND SUBSIDIARIES**CONSOLIDATED BALANCE SHEETS
| ** **                                                                                                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands  except share data)**                                                                                                                                                                                                  | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                            |       |                  |       |   |   |   |   |
| Current Assets:                                                                                                                                                                                                                                       |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                             |       |                  | $          | 9,460 |   |   | $ | 2,043 |   |
| Marketable securities                                                                                                                                                                                                                                 |       |                  | 762        |   |   | 5,532 |   |
| Account receivable, net of allowance for doubtful  accounts of $184 and $180 as of December 31, 2004 and 2003, respectively                                                                                                                      |       |                  | 2,999      |   |   | 2,534 |   |
| Inventories, net                                                                                                                                                                                                                                      |       |                  | 3,311      |   |   | 3,496 |   |
| Prepaid and other current assets                                                                                                                                                                                                                      |       |                  | 222        |   |   | 405 |   |
| Total current assets                                                                                                                                                                                                                                  |       |                  | 16,754     |   |   | 14,010 |   |
| Property and  equipment, net                                                                                                                                                                                                                          |       |                  | 1,134      |   |   | 1,497 |   |
| Goodwill, net                                                                                                                                                                                                                                         |       |                  | 1,443      |   |   | 1,443 |   |
| Other assets                                                                                                                                                                                                                                          |       |                  | 60         |   |   | 52 |   |
| Total Assets                                                                                                                                                                                                                                          |       |                  | $          | 19,391 |   |   | $ | 17,002 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                         |       |                  |       |   |   |   |   |
| Current Liabilities:                                                                                                                                                                                                                                  |       |                  |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                      |       |                  | $          | 1,084 |   |   | $ | 824 |   |
| Accrued compensation                                                                                                                                                                                                                                  |       |                  | 1,880      |   |   | 1,054 |   |
| Other current accrued liabilities                                                                                                                                                                                                                     |       |                  | 1,224      |   |   | 1,279 |   |
| Current portion of capital lease obligations and  long-term debt                                                                                                                                                                                      |       |                  | 175        |   |   | 149 |   |
| Total current liabilities                                                                                                                                                                                                                             |       |                  | 4,363      |   |   | 3,306 |   |
| Long-term debt and capital lease obligations                                                                                                                                                                                                          |       |                  | 192        |   |   | 171 |   |
| Total Liabilities                                                                                                                                                                                                                                     |       |                  | 4,555      |   |   | 3,477 |   |
| Commitments and contingencies                                                                                                                                                                                                                         |       |                  | —     |   |   | — |   |
| Stockholders’ equity:                                                                                                                                                                                                                            |       |                  |       |   |   |   |   |
| Preferred stock;  $.01 par value; 1,000,000 shares authorized:                                                                                                                                                                                        |       |                  |       |   |   |   |   |
| 6% series A convertible preferred stock, 12,000 and  no shares authorized, 8,000 and no shares issued and outstanding, as of  December 31, 2004 and 2003, respectively (aggregate liquidation  preference including accrued dividends of $8,068) |       |                  | 6,945      |   |   | — |   |
| Common stock; $.01 par value; 25,000,000 shares  authorized; 14,294,032 and 13,841,291 shares issued and outstanding as of  December 31, 2004 and 2003, respectively                                                                             |       |                  | 143        |   |   | 138 |   |
| Additional  paid-in capital                                                                                                                                                                                                                           |       |                  | 83,438     |   |   | 81,952 |   |
| Accumulated  deficit                                                                                                                                                                                                                                  |       |                  | (75,502    | ) |   | (68,593 | ) |
| Accumulated other  comprehensive income (loss)                                                                                                                                                                                                        |       |                  | (188       | ) |   | 28 |   |
| Total stockholders’ equity                                                                                                                                                                                                                       |       |                  | 14,836     |   |   | 13,525 |   |
| Total Liabilities  and Stockholders’ Equity                                                                                                                                                                                                      |       |                  | $          | 19,391 |   |   | $ | 17,002 |   |
|                                                                                                                                                                                                                                                       |            |                       |            |  |  |  |  |  |  |  |  |

 

 

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

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**BIOSPHEREMEDICAL, INC. AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF OPERATIONS
| ** **                                                    | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands except per  share data)** | ** ** | ** **                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                                                     |       |                                                          |       |   |   |   |   |
| Product sales                                                 |       | $                                                             | 14,058     |   | $ | 12,803 |   | $ | 12,152 |   |
| Licensing revenues                                            |       | 100                                                           |       | — |   | — |   |
| Total revenues                                                |       | 14,158                                                        |       | 12,803 |   | 12,152 |   |
| Costs and  expenses:                                          |       |                                                          |       |   |   |   |   |
| Costs of product sales                                        |       | 6,646                                                         |       | 5,558 |   | 3,261 |   |
| Research and development                                      |       | 2,393                                                         |       | 2,577 |   | 3,971 |   |
| Sales(1)                                                      |       | 4,923                                                         |       | 5,427 |   | 4,997 |   |
| Marketing(2)                                                  |       | 2,627                                                         |       | 4,096 |   | 3,024 |   |
| General and administrative                                    |       | 3,874                                                         |       | 3,126 |   | 4,006 |   |
| Stock-based compensation to non-employees                     |       | —                                                        |       | 39 |   | 38 |   |
| Litigation costs                                              |       | 874                                                           |       | — |   | — |   |
| Total costs and expenses                                      |       | 21,337                                                        |       | 20,823 |   | 19,297 |   |
| Loss from operations                                          |       | (7,179                                                        | )          | (8,020 | ) | (7,145 | ) |
| Interest income                                               |       | 92                                                            |       | 135 |   | 398 |   |
| Interest expense                                              |       | (16                                                           | )          | (27 | ) | (29 | ) |
| Foreign exchange  gains, net                                  |       | 389                                                           |       | 555 |   | 164 |   |
| Other income/  (expense), net                                 |       | (10                                                           | )          | 28 |   | 50 |   |
| Loss before income taxes                                      |       | (6,724                                                        | )          | (7,329 | ) | (6,562 | ) |
| Income tax  benefit/ (provision)                              |       | (117                                                          | )          | (23 | ) | 181 |   |
| Net loss                                                      |       | (6,841                                                        | )          | (7,352 | ) | (6,381 | ) |
| Preferred stock  dividends                                    |       | (68                                                           | )          | — |   | — |   |
| Net loss applicable to common stockholders                    |       | $                                                             | (6,909     | ) | $ | (7,352 | ) | $ | (6,381 | ) |
| Net loss per  common share applicable to common stockholders  |       |                                                          |       |   |   |   |   |
| Basic and diluted                                             |       | $                                                             | (0.49      | ) | $ | (0.55 | ) | $ | (0.49 | ) |
| Weighted average number  of common shares outstanding         |       |                                                          |       |   |   |   |   |
| Basic and diluted                                             |       | 14,152                                                        |       | 13,462 |   | 12,988 |   |
|                                                               |            |                                                               |            |  |  |  |  |  |  |  |  |  |

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(1)          Excludes $38 incompensation charges relating to the issuance of stock options to non-employeesin 2002

(2)          Excludes $39 incompensation charges relating to the issuance of stock options to non-employeesin 2003

 

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** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’** | ** ** |
|---------------------------------------------------------------------------|------------|---------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|---------------------------------------|------------|-------------------------------|------------|
| **(in thousands)**                                                   | ** ** | ** **    | ** ** | **Stock**             | ** ** | **Shares**              | ** ** | **Amount**      | ** ** | **Capital**                           | ** ** | **Deficit**                   | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** |
| **Balance  at December 31, 2001**                                    |       |          | $          | —                |       |                    |       | 12,721          |       |                                  |       | $                             | 127        |   |   |   | $ | 80,583 |   |   |   | $ | (54,860 | ) |   |   | $ | 23 |   |   |   | $ | 25,873 |   |   |
| Comprehensive loss:                                                       |       |          |       |                  |       |                    |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                  |       |          | —     |                  |       |                    | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | (6,381 | ) |   |   | — |   |   |   | (6,381 | ) |   |
| Unrealized gain on  marketable securities                            |       |          | —     |                  |       |                    | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | 21 |   |   |   | 21 |   |   |
| Translation  adjustment                                                   |       |          | —     |                  |       |                    | —     |            |       |                                  | —     |                          |       |   | — |   |   |   | — |   |   |   | 155 |   |   |   | 155 |   |   |
| Total  Comprehensive loss                                                 |       |          |       |                  |       |                    |       |            |       |                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (6,205 | ) |   |
| Issuance of common  stock under employee benefit and incentive plans |       |          | —     |                  |       |                    | 505        |            |       |                                  | 5          |                          |       |   | 548 |   |   |   | — |   |   |   | — |   |   |   | 553 |   |   |
| Stock-based  compensation to non-employees                           |       |          | —     |                  |       |                    | —     |            |       |                                  | —     |                          |       |   | 38 |   |   |   | — |   |   |   | — |   |   |   | 38 |   |   |
| **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 |   |   |
|                                                                           |            |               |            |                       |            |                         |            |                 |            |                                       |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

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

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**BIOSPHEREMEDICAL, INC. AND SUBSIDIARIES**CONSOLIDATED STATEMENTS OF CASH FLOWS
| ** **                                                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**                                                             | ** ** | ** **                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from  operating activities:                                              |       |                                                          |       |   |   |   |   |
| Net loss                                                                            |       | $                                                             | (6,841     | ) | $ | (7,352 | ) | $ | (6,381 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:        |       |                                                          |       |   |   |   |   |
| Provision for doubtful accounts                                                     |       | 80                                                            |       | 59 |   | 8 |   |
| Provision for inventory obsolescence                                                |       | 1,384                                                         |       | 593 |   | 292 |   |
| Depreciation                                                                        |       | 625                                                           |       | 658 |   | 607 |   |
| Realized (gain) loss on available-for-sale  investments                             |       | 4                                                             |       | (15 | ) | — |   |
| Non-cash stock-based compensation for non-employees                                 |       | —                                                        |       | 39 |   | 38 |   |
| Changes in  operating assets and liabilities:                                       |       |                                                          |       |   |   |   |   |
| Accounts receivable                                                                 |       | (510                                                          | )          | (364 | ) | (490 | ) |
| Inventories                                                                         |       | (938                                                          | )          | (640 | ) | (2,211 | ) |
| Prepaid and other current assets                                                    |       | 129                                                           |       | 384 |   | (153 | ) |
| Related party receivable / payable                                                  |       | —                                                        |       | — |   | 260 |   |
| Accounts payable                                                                    |       | 212                                                           |       | (115 | ) | 74 |   |
| Accrued compensation                                                                |       | 799                                                           |       | (216 | ) | (55 | ) |
| Other accrued expenses                                                              |       | (182                                                          | )          | (59 | ) | (720 | ) |
| Net cash used in operating activities                                               |       | (5,238                                                        | )          | (7,028 | ) | (8,731 | ) |
| Cash flows from  investing activities:                                              |       |                                                          |       |   |   |   |   |
| Purchase of property and equipment                                                  |       | (200                                                          | )          | (273 | ) | (564 | ) |
| Purchase of marketable securities                                                   |       | (255                                                          | )          | (11,841 | ) | (21,162 | ) |
| Proceeds from the maturity of marketable securities                                 |       | 5,016                                                         |       | 16,926 |   | 23,108 |   |
| Net cash provided by investing activities                                           |       | 4,561                                                         |       | 4,812 |   | 1,382 |   |
| Cash flows from  financing activities:                                              |       |                                                          |       |   |   |   |   |
| Proceeds from issuance of convertible preferred  stock and warrants, net  |       | 7,791                                                         |       | — |   | — |   |
| Proceeds from issuance of common stock under  employee benefit and incentive plans  |       | 645                                                           |       | 750 |   | 568 |   |
| Proceeds from long-term debt and capital lease  obligations                         |       | 210                                                           |       | — |   | 49 |   |
| Principal payments under long-term debt and capital  lease obligations              |       | (185                                                          | )          | (140 | ) | (125 | ) |
| Net cash provided by financing activities                                           |       | 8,461                                                         |       | 610 |   | 492 |   |
| Effect of exchange rate changes on cash and cash  equivalents                       |       | (367                                                          | )          | (463 | ) | 400 |   |
| Net decrease in cash and cash equivalents                                           |       | 7,417                                                         |       | (2,069 | ) | (6,457 | ) |
| Cash and cash equivalents at beginning of year                                      |       | 2,043                                                         |       | 4,112 |   | 10,569 |   |
| Cash and cash equivalents at end of year                                            |       | $                                                             | 9,460      |   | $ | 2,043 |   | $ | 4,112 |   |
|                                                                                     |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

 

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

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**BIOSPHERE MEDICAL, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**A—Nature of the Business**

BioSphere Medical, Inc. (the “Company”) wasincorporated in Delaware in December 1993. During 1999, the Companystrategically refocused its business on the development and commercializationof its proprietary Embosphere® Microspheres and other ancillary embolotherapy products for usein treating uterine fibroids, hypervascularized tumors and arteriovenousmalformations. The Company’s wholly owned subsidiary, Biosphere Medical S.A. (“BMSA”),a French societe anonyme, holds the license to the embolotherapy technologythat is the main focus of the Company’s business. In May 1999, the Companysold substantially all of the assets relating to chromatography, its formercore business, and changed its name from BioSepra, Inc. to BioSphereMedical, Inc.

The Company believes thatits existing working capital as of December 31, 2004, together withanticipated proceeds from sales of microspheres, delivery systems and otherproducts will be sufficient to fund operating and capital requirements, ascurrently planned, into the fourth quarter of 2006. In the longer term theCompany expects to fund its operations and sustaining capital requirementsthrough a combination of expected proceeds from product sales and capitalequipment financing. However, cash requirements may vary materially from thosenow planned due to a number of factors, including, without limitation, theCompany’s failure to achieve expected revenue amounts, costs associated withchanges in its uterine fibroid embolization (“UFE”) marketing programs,anticipated research and development expenses, the scope and results ofpre-clinical and clinical testing, changes in the focus and direction ofresearch and development programs, competitive and technological advances, thetiming and results of FDA regulatory review and the market’s acceptance of anyapproved products, including Embosphere Microspheres for UFE and HepaSphere SAPMicrospheres.

**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 translation adjustmentsare recorded in the cumulative translation adjustment account in stockholders’equity. Aggregate foreign exchange transaction gains and losses are included inother income 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 and 2003, all marketable securities were classified as available for sale,since the Company has 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 31,2004 or 2003, and no single customer accounted for greater than 10% of revenuesin 2004, 2003 or 2002.

***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.

***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.

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***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, 2004, 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. 101, “RevenueRecognition in Financial Statements,” as updated by 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 probable, persuasive evidence of an arrangement exists (a validpurchase order from an approved customer), and the sales price is fixed ordeterminable. Revenue from licensing agreements is recognized ratably over theperiod of the related agreement. The Company establishes reserves for potentialsales returns and evaluates, the adequacy of those reserves based upon realizedexperience. Under the Company’s current policy, only those products on acustomer’s initial order qualify for product satisfaction-related creditreturns. To date, returns related to product satisfaction have been minimal andimmaterial. While such returns have historically been within the Company’sexpectations and the provisions established, the Company cannot guarantee thatit will continue to experience the same return rates that it has in the past.Any significant change in product satisfaction and any resulting credit returnscould have a material adverse impact on the Company’s operating results for theperiod or periods in which such returns materialize. Shipping and handlingcosts 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.

***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, in turn,result in a significant impact on the value of the Company’s deferred taxassets and reported operating results.

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***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)**                               | ** ** | ** **            | ** ** | **2004** | ** ** | ** 2003 ** | ** ** |
| Foreign exchange  currency translation                |       | $                     | (181       | ) |   | $ | 29 |   |   |
| Unrealized  (losses)/gains on investments             |       | (7                    | )          |   | (1 | ) |   |
| Total accumulated  other comprehensive income/ (loss) |       | $                     | (188       | ) |   | $ | 28 |   |   |
|                                                       |            |                       |            |  |  |  |  |  |  |  |  |

 

***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. The following table illustrates the common stockequivalents, as determined in accordance with the treasury-stock accountingmethod and the total common stock and warrants outstanding:
| ** **                                                                        | ** ** | **For the years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)**                                                           | ** ** | ** **                                                    | ** ** | **2004** | ** ** | **2002** | ** ** | **2002** | ** ** |
| Common stock  equivalents                                                         |       |                                                          | 1,095      |   |   |   | 2,564 |   |   |   | 2,693 |   |   |
| Total common stock  options, warrants and convertible securities outstanding |       |                                                          | 5,617      |   |   |   | 3,087 |   |   |   | 3,930 |   |   |
|                                                                                   |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Common stock equivalentshave been excluded from the calculation of weighted average number of dilutedcommon shares as their effect would be antidilutive for all periods presenteddue to the loss incurred.

***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 common stock.Accordingly, no compensation expense has been recognized for its employeestock-based compensation plans.

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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 31,2003, 2002 and 2001 would have been adjusted to the pro forma amounts indicatedbelow:
| ** **                                                            | ** ** | **For the years ended December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | ** **                                                    | ** ** | **     2004     ** | ** ** | **     2003     ** | ** ** | **     2002     ** | ** ** |
| Net loss  applicable to common stockholders                           |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                           |       |                                                          | $          | (6,909 | ) |   |   | $ | (7,352 | ) |   |   | $ | (6,381 | ) |   |
| Pro forma compensation expense                                        |       |                                                          | (894       | ) |   |   | (1,617 | ) |   |   | (1,321 | ) |   |
| Pro forma net loss                                                    |       |                                                          | $          | (7,803 | ) |   |   | $ | (8,969 | ) |   |   | $ | (7,702 | ) |   |
| Basic and diluted loss per share                                      |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                           |       |                                                          | $          | (0.49 | ) |   |   | $ | (0.55 | ) |   |   | $ | (0.49 | ) |   |
| Pro forma                                                             |       |                                                          | $          | (0.55 | ) |   |   | $ | (0.67 | ) |   |   | $ | (0.59 | ) |   |
|                                                                       |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaverage estimated fair value of options granted during fiscal years 2004, 2003and 2002, was $2.09, $3.20, and $3.66 respectively, and was estimated using theBlack-Scholes option-pricing model using the following weighted-averageassumptions:
| ** **               | ** ** | **2004**       | ** ** | **2003**       | ** ** | **2002**       | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| Dividend yield           |       | None           |       | None           |       | None           |       |
| Volatility               |       | 93             | %          | 111            | %          | 110            | %          |
| Risk-free  interest rate |       | 2.80–3.81 | %          | 3.35–3.70 | %          | 3.15–4.48 | %          |
| Expected life (years)    |       | 5              |       | 5              |       | 5              |       |

 

The Black-Scholes option-pricingmodel was developed for use in estimating the fair value of traded options thathave no vesting restrictions and are fully transferable. In addition,option-pricing models require the use of highly subjective assumptions,including the expected stock price volatility. Because the Company’s employeestock options have characteristics significantly different from those of tradedoptions, and because changes in the subjective assumptions can materiallyaffect the fair value estimates, in management’s opinion, the existing modelsdo not necessarily provide a reliable single measure of the fair value of itsemployee stock-based compensation.

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

The Company accounts for stock-based compensation tonon-employees using the fair value method prescribed by SFAS No. 123. As aresult of stock options issued to non-employee medical board advisors, theCompany recognized $39,000 in non-employee compensation expense during the yearended December 31, 2003. The fair value of the non-employee stock optionswas derived from the Black-Scholes option-pricing model.

In connection with stockoptions previously issued to non-employees, during 2001 the Company’s Board ofDirectors authorized the Company to accelerate the vesting of all non-employeeadvisors’ stock options previously subject to variable accounting principles.Accordingly, $38,000 in non-cash compensation expense was recorded andpresented as a separate line item within the statement of operations for theyear ended December 31, 2002.

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***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 Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123R”). SFAS 123R addresses the accounting for transactions inwhich 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 No. 25 andrequires that such transactions be accounted for using a fair-value based method.SFAS 123R requires companies to recognize an expense for compensation costrelated to share-based payment arrangements including stock options andemployee stock purchase plans. The Company is required to implement theproposed standard no later than July 1, 2005. The cumulative effect ofadoption, applied on a modified retrospective basis, would be measured andrecognized on July 1, 2005. The Company is currently evaluating optionvaluation methodologies and assumptions related to its stock compensationplans.

As permitted by Statement 123, the Company currentlyaccounts for share-based payments to employees using APB 25’s intrinsic valuemethod and, as such, generally recognizes no compensation cost for employeestock options. Accordingly, the adoption of Statement 123(R) fair valuemethod will have a significant impact on our result of operations, although itwill have no impact on our overall financial position and cash position. Theimpact of adoption of Statement 123(R) cannot be predicted at this timebecause it will depend on levels of share-based payments granted in the future.However, had we adopted Statement 123(R) in prior periods, the impact ofthat standard would have approximated the impact of Statement 123 as describedin the disclosure of pro forma net loss per share earlier in this footnote.

In December 2004, the FASB issued FASB StaffPosition 109-2, “Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004”(“FSP 109-2”), in response to the American Jobs Creation Act of 2004which was signed into law in October, 2004 and which provides for a specialone-time tax deduction of 85% of certain foreign earnings that are repatriated(as defined). Based on the Company’s decision to reinvest rather than torepatriate current and prior year’s unremitted foreign earnings, theapplication of FSP 109-2 did not affect income tax expense in the periodof enactment or any related disclosures.

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs—an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS151 is the result of a broader effort by the FASB to improve the comparabilityof cross-border financial reporting by working with the InternationalAccounting Standards Board (“IASB”) toward development of a single set ofhigh-quality accounting standards. The FASB and the IASB noted that ARB 43,Chapter 4 and IAS 2, “Inventories,” require that abnormal amounts of idlefreight, handling costs, and wasted materials be recognized as period costs,however, the Boards noted that differences in the wording of the two standardscould lead to inconsistent application of those similar requirements. The FASBconcluded that clarifying the existing requirements in ARB 43 by adopting languagesimilar to that used in IAS 2 is consistent with its goals of improvingfinancial reporting in the United States and promoting convergence ofaccounting standards internationally. Adoption of SFAS 151 is required forfiscal years beginning after June 15, 2005. The provisions of SFAS 151will be applied prospectively. The Company is currently in the process ofevaluating the impact that SFAS 151, but does not believe it will have amaterial impact on the results of operations and financial position of theCompany.

 

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**C—StepAcquisition of Biosphere Medical S.A. and Minority Interest AcquisitionObligation**

On February 25, 1999, the Company acquired 51% ofthe outstanding capital stock of BMSA. Pursuant to a February 25, 1999purchase agreement, the Company acquired this ownership interest by granting toBMSA an exclusive sales and manufacturing license to certain patents andtechnology primarily relating to the Company’s Embosphere Microspherestechnology.

On April 7, 2000, theCompany purchased an additional 34% of BMSA for $950,000. As a result of thisstep-acquisition, the Company’s total ownership interest in BMSA increased to85%. On November 5, 2001, the Company acquired the remaining 15% interestin BMSA for approximately $953,000. Both step-acquisition transactions wereaccounted for under purchase accounting principles whereby the fair value inexcess of the net assets purchased was treated as an increase to goodwill. Netgoodwill, comprised entirely of the unamortized purchase price paid in excessof the net BMSA assets acquired, equaled $1.4 million as of December 31,2004 and 2003.

**D—Marketable Securities**

Cash and cash equivalents include commercial paper andmoney market funds of $8.89 million and $2.04 million at December 31, 2004and 2003, respectively.

The Company’scash, cash equivalents and marketable securities as of December 31, 2004are as follows:
| **(in thousands)**                               | ** ** | ** ** | ** ** | **WAV  Maturity  (Months)** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains/  (losses)** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------|------------|----------------------------------|------------|----------------------------|------------|
| Cash and money  market funds                          |       |       | N/A        |                        |       |                | $          | 8,515                            |       |                       |       | $ | — |   |   |   | $ | 8,515 |   |   |
| Corporate  obligations                                |       |       | 1          |                        |       |                | 1,185      |                             |       |                       | —     |   |   |   | 1,185 |   |   |
| Asset backed  securities                              |       |       | 32         |                        |       |                | 529        |                             |       |                       | (7         | ) |   |   | 522 |   |   |
| Total                                                 |       |       |       |                        |       |                | 10,229     |                             |       |                       | (7         | ) |   |   | 10,222 |   |   |
| Less amounts  classified as cash and cash equivalents |       |       |       |                        |       |                | (9,460     | )                                |       |                       | —     |   |   |   | (9,460 | ) |   |
| Total marketable  securities                          |       |       | 23         |                        |       |                | $          | 769                              |       |                       |       | $ | (7 | ) |   |   | $ | 762 |   |   |

 

TheCompany’s cash, cash equivalents and marketable securities as of December 31,2003 are as follows:
| **(in thousands)**                               | ** ** | ** ** | ** ** | **WAV  Maturity  (Months)** | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains/  (losses)** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------|------------|----------------------------------|------------|----------------------------|------------|
| Cash and money  market funds                          |       |       | N/A        |                        |       |                | $          | 2,043                            |       |                       |       | $ | — |   |   |   | $ | 2,043 |   |   |
| Corporate  obligations                                |       |       | 11         |                        |       |                | 1,716      |                             |       |                       | 2          |   |   |   | 1,718 |   |   |
| Asset backed  securities                              |       |       | 34         |                        |       |                | 2,206      |                             |       |                       | (4         | ) |   |   | 2,201 |   |   |
| Federal agency  obligations                           |       |       | 10         |                        |       |                | 1,312      |                             |       |                       | 1          |   |   |   | 1,313 |   |   |
| Government  treasury notes                            |       |       | 1          |                        |       |                | 300        |                             |       |                       | —     |   |   |   | 300 |   |   |
| Total                                                 |       |       |       |                        |       |                | 7,577      |                             |       |                       | (1         | ) |   |   | 7,575 |   |   |
| Less amounts  classified as cash and cash equivalents |       |       |       |                        |       |                | (2,043     | )                                |       |                       | —     |   |   |   | (2,043 | ) |   |
| Total marketable  securities                          |       |       | 19         |                        |       |                | $          | 5,534                            |       |                       |       | $ | (1 | ) |   |   | $ | 5,532 |   |   |

 

No material realized gainsor losses on the Company’s marketable securities were recognized during theyears ended December 31, 2004, 2003 and 2002.

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**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)** | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Raw material            |       | $                     | 468        |   | $ | 283 |   |
| Work in progress        |       | 1,393                 |       | 2,037 |   |
| Finished goods          |       | 1,450                 |       | 1,176 |   |
| Total inventory         |       | $                     | 3,311      |   | $ | 3,496 |   |
|                         |            |                       |            |  |  |  |  |  |  |

 

Included in inventory isan excess and obsolete product valuation allowance of $321,000 and $519,000 asof December 31, 2004 and 2003, respectively.

**F—Property and Equipment**

Propertyand equipment consists of the following:
| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                      | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Office equipment                             |       | $                     | 1,221      |   | $ | 1,101 |   |
| Laboratory and  manufacturing equipment |       | 2,276                 |       | 2,044 |   |
| Leasehold  improvements                      |       | 344                   |       | 332 |   |
| Total property and equipment                 |       | 3,841                 |       | 3,477 |   |
| Less: accumulated  depreciation              |       | (2,707                | )          | (1,980 | ) |
| Net property and  equipment                  |       | $                     | 1,134      |   | $ | 1,497 |   |
|                                              |            |                       |            |  |  |  |  |  |  |

 

Propertyand equipment under capital lease agreements, which are included in the tableabove, consist of the following:
| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                      | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Office equipment                             |       | $                     | 84         |   | $ | 27 |   |
| Laboratory and  manufacturing equipment |       | 638                   |       | 465 |   |
| Total property and equipment                 |       | 722                   |       | 492 |   |
| Less: accumulated  depreciation              |       | (389                  | )          | (225 | ) |
| Net property and  equipment                  |       | $                     | 333        |   | $ | 267 |   |
|                                              |            |                       |            |  |  |  |  |  |  |

 

Depreciation expense,including amortization on capital leases was $625,000, $658,000 and $607,000for the years ended December 31, 2004, 2003 and 2002, respectively.

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**G—Accrued Compensation**

Accruedcompensation consists of the following:
| ** **                                            | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                               | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Accrued payroll,  vacation and incentive compensation |       | $                     | 998        |   | $ | 1,054 |   |
| Accrued severance                                     |       | 549                   |       | — |   |
| Accrued  relocation                                   |       | 333                   |       | — |   |
|                                                  |       | $                     | 1,880      |   | $ | 1,054 |   |
|                                                       |            |                       |            |  |  |  |  |  |  |

 

In the fourth quarter of2004 we recorded a $589,000 charge for severance costs related to thetermination of two former executives. The amount accrued at December 31,2004 represents the remaining severance that will be paid out in 2005. At December 31,2004, there were $333,000 remaining of costs accrued to relocate two newexecutives, who were hired during the fourth quarter. There were no severanceor relocation costs accrued at December 31, 2003.

**H—Accrued Expenses**

Accruedexpenses consists of the following:
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                         | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Accrued royalties                               |       | $                     | 613        |   | $ | 697 |   |
| Accrued  professional and public reporting fees |       | 296                   |       | 242 |   |
| Accrued other                                   |       | 315                   |       | 340 |   |
|                                            |       | $                     | 1,224      |   | $ | 1,279 |   |
|                                                 |            |                       |            |  |  |  |  |  |  |

 

**I—Debt and Other Obligations**

Debtconsists of the following:
| ** **                                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                                             | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Capital lease  obligations                                          |       | $                     | 355        |   | $ | 267 |   |
| Euro term loan  payable to a bank secured by the net assets of BMSA |       | 12                    |       | 53 |   |
| Less: current  portion                                              |       | (175                  | )          | (149 | ) |
| Total long-term  debt and capital lease obligations                 |       | $                     | 192        |   | $ | 171 |   |
|                                                                     |            |                       |            |  |  |  |  |  |  |

 

On June 30, 2004, the Company entered into anagreement to extend the existing two-year credit facility with a bank that wasoriginally entered into in May 2002. The amended agreement provides thatthe credit facility will contain all of the terms and conditions of the Company’soriginal credit facility, with the exceptions that the amount under which theCompany could borrow for general working capital and corporate purposes,subject to limitations defined in the agreement, was reduced from $5.0 millionto $3.0 million.

There were no borrowings outstanding under thisagreement as of December 31, 2004 or 2003. Each available 30, 60, 90 or180-day advance will bear interest at a per annum rate, at the Company’soption, equal to either (i) a variable rate as determined by the bank or (ii) arate equal to the corresponding 30, 60, 90 or 180-day LIBOR rate (2.42% as of December 31,2004) 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 theCompany’s equity ownership of BMSA, as 

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collateral. As of December 31,2004 and 2003, the Company was in compliance with all credit facilitycovenants.

On February 28, 2004, the Company entered into afour-year capital lease agreement for the purchase of manufacturing equipmentat its facility in Roissy, France. The amount of the lease is for $165,000,payable over 48 months, at an effective annual interest rate of 4.64%. As of December 31,2004, there was $133,000 outstanding under this capital lease agreement.

In March 2001, the Company’s wholly-owned Frenchsubsidiary, Biosphere Medical, SA, or BMSA, entered into a €152,450($208,000 equivalent as of December 31, 2004) term loan with a Frenchnational bank that is payable in Euros over four years and accrues interest at5.4% per annum.

The Company leases approximately 13,000 square feet ofoffice and lab space at its Rockland, Massachusetts facility under an operatinglease expiring in March 2005 for approximately $270,000 per year,exclusive of periodic operating and maintenance expenses. Subsequent to December 31,2004, the Company amended this lease decreasing the total area to approximately7,797 square feet at a monthly cost of $13,000 per month, and extending theterm of the lease through March 31, 2007. BMSA leases approximately 18,150square feet of manufacturing and office space in Roissy, France through May 2010for approximately €171,000 per year (approximately $233,000 as of December 31,2004). BMSA also has several operating leases covering certain pieces of manufacturingand office equipment through September 2007.

During 2004 and 2002, the Company entered into severalcapital lease agreements in connection with the acquisition of certainmanufacturing and computer equipment. The leases have initial terms of 30 to 60months with interest rates of 5.4% to 13.4%. All equipment leased under theseagreements serves as pledged capital.

Futureminimum lease payments under non-cancelable operating leases and capital leasesin effect as of December 31, 2004, are as follows:
| **(in thousands)**                              | ** ** | ** ** | ** ** | **Operating  Leases** | ** ** | **Capital  Leases** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------|------------|---------------------|------------|
| 2005                                                 |       |       | $          | 493                   |       |                |       | $ | 176 |   |   |
| 2006                                                 |       |       | 470        |                  |       |                | 159        |   |   |
| 2007                                                 |       |       | 314        |                  |       |                | 51         |   |   |
| 2008                                                 |       |       | 234        |                  |       |                | 7          |   |   |
| 2009                                                 |       |       | 234        |                  |       |                | —     |   |   |
| Thereafter                                           |       |       | 97         |                  |       |                | —     |   |   |
| Total lease commitments                              |       |       | $          | 1,842                 |       |                |       | 393 |   |   |
| Less amount representing interest                    |       |       |       |                  |       |                | (38        | ) |   |
| Present value of  net minimum capital lease payments |       |       |       |                  |       |                | $          | 355 |   |   |

 

Total facility rentalexpense for the years ended December 31, 2004, 2003 and 2002 wasapproximately $509,000, $467,000 and $475,000, respectively.

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**J—Income Taxes**

As of December 31,2004, the Company had federal net operating loss (NOL) carry forwards ofapproximately $64.47 million, which will expire through the year 2024, stateNOL carry forwards of approximately $47.02 million, which will expire through theyear 2009, and foreign NOL carry forwards of approximately $3.97 million, whichdo not expire. As of December 31, 2004, the Company has $176,000 ofresearch and development credit carry forwards to offset future income taxes,which will expire through the year 2017. The components of the Company’s netdeferred tax asset at December 31, 2004 and 2003 are as follows:
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| **(in thousands)**             | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Assets derived from the  following: |       |                  |       |   |   |
| NOL carry forwards                  |       | $                     | 26,230     |   | $ | 22,113 |   |
| Tax credit carry forwards           |       | 161                   |       | 161 |   |
| Other                               |       | 398                   |       | 891 |   |
| Subtotal                            |       | 26,789                |       | 23,165 |   |
| Valuation allowance                 |       | (26,789               | )          | (23,165 | ) |
| Net deferred tax  asset             |       | $                     | —     |   | $ | — |   |
|                                     |            |                       |            |  |  |  |  |  |  |

 

The Company has established a full valuation allowanceagainst its deferred tax assets as of December 31, 2004 and 2003 as itconsiders the realizable value of any tax benefit against future taxable incometo be uncertain. The change in the valuation allowance from December 31,2003 to December 31, 2004 is a result of the increase in NOL carryforwards and deferred compensation.

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. The 2003 income tax provision of $23,000represents minimum corporate taxes due in both France and in the United States.For the years ended December 31, 2004, 2003, and 2002, the increase in thevaluation allowance relating to losses not resulting in a current period taxbenefit is the primary difference between the income tax provision (benefit)recorded by the Company and what the income tax benefit would be at statutoryincome tax rates.

Thecomponents of the Company’s pretax loss by tax jurisdiction, net of anyintercompany transactions, are as follows:
| ** **              | ** ** | **For the years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | ** **                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| United States           |       | $                                                             | (4,996     | ) | $ | (4,729 | ) | $ | (5,831 | ) |
| France                  |       | (1,728                                                        | )          | (2,600 | ) | (731 | ) |
| **Pretax  loss**        |       | $                                                             | (6,724     | ) | $ | (7,329 | ) | $ | (6,562 | ) |
|                         |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

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**K—Segment Information**

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)**        | ** ** | ** **                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Revenues:**                  |       |                                                          |       |   |   |   |   |
| United States                  |       | $                                                             | 9,080      |   | $ | 8,595 |   | $ | 8,681 |   |
| France                         |       | 2,883                                                         |       | 2,579 |   | 2,224 |   |
| Other European Union countries |       | 1,408                                                         |       | 1,102 |   | 1,094 |   |
| Other foreign countries        |       | 787                                                           |       | 527 |   | 153 |   |
| Total revenues                 |       | $                                                             | 14,158     |   | $ | 12,803 |   | $ | 12,152 |   |
| **Long-  lived assets:**       |       |                                                          |       |   |   |   |   |
| United States                  |       | $                                                             | 425        |   | $ | 616 |   | $ | 730 |   |
| France                         |       | 709                                                           |       | 881 |   | 962 |   |
| Total long- lived  assets      |       | $                                                             | 1,134      |   | $ | 1,497 |   | $ | 1,692 |   |
|                                |            |                                                               |            |  |  |  |  |  |  |  |  |  |

 

**L—Capital Stock**

***Common Stock***

In July 2001, theCompany completed an underwritten public offering of 4.0 million shares of itscommon stock at $11.00 per share. Of the 4.0 million shares of common stockoffered, the Company sold 2.0 million shares and Sepracor Inc. sold 2.0 millionshares. Net proceeds to the Company were approximately $20.40 million. On August 6,2001, Sepracor sold an additional 600,000 shares of the Company’s common stockpursuant to exercise of the underwriters’ over-allotment option. As a result ofthis offering, including the sale of shares pursuant to exercise of theover-allotment, Sepracor’s beneficial ownership interest in the Company’soutstanding common stock decreased from approximately 55% to approximately 25%.Due to subsequent exercises under the Company’s various equity incentive plans(See Note M), Sepracor’s ownership of outstanding common stock decreased toapproximately 23% as of December 31, 2004 and 2003. In May 2002,holders of warrants issued in 1997 to purchase 40,000 shares of the Company’scommon stock at $3.00 per share exercised their rights and purchased all 40,000shares of common stock for an aggregate purchase price of $120,000.

***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.

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***6% Series A Convertible Preferred Stock***

On November 10, 2004,the Company 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 have been assigned a value of $850,000 using theBlack-Scholes option-pricing model.

**M—Stock Plans**

***Stock Option Plans***

The Company’s 1997 Stock Option Plan, as amended (the “1997Plan”), provides for the grant of both ISOs and NSOs to officers, directors,advisors and key employees of the Company. The 1997 Plan also provides for thegrant of NSOs to consultants of the Company. A total of 5.0 million shares havebeen approved for issuance under the 1997 Plan and as of December 31,2004, approximately 794,000 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 both incentive stock options (“ISOs”) and non-statutory stockoptions (“NSOs”) to officers, directors, advisors and key employees of theCompany. The 1994 Plan also provided for the grant of NSOs to consultants ofthe Company. The exercise price for ISOs must be at least equal to the fairmarket value of the Company’s common stock on the date of grant and theexercise price of NSOs must be at least equal to 50% of the fair market valueof the Company’s common stock on the date of grant. Options generally becomeexercisable 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 31,2004, no shares were available for issuance.

The Director Option Plan (the “Director Plan”), asamended, provided for the granting of NSOs to directors of the Company who arenot officers or employees of the Company or of any subsidiary of the Company. Atotal of 300,000 shares of common stock were reserved for issuance under theDirector Plan subject to adjustments as provided therein. The exercise priceper share will equal the fair market value of a share of Company’s common stockon the date the option is granted. Options granted under the Director Plan willvest in either two or five equal installments beginning on the firstanniversary of the date of the grant depending on the nature of the grant andhave a maximum term of ten years from the date of grant. The Director Planexpired in January 2000, and as of December 31, 2004, no shares wereavailable 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, 2004:
| ** **                                                  | ** ** | **Options issued under the Plans** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **(in thousands, except option price)** | ** ** | ** **                                             | ** ** | **     Shares     ** | ** ** | **Average    Price Per Share  ** | ** ** |
| Outstanding at  December 31, 2001                      |       |                                                   | 3,883      |   |   |   | $ | 3.18 |   |   |
| Granted                                                     |       |                                                   | 1,126      |   |   |   | 4.74 |   |   |
| Exercised                                                   |       |                                                   | (472       | ) |   |   | 1.20 |   |   |
| Forfeited                                                   |       |                                                   | (770       | ) |   |   | 4.35 |   |   |
| 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 |   |   |
| Exercisable at December 31, 2004                       |       |                                                   | 1,741      |   |   |   | $ | 3.69 |   |   |
| Exercisable at December 31, 2003                       |       |                                                   | 1,904      |   |   |   | $ | 3.28 |   |   |
| Exercisable at  December 31, 2002                      |       |                                                   | 1,999      |   |   |   | $ | 2.75 |   |   |
|                                                             |            |                                                        |            |  |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes information about the range of exercise prices forstock options under the three plans, outstanding and exercisable as of December 31,2004:
| ** **                                                           | ** ** | ** ** | ** ** | **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                                                          | –     | 0.81       |            |                         |       | 341                                           |       |   |   | 4.06 |   |   |   | $ | 0.81 |   |   |   | 341 |   |   |   | $ | 0.81 |   |   |
| 1.02                                                                 | –     | 1.88       |            |                         |       | 555                                           |       |   |   | 3.56 |   |   |   | 1.50 |   |   |   | 555 |   |   |   | 1.50 |   |   |
| 2.00                                                                 | –     | 2.31       |            |                         |       | 115                                           |       |   |   | 3.25 |   |   |   | 2.04 |   |   |   | 115 |   |   |   | 2.04 |   |   |
| 2.55                                                                 | –     | 2.55       |            |                         |       | 600                                           |       |   |   | 9.84 |   |   |   | 2.55 |   |   |   | — |   |   |   | — |   |   |
| 2.70                                                                 | –     | 3.29       |            |                         |       | 489                                           |       |   |   | 7.16 |   |   |   | 3.11 |   |   |   | 126 |   |   |   | 3.10 |   |   |
| 3.31                                                                 | –     | 4.25       |            |                         |       | 539                                           |       |   |   | 7.96 |   |   |   | 3.85 |   |   |   | 334 |   |   |   | 4.17 |   |   |
| 4.38                                                                 | –     | 17.25      |            |                         |       | 375                                           |       |   |   | 6.22 |   |   |   | 9.23 |   |   |   | 234 |   |   |   | 10.30 |   |   |
| 18.38                                                                | –     | 18.38      |            |                         |       | 12                                            |       |   |   | 5.43 |   |   |   | 18.38 |   |   |   | 12 |   |   |   | 18.38 |   |   |
| 27.25                                                                | –     | 27.25      |            |                         |       | 28                                            |       |   |   | 5.13 |   |   |   | 27.25 |   |   |   | 24 |   |   |   | 27.25 |   |   |
| 0.81                                                                 | –     | 27.25      |            |                         |       | 3,054                                         |       |   |   | 6.54 |   |   |   | $ | 3.57 |   |   |   | 1,741 |   |   |   | $ | 3.69 |   |   |
|                                                                      |            |            |            |                              |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Employee Stock Purchase Plans***

In June 2000,stockholders approved the 2000 Employee Stock Purchase Plan (the “2000 ESPP”).Under the 2000 ESPP, an aggregate of 50,000 shares of common stock may bepurchased by employees at 85% of the fair market value on the first or last dayof each six-month offering period, whichever is lower. During each offeringperiod, the maximum number of shares which may be purchased by a participatingemployee is determined on the first day of the offering period and is equal tothe number of shares of common stock determined by dividing $12,500 by the lastreported sale price of the common stock on the NASDAQ National Market on thefirst day of the offering. An eligible employee may elect to have up to a 

63

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maximumof 10% deducted through payroll deductions from his or her regular salary.During 2004, 2003 and 2002, 9,207, 11,834 and 13,508 shares of the Company’scommon stock were issued under the 2000 ESPP, respectively.

**N—Employees Savings Plan**

The Company has a 401(k) savingsplan for all domestic employees pursuant to which eligible employees mayvoluntarily contribute up to $12,000 subject to statutory limitations. Inaddition, the Company matches in cash 50% of the first $3,000 contributed byemployees up to a $1,500 maximum per employee per year. Employer cash matchingcontributions amounted to approximately $38,000, $49,000, and $48,000 for theyears ended December 31, 2004, 2003 and 2002, respectively.

**O—Valuation and Qualifying Accounts**

TheCompany monitors the credit worthiness of its trade customers based uponhistorical payment experience. A rollforward of the allowance for doubtfulaccounts for the years ended December 31, 2004, 2003 and 2002 is asfollows:
| **(in thousands)**            | ** ** | ** ** | ** ** | **Balance,  Beginning  of Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions** | ** ** | **Balance,  End of  Period** | ** ** |
|------------------------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------------------------|------------|----------------|------------|-----------------------------------|------------|
| Year ended  December 31, 2004 |       |       | $          | 180                                     |       |                                          |       | $              | 80         |                              |       |   | $ | (76 | ) |   |   | $ | 184 |   |   |
| Year ended  December 31, 2003 |       |       | $          | 117                                     |       |                                          |       | $              | 71         |                              |       |   | $ | (8 | ) |   |   | $ | 180 |   |   |
| Year ended  December 31, 2002 |       |       | $          | 105                                     |       |                                          |       | $              | 22         |                              |       |   | $ | (10 | ) |   |   | $ | 117 |   |   |

 

**P—Contingencies**

In December 2004, the Company paid damages in alawsuit brought by Terumo Europe N.V. against the Company’s French subsidiary,BioSphere Medical, S.A. In the lawsuit, Terumo alleged that it suffered damagesfrom a purported 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 the exclusivedistributor of EmboSphere Microsphere and EmboGold Microsphere products incertain countries of Europe. The Commercial Court of Pontoise, France,determined that while both parties had ceased to perform their obligationsunder the agreement, the Company’s termination was not in accordance with theprovisions of the Agreement. Accordingly, BMSA was required to pay Terumo$784,000 in damages for breach of contract in December 2004. The $874,000charge recorded in the fourth quarter of 2004 includes $90,000 of relatedaccounts receivable written-off in addition to the settlement payment.

The Company may beinvolved in various legal proceedings in the normal course of business. TheCompany is not a party to any proceedings that involve amounts that would havea material effect on our financial position or results of operations if suchproceedings were resolved unfavorably.

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**Q—QuarterlyFinancial Data (Unaudited)**

Thefollowing is a summary of quarterly financial results:
| ** **                                                           | ** ** | ** ** | ** ** | **Fourth**  | ** ** | **Third**   | ** ** | **Second**  | ** ** | **First**   | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(in thousands except per share amounts)** | ** ** | ** ** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Net revenues                                                         |       |       |       |        |       |        |       |        |       |
| 2004                                                                 |       | $          | 4,279      |        | $          | 3,473       |       | $           | 3,226      |        | $          | 3,180 |   |
| 2003                                                                 |       | 3,645      |       | 2,986       |       | 3,122       |       | 3,050       |       |
| Gross profit                                                         |       |       |       |        |       |        |       |        |       |
| 2004                                                                 |       | 2,644      |       | 2,312       |       | 938         |       | 1,618       |       |
| 2003                                                                 |       | 1,505      |       | 1,825       |       | 1,891       |       | 2,024       |       |
| Net loss applicable to  common stockholders                          |       |       |       |        |       |        |       |        |       |
| 2004(1)                                                              |       | (1,962     | )          | (1,148      | )          | (2,243      | )          | (1,556      | )          |
| 2003                                                                 |       | (1,172     | )          | (1,461      | )          | (2,543      | )          | (2,176      | )          |
| Basic and diluted net  loss per share                                |       |       |       |        |       |        |       |        |       |
| 2004                                                                 |       | $          | (0.14      | )           | $          | (0.08       | )          | $           | (0.16      | )           | $          | (0.11 | ) |
| 2003                                                                 |       | (0.09      | )          | (0.11       | )          | (0.19       | )          | (0.16       | )          |

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

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

None.

**Item 9A.**                CONTROLSAND PROCEDURES

Our management, with the participation of our chiefexecutive officer and chief financial officer, evaluated the effectiveness ofour disclosure controls and procedures as of December 31, 2004. The term “disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended, or the Exchange Act, meanscontrols and other procedures of a company that are designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the Securities and Exchange Commission’srules 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. Managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving their objectivesand management necessarily applies its judgment in evaluating the cost-benefitrelationship of possible controls and procedures. Based on the evaluation ofour disclosure controls and procedures as of December 31, 2004, our chiefexecutive officer and chief financial officer concluded that, as of such date,our disclosure controls and procedures were effective.

No change in our internalcontrol over financial reporting occurred during the fiscal quarter ended December 31,2004 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Item 9B.**               OTHER INFORMATION

None.

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**PART III**

**Item 10.**                 DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT

**Directors and Executive Officers**

Information regarding ourdirectors will be included in the definitive proxy statement for the 2005Annual Meeting of Stockholders under “Nominees for Director” and is hereinincorporated by reference.

**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 2005 Annual Meeting ofStockholders under “Board and Committee Meetings” and “Report of the AuditCommittee” 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 2005 Annual Meeting of Stockholders under “Section 16(a)Beneficial Ownership Reporting Compliance” and is herein incorporated byreference.

**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 filed 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 2005 Annual Meetingof Stockholders under “Compensation of Executive Officers” and is hereinincorporated by reference.

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

The response to this itemwill be included in the definitive proxy statement for the 2005 Annual Meetingof Stockholders under “Stock Ownership of Certain Beneficial Owners andManagement” and “Equity Compensation Plan Information” and is hereinincorporated by reference.

**Item 13.**                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The response to this item willbe included in the definitive proxy statement for the 2005 Annual Meeting ofStockholders under “Certain Relationships and Related Transactions” and isherein incorporated by reference.

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**Item14.**                 PRINCIPALACCOUNTANT FEES AND SERVICES

The response to this itemwill be included in the definitive proxy statement for the 2005 Annual Meetingof Stockholders under “Report of the Audit Committee” and “IndependentAccountants, Fees and Other Matters” and is herein incorporated by reference.

**PART IV**

**Item15.**                 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, 2004 and 2003                                                                                  |
| Consolidated  Statements of Operations—Years ended December 31, 2004, 2003 and 2002                                                      |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive Income (Loss)—Years  ended December 31, 2004, 2003 and 2002 |
| Consolidated  Statements of Cash Flows—Years ended December 31, 2004, 2003 and 2002                                                      |
| Notes to  Consolidated Financial Statements                                                                                                        |

 

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

(a)   (3)  Exhibitsincluded or incorporated herein:

See Exhibit Index

**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)). |
| 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.                                                                                                                                                                                          |
| 10.5(1)*         |       | Form of Incentive Stock Option Agreement  granted under 1997 Stock Incentive Plan.                                                                                                                                                                                     |
| 10.6(1)*         |       | Form of Nonstatutory Stock Option Agreement granted  under 1997 Stock Incentive Plan.                                                                                                                                                                                  |
| 10.7(1)*         |       | Form of Restricted  Stock Agreement granted under 1997 Stock Incentive Plan.                                                                                                                                                                                           |

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| 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)).                               |
| 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 Form 10-K for  the year ended December 31, 2001).                                                                                                                                                                                 |
| 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  |   | Form of Stock and  Warrant Purchase Agreement dated as of February 4, 2000 together with  schedule of purchasers thereto. (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  |   | Form of Warrant  Agreement dated as of February 4, 2000, between the Company and certain  purchasers (together with schedule of purchasers thereto). (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)).                                                                            |
| 10.16  |   | 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)).                                                                                                                             |
| 10.17  |   | 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)).                                                                                                            |
| 10.18  |   | Stock Purchase Agreement  dated July 28, 2000. (Incorporated herein by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 30, 2000  (File No. 000-23678)).                                                                                                                                                                                     |
| 10.19  |   | Registration Rights  Agreement dated July 28, 2000. (Incorporated herein by reference to the  Company’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2000 (File No. 000-23678)).                                                                                                                                                                                |
| 10.20  |   | 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)).                                                                                               |

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| 10.21     |   | 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)).                                                                                             |
|-----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.22     |   | 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)).                                                                                           |
| 10.23     |   | 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)). |
| 10.24(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)).                                                                                     |
| 10.25(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)).                                                                                              |
| 10.26(1)  |   | Executive Retention  Agreement between BioSphere Medical, Inc. and Peter C. Sutcliffe, 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)).                                                                               |
| 10.27(1)  |   | Employment Agreement  between BioSphere Medical, Inc. and Peter C. Sutcliffe, 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)).                                                                                        |
| 10.28(1)* |   | Letter Agreement between  BioSphere Medical, Inc. and Gary M. Saxton, dated November 18,  2004.                                                                                                                                                                                                                                                                |
| 10.29(1)  |   | Severance Agreement and  General Release between BioSphere Medical, Inc. and Paul Looney,  effective 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)).                                                                                    |
| 10.30(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)).                                                                                                 |
| 10.31(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)).                                                                                        |
| 10.32     |   | 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)).                                                                    |
| 10.33     |   | 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)).                                                                           |
| 10.34     |   | 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)).                                                                                                                    |

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| 10.35     |   | 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)).                                                                                                        |
|-----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.36     |   | 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)).                                  |
| 10.37     |   | 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)).                                                                           |
| 10.38     |   | 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)).                                                                                      |
| 10.39     |   | 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)). |
| 10.40(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)).                                                                |
| 10.41(1)* |   | Compensation of Executive  Officers of BioSphere Medical, Inc.                                                                                                                                                                                                                                                                                |
| 10.42(1)* |   | Compensation Program for  Non-Employee Directors of BioSphere Medical, Inc.                                                                                                                                                                                                                                                                   |
| 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 29, 2005.                                                                                            |
| 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 29, 2005.                                                                                             |
| 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 29, 2005.                                                                                                                                                     |
| 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 29, 2005.                                                                                                                                                     |

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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 29, 2005 |                     |

 

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 29, 2005 |
| **Richard  J. Faleschini**             |          | (Principal Executive Officer)                    |       |                |
| /s/  MARTIN J. JOYCE                   |          | Vice President and Chief  Financial Officer      |       | March 29, 2005 |
| **Martin  J. Joyce**                   |          | (Principal Financial and Accounting Officer)     |       |                |
| /s/  TIMOTHY J. BARBERICH              |          | Director                                         |       | March 29, 2005 |
| **Timothy  J. Barberich**              |          |                                             |       |                |
| /s/  WILLIAM M. COUSINS, JR.           |          | Director                                         |       | March 29, 2005 |
| **William  M. Cousins, Jr.**      |          |                                             |       |                |
| /s/  ALEXANDER M. KLIBANOV, Ph.D. |          | Director                                         |       | March 29, 2005 |
| **Alexander  M. Klibanov, Ph.D.**      |          |                                             |       |                |
| /s/  JOHN H. MACKINNON                 |          | Director                                         |       | March 29, 2005 |
| **John H.  MacKinnon, CPA**            |          |                                             |       |                |
| /s/  RICCARDO PIGLIUCCI                |          | Director                                         |       | March 29, 2005 |
| **Riccardo  Pigliucci**                |          |                                             |       |                |
| /s/  DAVID P. SOUTHWELL                |          | Director and Chairman of  the Board              |       | March 29, 2005 |
| **David  P. Southwell**                |          |                                             |       |                |

 

 

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