<PAGE>

                            UNITED STATES OF AMERICA
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB


                     ANNUAL REPORT UNDER SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

                         Commission File Number 0-27035

                                MICROISLET, INC.
             (Exact name of registrant as specified in its charter)

             NEVADA                                            88-0408274
             ------                                            ----------
(State or other jurisdiction of                             (I.R.S. Employer
 incorporation or organization)                           Identification Number)

6370 NANCY RIDGE DRIVE, SUITE 112, SAN DIEGO, CALIFORNIA           92121
--------------------------------------------------------           -----
       (Address of principal executive offices)                 (Zip Code)

                                 (858) 657-0287
              (Registrant's telephone number, including area code)

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, $.001 Par Value                          American Stock Exchange
-----------------------------                          -----------------------

        SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
                                (Title of Class)

Check whether the issuer is not required to file reports pursuant to Section 13
or 15(d) of the Exchange Act. [ ]

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

The registrant's revenues for its most recent fiscal year were $153,000.

As of March 1, 2006, the aggregate market value of the voting stock of the
registrant held by non-affiliates of the registrant was $50,331,000.*

The number of shares of Common Stock, $.001 par value, outstanding on March 1,
2006, was 44,035,136.

* Excludes the Common Stock held by executive officers, directors and
stockholders whose ownership exceeds 5% of the Common Stock outstanding on March
1, 2006. The calculation does not reflect a determination that such persons are
affiliates for any other purposes.


<PAGE>


                                TABLE OF CONTENTS


                                                                            Page

                                     PART I

ITEM 1.    Business                                                            3
ITEM 2.    Properties                                                         13
ITEM 3.    Legal Proceedings                                                  14
ITEM 4.    Submission of Matters to a Vote of Security Holders                14

                                     PART II

ITEM 5.    Market for Common Equity,  Related Stockholder Matters,
            and Small Business Issuer Purchases of Equity Securities          15
ITEM 6.    Management's Discussion and Analysis or Plan of Operation          15
ITEM 7.    Financial Statements                                               35
ITEM 8.    Changes in and Disagreements with Accountants on
             Accounting and Financial Disclosure                              35
ITEM 8A.   Controls and Procedures                                            35
ITEM 8B.   Other Information                                                  35

                                    PART III

ITEM 9.    Directors, Executive Officers, Promoters and Control
            Persons; Compliance with Section 16(a) of the Exchange Act        36
ITEM 10.   Executive Compensation                                             39
ITEM 11.   Security Ownership of Certain Beneficial Owners and
            Management and Related Stockholder Matters                        45
ITEM 12.   Certain Relationships and Related Transactions                     47
ITEM 13.   Exhibits                                                           48
ITEM 14.   Principal Accountant Fees and Services                             51

                           FORWARD-LOOKING STATEMENTS

         This report contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, which reflect management's
current views with respect to future events and financial performance. In this
report the words "anticipates," "believes," "expects," "intends," "future,"
"may" and similar expressions identify forward-looking statements. These and
other forward-looking statements are subject to certain risks and uncertainties,
including those discussed in the "Business Risks" section of Item 6 and
elsewhere in this Form 10-KSB, that could cause actual results to differ
materially from historical results or those anticipated. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. We undertake no obligation to publicly release the
results of any revisions to these forward-looking statements which may be made
to reflect events or circumstances occurring subsequent to the original filing
date of this Form 10-KSB with the Securities and Exchange Commission.


                                       2



<PAGE>


                                     PART I

ITEM 1.  BUSINESS

OVERVIEW

We are a biotechnology company engaged in the research, development, and
commercialization of patented technologies in the field of transplantation
therapy for people with insulin-dependent diabetes. Patented islet
transplantation technology, exclusively licensed from Duke University, along
with our own developments, constitute methods for isolating, culturing,
cryopreservation, and immuno-protection (microencapsulation) of islet cells. We
intend to continue our research and development efforts and, ultimately, to
introduce products to the market.

PRODUCT

We intend to seek FDA approval for marketing in the U.S. a first product, called
MicroIslet-P(TM). MicroIslet-P(TM) will be an injectable suspension of
microencapsulated porcine islet cells for the treatment of insulin dependent
diabetes. MicroIslet-P(TM) is intended to be administered into the patient's
abdominal cavity, where the transplanted islet cells will produce insulin in
response to increases in blood glucose, much like the patient's original
pancreatic islet cells did prior to being destroyed by disease.

The primary function of microencapsulation is to protect the islets from the
host's immune system. The microcapsule coating is composed of layers of
biocompatible materials.

We have not sought any approvals from foreign or domestic regulatory agencies
with respect to this product candidate. We must first establish the feasibility
of the concepts behind MicroIslet-P(TM) as described under the heading
"Management's Discussion and Analysis - Plan of Operation" below.

LICENSE AND SPONSORED RESEARCH

We entered into a license agreement with Duke University in September 1998,
which was amended in February 1999. Pursuant to the license agreement we
sponsored research conducted by Duke from 1998 through 2001 in connection with
the isolation, culture, storage and encapsulation of insulin-producing islet
cells from porcine sources to be used for transplantation in patients with
insulin-dependent diabetes. The research was conducted under the supervision of
Dr. Emmanuel C. Opara. Under the license agreement we agreed to pay Duke
University for all direct and indirect costs incurred in the performance of the
research. As of December 31, 2005, we have paid Duke approximately $450,000 for
its research efforts.

The license agreement gives us the exclusive, worldwide commercialization rights
to any product in any field of use developed under our sponsorship, with the
right to sublicense. We are obligated to pay Duke a royalty of 5% of all
proceeds generated by any future commercial products derived from the licensed
technology. In the event we are required to pay a third party additional
royalties in order to commercialize a product, royalty stacking will be capped
so that the total royalty due to Duke and any other third parties will not
exceed 10% of the net proceeds received from sales of a product.

As additional consideration for the license, we issued 344,586 shares of our
common stock to Duke upon the execution of the agreement. We issued an
additional 344,586 shares to Duke upon its issuance of the first patent
involving the technology in October 2001. We are obligated to issue an
additional 344,586 shares to Duke upon approval of a licensed product.

The agreement imposes on us an obligation to indemnify Duke, its officers,
employees and agents against claims arising from our or any sublicensee's
development, manufacture, or sale of any products that are developed through the
use of the patented technology licensed from Duke. The agreement also imposes on
us an obligation to use best efforts to market for exploitation the licensed
technology, to develop manufacturing capabilities internally or through third
parties, and to continue active, diligent marketing efforts for products based
on the licensed technology, including a vigorous sublicensing program to effect
commercialization of such products in any field we do not exploit on our own. If
we fail to meet these obligations, Duke may reduce the license to a
non-exclusive one. Moreover, if we fail to meet our obligations under the
agreement, including our payment obligations, and fail to remedy our breach
within 30 days of notice of the breach from Duke, Duke may terminate the
agreement. The license agreement expires when the last patent within the patent
rights licensed to us by Duke has expired.

                                       3

<PAGE>

We also have an active collaboration with the University of Alberta, Edmonton
(Canada). This facility is assisting us with transplantation surgery and
subsequent monitoring in animal models. Under the terms of the arrangement we
paid the University approximately $53,754, $15,000, and $42,000 during the
fiscal years ended December 31, 2005, 2004, and 2003, respectively, and have
agreed to pay the University a maximum of $100,000 per year based on services
provided as agreed upon from time to time.

We have also entered into two broad collaboration agreements in the area of
islet cell transplantation therapies for treatment of insulin-dependent diabetes
with The Scripps Research Institute. Under the terms of the agreements, we and
The Scripps Research Institute are conducting preclinical studies utilizing our
proprietary technologies. We believe the completion of this work will set the
stage for studies enabling an Investigational New Drug application (IND) and may
be included as part of the IND process required by the FDA for human clinical
trials. The first agreement calls for us to fund The Scripps Research Institute
in the amount of approximately $610,000 over a two year period ending in June
2007, and the second for approximately $450,000 over a three year period ending
in August 2007. We paid to The Scripps Research Institute approximately
$367,200, $434,000, and $215,000 during the fiscal years ended December 31,
2005, 2004, and 2003, respectively.

We have also entered into a collaboration agreement with the California National
Primate Research Center at the University of California, Davis in the area of
islet cell transplantation therapies for treatment of insulin-dependent
diabetes. We believe the completion of this work may be included as part of the
IND process required by the FDA for human clinical trials. The agreement calls
for us to fund the University in the amount of approximately $1.3 million over a
three year period ending May 2007. We paid to the University of California,
Davis, approximately $115,000 and $120,000 during the fiscal years ended
December 31, 2005 and 2004, respectively.

INTELLECTUAL PROPERTY

Over the last year our team of scientists has developed new intellectual
property in the areas of islet cell processing, quantification, and
encapsulation. We have filed and will continue to file applications with the
U.S. Patent and Trademark Office to protect our intellectual property as deemed
appropriate.

Patents, trademarks and trade secrets are central to the profitability of
pharmaceutical products and our policy is to pursue intellectual property
protection aggressively for all our products. The license from Duke University
described above relates to two patents owned by Duke that are central to our
business plan. Both patents relate to methods of culturing, cryopreserving, and
encapsulating pancreatic islet cells. A summary of the patents is provided in
the following table:

PATENT                              CLAIMS
------                              ------

6,303,355                 Method of treating isolated pancreatic islet cells by:
   (granted 10/16/2001)          - Culturing with cocktail*
   (expires 3/22/2019)           - Cryopreservation with cocktail*
                                 - Encapsulation with polysaccharide gum
                                 - Culturing encapsulated islets with cocktail*

6,365,385                 Method of treating isolated pancreatic islet cells by:
   (granted 4/2/2002)            - Microencapsulated islet cells prepared
   (expires 3/22/2019)               according to claimed methods (above)
                                 - Microencapsulated islet cell product prepared
                                     according to claimed methods
                                 - Incubation of capsule containing a cell in
                                     a physiologically acceptable salt, where
                                     said salt is a sulfide salt, to increase
                                     capsule durability while retaining
                                     physiological responsiveness
                                 - Method of culturing with cocktail*
                                 - Semipermeable membrane to include
                                     poly-l-ornithine

                                       4



<PAGE>

6,783,964                        Product composition patent describing:
   (granted 8/31/2004)           - Microencapsulated islet cells
   (expires 3/22/2019)           - Microcapsule is comprised of a polysaccharide
                                     gum surrounded by a semipermeable membrane
                                 - Microcapsule is comprised of alginate in
                                     combination with polylysine, polyornithine
                                     and combinations thereof
                                 - Internal islet cell-containing core is
                                     comprised of alginate, gelled or not gelled
                                 - Microcapsule is 50um to 2mm in diameter
                                 - Microcapsule is incubated in physiologically
                                     acceptable salt to increase durability of
                                     the microcapsule
                                 - Physiological salt treatment of
                                     microencapsulated living islet cells
                                     results in not more than 10% increase by
                                     weight over one month at 37C and at least
                                     150% basal insulin secretion in response to
                                     16.7 mM glucose challenge in physiological
                                     solution at pH 7.4 after one month

* Possible components of cocktail include: anti-oxidants, anti-cytokines,
anti-endotoxin, and/or anti-biotics.

RESEARCH AND DEVELOPMENT STRATEGY

Our in-house research and development effort is focused on development of our
first product candidate called MicroIslet-P(TM). In our 3,000 square foot
laboratory we have 21 employees working full-time on this effort with assistance
from outside contractors. This research uses animal islet cells that have been
isolated and encapsulated using our proprietary technology, as well as any
additional processes, procedures, or scientific advances we develop in our
laboratory.

We are sponsoring research at the University of Alberta, Edmonton (Canada); The
University of California, Davis; and The Scripps Research Institute (TSRI) to
assist us with transplantation surgery and subsequent monitoring in animal
models.

Together with our sponsored research partners, and possibly other collaborators,
we will obtain data relating to the level of insulin delivery, blood glucose
control, the immune reaction of the animals to both the microencapsulated islets
and the capsule itself, and any side effects associated with the
transplantation. We will also develop information on dose and duration of
implanted cells in relevant diabetes models, as well as the longevity and
ultimate fate of the capsule in vivo. We will also work on developing approaches
for reduction and elimination of the use of systemic immunosuppression in islet
cell transplant recipients. Through these activities we are planning to
establish the feasibility of the concepts behind our product candidate in
animals.

We expect to add additional employees and collaborators as resources permit.

We have received preliminary data from TSRI showing interim results of
transplants using our proprietary technology in approximately 150 small animals.
Study groups of streptozotocin-induced diabetic NOD/SCID, as well as groups of
immunocompetent mice, were transplanted with MicroIslet's microencapsulated
porcine islet cells. The transplanted capsules at various dosing levels were
able to normalize blood glucose (normoglycemia) levels in all animals within one
week of transplantation. This ongoing study is being conducted under the
supervision of Dr. Daniel R. Salomon of the Department of Molecular and
Experimental Medicine at TSRI.

An analysis of the preliminary data supports the following observations:

     o   Porcine islet encapsulation technology we have developed preserves
         islet function and permits extended survival in an immunodeficient and
         immunocompetent rodent animal model of diabetes.

     o   These transplants resulted in a prompt return to normoglycemia
         occurring in 100% of the animals within a week of transplantation and
         continuing for the duration of the study demonstrating that the islet
         isolation and processing produced viable and functional graft tissue.

     o   Chemically induced diabetes can be reversed with as few as 500 islet
         equivalent units (IEQ) of encapsulated porcine islets in this model.

                                       5

<PAGE>

In August 2004 we received additional data from TSRI. An analysis of the
additional data supports the following additional observations:

     o   MicroIslet encapsulation technology preserves porcine islet function
         and extends survival in immunodeficient and immunocompetent diabetic
         animals.

     o   Diabetes is reversed in 80-85% of small animals. Graft function has
         been observed up to 256 days post transplantation to date.

     o   Transplantation of encapsulated islets does not sensitize the host to a
         second transplant. The graft survival in the second transplant is at
         least as long as the first transplant.

In September 2005 we received additional data from TSRI showing interim results
of transplants using our proprietary technology in small animals. Experiments
were conducted using encapsulated porcine islets transplanted into the
peritoneum of a diabetic rat model. The goal of these studies was to demonstrate
increased islet function and graft survival time using a proprietary combination
of novel encapsulation formulations and treatment regimens. An analysis of the
results of these preclinical animal studies appears to demonstrate graft
survival in diabetic rats for greater than 70 days when encapsulated porcine
islets are transplanted into the peritoneal cavity. These results were
accomplished through the use of a proprietary cocktail of islet survival factors
pre- and post-transplantation, in combination with a proprietary encapsulation
formulation, which together significantly improved the duration of islet
function in the recipient animal. In addition to supporting the potential
efficacy of our therapeutic approach, these results demonstrate that the rat
model continues to be an important tool for optimizing and refining the islet
survival formulation and transplantation procedures for our ongoing primate
studies.

In February 2006 we received additional data showing that minimally-invasive
transplantation of encapsulated porcine islets by intraperitoneal injection
resulted in significant and prolonged (greater than 30 days) improvement of
blood sugar with reduced insulin use in diabetic primates. These results were
accomplished by the use of a proprietary encapsulation formulation designed to
more effectively assure immunoisolation of the encapsulated islets with
preservation of access to nutrients, oxygen, and transport of low molecular
weight proteins.

Preliminary results of trials do not necessarily predict final results and
acceptable results in early trials may not be repeated in later trials.

We believe that patients receiving the MicroIslet-P(TM) therapy may require
periodic transplantations of additional islet cells annually. In order to
demonstrate the feasibility and safety of such re-transplantation, we conducted
re-transplantation experiments in small animals and found that the subsequent
transplants were effective and well tolerated.

In light of these results the near term objectives of our research and
development program are designed to prepare our current microencapsulated
porcine islet technology for clinical studies. These objectives are outlined as
follows:

     o   Optimization of our proprietary microencapsulated porcine islet
         technology.

     o   Performance of additional pre-clinical animal studies to establish
         safety and efficacy data in support of human clinical trials.

Once we are satisfied that we have adequately optimized our processes, and have
received FDA approval to proceed with human clinical trials, we expect to
undertake the following actions:

     o   Conduct allotransplantation human clinical studies in cooperation with
         the University of Alberta, Edmonton using their human islets and our
         encapsulation process. These studies are intended to validate the
         microencapsulation technology's ability to provide effective
         immunoisolation in humans prior to clinical trials of MicroIslet-P(TM).

     o   Conduct human clinical trials for MicroIslet-P(TM), using
         microencapsulated porcine islets.

Our total research and development expenses were approximately $5.6 and $2.9
million for 2005 and 2004, respectively.

                                       6

<PAGE>

PORCINE ISLET SUPPLY

Under the rules of the FDA, porcine islets used for implantation in humans must
come from purpose-bred, pathogen free, vaccinated pigs (referred to as
designated pathogen free pigs), raised in a United States Department of
Agriculture certified facility specifically designed for biomedical research
purposes. We currently receive our designated pathogen free pigs from the Mayo
Foundation for Medical Education and Research (the "Mayo Foundation"), and we
believe this is the only facility that can currently produce designated pathogen
free pigs to the required specification.

In November 2005, we entered into a long-term supply agreement with the Mayo
Foundation. Under the agreement the Mayo Foundation has agreed to supply us with
substantially all of its production of non-transgenic, designated pathogen free
pigs for our pre-clinical and human clinical xenotransplantation research for an
initial term expiring in November 2008 and extendable (at our option) for up to
an additional four years.

We have agreed to pay a monthly fee, subject to inflationary adjustments, to the
Mayo Foundation over the term of the long-term supply agreement for the right to
receive these pigs. We will also be required to pay the Mayo Foundation for its
expenses of harvesting pancreases or islets, should we ask the Mayo Foundation
to perform such harvesting for us. In addition we have agreed to grant to the
Mayo Foundation a warrant to purchase 75,000 shares of our common stock upon the
occurrence of each of the following events: (i) IND approval for a product using
the pigs; (ii) approval to start a Phase II clinical trial using the pigs; (iii)
approval to start a Phase III clinical trial using the pigs; and (iv) NDA/BLA
approval for a product using the pigs. Each warrant will have an exercise price
of $1.90 and will be exercisable for a term of ten years following the date of
grant. In the event the Mayo Foundation determines to close its facility or
cease production of pigs for xenotransplantation use during the term of the
agreement, we will have the right to enter into a lease with the Mayo Foundation
to operate such facility for the remaining term of the supply agreement,
including extensions.

We believe the quantity of pigs that the Mayo Foundation has agreed to supply
will be sufficient to meet our needs during the initial term of the long-term
supply agreement. The Mayo Foundation has agreed that during the term of the
long-term supply agreement it will not supply designated pathogen free pigs to
any other company for research related to, or use with respect to, the treatment
of diabetes. The long-term supply agreement supersedes in full the short-term
supply agreement between us and the Mayo Foundation dated February 2005. This
short-term supply agreement terminated upon the effective date of the long-term
supply agreement.

If this facility were to cease providing designated pathogen free pigs to us in
sufficient quantities, we would be required either to locate another facility
which is able to supply designated pathogen free pigs, which may not be
possible, or to construct and operate our own facility. The cost to construct
and operate our own farm facility would materially increase our costs of
clinical studies and would likely delay the commencement or continuation of
clinical studies for a period of two years or more.

We could also experience substantially increased costs and substantial delays if
the Mayo facility or any other facility which supplies designated pathogen free
pigs, including any facility we operate ourselves, were to become contaminated.
In such case there would be a delay of at least twelve months before such
facility could again deliver designated pathogen free pigs.

Were any of such events to occur before the commencement of clinical trials,
such trials might have to be delayed. Were any of such events to occur during
clinical trials, we may have to halt those clinical trials and could lose the
benefit of the data gathered and the costs incurred. We could also lose key
staff members and collaborators if clinical trials were substantially delayed.
We would be required to continue to pay our operating expenses while we waited
to recommence clinical trials and the payment of such expenses may deplete our
cash reserves and make it more difficult for us to raise capital for future
clinical trials. Our ability to execute our business plan could be threatened
and our stock price could decline substantially in response to any of these
occurrences.

                                       7

<PAGE>

MARKET OPPORTUNITY

Diabetes is the sixth leading cause of death in the United States, contributing
to more than 193,000 deaths per year. An estimated 1.4 million Americans are
insulin dependent diabetics. Currently, each diabetic patient costs the U.S.
health care system more than $10,000 per year. We believe that the market will
support a price significantly higher than $10,000 per year for a product that
can effectively cure insulin dependent diabetes. We estimate the potential
market size is $14 billion for the United States and an additional $18 billion
for the top six industrialized foreign countries.

COMPETITION

The pharmaceutical and biotechnology industries are intensely competitive and
technological progress can be rapid. Although, based upon the publicly available
information, it appears that there are no other products currently available or
in late stage clinical trials that can effectively cure insulin dependent
diabetes, we anticipate that the development of products that can better treat
and manage this disease will remain the focus of intense competition.

The strongest competition is anticipated to come from traditional and alternate
insulin delivery systems, such as inhalable insulin or insulin pumps. If
successful these new products would offer a moderately improved quality of life
for diabetics, but are not likely to eliminate the need for frequent blood
glucose monitoring or to address the inevitable long-term complications
resulting from exogenous insulin therapies.

There are several other companies engaged in the research of islet
transplantation technologies. Some of these companies include:

     o   Living Cell Technologies (LCT) (formerly Diatranz) -- publicly traded
         Australian-based biotech company developing an alginate-encapsulated
         porcine islet cell product;

     o   Cerco Medical (formerly Islet Sheet Biomedical) -- company engaged in
         the research and development of a bioartificial pancreas;

     o   Islet Technology -- developer of alginate-encapsulated islet cell
         products;

     o   Novocell -- developer of a polyethylene glycol (PEG) coating technology
         for immunoisolation of islet cells;

     o   Betacell -- developer of fetal islet cell products for transplantation;

     o   Amcyte (formerly VivoRx) -- developer of encapsulated human islet
         cells; and

     o   Geron Corporation - developer of cell-based therapeutics for several
         diseases based on differentiated cells derived from human embryonic
         stem cells, including pancreatic islet (beta) cells for diabetes.

Some of our competitors are larger than we are and may have greater financial
resources, technical expertise, or marketing, distribution, or support
capabilities. We expect that we will face increased competition in the future as
new companies enter the market and advanced technologies become available. Any
of our competitors could broaden the scope of their products through
acquisition, collaboration or internal development to more effectively compete
with us. Our competitors may also develop new, more effective or affordable
approaches or technologies that compete with our products or render them
obsolete.

There has also been a significant amount of recent activity in academic
institutions concerning the conceptual viability of islet cells as suitable
candidates for replacement of islets in insulin deficient diabetes. In 2006, a
team at the University of Minnesota published positive data on the use of
porcine islets in conjunction with immunosuppression to reverse diabetes in
non-human primates. This observation was followed by further work from a
collaborative project between scientists at the University of Alberta, Canada,
and scientists at Emory University School of Medicine, where data released in
2006 appeared to show that fetal porcine islets in conjunction with
immunosuppression were able to effectively reverse the diabetic condition in
non-human primates.

                                       8

<PAGE>

Also, the March, 2006 edition of Science published reports from Washington
University, the Joslin Diabetes Center, and the University of Chicago confirming
portions of the earlier studies of Dr. D. Faustman from Harvard Medical School
on the restoration of function in residual islet beta cells (the components of
islet cells which produce insulin) following interruption of the autoimmune
response that destroys beta cells in special strains of genetically-diabetic
mice. These results are thought by these investigators to provide evidence of
the formation of new beta cells from splenic lymphocytes or new
insulin-producing cells from residual beta cell precursors in these
insulin-deficient mice. It remains unclear whether these studies have practical
application as an approach for human diabetes, but a Phase I clinical trial has
been developed by the Juvenile Diabetes Research Foundation to test the
feasibility of this premise.

We note that our proprietary encapsulation approach is designed to avoid or
minimize the need for chronic immunosuppression, whereas the above findings have
relied substantially on immunosuppression or manipulation of the immune system.
Nevertheless, we could face increased competition from current or future
licensees of technology developed from the above studies.

SALES AND MARKETING

We currently have no sales and marketing employees and no immediate plans to
hire any. We will make decisions about sales and marketing at a later date when
our product is further along in the development stage.

MANUFACTURING

We do not currently have manufacturing capabilities but we are exploring
opportunities to produce ultrapure alginate. Exploitation of these opportunities
will depend on the availability of further capital, qualified personnel and
sufficient production resources. We do not currently have plans to manufacture
MicroIslet-P(TM) or any other products in the near future. We will make
decisions about manufacturing MicroIslet-P(TM) at a later date, when our product
is further along in the development stage.

GOVERNMENT REGULATION

OVERVIEW. The development and commercialization of our products will be subject
to extensive regulation in the United States by a number of regulatory
authorities, including the United States Food and Drug Administration, and by
comparable regulatory authorities in foreign countries. These regulatory
authorities and other federal, state and local entities will regulate, among
other things, the preclinical and clinical testing, safety, effectiveness,
approval, manufacturing, labeling, packaging, export, storage, recordkeeping,
adverse event reporting, and promotion and advertising of our products. We will
require FDA approval of our products, including a review of the manufacturing
processes and facilities used to produce our products, before we may market the
products in the United States. We believe that MicroIslet-P(TM) will be
classified as a biological product by the FDA. Biological products are subject
to dual regulation. Their approval for marketing, among other things, is
regulated under the Public Health Service Act through a biologics license
application, or BLA. However, biological products are also drugs and must meet
drug standards under the Federal Food, Drug and Cosmetic Act, including good
manufacturing practices regulations and regulations governing clinical trials.
Combination products are regulated on the basis of product's primary mode of
action and can require approval and/or review by more than one regulatory center
of FDA.

Xenotransplantation products are generally regulated as biologics, however, they
also can be part of a combination product. The Public Health Service and the FDA
have published a number of draft and final guidances on xenotransplantation
products. We cannot predict the content of future policy or regulations relating
to xenotransplantation products or the effect any future policy or regulation
may have on our ability to research, develop, manufacture, and market
xenotransplantation products.

CLINICAL TRIAL PROCESS. Development of a therapeutic product for human use under
applicable laws and regulations is a multi-step process. First, in vitro and/or
animal testing must be conducted in a manner consistent with good laboratory
practices to establish the potential safety and effectiveness of the
experimental product in a given disease. Before human clinical trials may begin
for new drugs and biologics, an investigational new drug application containing,
among other things, the preclinical data, chemistry, manufacturing and control
information, and an investigative plan, must be submitted to the FDA. Clinical
trials of medical devices generally require the same sort of submission in the
form of an application for an investigational device exemption. In addition,

                                       9

<PAGE>

products regulated by the FDA as medical devices require approval and oversight
by an Institutional Review Board (IRB) and adherence to requirements for proper
informed consent from study subjects are required, unless a device sponsor is
exempted from these requirements. Once a trial begins, changes to the
investigational product or study protocol may require prior approval before they
can be implemented. There can be no assurance that submission of an
investigational new drug application or an investigational device exemption will
result in the ability to commence clinical trials. In addition, the FDA may
place a clinical trial on hold or terminate it at any phase if, among other
reasons, it concludes that clinical subjects are being exposed to an
unacceptable health risk. Finally, pursuant to the FDA's Bioresearch Monitoring
(BIMO) program, the FDA conducts on-site inspections and data audits of the
conduct and reporting of all FDA-regulated research. The FDA's BIMO compliance
programs address inspections of non-clinical testing labs, clinical
investigators, clinical trial sponsors/monitors and IRBs.

Clinical trials of pharmaceuticals or biologics typically involve three phases,
although those phases can overlap.

     o   Phase I is conducted to evaluate the safety and pharmacokinetics of the
         experimental product in humans, and if possible, to gain early
         indications of effectiveness and begin to evaluate various routes,
         dosages and schedules of product administration.

     o   Phase I/II clinical trials are conducted to evaluate safety and initial
         efficacy indications in the patient population afflicted with a
         specific disease or condition for which the product is intended for
         use.

     o   Phase II clinical trials are conducted in groups of patients afflicted
         with a specific disease or condition for which the product is intended
         for use in order to further test safety, begin evaluating
         effectiveness, optimize dosage amounts and determine dose schedules and
         routes of administration.

     o   Phase III studies are usually randomized, double blind studies testing
         for product safety and effectiveness in an expanded patient population
         in order to evaluate the overall risk/benefit relationship of the
         product and to provide an adequate basis for product labeling. These
         studies also may compare the safety and effectiveness of the product
         with currently available products.

BIOLOGICS APPROVAL PROCESS. For products that are regulated through a BLA
application, following completion of clinical investigations, the preclinical
and clinical data that have been accumulated, together with chemistry and
manufacturing and controls specifications and information, are submitted to the
FDA in a BLA. The FDA may refuse to accept a BLA for filing if certain content
criteria are not met and may require additional information, including clinical
data, before approval. To approve a BLA, the agency must determine, among other
things, that the product is safe, pure, and potent, and that any facility in
which it is manufactured, processed, packed or held, meets standards designed to
assure the product's continued safety, purity, and potency.

If the FDA approves a BLA, we will need to continue to be compliant with strict
FDA requirements concerning good manufacturing practices, enforced by periodic
inspections, and adverse event reporting, as well as with any special
requirements imposed as a part of the biologics license application approval.
With certain exceptions, changes to the labeling of approved biological products
require approved supplemental applications. In addition, a supplemental
application is required to be submitted to FDA for any change in the product,
production process, quality controls, equipment, facilities, or responsible
personnel that has a substantial potential to have an adverse effect on the
identity, strength, quality, purity, or potency of the product as may relate to
the safety or effectiveness of the product. These supplemental applications may
require the submission of clinical or comparability data and require FDA
approval before the product may be marketed as modified. The approval process is
lengthy, expensive, and uncertain.

MEDICAL DEVICE APPROVAL PROCESS. Medical devices are regulated by the FDA
according to their classification. The FDA classifies a medical device into one
of three categories based on the device's risk and what is known about the
device. The three categories are as follows:

                                       10

<PAGE>

     o   Class I devices are generally lower risk products for which sufficient
         information exists establishing that general regulatory controls
         provide reasonable assurance of safety and effectiveness. Most class I
         devices are exempt from the requirement for premarket notification
         under section 510(k) of the Federal Food, Drug, and Cosmetic Act. FDA
         clearance of a premarket notification is necessary prior to marketing a
         non-exempt class I device in the United States.

     o   Class II devices are devices for which general regulatory controls are
         insufficient to provide a reasonable assurance of safety and
         effectiveness and for which there is sufficient information to
         establish special controls, such as guidance documents or performance
         standards, to provide a reasonable assurance of safety and
         effectiveness. A 510(k) clearance is necessary prior to marketing a
         non-exempt class II device in the United States.

     o   Class III devices are devices for which there is insufficient
         information demonstrating that general and special controls will
         provide a reasonable assurance of safety and effectiveness and which
         are life-sustaining, life-supporting or implantable devices, or devices
         posing substantial risk. Unless a device is a preamendments device that
         is not subject to a regulation requiring a Premarket Approval ("PMA"),
         the FDA generally must approve a PMA prior to the marketing of a class
         III device in the United States.

The PMA process is expensive and uncertain. A PMA must be supported by valid
scientific evidence which typically includes extensive data, including
pre-clinical data and clinical data from well-controlled or partially controlled
clinical trials, to demonstrate the safety and effectiveness of the device.
Product and manufacturing and controls specifications and information must also
be provided. As with BLAs, the FDA may refuse to accept a PMA for filing and
often will require additional clinical trial data or other information before
approval. Obtaining approval can take several years and approval may be
conditioned on, among other things, the conduct of postmarket clinical studies.
Any subsequent change to an approved PMA that affects the safety or
effectiveness of the device will require approval of a supplemental PMA. We
cannot be sure that approval of a PMA or PMA supplement will be granted on a
timely basis, if at all, or that the FDA's approval process will not involve
costs and delays that will adversely affect our ability to commercialize our
products.

Whether or not a product is required to be approved before marketing, we must
comply with strict FDA requirements applicable to devices, including quality
system requirements pertaining to all aspects of our product design and
manufacturing process, such as requirements for packaging, labeling, record
keeping, including complaint files, and corrective and preventive action related
to product or process deficiencies. The FDA enforces its quality system
requirements through periodic inspections of medical device manufacturing
facilities. In addition Medical Device Reports must be submitted to the FDA to
report an event or information that reasonably suggests that a device may have
caused or contributed to a death or serious injury; or has malfunctioned and
that the device or a similar device marketed by the same manufacturer would be
likely to cause or contribute to a death or serious injury if the malfunction
were to recur. Similar to adverse event reports applicable to drugs, medical
device reports can result in agency action such as inspections, recalls, and
patient/physician notifications, and are often the basis for agency enforcement
actions. Because the reports are publicly available, they can also become the
basis for private tort suits, including class actions.

LABELING AND ADVERTISING. The nature of marketing claims that the FDA will
permit us to make in the labeling and advertising of our biologics and medical
devices will be limited to those specified in an FDA approval and claims
exceeding those that are approved will constitute a violation of the Federal
Food, Drug, and Cosmetics Act. Violations of the Federal Food, Drug, and
Cosmetics Act, Public Health Service Act, or regulatory requirements at any time
during the product development process, approval process, or after approval may
result in agency enforcement actions, including voluntary or mandatory recall,
license suspension or revocation, premarket approval withdrawal, seizure of
products, fines, injunctions, and/or civil or criminal penalties. Any agency
enforcement action could have a material adverse effect on us. The advertising
of our products will also be subject to regulation by the Federal Trade
Commission, under the FTC Act. The FTC Act prohibits unfair methods of
competition and unfair or deceptive acts in or affecting commerce. Violations of
the FTC Act, such as failure to have substantiation for product claims, would
subject us to a variety of enforcement actions, including compulsory process,
cease and desist orders, and injunctions. FTC enforcement can result in orders
requiring, among other things, limits on advertising, corrective advertising,
consumer redress, and restitution. Violations of FTC enforcement orders can
result in substantial fines or other penalties.

                                       11

<PAGE>

FOREIGN REGULATION. Outside the United States our ability to market our products
will also depend on receiving marketing authorizations from the appropriate
regulatory authorities. The foreign regulatory approval process includes all of
the risks associated with FDA approval described above. The requirements
governing the conduct of clinical trials and marketing authorization vary widely
from country to country.

EMPLOYEES

As of March 1, 2006, we had 25 full time employees. Twenty-one of our employees
are engaged in research and development. We also maintain a Scientific Advisory
Board of seven outside consultants, all with doctoral degrees. These consultants
are as follows:

<TABLE>
<S>                                               <C>
MEMBER                                            AFFILIATIONS
------                                            ------------
Daniel R. Salomon, M.D.                           Associate Professor at The Scripps Research Institute (TSRI) in
Chairman of Scientific Advisory Board             the Department of Molecular and Experimental Medicine. Director of
                                                  the Center for Organ and Cell Transplantation for Scripps
                                                  Health and the Director of the Core Laboratory for TSRI's
                                                  General Clinical Research Center including the GCRC DNA
                                                  Microarray Core.

James Shapiro, M.D., Ph.D.                        Director of the Clinical Islet Transplant Program at the
                                                  University of Alberta in Edmonton, Canada.

Jonathan R. T. Lakey, Ph.D.                       Director of the Clinical Islet Laboratory and Assistant Professor
                                                  of Surgery at the University of Alberta in Edmonton, Canada.

Norma Sue Kenyon, Ph.D.                           Associate Professor of Surgery, Medicine, Microbiology and
                                                  Immunology at the University of Miami School of Medicine.
                                                  Associate Director for Research and Program Development,
                                                  Co-Director of the Cell Transplant Center, Responsible Head of
                                                  the Hematopoietic Cell Processing Facility, and Director,
                                                  Pre-Clinical Islet Cell Transplantation at the Diabetes Research
                                                  Institute.

Nora Sarvetnick, Ph.D.                            Professor in the Department of Immunology at The Scripps Research
                                                  Institute.

Athanassios Sambanis, Ph.D.                       Professor at the School of Chemical Engineering at the Georgia
                                                  Institute of Technology, a Fellow of the American Institute for
                                                  Medical and Biological Engineering and a Member of the American
                                                  Institute of Chemical Engineers and of the Tissue Engineering
                                                  Society International.

Bassam Damaj, Ph.D. President and Chief
                                                  Executive Officer of Bio-Quant, Inc., a company that seeks to
                                                  translate scientific discoveries into safer, more effective
                                                  treatments for people with immune and other life threatening
                                                  diseases.
</TABLE>

HISTORY

Our company was incorporated under the laws of the state of Nevada in November
1998 under the name ALD Services, Inc. Our business plan was to seek to provide
guidance to start-up and development stage companies in functional areas such as
logistics, supply, transportation, contracting, financial and manpower
management. In April 2002, we acquired MicroIslet, Inc., a Delaware corporation
(MicroIslet of Delaware) through a merger of our newly formed, wholly owned
subsidiary with MicroIslet of Delaware. As a result of the Merger, MicroIslet of
Delaware is now our wholly owned subsidiary and we share its business plan.

MicroIslet of Delaware was founded by John F. Steel IV, who at the time of the
merger owned 49% of the outstanding shares of MicroIslet of Delaware and was its
Chairman and CEO. DiaSense, Inc. and Richard Schoninger were also principal
stockholders of MicroIslet of Delaware, owning 18% and 11%, respectively, of the
outstanding shares at that time. The other executive officer of MicroIslet of
Delaware prior to the merger was Dr. Hartoun Hartounian, who served as its Chief
Operating Officer. Mr. Steel, Dr. Hartounian, Robert Anderson and James Gavin
made up the Board of Directors. MicroIslet of Delaware was incorporated in
Delaware in August 1998. From the time of its formation, the company has been
engaged in the research, development and commercialization of technologies in
the field of cell transplantation therapy for insulin-dependent diabetes.
MicroIslet of Delaware has licensed patented technologies from Duke University
Medical Center for the isolation, culture, storage and microencapsulation of
insulin-producing islet cells. Transplantation of cells using these proprietary
methods may enable diabetic patients to become free from insulin injections. Our
ultimate goal is to offer a treatment towards a cure for diabetes worldwide.

                                       12



<PAGE>

In October 2001, MicroIslet of Delaware entered into an Investment Banking
Agreement with ASA Investment Company, a registered broker-dealer. MicroIslet of
Delaware was introduced to ASA through Donald G. Saunders. At the time of the
introduction Mr. Saunders was negotiating with ASA to form a successor
broker-dealer in which Mr. Saunders, Thomas K. Russell and Mark C. Russell would
each have equity interests. Thomas and Mark Russell are brothers. Those
negotiations did not ultimately result in a restructuring of ASA, and none of
Mr. Saunders, Thomas K. Russell or Mark C. Russell obtained any ownership
interest or other interest in ASA.

Under the Investment Banking Agreement ASA was retained to raise equity
financing of up to $10 million in two stages. The first stage required ASA to
raise $1 million by November 2, 2001, after which ASA would have an exclusive
right to conduct a further private placement for between $3 million and $9
million on or before February 28, 2002. As a condition to closing the second
stage of the private placement, MicroIslet of Delaware was required to enter
into a business combination with us. MicroIslet of Delaware also agreed to give
ASA a right of first refusal until April 2003 to match the terms of any offer
for financing. ASA also had the right to receive a 10% finder's fee for any
completed financing from persons introduced to MicroIslet of Delaware by ASA,
and the first $200,000 of any completed financing in excess of $6 million. In
November 2001, MicroIslet of Delaware sold 166,668 shares of its common stock at
a price of $6.00 per share in a private placement, which raised gross proceeds
of $1 million. ASA received a commission of $100,000 in connection with this
sale. Pursuant to this investment the investors were granted the right to
receive additional shares of common stock if MicroIslet of Delaware sells any
securities for less than $6.00 per share. In the event of such a sale these
investors would have been entitled to an additional number of shares equal to
the number of additional shares they would have received had their initial
investment been made at the lower price.

On April 24, 2002, MicroIslet of Delaware sold 504,620 shares of its common
stock in the second stage of its private placement, raising approximately $3
million in gross proceeds. We simultaneously completed our business combination
with MicroIslet of Delaware. MicroIslet of Delaware's stockholders were issued a
total of 19,215,538 shares of our authorized but unissued common stock,
representing approximately 85% of our post-merger outstanding shares. In the
merger MicroIslet of Delaware common shares were exchanged on a one-for-one
basis for our common shares, and MicroIslet of Delaware's Series A Preferred
shares were exchanged on a 15.6275-for-one basis for our common shares. Soon
after the merger we changed our name from ALD Services, Inc. to MicroIslet, Inc.
ASA received a commission of $302,800 in connection with the second private
placement closing and earned an investment banking fee of $200,000 plus 33,334
of our common shares in connection with our acquisition of MicroIslet of
Delaware.

After the merger we sold an additional 34,667 shares of our common stock at a
price of $6.00 per share in private placements which raised net proceeds of
approximately $187,000. These shares were issued and sold on substantially
similar terms and conditions as MicroIslet of Delaware's April 2002 private
placement described above and were recorded in May and August 2002 upon receipt
of confirming documentation. ASA earned a commission of $20,800 in connection
with these subsequent sales.

In August 2003, we agreed to pay ASA an 11% finder's fee for any completed
financing from persons introduced to us by ASA. Pursuant to this agreement we
paid ASA a finder's fee of $55,000 in connection with our August 2003 financing.
See "Management's Discussion and Analysis - Liquidity and Capital Resources." We
are not obligated to use the services of ASA in connection with any future
financings.

REPORTING AVAILABILITY

We make our annual reports on Form 10-KSB, quarterly reports on Form 10-QSB,
current reports on Form 8-K, and amendments to those reports available free of
charge on our website at www.microislet.com, or at www.sec.gov as soon as
reasonably practicable after we file these materials with, or furnish them to,
the Securities and Exchange Commission.

ITEM 2. PROPERTIES

We own no real property. We lease approximately 12,000 square feet of office and
laboratory space in San Diego, California at a current rental rate of
approximately $17,000 per month. The lease has scheduled rent increases each
year and expires on February 28, 2008. This facility is adequate for our current
requirements.

                                       13



<PAGE>

ITEM 3. LEGAL PROCEEDINGS

In January 2005, MicroIslet of Delaware and our Chairman and Chief Executive
Officer were named as defendants in a lawsuit brought in the Superior Court of
California, County of Orange, by Donald Gallego. The complaint alleged breach of
oral contract, fraud, racketeering, intentional infliction of emotional
distress, unfair business practices, conversion and other related causes of
action arising from an alleged oral agreement to pay Mr. Gallego a commission in
connection with fundraising activities between 2000 and 2002. The racketeering
cause of action alleged that we made false statements concerning our
relationship with Duke University. The complaint sought damages of approximately
$10.5 million plus pre-judgment interest, punitive and exemplary damages and
attorney's fees and costs. In connection with the racketeering cause of action
the complaint sought damages of three times the amount of plaintiff's injury,
but did not allege the amount that plaintiff was injured. In March 2005, at the
request of the Company, the action was removed from the Orange County Superior
Court to the United States District Court for the Central District of California
and was subsequently transferred to the United States District Court for the
Southern District of California.

In November 2005, we entered into an agreement with Mr. Gallego to settle this
matter. The terms of the settlement were placed on the court record before
United States Magistrate Judge William McCurine, Jr. of the United States
District Court, Southern District of California. Any disputes that may arise in
connection with the final settlement documents or enforcement of the settlement
will be resolved by Judge McCurine. Any orders issued by Judge McCurine in this
regard will be final and binding on the parties.

In the settlement we agreed to pay $50,000 cash and to issue 170,000 shares of
our common stock to Mr. Gallego. We recognized expense of $229,300 (net of
insurance proceeds) and reported this as part of General and Administrative
expenses in the fourth quarter of 2005. In addition we agreed to file with the
Securities and Exchange Commission a registration statement for the resale of
these shares and an additional 150,000 shares owned by Mr. Gallego. If the
registration statement is not filed within thirty days of the execution of a
written settlement agreement, Mr. Gallego will be entitled to liquidated damages
equal to an additional 4,000 shares for the first month following this thirty
day period, and 8,000 shares per month for each month thereafter, prorated on a
daily basis. These liquidated damages began accruing in February 2006. The
registration statement is expected to be filed promptly after filing of this
report. Mr. Gallego has agreed to deposit his shares into a brokerage account
with a broker selected by us, and to limit his sales of these shares in the
public market to no more than 25,000 shares per week, unless the broker
indicates that more than 25,000 may be sold without materially affecting the
overall price of our stock, in which case Mr. Gallego may sell up to 50,000
shares in any one week.

A written settlement agreement setting forth the foregoing terms was executed in
January 2006.

We may from time to time become a party to legal proceedings arising in the
ordinary course of business. We are not currently a party to any material
pending litigation or other material legal proceeding.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On November 17, 2005, we held our Annual Meeting of Stockholders in San Diego,
California. At the meeting the stockholders elected management's slate of
directors and approved two additional proposals with the following vote
distribution:

ITEM                                         FOR         AGAINST       ABSTAIN
---------------------------------------  ------------- ------------- -----------

ELECTION OF BOARD MEMBERS
   John F. Steel IV                        30,126,778      151,415          --
   Myron A. Wick III                       30,126,778      151,415          --
   Hartoun Hartounian, Ph.D.               30,126,778      151,415          --
   Robert W. Anderson, M.D.                30,126,778      151,415          --
   Steven T. Frankel                       30,126,778      151,415          --
   James R. Gavin III, M.D., Ph.D.         30,126,778      151,415          --
   John J. Hagenbuch                       30,131,778      146,415          --
   Bradley A. Geier                        30,268,708       74,465          --


                                       14



<PAGE>

<TABLE>
OTHER MATTERS
<S>       <C>
                                                                                                                BROKER
                                                              FOR            AGAINST          ABSTAIN         NON-VOTES
                                                        ---------------- ---------------- ----------------  ---------------
Ratified the selection of Deloitte & Touche LLP as           30,114,400           42,576           85,192               --
   our independent registered public accounting firm
   for our fiscal year ending December 31, 2005.

Approved the MicroIslet, Inc. 2005 Equity Incentive
   Plan.                                                     19,623,171          144,951           91,825       10,485,226
</TABLE>


                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL
        BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

                               MARKET INFORMATION

Our common stock has been traded on the American Stock Exchange under the
trading symbol "MII" since June 1, 2004. Since January 19, 2006, our trading
symbol has included the extension ".BC" for reasons discussed under
"Management's Discussion and Analysis - Recent Developments." Before trading on
the American Stock Exchange, our common stock had been traded on the OTC
Bulletin Board under the trading symbol "MIIS" from May 9, 2002 to May 31, 2004.
The following table sets forth, for our common stock for the periods indicated,
the high and low sale prices as reported by the American Stock Exchange for the
period from June 1, 2004 to December 31, 2005 and the high and low bid prices as
quoted on the OTC Bulletin Board from January 1, 2004 to June 1, 2004. The
over-the-counter market quotations reflect inter-dealer prices and may not
reflect adjustments for retail markups, markdowns, or commissions and may not
reflect actual transactions.

                                                      BID QUOTATION/SALE PRICE
                                                      ------------------------
                                                         HIGH           LOW
                                                         ----           ---
2004
           First Quarter                                 $3.43          $0.60
           Second Quarter                                 3.59           1.55
           Third Quarter                                  1.60           1.00
           Fourth Quarter                                 1.38           1.01

2005
           First Quarter                                  1.94           1.04
           Second Quarter                                 1.54           1.10
           Third Quarter                                  2.80           1.18
           Fourth Quarter                                 2.25           1.50


On March 1, 2006, there were approximately 112 stockholders of record of our
common stock. This number does not include beneficial owners of the common stock
whose shares are held in the names of various dealers, clearing agencies, banks,
brokers and other fiduciaries.

MicroIslet does not pay dividends.

MicroIslet repurchased none of its equity securities during the fourth quarter
of the fiscal year ended December 31, 2005.


ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

THE DISCUSSION IN THIS SECTION CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING
NATURE RELATING TO FUTURE EVENTS OR OUR FUTURE PERFORMANCE. WORDS SUCH AS
"ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," "MAY" AND SIMILAR
EXPRESSIONS OR VARIATIONS OF SUCH WORDS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS, BUT ARE NOT THE ONLY MEANS OF IDENTIFYING FORWARD-LOOKING
STATEMENTS. SUCH STATEMENTS ARE ONLY PREDICTIONS AND ACTUAL EVENTS OR RESULTS
MAY DIFFER MATERIALLY. IN EVALUATING SUCH STATEMENTS, YOU SHOULD SPECIFICALLY
CONSIDER VARIOUS FACTORS IDENTIFIED IN THIS REPORT, INCLUDING THE MATTERS SET
FORTH UNDER THE CAPTION "BUSINESS RISKS," WHICH COULD CAUSE ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS.

                                       15



<PAGE>

OVERVIEW

We are a biotechnology company engaged in the research, development and
commercialization of patented technologies in the field of transplantation
therapy for people with insulin-dependent diabetes. Our patented islet
transplantation technology, exclusively licensed from Duke University, includes
methods for isolating, culturing, cryopreservation, and immuno-protection
(microencapsulation) of islet cells. We intend to continue our research and
development efforts and, ultimately, to begin market introduction of our
products.

We have no products for sale and are focused on research and development
activities. We have had only limited revenues from grants and we have had
significant losses since inception. We anticipate that we will incur substantial
additional operating losses in future years as we progress in our research and
development programs. At December 31, 2005, we had an accumulated deficit of
approximately $30.1 million. We do not expect to produce revenues from product
sales for the foreseeable future so our revenues will be limited to research
grants we are able to obtain. Our business plan for the next twelve months is to
demonstrate the efficacy of our product candidate in animal models. It is
necessary for us to establish evidence of efficacy of our approach in order to
advance to subsequent milestones.

In December 2005, we completed the sale of common stock for net cash proceeds of
$3 million. We have incurred substantial operating losses and negative operating
cash flows through December 31, 2005, and as of that date the our cash position
was $4.5 million. We have projected that cash on hand will be sufficient to
allow the Company to continue its operations only through the first half of
2006. These matters raise substantial doubt about our ability to continue as
a going concern.

Our future cash requirements will depend on many factors, including continued
scientific progress in our research and development programs, the scope and
results of pre-clinical and clinical trials, the time and costs involved in
obtaining regulatory approvals, the costs involved in filing, prosecuting and
enforcing patents, competing technological and market developments and the cost
of product commercialization. We do not expect to generate a positive cash flow
from operations at least until the commercial launch of our first product and
possibly later given the expected spending for research and development programs
and the cost of commercializing product candidates. Accordingly, we will require
external financing to sustain our operations, perhaps for a significant period
of time. Our plans include raising additional debt and/or equity financing to
sustain our operations. In addition, we will continue to seek funding in the
form of grants for our scientific research.

RECENT DEVELOPMENTS

In January 2006, Hartoun Hartounian, Ph.D., gave notice of his intent to resign
from his positions as President, Chief Operating Officer and a director of the
company, effective February 17, 2006. James R. Gavin III, M.D., Ph.D., a member
of our board of directors, was appointed as our Interim President and Chief
Executive Officer in January 2006. Dr. Gavin previously served as an independent
director on the board of directors, member of the compensation committee, the
nominating and governance committee, the executive committee and the audit
committee. As a result of his appointment Dr. Gavin no longer qualifies as an
independent director under applicable American Stock Exchange listing standards.
In accordance with our committee charters and applicable American Stock Exchange
listing standards, Dr. Gavin resigned from our compensation committee,
nominating and governance committee and audit committee. Dr. Gavin continues to
serve on our executive committee.

In March 2006 we entered into an employment agreement with Dr. Gavin which
contains the following terms:

     o   Dr. Gavin will earn a base salary of $600,000 per year.

     o   The agreement has an initial term of one year commencing January 20,
         2006, and will be renewed automatically for additional one year periods
         unless either party provides notice at least 90 days prior to the
         expiration of the then-current term of its intent not to renew.

     o   During the term of the agreement we have agreed to recommend to the
         nominating and governance committee, and to the board, that Dr. Gavin
         be included on management's slate of directors at each meeting of our
         stockholders at which directors are elected and that he continue to
         serve as a member of the executive committee of the board.

                                       16



<PAGE>

     o   Dr. Gavin will be an at-will employee and either we or Dr. Gavin may
         terminate employment at any time. However, if Dr. Gavin's employment is
         terminated by us without cause (as that term is defined in the
         employment agreement), Dr. Gavin will be entitled, subject to his
         execution of a general release of claims, to a severance payment equal
         to the amount of base salary that would have been paid for the
         remainder of the then-current term, subject to a minimum severance
         payment equal to three months' base salary.

     o   Dr. Gavin will be reimbursed for reasonable expenses incurred under the
         agreement including travel between San Diego and Dr. Gavin's primary
         residence in Atlanta, housing expenses in San Diego of up to $1,700 per
         month, and automobile expenses in San Diego of up to $1,000 per month.

     o   Dr. Gavin will be entitled to all benefits, including vacation, health
         and disability benefits, for which he is eligible under the terms and
         conditions of our standard benefit plans provided generally to senior
         level executives, as such may be in effect from time to time.

Dr. Gavin also received on his start date, January 20, 2006, an option to
purchase 1,750,000 shares of our common stock under our 2005 Equity Incentive
Plan at an exercise price per share of $2.20, which was the closing price of our
common stock on the start date as reported on the American Stock Exchange. The
option has a ten year life subject to continuing service to our company. The
option vested as to 25% of the shares immediately when granted and will vest an
additional 25% on each of the first, second, and third anniversaries of the date
of grant, subject to Dr. Gavin's continuing to serve as our principal executive
officer. Vesting of the option will accelerate upon a change of control.

In January 2006, John F. Steel IV was appointed as our Director of Corporate
Development, a non-executive position, and resigned as our Chairman and Chief
Executive Officer. Mr. Steel remains a member of the board of directors.

In January 2006, Kevin A. Hainley was appointed as our Interim Chief Financial
Officer. In connection with this appointment, we entered into a Professional
Services Agreement with Resources Global Professionals, of which Mr. Hainley was
an associate. Under this agreement, Resources Global Professionals was an
independent contractor, with Mr. Hainley designated as the associate assigned to
us. Resources Global Professionals was compensated for Mr. Hainley's time at the
rate of $155 per hour, and $232.50 per hour for each hour over eight in one day
or forty in one week. This agreement was terminated in March 2006 at which time
we entered into a Professional Services Agreement directly with Mr. Hainley in
March 2006 pursuant to which he serves as a consultant to us. We paid Resources
Global Professionals a $12,000 fee in consideration of the direct placement of
Mr. Hainley. Our current agreement with Mr. Hainley is for a period of
approximately two to three months, or as needed, and either party may terminate
this agreement earlier on 30 days prior written notice to the other party. Mr.
Hainley will be compensated for his time at the rate of $135 per hour.

In January 2006, John J. Hagenbuch, a member of our board of directors, was
appointed as our non-executive Chairman of the Board.

In January 2006, Bradley A. Geier, an independent member of our board of
directors, was appointed to serve on the audit committee.

In March 2006, we appointed Bertram E. Walls, M.D. to our board of directors.
Our board has determined that Dr. Walls is an independent director. Our board
now consists of eight directors, four of which are independent.

CRITICAL ACCOUNTING POLICIES

Our significant accounting policies are disclosed in Note 2 to our consolidated
financial statements. Certain of our policies require the application of
management judgment in making estimates and assumptions that affect the amounts
reported in the consolidated financial statements and disclosures made in the
accompanying notes. Those estimates and assumptions are based on historical
experience and various other factors deemed to be applicable and reasonable
under the circumstances. The use of judgment in determining such estimates and
assumptions is by nature, subject to a degree of uncertainty. Accordingly,
actual results could differ from the estimates made. Our significant accounting
policies include:

                                       17

<PAGE>

Stock-based Compensation
------------------------

Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," establishes the use of the fair value based method of
accounting for stock-based compensation arrangements under which compensation
cost is determined using the fair value stock-based compensation determined as
of the date of grant and is recognized over the periods in which the related
services are rendered. The statement also permits companies to elect to continue
using the intrinsic value accounting method specified in Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," to account for
stock-based compensation issued to employees. Through December 31, 2005, we have
elected to use the intrinsic value based method and have disclosed the pro forma
effect of using the fair value based method to account for our stock-based
compensation.

As a result of the recent issuance by the Financial Accounting Standards Board
of SFAS No. 123 (revised 2004) "Share-Based Payment," or SFAS No. 123(R), we
will be required, beginning in the quarter ending March 31, 2006, to apply the
fair value method as prescribed in SFAS No. 123(R). Determination of the fair
value of stock options will require use of valuation models that involve
significant estimates. Although our adoption of SFAS No. 123(R) could have a
material impact on our financial position and results of operations, we are
still evaluating the potential impact from adopting this statement.

Allocation of Costs
-------------------

We allocate certain indirect costs associated with support activities such as
the rent and utilities for facilities. These costs are allocated between
research and development expense and general and administrative expense based on
headcount and/or square footage.

Off-Balance Sheet Arrangements
------------------------------

We do not have off-balance sheet arrangements, financings, or other
relationships with unconsolidated entities or other persons, also known as
"special purpose entities" (SPEs).

RESULTS OF OPERATIONS

Grant revenue for fiscal year 2005 was $152,971, consisting entirely of research
grants. We recognized no grant revenue for the year ended December 31, 2004. The
increase reflects funding available to us under the Small Business Innovation
Research (SBIR) grant from the National Institutes of Health (NIH).

Total operating expenses were $8,791,662 in 2005 and $6,624,605 in 2004. The
increase in expenses was principally the result of increased sponsored research
funding with TSRI, UC Davis, and University of Alberta, Edmonton and our
agreement with the Mayo Foundation, as well as personnel expenses due to the
increase in the number of employees. Research and development expenses increased
to $5,637,478 in 2005 from $2,913,213 in 2004, reflecting increased headcount
and spending for our sponsored research and materials relating to testing of our
technology in animals. General and administrative expenses decreased to
$3,154,184 in 2005 from $3,711,392 in 2004. The decrease was primarily related
to lower investor relations expense due to fewer warrants and options issued to
consultants. We expect operating costs to increase significantly in 2006 as
discussed in our plan of operation below.

Interest income was $149,244 in 2005 and $110,666 in 2004. The increase in
interest income was due primarily to the higher levels of cash and cash
equivalents throughout the year compared to the previous year.

Our net loss was $8,505,966 or $0.21 per common share in 2005, and $6,518,460 or
$0.17 per common share in 2004. We expect to report additional significant net
losses for the foreseeable future.

We have not generated profits to date and therefore have not paid any federal
income taxes nor have we recognized any tax benefits since inception. At
December 31, 2005, our federal tax net operating loss and federal tax credit
carryforwards were $22,723,000 and $654,000, respectively, which will begin to
expire in 2019, if not utilized. Our ability to utilize our net operating loss
and tax credit carryforwards may become subject to limitation in the event of a
change in ownership.

                                       18



<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

We and MicroIslet of Delaware financed our operations since inception primarily
through private sales of equity securities, which, from inception through
December 31, 2005, have netted approximately $23.2 million, and to a lesser
extent, through short term debt, grant funding, and interest earned on cash and
cash equivalents. In 2003 we experienced significant strains on our cash
reserves, and during that time, we curtailed non-essential operations and
extended payment terms with our trade creditors.

Our combined cash and cash equivalents totaled $4.5 million at December 31,
2005, a decrease of $4.3 million from December 31, 2004. The primary source of
cash and cash equivalents for the year ended December 31, 2005 was the sale of
common stock and warrants in our March 2004 private placement and, to a lesser
extent, the exercise of stock warrants. The use of cash and cash equivalents
during the year ended December 31, 2005, totaled $7.7 million to finance our
operations and working capital requirements.

Our future cash requirements will depend on many factors, including continued
scientific progress in our research and development programs, the scope and
results of pre-clinical and clinical trials, the time and costs involved in
obtaining regulatory approvals, the costs involved in filing, prosecuting and
enforcing patents, competing technological and market developments, and the cost
of product commercialization. We do not expect to generate a positive cash flow
from operations at least until the commercial launch of our first product and
possibly later given the expected spending for research and development programs
and the cost of commercializing our product candidates. We have incurred
substantial operating losses and negative operating cash flows through December
31, 2005, and as of that date our cash position was $4.5 million. We have
projected that cash on hand will be sufficient to allow us to continue our
operations only through the first half of 2006. These matters raise substantial
doubt about our ability to continue as a going concern. We intend to seek
additional funding through grants and through public or private financing
transactions. Successful future operations are subject to a number of technical
and business risks, including our continued ability to obtain future funding,
satisfactory product development, regulatory approvals and market acceptance for
our products. See "Business Risks" below.

Fusion Capital
--------------

In April 2003, we entered into a common stock purchase agreement with Fusion
Capital Fund II, LLC, under which Fusion Capital agreed, subject to certain
conditions, to purchase on each trading day during the term of the agreement
$20,000 of our common stock up to an aggregate of $12.0 million. The common
stock purchase agreement was amended in May 2004 to, among other things, revise
the daily purchase amount and give us the option to increase the aggregate
amount that may be purchased under the agreement to $24 million and extend the
term of the agreement.

We terminated this agreement with Fusion Capital in December 2005. During the
years ended December 31, 2005 and 2004, we sold 37,066 and 415,094 shares of
common stock to Fusion Capital pursuant to the common stock purchase agreement,
for gross proceeds of $40,000 and $500,000, respectively.

Other Financings
----------------

In October 2005, we were awarded a three year $1.7 million Phase II Small
Business Innovation Research (SBIR) grant by the National Institutes of Health
(NIH). The grant will be used to further develop our islet cell transplantation
technology for treatment of insulin-dependent diabetes. Grant payments are
generally to be received shortly before or after the related qualifying
expenditures are incurred.

In December 2005, we sold to certain accredited investors 2,284,999 shares of
common stock at a purchase price of $1.50 per share. In connection with the
financing we also issued to the investors five-year warrants to purchase
1,142,500 shares at $1.65 per share. We paid placement fees to two placement
agents equal to 8% of the gross proceeds, or $274,200, and issued warrants to
the placement agents to purchase an aggregate of 91,400 common shares. The
placement agent warrants have exercise prices of $1.65 and $1.88 per share and
expire on December 29, 2010. See Note 8 to our consolidated financial
statements.

From January 1 to March 1, 2006, holders of outstanding stock options and
warrants have exercised such securities for an aggregate of 1,336,840 shares of
common stock, and paid gross proceeds to us of $1,246,900.

                                       19



<PAGE>

We expect that our available cash and expected grant and interest income will be
sufficient to finance currently planned activities only through the first half
of 2006.

We will also need additional funds or a collaborative partner, or both, to
finance the clinical development activities of our product candidate. We expect
that our primary sources of capital for the foreseeable future will be through
the public or private sale of our debt or equity securities and through
collaborative arrangements. There can be no assurance that such collaborative
arrangements, or any public or private financing, will be available on
acceptable terms, if at all, or can be sustained. Several factors will affect
our ability to raise additional funding, including, but not limited to, market
volatility of our common stock and economic conditions affecting the public
markets generally or some portion or all of the technology sector. If adequate
funds are not available, we may be required to delay, reduce the scope of, or
eliminate one or more of our research and development programs, which may have a
material adverse affect on our business. See "Business Risks" below.

PLAN OF OPERATION

We have budgeted our total costs for our operations for the next twelve months
at $9.7 million. We believe however that the costs of remaining pre-clinical
studies and the preparation for human clinical trials could range from $10 to
$16 million as further explained in the Milestone table below. The actual amount
of funds required within the next twelve months and the amount required to
complete initial pre-clinical studies will depend on a variety of factors, many
of which are outside of our control. These factors include, among others, the
results of initial and follow-up studies and unforeseen changes in
biopharmaceutical regulations.

The $9.7 million we have budgeted for the next twelve months is divided into the
following categories:

CATEGORY                                                      ESTIMATED COST
--------                                                      --------------
Personnel....................................................    $3,200,000
Sponsored research...........................................       800,000
Outside consultants and services.............................     2,300,000
Supplies and materials.......................................     1,600,000
Travel & entertainment.......................................       200,000
Facilities...................................................       400,000
General & administrative.....................................     1,200,000
                                                                -----------
Total........................................................    $9,700,000
                                                                ===========

The actual costs within each category, and the total costs for initial
pre-clinical studies, may vary significantly from the estimates set forth above
based on the factors discussed above.

Our in-house research and development effort is focused on development of our
first product candidate called MicroIslet-P(TM). In our 3,000 square foot
laboratory, we have 21 employees working full-time on this effort with
assistance from outside contractors. This research uses animal islet cells that
have been isolated and encapsulated using our proprietary technology licensed
from Duke University as well as any additional processes, procedures or
scientific advances we develop in our laboratory.

We are sponsoring research at the University of Alberta, Edmonton, The Scripps
Research Institute (TSRI) and the California Regional Primate Center at the
University of California, Davis to assist us with transplantation surgery and
subsequent monitoring in animal models.

Together with our sponsored research partners and possibly other collaborators,
we will obtain data relating to the level of insulin delivery, blood glucose
control, the immune reaction of the animals to both the microencapsulated islets
and the microcapsule itself, and any side effects associated with the
transplantation. We will also develop information on dose and duration of
implanted cells in relevant diabetes models, as well as the longevity and
ultimate fate of the microcapsule in vivo. Through these activities, we are
planning to establish the feasibility of the concepts behind our product
candidate in animals. The following are the milestones associated with our
initial feasibility studies, and the estimated time of completion and estimated
cost of each:

                                       20

<PAGE>

<TABLE>
<S>       <C>
                                                                 ESTIMATED TIME OF               ESTIMATED COST OF
MILESTONE                                                       MILESTONE COMPLETION          ACHIEVING EACH MILESTONE
                                                                --------------------          ------------------------
Ongoing  optimization  of viability  and  functionality  of      First Half of 2006               $2 to $3 million
  encapsulated islets in vitro and in small animals

Testing viability and functionality of encapsulated  islets     Second Half of 2006               $3 to $4 million
  in vitro and in non-human primates
</TABLE>

Our work toward achieving these milestones will overlap, and the amount of
effort and expense for each milestone may vary significantly depending on the
favorability, consistency and repeatability of results.

We have received preliminary data from TSRI showing interim results of
transplants using our proprietary technology in approximately 150 small animals.
In the study, groups of streptozotocin-induced diabetic NOD/SCID as well as
groups of immunocompetent mice were transplanted with MicroIslet's
microencapsulated porcine islet cells. The transplanted capsules at various
dosing levels were able to normalize blood glucose (normoglycemia) levels in all
animals within one week of transplantation. This ongoing study is being
conducted under the supervision of Dr. Daniel R. Salomon of the Department of
Molecular and Experimental Medicine at TSRI.

An analysis of the preliminary data supports the following observations:

     o   Porcine islets encapsulation technology we have developed preserves
         islet function and permits extended survival in an immunodeficient and
         an immunocompetent animal model of diabetes.

     o   These transplants resulted in a prompt return to normoglycemia
         occurring in 100% of the animals within a week of transplantation and
         continuing for the duration of the study demonstrating that the islet
         isolation and processing produced viable and functional graft tissue.

     o   Chemically induced diabetes can be reversed with as few as 500 IEQ
         (islet equivalent units) of encapsulated porcine islets in this
         immunodeficient model.

In August 2004 we received additional data from the Scripps Research Institute.

An analysis of the additional data supports the following additional
observations:

     o   MicroIslet encapsulation technology preserves porcine islet function
         and extends survival in immunodeficient and immunocompetent diabetic
         animals.

     o   Diabetes is reversed in 80-85% of small animals. Graft function has
         been observed up to 256 days post transplantation to date.

     o   Transplantation of encapsulated islets does not sensitize the host to a
         second transplant. The graft survival in the second transplant is at
         least as long as the first transplant of porcine islets.

In September 2005 we received additional data from TSRI showing interim results
of transplants using our proprietary technology in small animals. Experiments
were conducted using encapsulated porcine islets transplanted into the
peritoneum of a diabetic rat model. The goal of these studies was to demonstrate
increased islet function and graft survival time using a proprietary combination
of novel encapsulation formulations and treatment regimens, both developed by
our product development team. An analysis of the results of these preclinical
animal studies appears to demonstrate graft survival in diabetic rats for
greater than 70 days when encapsulated porcine islets are transplanted into the
peritoneal cavity. These results were accomplished through the use of a
proprietary cocktail of islet survival factors pre- and post-transplantation, in
combination with a proprietary encapsulation formulation, which together
significantly improved the duration of islet function in the recipient animal.
In addition to supporting the potential efficacy of our therapeutic approach,
these results demonstrate that the rat model continues to be an important tool
for optimizing and refining the islet survival formulation and transplantation
procedures for our ongoing primate studies.

Preliminary results of trials do not necessarily predict final results, and
acceptable results in early trials may not be repeated in later trials.

                                       21



<PAGE>

We believe that patients receiving the MicroIslet-P(TM) therapy may require
periodic transplantations of additional islet cells annually. In order to
demonstrate the feasibility and safety of such re-transplantation, we conducted
re-transplantation experiments in small animals and found that the subsequent
transplants were effective and well tolerated.

Since none of our product candidates have yet advanced beyond the research
stage, the process of developing product candidates will require significant
additional research and development, preclinical testing and clinical trials, as
well as regulatory approval activities.

The following chart is a summary of the significant milestones our management
believes we will have to meet after successfully completing initial feasibility
studies in order to begin and complete clinical human trials, and eventually to
generate revenue from the sale of our product candidates. The chart also
includes the estimated cost of achieving each milestone.

<TABLE>
<S>            <C>
                                                                              ESTIMATED TIME OF    ESTIMATED COST OF ACHIEVING
MILESTONE                                                                         COMPLETION              EACH MILESTONE
---------                                                                         ----------              --------------

COMPLETE FORMAL ANIMAL STUDIES IN ANTICIPATION OF FILING INVESTIGATIONAL       2nd Half of 2006          $8-12 Million
NEW DRUG APPLICATION WITH THE FOOD AND DRUG ADMINISTRATION. Once we have
established the "proof of concept" behind our product candidates, we plan to
initiate formal studies to demonstrate safety and efficacy in support of
human clinical trials. These studies will involve both small and large
mammals under controlled conditions and will likely be performed in our
academic collaborators' and outside contract facilities. These studies will
depend on our ability to identify one or more sources that will supply to us
or our collaborators a requisite amount of ultra-pure alginate for the
capsules and porcine islets. We intend to engage in ongoing discussions with
the FDA during these evaluations. Once we are comfortable with the safety and
efficacy results of these studies we plan to file the investigational new
drug application with the FDA.

INITIATE  ALLOTRANSPLANTATION HUMAN CLINICAL STUDIES. These studies involve    2nd Half of 2006          $2-4 Million
the transplantation of human islet cells using our encapsulation processes
from one human to another. We hope these studies will validate our
microencapsulation technology's effectiveness of immunoisolation in humans
prior to clinical trials.

INITIATE PHASE I HUMAN CLINICAL TRIALS.  Once the formal controlled animal           2007                   Unknown
studies have been completed, we plan to file the investigational new drug
application. If the application is approved, we hope to begin clinical trials
in humans with Type 1 diabetes shortly thereafter. Clinical trials of
pharmaceuticals or biologics typically involve three phases. The first of
these phases involves an evaluation of the safety of the experimental product
in humans, and if possible, an evaluation of the early indications of its
effectiveness.

INITIATE PHASE II HUMAN CLINICAL TRIALS.  The second phase involves further          2008                   Unknown
safety testing, and an evaluation of efficacy, dose schedules and routes of
administration in a larger human population. This phase sometimes overlaps
with the Phase I study.

INITIATE PHASE III HUMAN CLINICAL TRIALS.  These studies are usually                 2010                   Unknown
randomized, double-blind studies testing product safety and effectiveness in
an expanded patient population in order to evaluate the overall risk/benefit
relationship of the product and to provide an adequate basis for product
labeling. Because of the scope and the number of patients involved,
significant capital is required for these trials.

COMPLETE HUMAN CLINICAL TRIALS AND SUBMIT OUR PRODUCT TO THE FDA FOR            2011 or later               Unknown
APPROVAL. Once the clinical investigations are complete we intend to submit
an application to the FDA including all of our clinical and preclinical data.

BEGIN TO MANUFACTURE, MARKET AND SELL OUR PRODUCT.                              2011 or later               Unknown
</TABLE>

The success, cost, and estimated time of completion of each step will depend on
a variety of factors, many of which are out of our control. These factors
include, among others, our ability to demonstrate the efficacy of our concept,
access to sufficient capital to sustain our operations, unforeseen changes in
biopharmaceutical regulations and the success of competing products and
technologies. The actual timeline and cost of our product development may vary
significantly from the estimates set forth above.

We will not have any significant revenue from operations until the first of our
product candidates is approved by the Food and Drug Administration for sale. The
approval process is long and costly, and is dependent on the success of multiple
human clinical trials. It is difficult to estimate when, if ever, those trials
will be completed.

                                       22

<PAGE>

We continue to evaluate various possible strategic transactions, including
in-licensing or acquiring complementary products, technologies or companies. If
we in-license or acquire products, technologies or companies, we expect that our
operating expenses would increase as a result. We also expect that our research
and development expenses will increase over the current level, and that we will
require significant additional capital to fulfill our business plan. Research
and development activities, together with our general and administrative
expenses, will result in substantial operating losses for the foreseeable
future.

We expect to add additional employees and collaborators as they become necessary
including three additional employees in research and development over the next
twelve months.

RECENT DEVELOPMENTS

Over the last year our team of scientists has developed new intellectual
property in the areas of islet cell processing, quantification and
encapsulation. We have filed and will continue to file applications with the
U.S. Patent and Trademark Office to protect our intellectual property as deemed
appropriate.

NEW ACCOUNTING PRONOUNCEMENTS

The possible effect on our financial statements of new accounting pronouncements
that have been issued for future implementation is discussed in the footnotes to
our audited financial statements (see Note 2).

                                 BUSINESS RISKS

The following is a summary of the many risks and uncertainties we face in our
business. You should carefully read these risks and uncertainties as well as the
other information in this report in evaluating our business and its prospects.

WE HAVE A HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT, AND WE MAY NOT
ACHIEVE OR MAINTAIN PROFITABILITY IN THE FUTURE. THESE FACTORS, WHEN COMBINED
WITH OUR CASH POSITION, RAISE SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS
A GOING CONCERN.

We have experienced significant operating losses in each period since our
inception. As of December 31, 2005, we have incurred total accumulated losses of
$30.1 million and our cash and cash equivalents was $4.5 million. We expect the
recognition of operating losses to continue and it is uncertain when, if ever,
we will become profitable. Even if we do achieve profitability, we may not be
able to sustain or increase profitability on a quarterly or annual basis.

We anticipate that our existing funds will be sufficient to fund our operating
expenses and capital requirements through the first half of 2006. We expect to
incur substantial additional costs, including costs related to ongoing research
and development activities, preclinical studies and trials. Future funding is
subject to a number of risks and uncertainties, many of which are outside of our
control. In the event funding is not obtained we may be required to curtail
operations. These factors raise substantial doubt about our ability to continue
as a going concern, and our independent registered public accounting firm has
included in its report on our 2005 audited financial statements an explanatory
paragraph regarding our ability to continue as a going concern.

WE WILL NEED ADDITIONAL CAPITAL IN THE FUTURE TO SUPPORT OUR GROWTH AND RAISING
SUCH CAPITAL WILL LIKELY CAUSE SUBSTANTIAL DILUTION TO EXISTING STOCKHOLDERS. IF
ADDITIONAL CAPITAL IS NOT AVAILABLE WE MAY HAVE TO CURTAIL OR CEASE OPERATIONS
AND YOU COULD LOSE SOME OR ALL OF YOUR INVESTMENT IN THE COMPANY.

Our current plans indicate we will need substantial additional capital for
research and development, including costs associated with developing our
technology and conducting pre-clinical testing and clinical trials of our
product candidates, before we have any anticipated revenue generating products.

When we require additional funds general market conditions or the then-current
market price of our common stock may not support capital raising transactions
such as an additional public or private offerings of our common stock. If we
require additional funds and we are unable to obtain them on a timely basis or
on terms favorable to us, we may be required to scale back our development of
new products, sell or license some or all of our technology or assets, or
curtail or cease operations. If we raise additional funds by selling additional
shares of our capital stock the ownership interest of our stockholders will be
diluted.

                                       23

<PAGE>

WE HAVE RELIED ON CAPITAL CONTRIBUTED BY RELATED PARTIES AND SUCH CAPITAL MAY
NOT BE AVAILABLE IN THE FUTURE.

A trust affiliated with Mr. John J. Hagenbuch, a significant stockholder and a
director of our company made short-term loans to us for a total of $500,000 on
April 11, 2003 and May 12, 2003 to meet working capital needs. In October 2003,
the notes evidencing these loans were cancelled in exchange for shares of our
common stock and warrants to purchase common stock. At the same time Mr.
Hagenbuch's trust purchased additional shares of our common stock for $150,000
cash. We may not be able to obtain capital from related parties in the future.
Neither Mr. Hagenbuch nor any of our officers, directors, or other stockholders
are under any obligation to continue to provide cash to meet our future
liquidity needs.

OUR EXECUTIVE MANAGEMENT TEAM HAS UNDERGONE SIGNIFICANT CHANGES. OUR SUCCESS IS
DEPENDENT ON THE PERFORMANCE AND INTEGRATION OF OUR NEW MANAGEMENT TEAM AND THE
COOPERATION, RETENTION AND PERFORMANCE OF OUR KEY EMPLOYEES, CONSULTANTS, AND
ADVISORS.

In January 2006, William G. Kachioff, our former Vice President, Finance and
Chief Financial Officer resigned from our company. Also in January 2006, Hartoun
Hartounian, Ph.D., our former President and Chief Operating Officer and a
director, gave notice of his intent to resign from these positions, effective
February 17, 2006. In January 2006, James R. Gavin III, M.D., Ph.D., a member of
our board of directors since 2002, was appointed as our Interim President and
Chief Executive Officer, Kevin A. Hainley was appointed as our Interim Chief
Financial Officer and John F. Steel IV was appointed our Director of Corporate
Development, a non-executive position, and resigned as our Chairman and Chief
Executive Officer. Our business could be seriously harmed if integration of our
management team into our company is not successful. We expect that it will take
time for our new management team to integrate into our company and it is too
early to predict whether these changes will be successful.

In addition our success is substantially dependent on the cooperation, retention
and performance of our key scientific and technical personnel and advisers. The
loss of the services of any of our scientific or technical staff or advisory
board may significantly delay or prevent the achievement of product development
and other business objectives and could have a material adverse effect on our
business, operating results and financial condition.

WE ARE SUBJECT TO NEW CORPORATE GOVERNANCE AND INTERNAL CONTROL REPORTING
REQUIREMENTS AND OUR COSTS RELATED TO COMPLIANCE WITH, OR OUR FAILURE TO COMPLY
WITH, EXISTING AND FUTURE REQUIREMENTS COULD ADVERSELY AFFECT OUR BUSINESS.

We face new corporate governance requirements under the Sarbanes-Oxley Act of
2002, as well as new rules and regulations subsequently adopted by the SEC, the
Public Company Accounting Oversight Board and the American Stock Exchange. These
laws, rules, and regulations continue to evolve and may become increasingly
stringent in the future. In particular, we will be required to include
management and independent registered public accounting firm reports on internal
control over financial reporting as part of our annual report for the year
ending December 31, 2007 pursuant to Section 404 of the Sarbanes-Oxley Act. We
are in the process of evaluating our control structure to help ensure that we
will be able to comply with Section 404 of the Sarbanes-Oxley Act. We may not be
able to fully comply or have the capital needed for the costs of compliance,
with these laws, rules and regulations that address corporate governance,
internal control reporting and similar matters.

Failure to comply with these laws, rules and regulations could materially
adversely affect our reputation, financial condition and the value of our
securities.

OUR PRODUCTS MAY NOT BE SUCCESSFULLY DEVELOPED OR COMMERCIALIZED, WHICH WOULD
HARM US AND FORCE US TO CURTAIL OR CEASE OPERATIONS.

Our technologies are still in the early stages of development and we do not have
any product candidate in clinical trials or on the market. We are currently
working to develop our first product candidate, MicroIslet-P(TM).

Any product candidate will require significant research and development and
preclinical and clinical testing prior to regulatory approval in the United
States and other countries. We may not be able to develop any products, to
obtain regulatory approvals for product candidates we develop, to enter clinical
trials for any of our product candidates, or to commercialize any products, on a
timely basis or at all. If we are unable, for technological or other reasons, to
complete the development, introduction or scale-up of manufacturing of this
product or other potential products, or if our products do not achieve a
significant level of market acceptance, we would be forced to curtail or cease
operations.

                                       24

<PAGE>

Even if we develop our product candidates for commercial use and obtain all
necessary regulatory approvals, we may not be able to develop products that:

     o   are accepted by, and marketed successfully to, the diabetes
         marketplace;

     o   are safe and effective, without undesirable or unintended side effects
         or other characteristics adversely affecting their safety, efficacy or
         cost-effectiveness;

     o   are protected from competition by others;

     o   do not infringe the intellectual property rights of others;

     o   are developed prior to the successful marketing of similar products by
         competitors; or

     o   can be manufactured in sufficient quantities or at a reasonable cost.

OUR RESEARCH AND DEVELOPMENT PROGRAMS RELY ON TECHNOLOGY LICENSED FROM THIRD
PARTIES AND TERMINATION OF ANY OF THOSE LICENSES WOULD RESULT IN LOSS OF RIGHTS
TO DEVELOP AND MARKET OUR PRODUCTS, WHICH WOULD SIGNIFICANTLY IMPAIR OUR
BUSINESS.

We have exclusive worldwide rights to our technology for the isolation, culture,
storage and encapsulation (microencapsulation) of insulin-producing islet cells
from porcine sources, through a license agreement with Duke University. Our
license generally may be terminated by Duke University if we fail to perform our
obligations, including obligations to conduct a research and development program
and develop the licensed products for commercialization. If terminated we would
lose the right to develop the licensed products, which would significantly harm
our business. The license agreement contemplates that once the research and
development program is completed, we and Duke University will agree upon
milestones toward commercialization of the licensed products. We will be
required to meet those agreed milestones, and if we fail to do so in a material
way, our license rights may become non-exclusive. If disputes arise in the
negotiation of those milestones, or once agreed upon, over the definition of
these requirements or whether we have satisfied the requirements in a timely
manner, or if any other obligations in the license agreement are disputed by
Duke University, the other party could terminate the agreement and we could lose
our rights to develop the licensed technology.

WE WILL REQUIRE A SUPPLY OF DESIGNATED PATHOGEN FREE PIGS IN ORDER TO COMMENCE
AND CONTINUE HUMAN CLINICAL TRIALS ON OUR MICROISLET P (TM) PRODUCT CANDIDATE.
IF WE CANNOT SECURE A SUFFICIENT ONGOING SUPPLY OF THESE PIGS FROM THE SINGLE
FACILITY WHICH IS CURRENTLY ABLE TO PRODUCE THEM, WE MAY BE REQUIRED TO BUILD
OUR OWN FACILITY, WHICH WOULD SUBSTANTIALLY INCREASE OUR COSTS AND LIKELY
SUBSTANTIALLY DELAY OUR ABILITY TO COMMENCE CLINICAL TRIALS.

Under the rules of the Food and Drug Administration islets used for implantation
in humans must come from purpose-bred, pathogen free, vaccinated pigs (referred
to as designated pathogen free pigs), raised in a United States Department of
Agriculture certified facility specifically designed for biomedical research
purposes. Establishing such a herd requires a clean room facility, a significant
amount of time, and veterinary expertise. We currently receive designated
pathogen free pigs for our preclinical research from the Mayo Foundation for
Medical Education and Research. We have not identified other suppliers in North
America that can currently produce designated pathogen free pigs to the required
specification, although others may exist. If the Mayo Foundation were to cease
providing designated pathogen free pigs to us in sufficient quantities, we would
be required either to locate another facility which is able to supply designated
pathogen free pigs, which may not be possible, or to construct and operate our
own facility. The cost to construct and operate our own farm facility would
materially increase our costs of clinical studies and would likely delay the
commencement or continuation of clinical studies for a period of two years or
more.

We could also experience substantially increased costs and substantial delays if
the Mayo Foundation or any other facility which supplies designated pathogen
free pigs, including any facility we operate ourselves, were to become
contaminated. In such case there would be a delay of at least twelve months
before such facility could again deliver designated pathogen free pigs. Were any
of such events to occur before the commencement of clinical trials such trials
might have to be delayed. Were any of such events to occur during clinical
trials we may have to halt those clinical trials and could lose the benefit of
the data gathered and the costs incurred. We could also lose key staff members
and collaborators if clinical trials were substantially delayed. We would be
required to continue to pay our operating expenses while we waited to recommence
clinical trials and the payment of such expenses may deplete our cash reserves
and make it more difficult for us to raise capital for future clinical trials.
Our ability to execute our business plan could be threatened and our stock price
could decline substantially in response to any of these occurrences.

                                       25

<PAGE>

WE MAY NOT BE ABLE TO FORM AND MAINTAIN THE COLLABORATIVE RELATIONSHIPS THAT OUR
BUSINESS STRATEGY REQUIRES AND IF WE CANNOT DO SO, OUR ABILITY TO DEVELOP
PRODUCTS AND REVENUE WILL SUFFER.

We must form research collaborations and licensing arrangements with several
partners at the same time to operate our business successfully. To succeed we
will have to maintain our existing relationships and establish additional
collaborations. We may not be able to establish any additional research
collaborations or licensing arrangements necessary to develop and commercialize
products using our technology or that we can do so on terms favorable to us. If
our collaborations are not successful or we are not able to manage multiple
collaborations successfully, our programs may suffer.

Collaborative agreements generally pose the following risks:

     o   collaborators may not pursue further development and commercialization
         of products resulting from collaborations or may elect not to continue
         or renew research and development programs;

     o   collaborators may delay clinical trials, underfund a clinical trial
         program, stop a clinical trial or abandon a product, repeat or conduct
         new clinical trials or require a new formulation of a product for
         clinical testing;

     o   collaborators could independently develop, or develop with third
         parties, products that could compete with our future products;

     o   the terms of our agreements with our current or future collaborators
         may not be favorable to us;

     o   a collaborator with marketing and distribution rights to one or more
         products may not commit enough resources to the marketing and
         distribution of our products, limiting our potential revenues from the
         commercialization of a product;

     o   disputes may arise delaying or terminating the research, development or
         commercialization of our products or result in significant litigation
         or arbitration; and

     o   collaborations may be terminated and, if terminated, we would
         experience increased capital requirements if we elected to pursue
         further development of the product.

In addition there have been a significant number of recent business combinations
among large pharmaceutical companies which have resulted in a reduced number of
potential future collaborators. If business combinations involving our
collaborators were to occur, the effect could be to diminish, terminate, or
cause delays in one or more of our product development programs.

DELAYS IN THE COMMENCEMENT OR COMPLETION OF CLINICAL TESTING COULD RESULT IN
INCREASED COSTS TO US AND DELAY OUR ABILITY TO GENERATE SIGNIFICANT REVENUES.

Delays in the commencement or completion of clinical testing could significantly
impact our product development costs. We do not know whether planned clinical
trials will begin on time or be completed on schedule, if at all. The
commencement of clinical trials can be delayed for a variety of reasons,
including delays in:

     o   obtaining regulatory approval to commence a clinical trial;

     o   reaching agreement on acceptable terms with prospective contract
         research organizations and trial sites;

     o   manufacturing sufficient quantities of a product candidate;

     o   obtaining institutional review board approval to conduct a clinical
         trial at a prospective site; and

     o   identifying, recruiting and enrolling patients to participate in a
         clinical trial.

In addition, once a clinical trial has begun, patient recruitment and enrollment
may be slower than we anticipate. Further, a clinical trial may be suspended or
terminated by us, our collaborators, the FDA or other regulatory authorities due
to a number of factors, including:

     o   failure to conduct the clinical trial in accordance with regulatory
         requirements or our clinical protocols;

                                       26

<PAGE>

     o   inspection of the clinical trial operations or trial site by the FDA or
         other regulatory authorities resulting in the imposition of a clinical
         hold;

     o   unforeseen safety issues; or

     o   lack of adequate funding to continue the clinical trial.

If we experience delays in the completion of, or termination of, any clinical
trial of any product candidate we advance into clinical trials, the commercial
prospects for product candidates we may develop will be harmed, and our ability
to generate product revenues from any product candidate we may develop will be
delayed. In addition, many of the factors that cause, or lead to, a delay in the
commencement or completion of clinical trials may also ultimately lead to the
denial of regulatory approval of a product candidate. Even if we are able to
ultimately commercialize MicroIslet-P(TM) or any other product candidates, other
therapies for the same indications may have been introduced to the market during
the period we have been delayed and such therapies may have established a
competitive advantage over our products.

MICROISLET-P(TM) AND ANY OTHER PRODUCT CANDIDATES WE ADVANCE INTO CLINICAL
TRIALS ARE SUBJECT TO EXTENSIVE REGULATION, WHICH CAN BE COSTLY AND TIME
CONSUMING, CAUSE UNANTICIPATED DELAYS OR PREVENT THE RECEIPT OF THE REQUIRED
APPROVALS TO COMMERCIALIZE OUR PRODUCT CANDIDATES.

The clinical development, manufacturing, labeling, storage, record-keeping,
advertising, promotion, export, marketing and distribution of MicroIslet-P(TM)
or any other product candidates we advance into clinical trials are subject to
extensive regulation by the FDA in the United States and by comparable
governmental authorities in foreign markets. In the United States, neither we
nor our collaborators are permitted to market our product candidates until we or
our collaborators receive approval of a Biologics License Application, or BLA,
and/or a New Drug Application, or NDA, from the FDA. The process of obtaining
BLA and/or NDA approval is expensive, often takes many years, and can vary
substantially based upon the type, complexity and novelty of the products
involved. Approval policies or regulations may change. In addition, as a
company, we have not previously filed a BLA or an NDA with the FDA. This lack of
experience may impede our ability to obtain FDA approval in a timely manner, if
at all, for our product candidates for which development and commercialization
is our responsibility. Despite the time and expense invested, regulatory
approval is never guaranteed. The FDA or any of the applicable foreign
regulatory bodies can delay, limit or deny approval of a product candidate for
many reasons, including:

     o   a product candidate may not be safe and effective;

     o   regulatory agencies may not find the data from preclinical testing and
         clinical trials to be sufficient;

     o   regulatory agencies may not approve of our, or our third party
         manufacturers', manufacturing processes or facilities; or

     o   regulatory agencies may change their approval policies or adopt new
         regulations.

Also, recent events implicating questions about the safety of marketed drugs,
including those pertaining to the lack of adequate labeling, may result in
increased caution by the FDA in reviewing new drugs based on safety, efficacy or
other regulatory considerations and may result in significant delays in
obtaining regulatory approvals. Any delay in obtaining, or inability to obtain,
applicable regulatory approvals would prevent us from commercializing our
product candidates.

MICROISLET-P(TM) OR ANY OTHER PRODUCT CANDIDATE WE ADVANCE INTO CLINICAL TRIALS
MAY CAUSE UNDESIRABLE SIDE EFFECTS THAT COULD DELAY OR PREVENT ITS REGULATORY
APPROVAL OR COMMERCIALIZATION.

Undesirable side effects caused by MicroIslet-P(TM) or any other product
candidate we advance into clinical trials could interrupt, delay or halt
clinical trials and could result in the denial of regulatory approval by the
FDA or other regulatory authorities for any or all targeted indications. This,
in turn, could prevent us from commercializing MicroIslet-P(TM) or any other
product candidate we advance into clinical trials. Any one or a combination of
these events could prevent us from achieving or maintaining market acceptance
of the affected product or could substantially increase the costs and expenses
of commercializing the product, which in turn could delay or prevent us from
generating significant revenues from the sale of the product.

                                       27

<PAGE>

WHILE WE MAY SEEK TO TAKE ADVANTAGE OF VARIOUS REGULATORY MECHANISMS INTENDED TO
ACCELERATE DEVELOPMENT AND APPROVAL FOR MICROISLET-P(TM) FOR THE TREATMENT OF
INSULIN DEPENDENT DIABETES, WE MAY NOT BE ABLE TO SUBMIT A BLA OR NDA FOR
MICROISLET-P(TM) UNTIL 2011, AT THE EARLIEST.

If the results of our ongoing trials were positive, we may in the future file an
NDA on the basis of a single study and seek FDA review under its accelerated
approval regulations. Accelerated approval provides the opportunity for
regulatory approval based on additional endpoints. However, there is no
guarantee that we will successfully complete clinical trials. Even if clinical
trials were successfully completed, there are no assurances that the FDA will
accept an NDA on the basis of a single study or review the NDA under the
accelerated approval regulations. Failure to obtain review on the basis of a
single study or accelerated approval could require us to complete additional and
more extensive clinical trials, which would be costly and time consuming and
delay potential FDA approval for several years. Even if we are able to obtain
accelerated approval from the FDA, the FDA still may not grant our product full
approval for commercial sale. The FDA would likely require that we conduct
additional post-approval clinical studies as a condition of any approval.

If a drug is intended for the treatment of a serious or life-threatening
condition and the drug demonstrates the potential to address an unmet medical
need for this condition, the drug sponsor may apply for FDA fast track
designation. In addition to the benefits of accelerated approval, fast track
designation may lead to a shorter FDA review period, which can be as short as
six months, and the ability to submit portions of an NDA as they become
available for required FDA review. Any fast track designation we may obtain may
be withdrawn by the FDA if the FDA believes that the designation is no longer
supported by data from our clinical development program or if a competitor's
product is approved for the indication we are seeking. Any fast track
designation we may obtain will not guarantee that we will qualify for or be able
to take advantage of the priority review procedures following the submission of
an NDA. Additionally, if fast track designation were to be withdrawn for any
product for which we obtain such designation, our ability to receive FDA
approval could be delayed considerably.

IF WE RECEIVE REGULATORY APPROVAL WE WILL ALSO BE SUBJECT TO ONGOING FDA
OBLIGATIONS AND CONTINUED REGULATORY REVIEW, SUCH AS CONTINUED SAFETY REPORTING
REQUIREMENTS AND WE MAY ALSO BE SUBJECT TO ADDITIONAL FDA POST-MARKETING
OBLIGATIONS. FDA AND APPLICABLE FOREIGN REGULATORY REQUIREMENTS COULD ADVERSELY
AFFECT OUR ABILITY TO GENERATE REVENUE AND REQUIRE ADDITIONAL EXPENDITURES TO
BRING OUR PRODUCTS TO MARKET.

Any regulatory approvals that we receive for our products may also be subject to
limitations on the indicated uses for which the product may be marketed or
contain requirements for potentially costly post-marketing follow-up studies. In
addition we or our third party manufacturers may be required to undergo a
pre-approval inspection of manufacturing facilities by the FDA and foreign
authorities before obtaining marketing approval and will be subject to periodic
inspection by the FDA and corresponding foreign regulatory authorities under
reciprocal agreements with the FDA. Such inspections may result in compliance
issues that could prevent or delay marketing approval or require the expenditure
of money or other resources to correct.

If a regulatory agency discovers previously unknown problems with a product,
such as adverse events of unanticipated severity or frequency, or problems with
the facility where the product is manufactured, a regulatory agency may impose
restrictions on that product, our collaborators or us, including requiring
withdrawal of the product from the market. Our product candidates will also be
subject to ongoing FDA requirements for the labeling, packaging, storage,
advertising, promotion, record-keeping and submission of safety and other
post-market information on the drug. If our product candidates fail to comply
with applicable regulatory requirements, a regulatory agency may:

     o   issue warning letters;

     o   impose civil or criminal penalties;

     o   withdraw regulatory approval;

     o   suspend any ongoing clinical trials;

     o   refuse to approve pending applications or supplements to approved
         applications filed by us or our collaborators;

     o   impose restrictions on operations, including costly new manufacturing
         requirements; or

     o   seize or detain products or require a product recall.

                                       28

<PAGE>

Moreover, in order to market any products outside of the United States, we and
our collaborators must establish and comply with numerous and varying regulatory
requirements of other countries regarding safety and efficacy. Approval
procedures vary among countries and can involve additional product testing and
additional administrative review periods. The time required to obtain approval
in other countries might differ from that required to obtain FDA approval. The
regulatory approval process in other countries may include all of the risks
described above regarding FDA approval in the United States. Regulatory approval
in one country does not ensure regulatory approval in another, but a failure or
delay in obtaining regulatory approval in one country may negatively impact the
regulatory process in others. Failure to obtain regulatory approval in other
countries or any delay or setback in obtaining such approval could have the same
adverse effects detailed above regarding FDA approval in the United States. As
described above, such effects include the risk that our product candidates may
not be approved for all indications requested, which could limit the uses of our
product candidates and adversely impact potential royalties and product sales,
and that such approval may be subject to limitations on the indicated uses for
which the product may be marketed or require costly, post-marketing follow-up
studies.

If we or our collaborators fail to comply with applicable domestic or foreign
regulatory requirements, we and our collaborators may be subject to fines,
suspension or withdrawal of regulatory approvals, product recalls, seizure of
products, operating restrictions and criminal prosecution.

THE TRANSPLANTATION OF ANIMAL CELLS INTO HUMANS INVOLVES RISKS WHICH HAVE
RESULTED IN ADDITIONAL FDA OVERSIGHT AND WHICH IN THE FUTURE MAY RESULT IN
ADDITIONAL REGULATION THAT MAY PREVENT OR DELAY APPROVAL OF OUR POTENTIAL
PRODUCTS AND REQUIRE ADDITIONAL EXPENDITURES TO BRING THESE PRODUCTS TO MARKET.

Our business involves the transplantation of animal cells into humans, a process
known as xenotransplantation. Xenotransplantation poses a risk that viruses or
other animal pathogens may be unintentionally transmitted to a human patient.
The FDA will require testing to determine whether infectious agents, including
porcine endogenous retroviruses, also known as PERV, are present in patients who
have received cells, tissues or organs from porcine sources. While PERV has not
been shown to cause any disease in pigs, it is not known what effect, if any,
PERV may have on humans.

Other companies are currently conducting clinical trials involving the
transplantation of porcine cells into humans. The FDA requires lifelong
monitoring of these transplant recipients. If PERV or any other virus or
infectious agent is detected in tests or samples from these transplant
recipients, the FDA may require that we not initiate or we halt our clinical
trials and perform additional tests to assess the risk of infection to potential
patients. This could result in additional costs to us and delay in the trials of
our products under development.

The FDA has published guidelines for development of xenotransplantation products
and is continuing to monitor closely the development of such products to
determine if additional guidelines are required as more data is obtained. We may
not be able to comply with any final guidelines the FDA may issue.

TO BE SUCCESSFUL, OUR PRODUCT CANDIDATES MUST BE ACCEPTED BY THE HEALTH CARE
COMMUNITY, WHICH CAN BE VERY SLOW TO ADOPT OR UNRECEPTIVE TO NEW TECHNOLOGIES
AND PRODUCTS.

Our product candidates, if approved for marketing, may not achieve market
acceptance since hospitals, physicians, patients or the medical community in
general may decide to not accept and utilize these products. The product
candidates that we are attempting to develop represent substantial departures
from established treatment methods and will compete with a number of more
conventional drugs and therapies manufactured and marketed by major
pharmaceutical companies. The degree of market acceptance of any of our
developed products will depend on a number of factors, including:

     o   our establishment and demonstration to the medical community of the
         clinical efficacy and safety of our product candidates;

     o   our ability to create products that are superior to alternatives
         currently on the market, including in terms of pricing and
         cost-effectiveness, relative convenience and ease of administration;

     o   the prevalence and severity of adverse side effects; and

     o   our ability to establish in the medical community the potential
         advantage of our treatments over alternative treatment methods.

If the health care community does not accept our products for any of the
foregoing reasons our business would be materially harmed.

                                       29

<PAGE>

THE REIMBURSEMENT STATUS OF NEWLY APPROVED HEALTHCARE PRODUCTS AND TREATMENTS IS
NOT ESTABLISHED AND FAILURE TO OBTAIN ADEQUATE REIMBURSEMENT COULD LIMIT OUR
ABILITY TO MARKET ANY PRODUCTS WE MAY DEVELOP AND DECREASE OUR ABILITY TO
GENERATE REVENUE.

Our ability to commercialize our product candidates in both domestic and foreign
markets successfully will depend in part on the extent to which governmental
authorities, private health insurers, managed care programs and other
organizations establish appropriate coverage and reimbursement levels for the
cost of our products and related treatments. There is significant uncertainty
related to the reimbursement of newly approved pharmaceutical products. Third
party payors are increasingly attempting to contain healthcare costs and
challenging the prices charged for medical products and services, both by
limiting coverage and by reducing the level of reimbursement for pharmaceutical
products and treatments. For example, the trend toward managed health care in
the United States, which could significantly influence the purchase of health
care services and products, as well as legislative proposals to reform health
care or reduce government insurance programs, may result in lower prices for our
product candidates or exclusion of our product candidates from coverage and
reimbursement programs. If third parties fail to provide adequate reimbursement
for our products, consumers and health care providers may choose not to use our
products, which could significantly reduce our revenues from the sale of any
approved product and prevent us from realizing an acceptable return on our
investment in product development.

IF OUR COMPETITORS DEVELOP TREATMENTS FOR INSULIN DEPENDENT DIABETES THAT ARE
APPROVED MORE QUICKLY, MARKETED MORE EFFECTIVELY OR DEMONSTRATED TO BE MORE
EFFECTIVE THAN OUR PRODUCT CANDIDATES, OUR ABILITY TO GENERATE PRODUCT REVENUE
WILL BE REDUCED OR ELIMINATED.

The biotechnology and biopharmaceutical industries are characterized by rapidly
advancing technologies, intense competition and a strong emphasis on proprietary
products. We face competition from many different sources, including commercial
pharmaceutical and biotechnology enterprises, academic institutions, government
agencies, and private and public research institutions. Most major
pharmaceutical companies and many biotechnology companies are aggressively
pursuing new diabetes treatment programs, including both therapies with
traditional as well as novel mechanisms of action. We are aware of competitive
products, including approved and marketed products as well as products in
development. See "Competition" under Part I, Item 1 above.

Many of our competitors have significantly greater financial, product
development, manufacturing and marketing resources than us. Large pharmaceutical
companies have extensive experience in clinical testing and obtaining regulatory
approval for drugs. These companies also have significantly greater research
capabilities than us. In addition, many universities and private and public
research institutes are active in diabetes research, some in direct competition
with us. Smaller or early-stage companies may also prove to be significant
competitors, particularly through collaborative arrangements with large and
established companies, universities or research institutes. Our competitors may
succeed in developing products for the treatment of insulin dependent diabetes
that are more effective, better tolerated or less costly than any which we may
offer or develop. Our competitors may succeed in obtaining approvals from the
FDA and foreign regulatory authorities for their product candidates sooner than
we do for ours. We will also face competition from these third parties in
recruiting and retaining qualified scientific and management personnel,
establishing clinical trial sites and patient registration for clinical trials,
and in acquiring and in-licensing technologies and products complementary to our
programs or advantageous to our business.

IF WE ARE UNABLE TO PROTECT EFFECTIVELY OUR INTELLECTUAL PROPERTY THIRD PARTIES
MAY USE OUR TECHNOLOGY, WHICH COULD IMPAIR OUR ABILITY TO COMPETE IN OUR
MARKETS.

Our success will depend on our ability to obtain and protect patents on our
technology and to protect our trade secrets. The patents we currently license
and any future patents we may obtain or license, may not afford meaningful
protection for our technology and products. Others may challenge our patents
and, as a result, our patents could be narrowed, invalidated or unenforceable.
In addition our current and future patent applications may not result in the
issuance of patents in the United States or foreign countries. Competitors might
develop products similar to ours that do not infringe our patents. In order to
protect or enforce our patent rights, we may initiate interference proceedings,
oppositions, or patent litigation against third parties, such as infringement
suits. These lawsuits could be expensive, take significant time and divert
management's attention from other business concerns. The patent position of
biotechnology firms generally is highly uncertain, involves complex legal and
factual questions, and has recently been the subject of much litigation. No
consistent policy has emerged from the U.S. Patent and Trademark Office or the
courts regarding the breadth of claims allowed or the degree of protection
afforded under biotechnology patents. In addition there is a substantial backlog
of biotechnology patent applications at the U.S. Patent and Trademark Office,
and the approval or rejection of patent applications may take several years.

                                       30

<PAGE>

In addition to patent protection we require our employees, consultants,
advisors, and collaborators to execute confidentiality agreements. However these
agreements may not provide us with adequate protection against improper use or
disclosure of confidential information. In addition, in some situations, these
agreements may conflict with, or be subject to, the rights of third parties with
whom our employees, consultants or advisors have prior employment or consulting
relationships. Further, others may gain access to our trade secrets or
independently develop substantially equivalent proprietary information and
techniques.

OUR SUCCESS WILL DEPEND PARTLY ON OUR ABILITY TO OPERATE WITHOUT INFRINGING ON
OR MISAPPROPRIATING THE PROPRIETARY RIGHTS OF OTHERS. IF WE ARE SUED
SUCCESSFULLY FOR INFRINGEMENT OR MISAPPROPRIATION OF ANOTHER'S PROPRIETARY
RIGHTS, OUR ABILITY TO GENERATE REVENUE COULD BE SUBSTANTIALLY REDUCED OR
ELIMINATED.

Any of our anticipated products may infringe patent and other proprietary rights
of third parties. In addition, our competitors, many of which have substantially
greater resources than us and have made significant investments in competing
technologies or products, may seek to apply for and obtain patents that will
prevent, limit or interfere with our ability to make, use and sell products
either in the U.S. or international markets. Intellectual property litigation is
costly, and, even if we prevail, the cost of such litigation could adversely
affect our business, financial condition and results of operations. In addition,
litigation is time consuming and could divert management attention and resources
away from our business. If we do not prevail in any litigation, we could be
required to stop the infringing activity and/or pay substantial damages. Under
some circumstances in the United States, these damages could be triple the
actual damages the patent holder incurs. If we have supplied infringing products
to third parties for marketing or licensed third parties to manufacture, use or
market infringing products, we may be obligated to indemnify these third parties
for any damages they may be required to pay to the patent holder and for any
losses the third parties may sustain themselves as the result of lost sales or
damages paid to the patent holder.

If a third party holding rights under a patent successfully asserts an
infringement claim with respect to any of our products, we may be prevented from
manufacturing or marketing our infringing product in the country or countries
covered by the patent we infringe, unless we can obtain a license from the
patent holder. Any required license may not be available to us on acceptable
terms, or at all. Some licenses may be non-exclusive, and therefore, our
competitors may have access to the same technology licensed to us. If we fail to
obtain a required license or are unable to design around a patent, we may be
unable to market some of our anticipated products, which could have a material
adverse effect on our business, financial condition and results of operations.

SOME JURISDICTIONS MAY REQUIRE US TO GRANT LICENSES TO THIRD PARTIES. SUCH
COMPULSORY LICENSES COULD BE EXTENDED TO INCLUDE SOME OF OUR PRODUCT CANDIDATES,
WHICH MAY LIMIT OUR POTENTIAL REVENUE OPPORTUNITIES.

Many countries, including certain countries in Europe, have compulsory licensing
laws under which a patent owner may be compelled to grant licenses to third
parties. In addition, most countries limit the enforceability of patents against
government agencies or government contractors. In these countries, the patent
owner may be limited to monetary relief and may be unable to enjoin
infringement, which could materially diminish the value of the patent.
Compulsory licensing of life-saving products is also becoming increasingly
popular in developing countries, either through direct legislation or
international initiatives. Such compulsory licenses could be extended to include
some of our product candidates, which may limit our potential revenue
opportunities.

WE HAVE NO COMMERCIAL PRODUCTION CAPABILITY AND WE MAY ENCOUNTER PRODUCTION
PROBLEMS OR DELAYS, WHICH COULD RESULT IN LOWER REVENUE.

To date, we have not produced any product. To achieve anticipated customer
demand levels we will need to scale-up our production capability and maintain
adequate levels of inventory. We may not be able to produce sufficient
quantities to meet market demand. We may not be able to maintain acceptable
quality standards if we ramp up production. If we cannot achieve the required
level and quality of production, we may need to outsource production or rely on
licensing and other arrangements with third parties. We may not be able to
successfully outsource our production or enter into licensing or other
arrangements under acceptable terms with these third parties, which could
adversely affect our business. Our inability to identify potential
manufacturers, or to enter into or maintain agreements with them on acceptable
terms, could delay or prevent the commercialization of our products, which would
adversely affect our ability to generate revenues and could prevent us from
achieving or maintaining profitability. In addition, reliance on third-party
manufacturers could reduce our gross margins and expose us to the risks inherent
in relying on others.

                                       31

<PAGE>

We, our collaborators or other third party manufacturers of our products must
comply with current good manufacturing practice, or cGMP, requirements demanded
by customers and enforced by the FDA through its facilities inspection program.
These requirements include quality control, quality assurance and the
maintenance of records and documentation. We, our collaborators or other third
party manufacturers of our products may be unable to comply with these cGMP
requirements and with other FDA, state and foreign regulatory requirements. We
have little control over third party manufacturers' compliance with these
regulations and standards. These requirements may change over time and we or
third party manufacturers may be unable to comply with the revised requirements.
A failure to comply with these requirements may result in fines and civil
penalties, suspension of production, suspension or delay in product approval,
product seizure or recall, or withdrawal of product approval. If the safety of
any quantities supplied by third-parties is compromised due to their failure to
adhere to applicable laws or for other reasons, we may not be able to obtain
regulatory approval for or successfully commercialize product candidates that we
may develop. We may also encounter problems with production yields; shortages of
qualified personnel; production costs; and the development of advanced
manufacturing techniques and process controls.

WE MAY INCUR SUBSTANTIAL LIABILITIES FROM ANY PRODUCT LIABILITY CLAIMS,
INCLUDING CLAIMS MADE AGAINST THIRD PARTIES WE HAVE AGREED TO INDEMNIFY. OUR
INSURANCE COVERAGE FOR THOSE CLAIMS MAY BE UNAVAILABLE OR INADEQUATE.

We face an inherent risk of product liability exposure related to the testing of
our product candidates in human clinical trials, and will face an even greater
risk if we sell our product candidates commercially. An individual may bring a
liability claim against us if one of our product candidates causes, or merely
appears to have caused, an adverse effect or injury. These risks will exist even
for products developed that may be cleared for commercial sale. If we cannot
successfully defend ourselves against any product liability claims, we may incur
substantial liabilities. Regardless of merit or eventual outcome, liability
claims may result in any one or a combination of the following:

     o   decreased demand for our product candidates;

     o   injury to our reputation;

     o   withdrawal of clinical trial participants;

     o   costs of related litigation;

     o   substantial monetary awards to patients or other claimants;

     o   loss of revenues; and

     o   the inability to commercialize our product candidates.

We intend to secure limited product liability insurance coverage, but may not be
able to obtain such insurance on acceptable terms with adequate coverage, or at
reasonable or affordable costs. The amount of insurance coverage we obtain may
not be adequate to protect us from all liabilities. We may not have sufficient
resources to pay for any liabilities resulting from a claim beyond the limit of,
or excluded from, our insurance coverage.

WE USE BIOLOGICAL AND HAZARDOUS MATERIALS IN OUR BUSINESS. IF WE ARE SUBJECT TO
CLAIMS RELATING TO IMPROPER HANDLING, STORAGE OR DISPOSAL OF THESE MATERIALS OUR
FINANCIAL CONDITION WOULD SUFFER.

Our research and development processes involve the storage, use and disposal of
hazardous materials, including biological hazardous materials that could be
dangerous to human health and safety or the environment. We are subject to
federal, state and local regulations governing the use, manufacture, storage,
handling and disposal of materials and waste products. Compliance with
applicable environmental laws and regulations may be expensive, and current or
future environmental laws and regulations may impair our product development
efforts.

In the event of an accident we could be held liable for any damages that result
and any liability could exceed the limits or fall outside the coverage of our
insurance. We may not be able to maintain insurance on acceptable terms, or at
all. We could be required to incur significant costs to comply with current or
future environmental laws and regulations.

A SUBSTANTIAL NUMBER OF SHARES WE HAVE ISSUED IN EXEMPT TRANSACTIONS ARE, OR ARE
BEING MADE, AVAILABLE FOR SALE ON THE OPEN MARKET. THE RESALE OF THESE
SECURITIES MIGHT ADVERSELY AFFECT OUR STOCK PRICE.

The sale of a substantial number of shares of our common stock under our
registration statements, or in anticipation of such sales, could make it more
difficult for us to sell equity or equity-related securities in the future at a
time and at a price that we might otherwise wish to effect sales.

                                       32

<PAGE>

As of March 1, 2006 we have on file with the SEC an effective registration
statement for a total of 13,364,316 shares for resale by investors and
investment-related service providers. The selling stockholders under this
registration statement will be permitted to sell their registered shares in the
open market from time to time without advance notice to us or to the market and
without limitations on volume. We are also obligated to file one or more
registration statements for the resale of an aggregate of approximately 3.4
million shares issued in private transactions, or issuable upon exercise of
warrants issued in private transactions. We intend to file such registration
statement promptly following the filing of this report.

Sales of shares pursuant to exercisable options and warrants could also lead to
subsequent sales of the shares in the public market. These sales, together with
sales by other existing stockholders, could depress the market price of our
stock by creating an excess in supply of shares for sale. Availability of these
shares for sale in the public market could also impair our ability to raise
capital by selling equity securities.

OUR STOCK IS THINLY TRADED, WHICH CAN LEAD TO PRICE VOLATILITY AND DIFFICULTY IN
LIQUIDATING YOUR INVESTMENT.

The trading volume of our stock has been low, which can cause the trading price
of our stock to change substantially in response to relatively small orders.
During the year ended December 31, 2005, the average daily trading volume of our
stock was approximately 77,200 shares and the shares traded as low as $1.04 and
as high as $2.80 per share. Both volume and price could also be subject to wide
fluctuations in response to the following:

     o   announcements of technological innovations by us or by our competitors;

     o   the introduction of new products by us or by our competitors;

     o   costs and expenses associated with delays or changes and regulatory
         requirements for pre-clinical testing and clinical trials;

     o   the timing and achievement of regulatory approvals or disapprovals;

     o   developments or disputes concerning patent or proprietary rights; and

     o   general market perception of biotechnology and pharmaceutical
         companies.

SHARES ISSUED UPON THE EXERCISE OF OPTIONS AND WARRANTS COULD DILUTE YOUR STOCK
HOLDINGS AND ADVERSELY AFFECT OUR STOCK PRICE.

We have issued options and warrants to acquire common stock to our employees,
directors, consultants and investors at various prices, some of which are or may
in the future be below the market price of our stock. If exercised, these
options and warrants will cause immediate and possibly substantial dilution to
our stockholders. We currently have options and warrants for approximately 10.6
million shares outstanding that have exercise prices at or below the recent
market price of our stock of $1.93 per share. We have options and warrants for
4.1 million shares outstanding at prices above the recent $1.93 market price,
and if the market price increases, these options and warrants could have a
dilutive effect on stockholders if exercised. Future options issued under our
stock option plan may have further dilutive effects.

IF THE OWNERSHIP OF OUR COMMON STOCK CONTINUES TO BE HIGHLY CONCENTRATED IT MAY
PREVENT YOU AND OTHER STOCKHOLDERS FROM INFLUENCING SIGNIFICANT CORPORATE
DECISIONS AND MAY RESULT IN CONFLICTS OF INTEREST THAT COULD CAUSE OUR STOCK
PRICE TO DECLINE.

As of March 1, 2006, our executive officers, directors and their affiliates
beneficially own or control approximately 31.2% of the outstanding shares of our
common stock (after giving effect to the exercise of all options and warrants
held by them which are exercisable within sixty days of March 1, 2006).
Accordingly, our current executive officers, directors and their affiliates will
have substantial control over the outcome of corporate actions requiring
stockholder approval, including the election of directors, any merger,
consolidation or sale of all or substantially all of our assets or any other
significant corporate transactions. These stockholders may also delay or prevent
a change of control of us, even if such a change of control would benefit our
other stockholders. The significant concentration of stock ownership may
adversely affect the trading price of our common stock due to investors'
perception that conflicts of interest may exist or arise.

                                       33

<PAGE>

WE MAY ISSUE PREFERRED STOCK IN THE FUTURE AND THE TERMS OF THE PREFERRED STOCK
MAY REDUCE THE VALUE OF YOUR COMMON STOCK.

We are authorized to issue up to 10,000,000 shares of preferred stock in one or
more series. Our board of directors will be able to determine the terms of
preferred stock without further action by our stockholders. If we issue
preferred stock it could affect your rights or reduce the value of your common
stock. In particular, specific rights granted to future holders of preferred
stock could be used to restrict our ability to merge with or sell our assets to
a third party. These terms may include voting rights, preferences as to
dividends and liquidation, conversion and redemption rights, and sinking fund
provisions.

NEVADA LAW AND PROVISIONS IN OUR CHARTER DOCUMENTS MAY DELAY OR PREVENT A
POTENTIAL TAKEOVER BID THAT WOULD BE BENEFICIAL TO COMMON STOCKHOLDERS.

Our articles of incorporation and our bylaws contain provisions that may enable
our board of directors to discourage, delay or prevent a change in our ownership
or in our management. In addition, these provisions could limit the price that
investors would be willing to pay in the future for shares of our common stock.
These provisions include the following:

     o   our board of directors may increase the size of the board of directors
         and fill vacancies on the board of directors;

     o   stockholder proposals and nominations for directors to be brought
         before an annual meeting of our stockholders must comply with advance
         notice procedures, which require, among other things, that all such
         proposals and nominations must be received at our principal executive
         offices not less than 90 days nor more than 120 days prior to the first
         anniversary date of the annual meeting for the preceding year;

     o   our bylaws provide that a special meeting of stockholders may be called
         only by our chairman, chief executive officer or a majority of our
         board of directors; and

     o   our board of directors is expressly authorized to make, alter or repeal
         our bylaws.

In addition, provisions of Chapter 78 of the Nevada Revised Statutes contain
provisions that may enable our board of directors to discourage, delay or
prevent a change in our ownership or in our management. The combinations with
interested stockholders provisions of the Nevada Revised Statutes, subject to
certain exceptions, restrict the ability of our company to engage in any
combination with an interested stockholder for three years after the date a
stockholder becomes an interested stockholder, unless, prior to the stockholder
becoming an interested stockholder, our board of directors gave approval for the
combination or the acquisition of shares which caused the stockholder to become
an interested stockholder. If the combination or acquisition was not so approved
prior to the stockholder becoming an interested stockholder, the interested
stockholder may effect a combination after the three-year period only if either
the stockholder receives approval from a majority of the outstanding voting
shares, excluding shares beneficially owned by the interested stockholder or its
affiliates or associates, or the consideration to be paid by the interested
stockholder exceeds certain thresholds set forth in the statute. For purposes of
the foregoing provisions, "interested stockholder" means either a person, other
than our company or our subsidiaries, who directly or indirectly beneficially
owns 10% or more of the voting power of our outstanding voting shares, or one of
our affiliates or associates which at any time within three years immediately
before the date in question directly or indirectly beneficially owned 10% or
more of the voting power of our outstanding shares.

In addition, the acquisition of controlling interest provisions of the Nevada
Revised Statutes provide that a stockholder acquiring a controlling interest in
our company, and those acting in association with that stockholder, obtain no
voting rights in the control shares unless voting rights are conferred by
stockholders holding a majority of our voting power (exclusive of the control
shares). For purposes of these provisions, "controlling interest" means the
ownership of outstanding voting shares enabling the acquiring person to exercise
(either directly or indirectly or in association with others) one-fifth or more
but less than one-third, one-third or more but less than a majority, or a
majority or more of the voting power in the election of our directors, and
"control shares" means those shares the stockholder acquired on the date it
obtained a controlling interest or in the 90-day period preceding that date.
Accordingly, the provisions could require multiple votes with respect to voting
rights in share acquisitions effected in separate stages, and the effect of
these provisions may be to discourage, delay or prevent a change in control of
our company.

                                       34

<PAGE>

ITEM 7. FINANCIAL STATEMENTS

The financial statements required by this Item 7 begin on page F-1 and are
located following the signature page and officer certifications.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

Not applicable.

ITEM 8A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
------------------------------------------------

The Company's management, with the participation of the Company's Interim Chief
Executive Officer and Interim Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures as of December
31, 2005 (as such term is defined in Rules 13(a)-15(e) and 15(d)-15(e) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act")). The Company's
disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported on a timely
basis and that such information is accumulated and communicated to management,
including the Interim Chief Executive Officer and Interim Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure. Based on that evaluation, the Interim Chief Executive Officer and
Interim Chief Financial Officer concluded that the Company's disclosure controls
and procedures were effective as of December 31, 2005.

Changes in Internal Control Over Financial Reporting
----------------------------------------------------

During the fourth quarter of fiscal 2005, there were no changes in our internal
control over financial reporting that have materially affected or are reasonably
likely to materially affect our internal control over financial reporting.

ITEM 8B. OTHER INFORMATION.

On March 28, 2006, we entered into an employment agreement with James R. Gavin
III, M.D., Ph.D., our Interim President and Chief Executive Officer and
terminated a professional services agreement with Resources Global
Professionals, a company of which Kevin A. Hainley, our Interim Chief Financial
Officer was an associate. On March 30, 2006, we entered into a professional
services agreement with Mr. Hainley. A description of each of these agreements
is included in Item 6 under the heading "Recent Developments" and is
incorporated herein by reference.

The foregoing disclosure is made in lieu of disclosure under Items 1.01 and 1.02
on Form 8-K.


                                       35



<PAGE>

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(a) OF THE EXCHANGE ACT

DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

Unless otherwise indicated, the following table sets forth information as of
March 1, 2006, including the names, ages and business experience of the
directors, executive officers and certain other significant employees of our
company. Our directors hold their offices for a term of one year or until their
successors are elected and qualified. Our officers serve at the discretion of
the Board of Directors. Each officer devotes all of his or her working time to
our business.

<TABLE>
<S>            <C>
                                                                                                         DIRECTOR
NAME                                        AGE               POSITION HELD                               SINCE
----                                        ---               -------------                               -----

1)  James R. Gavin III, M.D., Ph.D. (4)*    59                Interim President, Chief Executive          2002
Officer and Director

2)  John J. Hagenbuch (4)**                 54                Chairman and Director                       2005

3)  Myron A. Wick III (4)                   62                Vice Chairman and Director                  2005

4)  Kevin A. Hainley**                      49                Interim Chief Financial Officer               --

5)  John F. Steel IV**                      47                Director of Corporate Development           2002
                                                              and Director

6)  Robert W. Anderson, M.D. (1)(2)(3)      68                Director                                    2002

7)  Steven T. Frankel (1)(2)(3)             62                Director                                    2002

8)  Bradley A. Geier (1)(2)(3)**            47                Director                                    2005

9) Bertram E. Walls, M.D. ***               54                Director                                    2006
_____________
(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Nominating and Governance Committee
(4) Member of Executive Committee
</TABLE>

* On January 20, 2006, James R. Gavin III, M.D., Ph.D., became our Interim
President and Chief Executive Officer and Hartoun Hartounian, Ph.D. ceased to
serve as our President. On February 17, 2006, Dr. Hartounian ceased to serve as
an officer and director of our company.

** On January 18, 2006, John F. Steel IV resigned as our Chairman and Chief
Executive Officer and was appointed our Director of Corporate Development, a
non-executive position; John J. Hagenbuch was appointed Chairman; Kevin A.
Hainley was appointed Interim Chief Financial Officer; and Bradley A. Geier was
appointed to the Audit Committee.

*** Bertram E. Walls, M.D. was appointed to our board of directors on March 17,
2006.

SIGNIFICANT EMPLOYEES

Ronnda Bartel, Ph.D.                47            Executive Director of
                                                    Biological Sciences

Mayank Patel                        36            Senior Director of Operations

Noushin Dunkelman                   41            Senior Director of Cell
                                                    Process Development

Jain Krotz, Ph.D.                   44            Director of Delivery Sciences

Ingrid Stuiver, Ph.D.               44            Director of Research

                                       36



<PAGE>

JAMES R. GAVIN III, M.D., PH.D. Dr. Gavin has served as our Interim President
and Chief Executive Officer since January 20, 2006. Dr. Gavin has been a
director since April 2002 and was a director of MicroIslet of Delaware from
March 2001 to April 2002. Dr. Gavin is Clinical Professor of Medicine, Emory
University School of Medicine, Atlanta, GA. He also serves as Executive Vice
President for Clinical Affairs, Healing Our Village, LLC, and as National
Director of the Harold Amos Medical Faculty Development Program. He was
president of the Morehouse School of Medicine, Atlanta, GA from 2002-2004. Dr.
Gavin has been a member of the Board of Directors of Baxter International Inc.
(NYSE: BAX) since February 2003, Anastasia Marie Laboratories, Inc. since
February 1998, dLife, Inc. since 2005, and Amylin Pharmaceuticals, Inc. (Nasdaq:
AMLN) since December 2005. Dr. Gavin was Chairman of the Board of Directors of
Equidyne Corporation from August 2001 to 2003. He was also a member of the Board
of Directors of Taste for Living, Inc. from 1999 to 2002. From July 1991 to June
2002, Dr. Gavin was the Senior Scientific Officer of the Howard Hughes Medical
Institute in Chevy Chase, Maryland. From 2002 until 2005 he served as national
chairman of the National Diabetes Education Program. He completed his B.S. in
Chemistry at Livingstone College, a Ph.D. in Biochemistry at Emory University
and his M.D. at Duke University Medical School.

JOHN J. HAGENBUCH. Mr. Hagenbuch has been one of our directors since April 2005.
Mr. Hagenbuch was elected by the board to fill a newly-created vacancy upon the
recommendation of our Nominating and Governance Committee, which acted after Mr.
Hagenbuch filed a Schedule 13D with the Securities and Exchange Commission
indicating his intention to effect a change in the size and composition of our
board of directors and to have Mr. Hagenbuch, and possibly another nominee
nominated by Mr. Hagenbuch, appointed to our board. Mr. Hagenbuch is co-founder
and Chairman of M&H Realty Partners, a real estate opportunity fund business
that manages money for institutional investors. Prior to forming M&H in 1993,
Mr. Hagenbuch was a General Partner of Hellman & Friedman, a private firm that
initially provided strategic investment banking and financial advisory services
to a number of large, public corporations, and then later raised and managed
several private equity funds. Before joining Hellman & Friedman as its third
partner in 1985, Mr. Hagenbuch spent nearly seven years at Salomon Brothers as a
generalist investment banker. In addition to his current position at M&H Realty
Partners, Mr. Hagenbuch is an active private equity investor and has served on
the boards of a number of public and private companies as well as not-for-profit
organizations. Mr. Hagenbuch is the brother-in-law of John F. Steel IV, our
Director of Corporate Development, and is a partner of Mr. Geier in M&H Realty
Partners. Mr. Hagenbuch completed his A.B. in Politics at Princeton University
and his M.B.A. in Finance at Stanford University.

MYRON A. WICK III. Mr. Wick has been one of our directors since July 2004 and
was appointed Vice Chairman in December 2004. Mr. Wick was elected by the board
to fill a newly-created vacancy upon the recommendation of our Nominating and
Governance Committee, which acted upon the recommendation of John J. Hagenbuch,
one of our major stockholders and the brother-in-law of John F. Steel IV, our
Director of Corporate Development. Mr. Wick is currently a managing director and
co-founder of McGettigan, Wick & Co., Inc., an investment banking firm formed in
1988, and a general partner of Proactive Investment Managers, L.P., the general
partner of Proactive Partners, L.P., a merchant banking fund formed in 1991. Mr.
Wick was also a co-founder of StoryFirst Communications, Inc. and served as its
Chairman from 1993 through 2003. StoryFirst is the largest privately-owned
television and radio broadcast company in Russia. Mr. Wick also serves on the
Boards of Directors of several public and private corporations and
not-for-profit organizations, including ModTech Holdings, Inc. (NASDAQ: MODT),
the Hoffman Institute, The Natural Step, The Tanager Foundation and Citizens
Communications Company (NYSE: CZN). Mr. Wick has a B.A. from Yale University and
an M.B.A. from Harvard University .

KEVIN A. HAINLEY, INTERIM CHIEF FINANCIAL OFFICER. Kevin A. Hainley was
appointed as our interim Chief Financial Officer on January 18, 2006. Mr.
Hainley became an associate with Resources Global Professionals in 2004. From
1996 to 2003, he was Chief Financial Officer and Secretary of Ontro, Inc., a
publicly traded company in research and development. Mr. Hainley has a B.A. in
Communications from the University of Portland and an M.B.A. from Portland State
University.

JOHN F. STEEL IV, DIRECTOR OF CORPORATE DEVELOPMENT. Mr. Steel has served as our
Director of Corporate Development, a non-executive position, since January 18,
2006 and has been one of our directors since he joined us in April 2002. Since
April 2002 and prior to his role as Director of Corporate Development, Mr. Steel
was our Chairman of the Board of Directors and Chief Executive Officer. In
January 1998 Mr. Steel founded MicroIslet of Delaware, Inc., a company acquired
by us that is now our wholly owned subsidiary, and served as its Chairman and
Chief Executive Officer from September 1998 to April 2002. Mr. Steel also served
as a director of DiaSense, Inc. from January 4, 2001 to April 2, 2002. From
January 1996 to December 1997, Mr. Steel was Chief Executive Officer of AKESIS
Pharmaceuticals, Inc., a company that developed a patented treatment for insulin
resistance for Type II diabetes. Mr. Steel continues to serve as a director of
AKESIS Pharmaceuticals, Inc. (OTCBB:AKES), which became a public company in
December 2004 through a merger with Liberty Mint, Ltd. From January 1987 to June
1990, Mr. Steel served as the Vice President of Defined Benefit Inc., a company
he founded in 1986 that provided financial services to health care
professionals. From 1989 to 1994, Mr. Steel consulted to several public and
private companies on business issues related to distribution of goods, services,
and finances through Steel Management. Mr. Steel is the brother-in-law of John
J. Hagenbuch, our Chairman and a director. Mr. Steel has a B.A. in Economics
from Dartmouth College and an M.B.A. from the University of Southern
California.

                                       37



<PAGE>

ROBERT W. ANDERSON, M.D. Dr. Anderson has been one of our directors since April
2002 and was a director of MicroIslet of Delaware from March 2001 to April 2002.
From June 1994 to the present, Dr. Anderson has served as the David C. Sabiston,
Jr., Distinguished Professor and Chairman Emeritus of the Department of Surgery
at Duke University Medical Center in Durham, North Carolina. Dr. Anderson
received his B.S. degree in Engineering from Duke University, his MBA from
Northwestern University, and his M.D. degree from Northwestern University.

STEVEN T. FRANKEL. Mr. Frankel has been one of our directors since May 2002. Mr.
Frankel has been President of Acon Laboratories, Inc., a provider of rapid
diagnostic products, since October 2003 and Senior Advisor since September 2002.
From October 2001 to September 2002 he was the Chief Executive Officer and
President of Genetic Diagnostics, Inc. Since April 1998, he has been the Chief
Executive Officer, President and a director of A-Fem Medical Corp., a developer
of women's healthcare products. From May 1992 to March 1998 he was the Chief
Executive Officer and President of Quidel Corp., a manufacturer of physicians'
office diagnostic test kits. Mr. Frankel was also President of various divisions
of Becton, Dickinson and Company from October 1979 to May 1992. Mr. Frankel
received his B.A. in Philosophy from Clark University and attended the Executive
Program at Stanford University.

BRADLEY A. GEIER. Mr. Geier has been one of our directors since April 2005. Mr.
Geier was elected by the board to fill a newly-created vacancy upon the
recommendation of our Nominating and Governance Committee, which acted after Mr.
Hagenbuch filed a Schedule 13D with the Securities and Exchange Commission
indicating his intention to effect a change in the size and composition of our
board of directors and to have Mr. Hagenbuch, and possibly another nominee
nominated by Mr. Hagenbuch, appointed to our board. Mr. Geier has been a
managing director of M&H Realty Partners, a real estate opportunity fund
business, for the past twelve years. Mr. Geier is a partner of Mr. Hagenbuch in
M&H Realty Partners. Mr. Geier completed his B.A. in History at Stanford
University and his M.B.A. at Harvard University.

BERTRAM E. WALLS, M.D. Dr. Walls has been one of our directors since March 2006.
From April 2004 to the present Dr. Walls has been the President of Phoenix
Obstetrics/Gynecology, LLC, an Obstetrical and Gynecology Hospitalist women's
health services company. In 2002 Dr. Walls founded, and is currently the
President and Chief Executive Officer, of Plexus Consulting Group, LLC, a
comprehensive healthcare and business solutions consulting and advisory company.
From October 2000 to October 2001 Dr. Walls was the Chief Executive Officer of
E&C Medical Intelligence, Inc., an international medical software company, and
was responsible for development and operational infrastructure and marketing
strategies for the U.S. division. Dr. Walls completed his B.S. at North Carolina
A&T State University and his M.D. at Duke University School of Medicine. He
received an M.B.A. degree from Duke Fuqua School of Business.

RONNDA BARTEL, PH.D., EXECUTIVE DIRECTOR OF BIOLOGICAL RESEARCH. Dr. Bartel has
over 15 years experience in the biotechnology and pharmaceutical industries,
including discovery and preclinical research, product development and
manufacturing of cell-based products. From 2002 to 2004 she maintained her own
consulting business specializing in stem cell therapy. As the Senior Director of
Science and Technology at SRS Capital LLC from 2001 to 2002, she was responsible
for assisting large pharmaceutical and healthcare clients on technology
assessment, acquisition, and strategic partnering in the therapeutic monoclonal
antibody and stem cell therapy fields From 1999 to 2001 she was the Vice
President of Scientific Development at StemCells Inc. where she was responsible
for the preclinical development of human neural stem cells for the treatment of
neurodegenerative diseases. She was also a key player in the first
commercialization of tissue-engineered products while holding both research and
management positions at Advanced Tissue Sciences from 1995 to 1998. Dr. Bartel
received her Ph.D. in Biochemistry from the University of Kansas and her
postdoctoral training at the University of Michigan.

MAYANK PATEL, SENIOR DIRECTOR OF OPERATIONS. Mr. Patel joined us in April 2002
and was the Director of Engineering and Manufacturing at MicroIslet of Delaware
from December 2000 to April 2002. From December 1998 to December 2000 he was a
senior process engineer at Sequenom Inc., where he was responsible for
consumable product design, product validation, and development of manufacturing
equipment for silicon-based DNA chips. From May 1995 to January 1999 he worked
at SkyePharma PLC (formerly DepoTech) where he was a senior engineer responsible
for the design and commissioning of an FDA approved pharmaceutical production
system. From April 1993 to May 1995 he was the Manufacturing Associate at
Regeneron Pharmaceuticals, where he performed large-scale development and GMP
production of clinical protein products. Mr. Patel received his B.S. in Chemical
Engineering from Rutgers University and his M.B.A. in Operations Management.

NOUSHIN DUNKELMAN, SENIOR DIRECTOR OF CELL PROCESS DEVELOPMENT. Mrs. Dunkelman
joined us in June 2004 with over 15 years experience in research, bio-process
engineering and product development of cell-based products. As the Sr. Director
Process Development at Forest Life Sciences, she led the development of
activated Th1 cells for treatment of renal cell carcinoma. From 2000 to 2002,
she was the Director of Product and Process Development at MorphoGen
Pharmaceuticals, where she managed the research and product development for
pluripotent stem cells for treatment of diabetes, skeletal, and
neurodegenerative diseases. From 1992 to 2000, she was a Research Scientist at
Advanced Tissue Sciences, where she was the project leader responsible for
bioreactor design from R&D concept to pre-clinical stage for cartilage product
manufacturing. She also led the design and development of a bioreactor system
for vascular graft production. Mrs. Dunkelman received her B.S. in
Bioengineering from University California San Diego.

                                       38



<PAGE>

JAIN KROTZ, PH.D., DIRECTOR OF DELIVERY SCIENCES. Dr. Krotz joined us in
September 2004 with over 10 years experience in commercial research and
development of implantable devices and in-vitro diagnostic products. From 1998
to 2004 she led the development of platforms for microelectronic DNA arrays at
Nanogen, Inc. From 1995 to 1998 she was with Medical Research Group, LLC,
developing implantable glucose sensors. Dr. Krotz received her Ph.D. in Polymer
Chemistry from the Indian Institute of Technology.

INGRID STUIVER, PH.D., DIRECTOR OF RESEARCH. Dr. Stuiver joined us in April 2002
and was the Director of Research at MicroIslet of Delaware from March 2001 to
April 2002. Dr. Stuiver was the Assistant Director of Clinical Research and
Research Scientist at Maxia Pharmaceuticals from June 1998 to March 2001. From
December 1993 to January 1998, she was a Senior Research Associate/Postdoctoral
Fellow at The Scripps Research Institute and studied adhesion receptors in
cancer, hemostasis, thrombosis and the central nervous system. Dr. Stuiver
received her Ph.D. in Molecular and Cellular Biology from the University of
Arizona and her B.A. in Biochemistry and Cell Biology from the University of
California, San Diego.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act requires our officers, directors
and persons who own more than 10% of a class of the our securities registered
under Section 12(g) of the Exchange Act to file reports of ownership and changes
in ownership with the SEC. Officers, directors and greater than 10% stockholders
are required by SEC regulation to furnish us with copies of all Section 16(a)
forms they file.

Based solely on a review of copies of such reports furnished to us and written
representations that no other reports were required during the fiscal year ended
December 31, 2005, we believe that all persons subject to the reporting
requirements of Section 16(a) filed the required reports on a timely basis with
the SEC, except as follows. Bradley A. Geier failed to file timely one Form 4
reporting one transaction, an option grant.

CODE OF ETHICS

We have adopted a "Code of Business Conduct and Ethics", a code of ethics that
applies to all employees, including our executive officers. A copy of the Code
of Business Conduct and Ethics is posted on our Internet site at
www.microislet.com. In the event we make any amendments to, or grant any waiver
of, a provision of the Code of Business Conduct and Ethics that applies to the
principal executive officer, principal financial officer, or principal
accounting officer that requires disclosure under applicable SEC rules, we
intend to disclose such amendment or waiver and the reasons therefore on a Form
8-K or on our next periodic report.

AUDIT COMMITTEE

The Board of Directors has a separately designated standing audit committee
established in accordance with Section 3(a)(58)(A) of the Exchange Act. The
audit committee, as of the end of fiscal 2005, was composed of Dr. Anderson, Mr.
Frankel and Dr. Gavin. In January 2006 Dr. Gavin resigned from the audit
committee in connection with his acceptance of the appointment as Interim
President and Chief Executive Officer, and Mr. Geier was appointed to the audit
committee to replace Dr. Gavin.

AUDIT COMMITTEE FINANCIAL EXPERT

The Board of Directors has determined that Steven T. Frankel is an "audit
committee financial expert" as defined by Item 401(e) of Regulation S-B of the
Securities Exchange Act of 1934. The Board of Directors made this affirmative
determination based upon his experience, training, and education. The Board of
Directors further determined that Mr. Frankel is "independent" as that term is
used in Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act and Section 121A of
the American Stock Exchange Company Guide.

ITEM 10. EXECUTIVE COMPENSATION

COMPENSATION OF DIRECTORS

Our non-employee directors are entitled to a retainer of $1,500 each month.
During the fiscal year ended December 31, 2005, we paid $18,000 to James R.
Gavin III, M.D., Ph.D.; $18,000 to Robert W. Anderson, M.D.; $18,000 to Steven
T. Frankel; $16,500 to Cynthia Tsai (a former director); $18,000 to Myron A.
Wick III; and $12,000 to Bradley A. Geier. Mr. Hagenbuch waived director's fees
during 2005.

In September 2005 Mr. Geier received a non-qualified option to purchase 100,000
shares of common stock at an exercise price of $2.35 per share. The option was
vested as to 1/9 of the shares on the date of grant and the remainder of the
shares vest in equal monthly installments until the option is fully vested on
the third anniversary of the date of grant. The option expires ten years after
the date of grant, subject to continuing service.

                                       39



<PAGE>

COMPENSATION OF EXECUTIVE OFFICERS

The following table sets forth the annual and long-term compensation paid by our
company for services performed on our company's behalf for the three fiscal
years ended December 31, 2005, with respect to those persons who served as the
Chief Executive Officer during the year ended December 31, 2005, and those
executive officers who received more than $100,000 in compensation for fiscal
2005.
<TABLE>
<S>            <C>
                                   Summary Compensation Table (1)
                                   ------------------------------

                                                                                               Long-Term
                                                              Annual Compensation             Compensation
                                                              -------------------             ------------
                                                                                               Securities
Name and Principal Position                   Year         Salary              Bonus        Underlying Options
---------------------------                   ----         ------              -----        ------------------
John F. Steel IV, Former Chairman,            2005         $168,000                --                   --
    Chief Executive Officer(2)                2004         $168,000                --                   --
                                              2003         $168,000            $2,000                   --

Hartoun Hartounian, Ph.D., Former President   2005         $250,000           $75,000                   --
    and Chief Operating Officer (3)           2004         $230,000           $90,000                   --
                                              2003         $234,200            $2,000              150,000

William G. Kachioff, Former Vice President,   2005         $180,000                --                   --
    Finance and Chief Financial Officer (4)   2004         $165,000           $32,400                   --
                                              2003         $150,000            $2,000              150,000
</TABLE>

(1) The columns for "Other Annual Compensation," "Restricted Stock Awards,"
"LTIP Payouts" and "All Other Compensation" have been omitted because there is
no compensation required to be reported. All options were granted at an exercise
price equal to market value.

(2) Mr. Steel resigned as Chairman and Chief Executive Officer and became our
Director of Corporate Development on January 16, 2006.

(3) Dr. Hartounian resigned as an executive officer and as a director effective
February 17, 2006.

(4) Mr. Kachioff resigned as our Vice President, Finance and Chief Financial
Officer effective January 3, 2006.


Option Grants in the Last Fiscal Year
-------------------------------------

There were no options granted to executive officers during 2005. We do not have
any stock appreciation rights plans in effect and we have no long-term incentive
plans, as those terms are defined in SEC regulations. During the fiscal year
ended December 31, 2005, we did not adjust or amend the exercise price of stock
options awarded to the named executive officers. We have no defined benefit or
actuarial plans covering any named executive officer.

The following table sets forth information concerning options exercised by our
named executive officers during the fiscal year ended December 31, 2005, and
unexercised options held by our named executive officers as of December 31,
2005.

<TABLE>
<S>       <C>
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option Values
---------------------------------------------------------------------------------

                                                           Number of Securities            Value of Unexercised
                                                          Underlying Unexercised               In-the-Money
                              Shares                       Options At 12/31/05           Options At Year End (1)
                           Acquired or      Value       --------------------------    ----------------------------
Name                      Exercised (#)    Realized     Exercisable  Unexercisable    Exercisable    Unexercisable
----                      -------------    --------     -----------  -------------    -----------    -------------

John F. Steel IV                --            --            --            --               --              --

Hartoun Hartounian, PH.D.       --            --         1,212,710        --           $1,425,252          --

William G. Kachioff            100           $184          292,400        --              $29,900          --
</TABLE>

(1) Represents the difference between the $1.55 closing selling price of our
common stock on December 31, 2005 and the exercise price(s) of the named
executive officers' options.

                                       40



<PAGE>

EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS AND CHANGE OF
CONTROL AGREEMENTS

MicroIslet of Delaware entered into an agreement with Hartoun Hartounian, Ph.D.
dated June 23, 2000, which agreement was assumed by us and amended effective
January 30, 2004, July 1, 2004 and May 1, 2005. In January 2006 Dr. Hartounian
gave notice of his resignation, effective February 17, 2006. Under this
agreement we had the right to terminate Dr. Hartounian's employment at any time
and for any reason. If, however, we did so without cause or if Dr. Hartounian
terminated his agreement for good reason, we were required to continue to pay
salary for six months following termination. Upon such termination Dr.
Hartounian would also be provided up to twelve months to exercise his vested
options. Additionally, the agreement provided that in the event Dr. Hartounian
voluntarily resigned his employment for any reason on or before May 1, 2006, Dr.
Hartounian was entitled to the foregoing benefits. In order to receive these
benefits Dr. Hartounian executed a waiver and release of claims, and
accordingly, was paid a severance payment equal to six months base salary,
continuation of the health care benefits paid by us during employment for a
period not to extend beyond February 2007, and the opportunity to exercise all
his vested stock options until December 31, 2006. Dr. Hartounian's base salary
at the time of termination was $250,000 per year.

We entered into an agreement with William G. Kachioff dated May 1, 2002, which
agreement was amended effective January 30, 2004, July 1, 2004 and May 1, 2005.
Under this agreement we had the right to terminate Mr. Kachioff's employment at
any time and for any reason. If, however, we did so without cause or if Mr.
Kachioff terminated his agreement for good reason, we were required to continue
to pay salary for six months following termination. Upon such termination Mr.
Kachioff would also be provided up to twelve months to exercise his vested
options. Additionally, the agreement provided that in the event Mr. Kachioff
voluntarily resigned his employment for any reason on or before May 1, 2006, Mr.
Kachioff would be entitled to the foregoing benefits. Mr. Kachioff executed the
waiver and release of claims, and accordingly, was paid a severance payment
equal to six months base salary, continuation of the health care benefits paid
by us during employment for a period not to extend beyond January 2007, and the
opportunity to exercise his stock options, all of which were vested, until
December 31, 2006. Mr. Kachioff's base salary at the time of termination was
$180,000 per year. In November 2005, Mr. Kachioff gave notice of his
resignation, and his last day of employment was January 2, 2005.

In March 2006 we entered into an employment agreement with James R. Gavin III,
M.D., Ph.D., our Interim President and Chief Executive Officer. Dr. Gavin is
also a director of our company and a member of the executive committee of the
board, and until his appointment as Interim President and Chief Executive
Officer in January 2006, served as a member of the compensation committee,
nominating and governance committee and audit committee. The employment
agreement with Dr. Gavin contains the following terms:

     o   Dr. Gavin will earn a base salary of $600,000 per year.

     o   The agreement has an initial term of one year commencing January 20,
         2006, and will be renewed automatically for additional one year periods
         unless either party provides notice at least 90 days prior to the
         expiration of then-current term of its intent not to renew.

     o   During the term of the agreement we have agreed to recommend to the
         nominating and governance committee, and to the board, that Dr. Gavin
         be included on management's slate of directors at each meeting of our
         stockholders at which directors are elected and that he continue to
         serve as a member of the executive committee of the board.

     o   Dr. Gavin will be an at-will employee and either we or Dr. Gavin may
         terminate employment at any time. However, if Dr. Gavin's employment is
         terminated by us without cause (as that term is defined in the
         employment agreement), Dr. Gavin will be entitled, subject to his
         execution of a general release of claims, to a severance payment equal
         to the amount of base salary that would have been paid for the
         remainder of the then-current term, subject to a minimum severance
         payment equal to three months' base salary.

     o   Dr. Gavin will be reimbursed for reasonable expenses incurred under the
         agreement including travel between San Diego and Dr. Gavin's primary
         residence in Atlanta, housing expenses in San Diego of up to $1,700 per
         month, and automobile expenses in San Diego of up to $1,000 per month.

     o   Dr. Gavin will be entitled to all benefits including vacation, health
         and disability benefits, for which he is eligible under the terms and
         conditions of our standard benefit plans provided generally to senior
         level executives, as such may be in effect from time to time.

Dr. Gavin also received on his start date, January 20, 2006, an option to
purchase 1,750,000 shares of our common stock under our 2005 Equity Incentive
Plan at an exercise price per share of $2.20, which was the closing price of our
common stock as reported on the American Stock Exchange on that date. The option
has a ten year life subject to continuing service to our company. The option
vested as to 25% of the shares immediately when granted and will vest an
additional 25% on each of the first, second, and third anniversaries of the date
of grant, subject to Dr. Gavin's continuing to serve as our principal executive
officer. Vesting of the option will accelerate upon a change of control.

                                       41



<PAGE>

PERFORMANCE CASH BONUS PLAN

For fiscal years 2004 and 2005, we had in effect a performance cash bonus plan
applicable to Dr. Hartounian and Mr. Kachioff. Under the plan Dr. Hartounian was
eligible for a bonus of up to 40% of his annual salary and Mr. Kachioff was
eligible for a bonus of up to 20% of his annual salary, based on the evaluation
of specific performance goals and accomplishments which were submitted by each
of them and approved by the compensation committee or the full board of
directors. The specific performance objectives were assigned a percentage
weighting for purposes of calculating the potential bonuses. For the 2005 fiscal
year the performance objectives for Dr. Hartounian were based on (a) progression
of preclinical development programs and advancement of scientific research
(weighted 55%), (b) operational and administrative goals, including matters
relating to human resources (weighted 40%), and (c) oversight of budget,
financial transactions and Securities and Exchange Commission reporting matters
(weighted 5%). The performance objectives for Mr. Kachioff were based on (a)
safeguarding corporate assets and managing corporate expenses (weighted 35%),
(b) maintaining compliance with the rules and regulations of the Securities and
Exchange Commission (weighted 45%) and (c) operational and administrative goals
including matters relating to human resources (weighted 20%).

In February 2006 the board awarded to Dr. Hartounian a cash bonus of $75,000
under the plan, based on the determination by the compensation committee of the
achievement by Dr. Hartounian of the established performance criteria. Mr.
Kachioff was not considered for a bonus as a result of his resignation notice
given in November 2005.

The performance cash bonus plan is not in effect for our officers at this time,
but our board, in consultation with our compensation committee, may establish a
bonus plan for the 2006 fiscal year.

MICROISLET, INC. 2005 EQUITY INCENTIVE PLAN

Our board of directors adopted the MicroIslet, Inc. 2005 Equity Incentive Plan
(the "2005 Plan") in June 2005 and our stockholders approved the 2005 Plan in
November 2005.

Description of the Plan
-----------------------

BACKGROUND AND PURPOSE OF THE 2005 PLAN. The purpose of the 2005 Plan is to
encourage ownership in our company by key personnel, whose long-term service is
considered essential to our continued progress, thereby linking these employees
directly to shareholder interests through increased stock ownership.

ELIGIBLE PARTICIPANTS. Awards under the 2005 Plan may be granted to any of our
employees, directors or consultants or those of our affiliates. As of March 1,
2006, there were approximately 25 full-time employees, six non-employee
directors, and eight consultants who would be eligible to participate. An
incentive stock option may be granted under the 2005 Plan only to a person who,
at the time of the grant, is an employee of us or a related corporation.

NUMBER OF SHARES OF COMMON STOCK AVAILABLE UNDER THE 2005 PLAN. A total of
2,000,000 new shares of our common stock are reserved for issuance under the
2005 Plan. In addition, because the 2000 Plan terminated with respect to the
availability of future option grants after approval by the stockholders, the
pool of shares under the 2005 Plan includes:

     o   shares of our common stock available for issuance under the 2000 Stock
         Option Plan, which we refer to as the 2000 Plan and which is further
         described below, as of the date of approval of the 2005 Plan by the
         stockholders; and

     o   shares of our common stock that are issuable upon exercise of options
         granted pursuant to the 2000 Plan that expire or become unexercisable
         for any reason without having been exercised in full after approval by
         the stockholders of the 2005 Plan.

The effect of establishing a pool of this nature is to merge into the 2005 Plan
any shares available or which would otherwise in the future become available
under the 2000 Plan. The total plan reserve, including the new shares and shares
currently reserved under the 2000 Plan, cannot therefore exceed 7,471,239
shares, which represents the number of reserved but unissued shares under the
2000 Plan as of the date of approval of the 2005 Plan by our board, plus the
2,000,000 new shares reserved. If an award is cancelled, terminates, expires or
lapses for any reason without having been fully exercised or vested, or is
settled by less than the full number of shares of common stock represented by
such award actually being issued, the unvested, cancelled or unissued shares of
common stock generally will be returned to the available pool of shares reserved
for issuance under the 2005 Plan. Also, if we experience a stock dividend,
reorganization or other change in our capital structure, the plan administrator
has discretion to adjust the number of shares available for issuance under the
2005 Plan and any outstanding awards as appropriate to reflect the stock
dividend or other change. The share number, award type, and price limitations
included in the 2005 Plan will also adjust appropriately upon such event.

                                       42



<PAGE>

The maximum aggregate number of shares that may be issued under the 2005 Plan
through the exercise of incentive stock options is 7,471,239.

ADMINISTRATION OF THE PLAN. The 2005 Plan will be administered by the board or a
committee of the board, which we refer to as the Committee. Our board has
appointed our Compensation Committee as the Committee referred to in the 2005
Plan, subject to a requirement that all awards granted to executive officers and
directors be submitted to the full board for ratification. In the case of awards
intended to qualify as "performance-based-compensation" within the meaning of
Section 162(m) of the Internal Revenue Code of 1986, which we refer to as the
Code, the Committee will consist of two or more "outside directors" within the
meaning of Section 162(m) of the Code. Under the 2005 Plan the administrator has
the power to determine the terms of the awards, including the exercise price,
the number of shares subject to each award, the exercisability of the awards and
the form of consideration payable upon exercise. The administrator also has the
power to implement an award transfer program, whereby awards may be transferred
to a financial institution or other person or entity selected by the
administrator, and an exchange program whereby outstanding awards are
surrendered or cancelled in exchange for awards of the same type (which may have
lower exercise prices and different terms). Except to the extent prohibited by
any applicable law, the Committee may delegate to one or more individuals the
day-to-day administration of the 2005 Plan.

AWARD TYPES

OPTIONS. A stock option is the right to purchase shares of our common stock at a
fixed exercise price for a fixed period of time. The exercise price of options
granted under the 2005 Plan must be at least equal to the fair market value of
our common stock on the date of grant. In addition the exercise price for any
incentive stock option granted to any employee owning more than 10% of our
common stock may not be less than 110% of the fair market value of our common
stock on the date of grant. The 2005 Plan provides that the maximum number of
shares for which awards may be made to any participant in any calendar year is
500,000, except that in connection with his or her initial service, a
participant may be granted awards covering up to an additional 2,000,000 shares.

Unless the administrator determines to use another method, the fair market value
of our common stock on the date of grant will be determined as the closing price
for our common stock on the date the option is granted (or if no sales are
reported that day, the last preceding day on which a sale occurred), using a
reporting source selected by the administrator. The administrator determines the
acceptable form of consideration for exercising an option, including the method
of payment, either through the terms of the option agreement or at the time of
exercise of an option.

An option granted under the 2005 Plan generally cannot be exercised until it
becomes vested. The administrator establishes the vesting schedule of each
option at the time of grant and the option will expire at the times established
by the administrator. After termination of one of our employees, directors or
consultants, he or she may exercise his or her option for the period of time
stated in the option agreement, to the extent the option is vested on the date
of termination. If termination is due to death or disability, the option
generally will remain exercisable for 12 months following such termination. In
all other cases, the option generally will remain exercisable for three months.
However, an option may never be exercised later than the expiration of its term.
The term of any stock option may not exceed ten years, except that with respect
to any participant who owns 10% or more of the voting power of all classes of
our outstanding capital stock, the term for incentive stock options must not
exceed five years.

STOCK AWARDS. Stock awards are awards or issuances of shares of our common stock
that vest in accordance with terms and conditions established by the
administrator. Stock awards include stock units, which are bookkeeping entries
representing an amount equivalent to the fair market value of a share of common
stock, payable in cash, property or other shares of stock. The administrator may
determine the number of shares to be granted and impose whatever conditions to
vesting it determines to be appropriate, including performance criteria and
level of achievement versus the criteria that the administrator determines. The
criteria may be based on financial performance, personal performance
evaluations, and completion of service by the participant. Unless the
administrator determines otherwise shares that do not vest typically will be
subject to forfeiture or to our right of repurchase, which we may exercise upon
the voluntary or involuntary termination of the awardee's service with us for
any reason, including death or disability.

In the case of stock awards intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Code, the measures
established by the administrator must be qualifying performance criteria.

                                       43



<PAGE>

STOCK APPRECIATION RIGHTS. A stock appreciation right is the right to receive
the appreciation in the fair market value of our common stock in an amount equal
to the difference between (a) the fair market value of a share of our common
stock on the date of exercise, and (b) the exercise price. This amount will be
paid in shares of our common stock with equivalent value. The exercise price
must be at least equal to the fair market value of our common stock on the date
of grant. Subject to these limitations the administrator determines the exercise
price, term, vesting schedule, and other terms and conditions of stock
appreciation rights; however, stock appreciation rights terminate under the same
rules that apply to stock options.

CASH AWARDS. Cash awards are awards that confer upon the participant the
opportunity to earn future cash payments tied to the level of achievement with
respect to one or more performance criteria established by the administrator for
a performance period. The administrator will establish the performance criteria
and level of achievement versus these criteria, which will determine the target
and the minimum and maximum amount payable under a cash award. In the case of
cash awards intended to qualify as "performance-based compensation" within the
meaning of Section 162(m) of the Code, the maximum amount payable under the 2005
Plan to any participant in a fiscal year may not exceed $500,000. The criteria
may be based on financial performance and/or personal performance evaluations.
In the case of cash awards intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Code, the measures
established by the administrator must be specified in writing.

TRANSFERABILITY OF AWARDS. Unless the administrator determines otherwise, the
2005 Plan does not allow for the transfer of awards other than by beneficiary
designation, will, or by the laws of descent or distribution and only the
participant may exercise an award during his or her lifetime.

ADJUSTMENTS UPON MERGER OF CHANGE IN CONTROL. The 2005 Plan provides that in the
event of a merger with or into another corporation or our "change in control,"
including the sale of all or substantially all of our assets, and certain other
events, our board or the Committee may, in its discretion, provide for the
assumption or substitution of, or adjustment to, each outstanding award,
accelerate the vesting of options and stock appreciation rights, and terminate
any restrictions on stock awards or cash awards or provide for the cancellation
of awards in exchange for a cash payment to the participant.

AMENDMENT AND TERMINATION OF THE 2005 PLAN. The administrator has the authority
to amend, alter or discontinue the 2005 Plan, subject to the approval of the
stockholders, and no amendment will impair the rights of any award, unless
mutually agreed to between the participant and the administrator.

AMERICAN JOBS CREATION ACT OF 2004. The American Jobs Creation Act of 2004
contains deferred compensation provisions added as Section 409A of the Code.
These provisions make compensation deferred under a nonqualified deferred
compensation plan taxable on a current basis (or, if later, when vested), unless
certain requirements are met. The Internal Revenue Service has recently issued
proposed regulations on the provisions of Section 409A, and further guidance is
expected to follow. The 2005 Plan provides that it is the intent of our company
that all awards granted under the 2005 Plan will not cause an imposition of
additional taxes provided by Section 409A of the Code, and that the 2005 Plan
should be administered so that such taxes are not imposed.

OTHER PLANS

Our Board of Directors adopted the MicroIslet of Delaware 2000 Stock Option Plan
in May 2002 and our stockholders approved it on May 28, 2002. All options
granted by MicroIslet of Delaware prior to our acquisition of MicroIslet of
Delaware were assumed by us and those options became exercisable for shares of
our common stock. In January 2004 our Board amended the 2000 Plan to increase
the number of shares reserved under the plan from 4,000,000 to 6,000,000, and to
implement per person annual grant maximums. As a result of the approval of the
2005 Plan by our stockholders in November 2005, no additional options may be
granted under the 2000 Plan. Options with respect to 3,992,485 shares are
outstanding under the Prior Plan as of March 1, 2006.

                                       44


<PAGE>

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
         RELATED STOCKHOLDER MATTERS

EQUITY COMPENSATION PLAN INFORMATION

The following table gives information as of December 31, 2005:

<TABLE>
<S>       <C>
                                                                                                NUMBER OF SECURITIES
                                                                                               REMAINING AVAILABLE FOR
                                          NUMBER OF SECURITIES TO       WEIGHTED-AVERAGE        FUTURE ISSUANCE UNDER
                                          BE ISSUED UPON EXERCISE      EXERCISE PRICE OF      EQUITY COMPENSATION PLANS
                                          OF OUTSTANDING OPTIONS,     OUTSTANDING OPTIONS,      (EXCLUDING SECURITIES
             PLAN CATEGORY                  WARRANTS AND RIGHTS       WARRANTS AND RIGHTS     REFLECTED IN COLUMN (a))
             -------------                  -------------------       -------------------     ------------------------
                                                     (a)                        (b)                      (c)
Equity compensation plans approved by
security holders (1)                              4,205,479 (2)              $1.12                   3,265,760

Equity compensation plans not approved
by security holders                               3,398,421 (3)              $4.20                          --
                                               -------------                                      --------------

Total                                             7,603,900                  $2.50                   3,265,760
                                               =============                                      =============
</TABLE>


(1) At December 31, 2005, we had two equity incentive plans under which equity
securities are or have been authorized for issuance to our employees,
consultants or directors: the 2005 Equity Incentive Plan and the 2000 Stock
Option Plan. Our Board of Directors adopted the 2005 Equity Incentive Plan in
June 2005 and our stockholders approved it in November 2005. Our Board of
Directors adopted the MicroIslet of Delaware 2000 Stock Option Plan and our
stockholders approved it in May 2002. All options granted by MicroIslet of
Delaware prior to our acquisition of MicroIslet of Delaware were assumed by us
and those options became exercisable for shares of our common stock.

(2) Options representing 2,705,124 shares of common stock granted pursuant to
the 2000 Stock Option Plan were assumed by us pursuant to our acquisition of
MicroIslet of Delaware. Of those, options representing 2,695,124 shares remain
outstanding.

(3) Consists of individual stock options and warrant grants to employees,
directors, consultants, and advisors. Options representing 50,000 shares of
common stock were granted outside of the 2000 Stock Option Plan each to Robert
W. Anderson, James R. Gavin III and Steven T. Frankel in November 2003. Options
representing those 150,000 shares remain outstanding. Dr. Anderson, Dr. Gavin
and Mr. Frankel are directors of our company. The option agreements entered into
with each of Dr. Anderson, Dr. Gavin and Mr. Frankel are attached hereto as
Exhibits 10.28, 10.29 and 10.30 respectively. In addition options representing a
total of 460,000 shares of common stock were granted outside of the 2000 Stock
Option Plan to five individuals in 2003 and 2004, none of whom is an officer or
director of the company pursuant to the form of option agreement attached hereto
as Exhibit 10.26. Of those, options representing 460,000 shares remain
outstanding. Warrants representing 1,500,000 shares of common stock in the
aggregate were granted to Donald Saunders, Thomas K. Russell and Mark C. Russell
for services in connection with the merger of MicroIslet of Delaware and us in
April 2002, as described in greater detail in Item 1 under the heading
"History". Of those, warrants representing 1,500,000 shares remain outstanding.
Options representing 140,649 shares of common stock granted outside of the 2000
Stock Option Plan were assumed by us pursuant to our acquisition of MicroIslet
of Delaware. Of those, options representing 140,649 shares remain outstanding.
Warrants representing 738,038 shares in the aggregate were granted in 2004 to
finders in consideration of services rendered in connection with our March 2004
private placement. Of those, warrants representing 578,038 shares remain
outstanding pursuant to the form of Warrant Agreement attached hereto as Exhibit
10.32. Warrants representing 638,334 shares in the aggregate were granted in
2004 to investor relations consulting firms in consideration of investor
relations services rendered pursuant to the forms of Warrant Agreement attached
hereto as Exhibit 10.32, 10.34, 10.35, 10.36 and 10.37. Of those, warrants
representing 478,334 shares remain outstanding. Warrants representing 91,400
shares in the aggregate were granted in 2005 to finders in consideration of
services rendered in connection with our December 2005 private placement
pursuant to the form of warrant agent attached hereto as Exhibit 10.49.

                                       45



<PAGE>

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the ownership of
our common stock as of March 1, 2006, by: (i) each director; (ii) each person
who is known to us to be the beneficial owner of more than five percent of our
outstanding common stock; (iii) each of our executive officers named in the
Summary Compensation Table; and (iv) all our current executive officers and
directors as a group. Except as otherwise indicated in the footnotes all
information with respect to share ownership and voting and investment power has
been furnished to us by the persons listed. Except as otherwise indicated in the
footnotes each person listed has sole voting power with respect to the shares
shown as beneficially owned.

<TABLE>
<S>            <C>
                                                     Number of Shares
Name and Address of Beneficial Owner (1)           Beneficially Owned (2)        Percent of Class (2)
----------------------------------------          -----------------------        --------------------

John F. Steel IV                                          8,983,251 (3)                  20.4%

Richard Schoninger                                        3,190,850 (4)                   7.2%
667 Madison Avenue
New York, NY 10021

Don and Bonnie Saunders Family Trust                      2,588,497 (5)                   5.9%
900 E. Desert Inn Road, Apt. 521
Las Vegas, NV 89109

John J. Hagenbuch                                         3,834,852 (6)                   8.6%

Hartoun Hartounian, Ph.D.                                 1,112,710 (7) (11)              2.5%

William G. Kachioff                                         282,500 (7) (12)                *

Robert W. Anderson, M.D.                                    190,648 (7)                     *

Steven T. Frankel                                           144,000 (7)                     *

James R. Gavin III, M.D., Ph.D.                             628,148 (7)                   1.4%

Myron A. Wick III                                           404,210 (8)                     *

Bradley A. Geier                                            133,333 (9)                     *

Bertram E. Walls, M.D.                                            0                        --

All current executive officers and
directors as a group (9 in number)                        14,318,442 (10)                31.2%
</TABLE>

* Less than one percent.

(1) Except as otherwise indicated, the address for each beneficial owner is 6370
Nancy Ridge Drive, Suite 112, San Diego, CA 92121.

(2) Unless otherwise indicated in the footnotes to this table and subject to
community property laws where applicable, we believe that each of the
stockholders named in this table has sole voting and investment power with
respect to the shares indicated as beneficially owned. Applicable percentages
are based on 44,035,136 shares outstanding on March 1, 2006, adjusted as
required by rules promulgated by the Commission.

(3) Excludes 10,000 shares held by Mr. Steel's daughter. Mr. Steel disclaims
beneficial ownership of such shares, as he does not have voting or investment
control over such shares.

(4) Includes 3,000 shares held by Mr. Schoninger's minor son, for which Mr.
Schoninger may be deemed to share voting and investment control with the child's
mother. The ownership information for Mr. Schoninger in this table is based
solely on information provided by Mr. Schoninger in June 2005.

(5) Don and Bonnie Saunders are the trustees of the Don and Bonnie Saunders
Family Trust, and share voting and investment power over the 1,941,129 shares
held by such trust. Also includes 647,368 shares held by Mr. Saunders and his
wife as trustees of an irrevocable trust for which Mr. and Mrs. Saunders share
voting and investment power. Excludes 850,000 shares subject to a warrant with
an exercise price of $6.00 per share and 425,000 shares subject to a warrant
with an exercise price of $12.00 per share, as these warrants are substantially
out of the money. If and when Mr. and Mrs. Saunders determine to sell any of the
2,588,497 shares beneficially owned by them, or Mr. Saunders determines to sell
any of the 1,275,000 shares subject to the warrants, they may do so only
pursuant to a registration statement covering such resales. The ownership
information for the Don and Bonnie Saunders Family Trust in this table is based
solely on information provided by Mr. Saunders in March 2004 and certain updated
information provided by our transfer agent.

                                       46



<PAGE>

(6) Includes 1,758,772 shares held by Jackson St. Partners; 1,337,200 shares
held by a trust affiliated with Mr. Hagenbuch; and 10,000 shares held by Mr.
Hagenbuch's minor children, for which Mr. Hagenbuch may be deemed to share
voting and investment control with his spouse. Mr. Hagenbuch's spouse is the
sister of John F. Steel IV. Also includes 728,880 shares subject to immediately
exercisable warrants issued to a trust affiliated with Mr. Hagenbuch.

(7) For each person, the shares shown represent shares that are issuable upon
exercise of options exercisable within 60 days of March 1, 2006.

(8) Includes 121,794 shares of common stock beneficially owned by D-W
Investments, L.L.C., over which Mr. Wick shares voting and investment control
with James W. DeYoung, Walter D. Wick, Penelope W. DeYoung and Wendy W. Chase.
Also includes 19,231 warrants held by D-W Investments that are exercisable
within 60 days of March 1, 2006, 55,556 shares that are issuable upon exercise
of options held by Mr. Wick that are exercisable within 60 days of March 1,
2006, and 29,167 shares that D-W Investments has the right to purchase from John
F. Steel IV within 60 days of March 1, 2006.

(9) Includes 100,000 shares held by a trust affiliated with Mr. Geier, and
33,333 shares issuable upon exercise of options exercisable within 60 days of
March 1, 2006.

(10) Includes 1,828,963 shares issuable upon exercise of options and warrants
exercisable within 60 days of March 1, 2006.

(11) Hartoun Hartounian, Ph.D. resigned as our President and Chief Operating
Officer and a director effective in February 2006.

(12) William G. Kachioff resigned as our Vice President, Finance and Chief
Financial Officer effective in January 2006.

We are aware of no arrangements which may result in a change of control of
MicroIslet.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In March 2004, we sold to D-W Investments, L.L.C., 38,461 shares of common stock
at a purchase price of $1.30 per share. In connection with the financing we also
issued to the investor a five-year warrant to purchase 19,231 shares at $1.00
per share. Mr. Myron A. Wick III is the Managing Member of D-W Investments,
L.L.C. and possesses voting and investment control over the shares held. In
March 2004 we also issued 89,231 shares and a warrant to purchase 89,231 shares
to Mr. Wick for placement agent services received in connection with the
financing. The warrant has an exercise price of $1.30 per share and expires on
March 16, 2006. Mr. Wick joined our Board of Directors in July 2004 and
exercised his warrant on March 16, 2006.

As discussed in Part I, Item 3, our wholly owned subsidiary, MicroIslet of
Delaware, and John F. Steel IV, our former Chairman and Chief Executive Officer,
were named as defendants in a lawsuit brought in the Superior Court of
California, County of Orange, by Donald Gallego. We were obligated under our
articles of incorporation, and MicroIslet of Delaware was obligated under its
bylaws, to advance expenses to Mr. Steel for his defense of this lawsuit. From
November 2004 to January 2006, we paid an aggregate of $432,352 in legal fees
incurred by Mr. Steel in defense this action.


                                       47




<PAGE>

<TABLE>
<S>            <C>

ITEM 13. EXHIBITS

------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
Exhibit No.  Description                           Filed        Incorporated    Form         Date Filed     Exhibit
                                                   Herewith     by Reference                                No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.1          Articles of Incorporation                                X         10-SB        Aug. 13, 1999  3.(a)
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.2          Certificate of Amendment to the                          X         SB-2         July 25, 2002  3.2
             Articles of Incorporation
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.3          Amended and Restated Bylaws                X
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
4.1          Specimen Common Stock Certificate                        X         SB-2/A       Nov. 20, 2002  4.1
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.1         Amended and Restated 2000 Stock                          X         10-KSB       March 30,      10.1
             Option Plan, as amended and                                                     2004
             restated January 30, 2004*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.2         Form of Stock Option Grant Notice                        X         10-KSB       March 30,      10.2
             and Stock Option Agreement under                                                2005
             2000 Stock Option Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.3         Investment Banking Agreement dated                       X         SB-2         July 25, 2002  10.2
             October 22, 2001 between MicroIslet
             of Delaware and ASA Investment
             Company, as amended
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.4         License and Sponsored Research                           X         SB-2/A       Feb. 10, 2003  10.3
             Agreement dated September 15, 1998
             between MicroIslet of Delaware and
             Duke University
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.5         Amendment to License and Sponsored                       X         SB-2/A       Feb. 10, 2003  10.14
             Research Agreement dated February
             5, 1999 between MicroIslet of
             Delaware and Duke University
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.6         Research Service Agreement dated                         X         SB-2/A       Feb. 10, 2003  10.15
             November 20, 2002 between
             MicroIslet, Inc. and The Governors
             of the University of Alberta
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.7         Research Funding and Option                              X         10-KSB       March 28,      10.6
             Agreement dated February 20, 2003                                               2003
             between MicroIslet, Inc. and the
             Scripps Research Institute, a
             California nonprofit public benefit
             corporation +
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.8         Standard Industrial/Commercial                           X         SB-2         July 25, 2002  10.6
             Multi-Tenant Lease dated July 3,
             2002 between MicroIslet, Inc. and
             Nancy Ridge Technology Center, L.P.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.9         First Amendment dated February 17,                       X         8-K          Feb. 24, 2005  99.1
             2005 to the Lease dated July 3,
             2002 between MicroIslet, Inc. and
             Nancy Ridge Technology Center, L.P.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.10        Warrant Agreement between ALD                            X         8-K          March 6,       2.1
             Services, Inc. and Pacific Stock                                                2002
             Transfer Company dated April 2,
             2002.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.11        Class A Warrant Certificate dated                        X         SB-2         July 25, 2002  10.8
             April 2, 2002, issued to Donald G.
             Saunders
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.12        Class B Warrant Certificate dated                        X         SB-2         July 25, 2002  10.9
             April 2, 2002, issued to Donald G.
             Saunders
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.13        Class A Warrant Certificate dated                        X         SB-2         July 25, 2002  10.10
             April 2, 2002, issued to Thomas K.
             Russell
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.14        Class B Warrant Certificate dated                        X         SB-2         July 25, 2002  10.11
             April 2, 2002, issued to Thomas K.
             Russell
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

                                                               48



<PAGE>
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
Exhibit No.  Description                           Filed        Incorporated    Form         Date Filed     Exhibit
                                                   Herewith     by Reference                                No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

10.15        Class A Warrant Certificate dated                        X         SB-2         July 25, 2002  10.12
             April 2, 2002, issued to Mark C.
             Russell
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.16        Class B Warrant Certificate dated                        X         SB-2         July 25, 2002  10.13
             April 2, 2002, issued to Mark C.
             Russell
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.17        Employment Agreement between                             X         10-KSB       March 30,      10.15
             MicroIslet of Delaware and Hartoun                                              2004
             Hartounian dated June 23, 2000*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.18        Amendment Agreement dated January                        X         10-KSB       March 30,      10.16
             30, 2004 to Employment Agreement                                                2004
             between MicroIslet of Delaware and
             Hartoun Hartounian dated June 23,
             2000*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.19        Employment Agreement between                             X         10-KSB       March 28,      10.15
             MicroIslet, Inc. and William                                                    2003
             Kachioff dated May 1, 2002*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.20        Amendment Agreement dated January                        X         10-KSB       March 30,      10.18
             30, 2004 to Employment Agreement                                                2004
             between MicroIslet, Inc. and
             William Kachioff dated May 1, 2002*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.21        Warrant Agreement, dated April 11,                       X         SB-2         April 15,      10.19
             2003 between MicroIslet, Inc. and                                               2003
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.22        Warrant Agreement, dated May 12,                         X         8-K          May 13, 2003   10.2
             2003 between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.23        Warrant Amendment, dated August 26,                      X         8-K          Aug. 28, 2003  10.2
             2003 between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.24        Warrant Amendment, dated August 26,                      X         8-K          Aug. 28, 2003  10.4
             2003 between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.25        Amended and Restated Securities                          X         8-K          Nov. 3, 2003   10.1
             Purchase Agreement dated October
             31, 2003 between MicroIslet, Inc.
             and the purchasers named therein
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.26        Form of Warrant dated October 31,                        X         8-K          Nov. 3, 2003   10.2
             2003
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.27        Form of Special Stock Option used                        X         S-8          Sept. 26,      99.2
             in connection with option grants                                                2003
             outside of MicroIslet, Inc.'s stock
             option plans*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.28        Special Stock Option granted to                          X         10-KSB       March 30,      10.34
             Robert W. Anderson on November 10,                                              2004
             2003*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.29        Special Stock Option granted to                          X         10-KSB       March 30,      10.35
             James R. Gavin III on November 10,                                              2004
             2003*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.30        Special Stock Option granted to                          X         10-KSB       March 30,      10.36
             Steven T. Frankel on November 10,                                               2004
             2003*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.31        Form of Securities Purchase                              X         10-KSB       March 30,      10.37
             Agreement dated as of March 16, 2004                                            2004
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.32        Form of Warrant Agreement dated as                       X         10-KSB       March 30,      10.38
             of March 16, 2004                                                               2004
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

                                                               49



<PAGE>
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
Exhibit No.  Description                           Filed        Incorporated    Form         Date Filed     Exhibit
                                                   Herewith     by Reference                                No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

10.33        Table of Special Stock Options                           X         10-KSB       March 30,      10.39
             granted outside of MicroIslet,                                                  2005
             Inc.'s Stock Option plans*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.34        Warrant Agreement, dated January                         X         10-QSB       May 13, 2004   10.3
             30, 2004, between MicroIslet, Inc.
             and Strategic Growth International,
             Inc.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.35        Warrant Agreement, dated April 1,                        X         S-2          May 28, 2004   10.42
             2004, between MicroIslet, Inc. and
             BetaDynamics, LLC
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.36        Warrant Agreement, dated April 1,                        X         S-2          May 28, 2004   10.43
             2004, between MicroIslet, Inc. and
             SBI Brightline VII, LLC
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.37        Warrant Agreement, dated May 25,                         X         10-QSB       Aug. 13, 2004  10.3
             2004, between MicroIslet, Inc. and
             Strategic Growth International, Inc.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.38        MicroIslet, Inc. Executive                               X         10-QSB/A     Feb. 15, 2005  10.1
             Performance Cash Bonus Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.39        Summary Sheet of Director                  X
             Compensation*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.40        Undertaking to Repay Costs dated                         X         10-QSB       Sept. 27,      10.1
             April 21, 2005                                                                  2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.41        Second Amendment Agreement with                          X         8-K          June 22, 2005  99.1
             Hartoun Hartounian, Ph.D., dated
             June 16, 2005*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.42        Second Amendment Agreement with                          X         8-K          June 22, 2005  99.2
             William G. Kachioff dated June 16,
             2005*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.43        2005 Equity Incentive Plan of                            X         POS AM to    Nov. 23, 2005  10.51
             MicroIslet, Inc.*                                                  SB-2
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.44        Form of Stock Option Grant Notice                        X         8-K          Jan. 19, 2006  99.1
             and Stock Option Agreement under
             2005 Equity Incentive Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.45        Form of Stock Award Agreement under                      X         8-K          Jan. 19, 2006  99.2
             2005 Equity Incentive Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.46        System lease dated August 23, 2005                       X         10QSB        Nov. 14, 2005  10.1
             between MicroIslet, Inc. and
             Beckman Coulter Corporation
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.47        Securities Purchase Agreement dated                      X         8-K          Dec. 27, 2005  99.1
             as of December 23, 2005 between
             MicroIslet, Inc. and certain
             purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.48        Registration Rights Agreement dated                      X         8-K          Dec. 27, 2005  99.2
             as of December 23, 2005 between
             MicroIslet, Inc. and certain
             investors
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.49        Form of Warrant dated December 23,                       X         8-K          Dec. 27, 2005  99.3
             2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.50        Long Term Supply Agreement dated                         X         8-K/A        Jan. 1, 2006   99.2
             November 15, 2005 between
             MicroIslet, Inc. and Mayo
             Foundation for Medical Education
             and Research +
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.51        Professional Services Agreement                          X         8-K          Jan. 19, 2006  99.3
             dated January 18, 2006 between
             MicroIslet, Inc. and Resources
             Connection, LLC*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

                                                               50



<PAGE>
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
Exhibit No.  Description                           Filed        Incorporated    Form         Date Filed     Exhibit
                                                   Herewith     by Reference                                No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

10.52        Stock Option Agreement dated               X
             January 20, 2006 between
             MicroIslet, Inc. and James R. Gavin
             III, M.D., Ph.D.*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.53        Employment Agreement dated March           X
             28, 2006 between MicroIslet, Inc.
             and James R. Gavin III, M.D., Ph.D.*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.54        Professional Services Agreement            X
             dated March 30, 2006 between
             MicroIslet, Inc. and Kevin A.
             Hainley*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
21.1         List of Subsidiaries of MicroIslet,                      X         SB-2         July 25, 2002  21.1
             Inc.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
23.1         Consent of  Independent Registered         X
             Public Accounting Firm.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
24.1         Power of Attorney (included as a           X
             part of the signature page attached
             hereto)
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
31.1         Certification of James R. Gavin            X
             III, M.D., Ph.D., Principal
             Executive Officer, pursuant to Rule
             13a-14(a) or 15d-14(a) of the
             Securities Exchange Act of 1934, as
             adopted pursuant to Section 302 of
             the Sarbanes-Oxley Act of 2002.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
31.2         Certification of Kevin A. Hainley,         X
             Principal Financial Officer,
             pursuant to Rule 13a-14(a) or
             15d-14(a) of the Securities
             Exchange Act of 1934, as adopted
             pursuant to Section 302 of the
             Sarbanes-Oxley Act of 2002.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
32.1         Certificate pursuant to 18 U.S.C.          X
             Section 1350, as adopted pursuant
             to Section 906 of the
             Sarbanes-Oxley Act of 2002,
             executed by James R. Gavin III,
             M.D., PhD, Principal Executive
             Officer, and Kevin A. Hainley,
             Principal Financial Officer
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
</TABLE>

+ Confidential treatment has been requested with respect to certain portions of
this exhibit. Omitted portions have been filed separately with the Securities
and Exchange Commission.

*Management contract or compensatory plan or arrangement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The following table summarizes the aggregate fees billed to MicroIslet by
Deloitte & Touche LLP, our independent registered public accounting firm, for
the audit of our annual financial statements for the years ended December 31,
2005 and December 31, 2004 and fees billed for other services rendered by
Deloitte & Touche LLP during those periods.

TYPE OF FEE                                         2005             2004
-----------                                    -------------     -------------
Audit Fees (1)                                 $     321,200     $      97,900
Audit Related Fees (2)                                13,500             8,300
Tax Fees (3)                                           9,700             8,500
All Other Fees (4)                             -------------     -------------
Total                                          $     344,400     $     114,700
                                               =============     =============

(1) Audit Fees include fees and expenses for professional services rendered in
connection with the audit of our financial statements for those years, reviews
of the financial statements included in each of our quarterly reports on Form
10-QSB during those years and services that are normally provided by the
independent registered public accounting firm in connection with statutory and
regulatory filings or engagements. Audit fees for 2005 also include fees
incurred in connection with the restatement of our financial statements for the
fiscal year ended December 31, 2004, and with the restatement of our unaudited
financial statements for the quarter ended March 31, 2005.

                                       51



<PAGE>

(2) Audit Related Fees consist of fees billed for assurance related services
that are reasonably related to the performance of the audit or review of our
financial statements and are not reported under "Audit Fees."

(3) Tax Fees include the aggregate fees paid by us during the fiscal year
indicated for professional services for tax compliance, tax advice and tax
planning.

(4) All Other Fees consist of fees for products and services other than the
services reported above. No Other Fees were billed during the fiscal years ended
December 31, 2005 and 2004.

AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES

All audit and non-audit services are pre-approved by the Audit Committee, which
considers, among other things, the possible effect of the performance of such
services on the auditors' independence. The Audit Committee pre-approves the
annual engagement of the principal independent registered public accounting
firm, including the performance of the annual audit and quarterly reviews for
the subsequent fiscal year, and pre-approves specific engagements for tax
services performed by such firm. The Audit Committee has also established
pre-approval policies and procedures for certain enumerated audit and audit
related services performed pursuant to the annual engagement agreement with such
firm, including: such firm's attendance at and participation at Board and
committee meetings; services associated with SEC registration statements
approved by the Board of Directors; review of periodic reports and other
documents filed with the SEC or other documents issued in connection with
securities offerings, such as comfort letters and consents; assistance in
responding to any SEC comments letters; and consultations with such firm as to
the accounting or disclosure treatment of transactions or events and the actual
or potential impact of final or proposed rules, standards or interpretations by
the SEC, Public Company Accounting Oversight Board (PCAOB), Financial Accounting
Standards Board (FASB), or other regulatory or standard-setting bodies. In
addition, the Audit Committee has authorized the Chair of the Committee to
pre-approve audit and non-audit services to be provided by the principal
independent registered public accounting firm (to the extent such services are
not subject to the pre-approval policies and procedures specified above), on a
case-by-case basis, provided the fees and expenses for such services
pre-approved by the Chair of the Committee shall not exceed $25,000 per
engagement without further approval of the full Committee. The Audit Committee
is informed of each service performed pursuant to its pre-approval policies and
procedures.

The Audit Committee has considered the role of Deloitte & Touche LLP in
providing services to us for the fiscal year ended December 31, 2005 and has
concluded that such services are compatible with such firm's independence.

                                       52



<PAGE>


                                   SIGNATURES

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

MICROISLET, INC.


By: /S/ JAMES R GAVIN III                           Date: April 6, 2006
    ---------------------
    James R. Gavin III, M.D., Ph.D
    Interim President and Chief Executive Officer
    (Principal Executive Officer)

Each person whose signature appears below hereby severally constitutes and
appoints James R. Gavin III and Kevin A. Hainley, and each of them, his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities to sign any and all amendments to this Report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Commission, granting unto said attorney-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite or necessary fully to all intents and purposes as he might or could do
in person, hereby ratifying and confirming all that each said attorneys-in-fact
and agents or any of them or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.

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

<TABLE>
<S>                 <C>
Signature                                                        Title                             Date
---------                                                        -----                             ----

/S/ JAMES R. GAVIN III                           Interim President and Chief Executive       April 6, 2006
-----------------------------------              Officer and Director
James R. Gavin III, M.D., Ph.D                   (Principal Executive Officer)

/S/ KEVIN A. HAINLEY                             Interim Chief Financial Officer             April 6, 2006
-----------------------------------              (Principal Financial and Accounting
Kevin A. Hainley                                 Officer)

                                                 Chairman and Director                       April 6, 2006
-----------------------------------
John J. Hagenbuch

/S/ MYRON A. WICK III                            Vice Chairman and Director                  April 6, 2006
-----------------------------------
Myron A. Wick III

/S/ ROBERT W. ANDERSON                           Director                                    April 6, 2006
-----------------------------------
Robert W. Anderson, M.D.

/S/ JOHN F. STEEL IV                             Director                                    April 6, 2006
-----------------------------------
John F. Steel IV

/S/ STEVEN T. FRANKEL                            Director                                    April 6, 2006
-----------------------------------
Steven T. Frankel

/S/ BRADLEY A. GEIER                             Director                                    April 6, 2006
-----------------------------------
Bradley A. Geier

/S/ BERTRAM E. WALLS                             Director                                    April 6, 2006
-----------------------------------
Bertram E. Walls, M.D.

</TABLE>

                                       53




<PAGE>


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            Page


Report of Independent Registered Public Accounting Firm                     F-2

                        CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Balance Sheets                                                 F-3
Consolidated Statements of Operations                                       F-4
Consolidated Statements of Shareholders' Equity                             F-5
Consolidated Statements of Cash Flows                                       F-10
Notes to Consolidated Financial Statements                                  F-12





                                      F-1



<PAGE>




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
MicroIslet, Inc.
San Diego, California

We have audited the accompanying consolidated balance sheets of MicroIslet, Inc.
and subsidiary, a development stage company, (the "Company") as of December 31,
2005 and 2004, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the years then ended and for the period
from August 21, 1998 (date of inception) to December 31, 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of MicroIslet, Inc. and subsidiary as
of December 31, 2005 and 2004, and the results of their operations and their
cash flows for the years then ended and for the period from August 21, 1998
(date of inception) to December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred substantial operating losses and
negative operating cash flows through December 31, 2005, and as of that date the
Company's cash position was $4.5 million. Management has projected that cash on
hand will be sufficient to allow the Company to continue its operations only
through the first half of 2006. These matters raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.


/s/ Deloitte & Touche LLP

San Diego, California
April 6, 2006


                                      F-2



<PAGE>
<TABLE>


                                            MICROISLET, INC.
                                     (A Development Stage Company)
                                      Consolidated Balance Sheets


                                                                          December 31,    December 31,
                                                                              2005            2004
                                                                          ------------    ------------
<S>                                                                       <C>             <C>
ASSETS

Current Assets:
         Cash and cash equivalents                                        $  4,518,846    $  8,777,364
         Grant receivable                                                      102,971              --
         Other receivables                                                     133,811              --
         Prepaid expenses                                                      154,001         223,284
                                                                          ------------    ------------

                  Total current assets                                       4,909,629       9,000,648
                                                                          ------------    ------------

Property and equipment, net                                                    359,042         203,018
Patents, net                                                                    10,574          11,048
Deposits and other assets                                                       55,210          57,602
                                                                          ------------    ------------

                  Total assets                                            $  5,334,455    $  9,272,316
                                                                          ============    ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
         Accounts payable                                                 $    509,572    $    116,465
         Accrued payroll                                                       261,167         215,755
         Accrued legal and other expenses                                      438,647          61,050
         Current portion of capital lease obligation                            33,029              --
                                                                          ------------    ------------

                  Total current liabilities                                  1,242,415         393,270
                                                                          ------------    ------------

Capital lease obligation - net of current portion                               60,228              --
                                                                          ------------    ------------

                  Total liabilities                                          1,302,643         393,270
                                                                          ------------    ------------

Commitments (Note 5)

Stockholders' Equity:
         Convertible preferred stock - $.001 par value: 10,000,000
              shares authorized; zero shares issued and outstanding
              at December 31, 2005 and December 31, 2004                            --              --
         Common stock - $.001 par value: 100,000,000 shares authorized;
              42,545,161 and 39,646,846 shares issued and outstanding
              at December 31, 2005 and December 31, 2004, respectively          42,545          39,647
         Additional paid-in capital                                         34,091,751      30,435,917
         Deficit accumulated during the development stage                  (30,102,484)    (21,596,518)
                                                                          ------------    ------------
                  Total stockholders' equity                                 4,031,812       8,879,046
                                                                          ------------    ------------

                  Total liabilities and stockholders' equity              $  5,334,455    $  9,272,316
                                                                          ============    ============



                            See notes to consolidated financial statements.


                                                  F-3



<PAGE>



                                       MICROISLET, INC.
                                (A Development Stage Company)
                            Consolidated Statements of Operations


                                                                              August 21, 1998
                                                          Year Ended        (Date of Inception)
                                                         December 31,               to
                                                ----------------------------    December 31,
                                                    2005            2004            2005
                                                ------------    ------------    ------------



Grant revenue                                   $    152,971    $         --    $    562,761

Expenses:
     Research and development expenses             5,637,478       2,913,213      15,913,705
     General and administrative expenses           3,154,184       3,711,392      14,866,471
                                                ------------    ------------    ------------
          Operating expenses                      (8,791,662)     (6,624,605)    (30,780,415)
                                                                ------------    ------------
          Loss from operations                    (8,638,691)     (6,624,605)    (30,217,415)
                                                ------------    ------------    ------------

Other income (expense):
     Interest income                                 149,244         110,666         313,793
     Interest expense                                 (4,603)           (194)       (177,498)
     Other                                           (11,916)         (4,327)        (21,364)
                                                ------------    ------------    ------------
              Total other income                     132,725         106,145         114,931
                                                ------------    ------------    ------------

              Net loss                          $ (8,505,966)   $ (6,518,460)   $(30,102,484)
                                                ============    ============    ============

Basic and diluted net loss per share            $       (.21)   $       (.17)   $      (1.25)
                                                ============    ============    ============

Weighted average number of shares outstanding
     used in calculation                          40,180,567      37,478,449      24,071,817



                       See notes to consolidated financial statements.

                                             F-4




<PAGE>


                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                           Consolidated Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2005

                                                                                        ADDITIONAL
                                     PREFERRED STOCK              COMMON STOCK            PAID-IN      ACCUMULATED
                                  SHARES        AMOUNT        SHARES        AMOUNT        CAPITAL        DEFICIT         TOTAL
                                -----------   -----------   -----------   -----------   -----------    -----------    -----------

Sale of common stock to
  founders, August 21, 1998              --            --    12,594,203   $    12,594   $   (12,110)            --    $       484

Stock issued pursuant to
  license agreement,
  September 15, 1998                     --            --       344,586           345          (323)            --             22
                                -----------   -----------   -----------   -----------   -----------    -----------    -----------

Balance, December 31, 1998               --            --    12,938,789   $    12,939   $   (12,433)            --    $       506
                                ===========   ===========   ===========   ===========   ===========    ===========    ===========

Sale of preferred stock, net:
  May 4, 1999                        82,888   $        83            --            --       186,417             --        186,500

Net loss                                 --            --            --            --            --    $   (72,775)       (72,775)
                                -----------   -----------   -----------   -----------   -----------    -----------    -----------

Balance, December 31, 1999           82,888   $        83    12,938,789   $    12,939   $   173,984    $   (72,775)   $   114,231
                                ===========   ===========   ===========   ===========   ===========    ===========    ===========

Sale of common stock, net:
  January 20, 2000                       --            --     1,706,679         1,707       498,293             --        500,000
  January 24, 2000                       --            --       500,080           500          (468)            --             32

Payments received in
  advance of January 1, 2001
  stock issuance                         --            --            --            --       500,000             --        500,000

Compensation expense
  related to options issued
  in exchange for services               --            --            --            --       211,022             --        211,022

Net loss                                 --            --            --            --            --       (965,235)      (965,235)
                                -----------   -----------   -----------   -----------   -----------    -----------    -----------

Balance, December 31, 2000           82,888   $        83    15,145,548   $    15,146   $ 1,382,831    $(1,038,010)   $   360,050


                                                                                                                        (Continued)

                                           See notes to consolidated financial statements.


                                                                F-5



<PAGE>



                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                           Consolidated Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2005

                                                                                      ADDITIONAL
                                  PREFERRED STOCK             COMMON STOCK              PAID-IN       ACCUMULATED
                                SHARES       AMOUNT       SHARES         AMOUNT         CAPITAL         DEFICIT           TOTAL
                              -----------  ---------   ------------   ------------    ------------    ------------    ------------
Balance, December 31, 2000         82,888  $      83     15,145,548   $     15,146    $  1,382,831    $ (1,038,010)   $    360,050
                              ===========  =========   ============   ============    ============    ============    ============

Sale of common stock, net:
  January 1, 2001                      --         --       1,706,679          1,707        498,293              --         500,000
  July 2, 2001                         --         --          52,094             52         99,948              --         100,000
  November 2, 2001                     --         --         166,668            166        887,334              --         887,500

Stock issued pursuant to
  license agreement,
  October 16, 2001                     --         --         344,586            345      2,067,173              --       2,067,518

Compensation expense
  related to options issued
  in exchange for services             --         --              --             --      1,340,746              --       1,340,746

Net loss                               --         --              --             --             --      (4,894,096)     (4,894,096)
                              -----------  ---------   ------------   ------------    ------------    ------------    ------------

Balance, December 31, 2001         82,888  $      83     17,415,575   $     17,416    $  6,276,325    $ (5,932,106)   $    361,718
                              ===========  =========   ============   ============    ============    ============    ============

Sale of common stock, net:
  April 24, 2002                       --         --        504,620            505       2,430,351              --       2,430,856
  May 13, 2002                         --         --         10,000             10          53,990              --          54,000
  May 15, 2002                         --         --          8,333              8          44,992              --          45,000
  August 31, 2002                      --         --         16,334             17          88,185              --          88,202

33,334 shares of common
  stock due pursuant to
  investment banking
  agreement                            --         --              --             --       (200,000)             --        (200,000)

Conversion of preferred
  stock to common stock           (82,888)       (83)      1,295,332          1,295         (1,212)             --              --

Issuance of shares in merger
  with ALD Services, Inc.              --         --       3,408,398          3,408         (3,408)             --              --

Reverse merger warrant
  expense                              --         --              --             --      3,477,723              --       3,477,723

Compensation expense
  related to options issued
  in exchange for services             --         --              --             --        331,473              --         331,473

Net loss                               --         --              --             --             --      (6,106,135)     (6,106,135)
                              -----------  ---------   ------------   ------------    ------------    ------------    ------------

Balance, December 31, 2002             --  $      --     22,658,592   $     22,659    $ 12,498,419    $(12,038,241)   $    482,837


                                                                                                                         (Continued)

                                           See notes to consolidated financial statements.


                                                                F-6




<PAGE>


                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                           Consolidated Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2005

                                                                                        ADDITIONAL
                                   PREFERRED STOCK               COMMON STOCK             PAID-IN      ACCUMULATED
                                SHARES         AMOUNT        SHARES         AMOUNT        CAPITAL        DEFICIT          TOTAL
                              ------------   ----------   ------------   ------------   ------------   ------------    ------------

Balance, December 31, 2002              --   $       --     22,658,592   $     22,659   $ 12,498,419   $(12,038,241)   $    482,837
                              ============   ==========   ============   ============   ============   ============    ============

Sale of common stock, net:
  June 26, 2003                         --           --        500,000            500        249,500             --         250,000
  September 4, 2003                     --           --      1,000,600          1,001        399,429             --         400,430
  October 31, 2003                      --           --      1,080,000          1,080        468,984             --         470,064

Common stock sold to
  related party,
  October 31, 2003                      --           --        300,000            300        149,700             --         150,000

Common stock sold under
  agreement with Fusion
  Capital, net                          --           --      1,017,505          1,018        533,645             --         534,663

  Common stock issued
  under Agreement with
  Fusion Capital as
  issuance cost                         --           --        501,468            501           (501)            --              --

Compensation expense
  related to options issued
  in exchange for services              --           --             --             --        253,717             --         253,717

Common stock issued in
  conversion of related
  party debt                            --           --      1,022,200          1,022        510,078             --         511,100

Stock issued on exercise of
  employee stock options                --           --         30,000             30         11,870             --          11,900

Warrants issued in relation
  to related party debt                 --           --             --             --        142,300             --         142,300

Common stock issued as
  commission                            --           --         33,334             33        199,967             --         200,000

Net loss                                --                          --             --             --     (3,039,817)     (3,039,817)
                              ------------   ----------   ------------   ------------   ------------   ------------    ------------

Balance, December 31, 2003              --   $       --     28,143,699   $     28,144   $ 15,417,108   $(15,078,058)   $    367,194
                              ============   ==========   ============   ============   ============   ============    ============


                                                                                                                         (Continued)

                                           See notes to consolidated financial statements.


                                                                F-7



<PAGE>


                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                           Consolidated Statements of Stockholders' Equity
                               For the period August 21, 1998 (Date of Inception) to December 31, 2005

                                                                                        ADDITIONAL
                                    PREFERRED STOCK              COMMON STOCK             PAID-IN      ACCUMULATED
                                 SHARES         AMOUNT       SHARES         AMOUNT        CAPITAL        DEFICIT           TOTAL
                               ------------   ---------   ------------   ------------   ------------   ------------    ------------

Balance, December 31, 2003               --   $      --     28,143,699   $     28,144   $ 15,417,108   $(15,078,058)   $    367,194
                               ============   =========   ============   ============   ============   ============    ============

Sale of common stock, net:
  March 16, 2004                         --          --      9,923,449          9,923     11,748,783             --      11,758,706

Common stock sold under
  agreement with Fusion
  Capital                                --          --        415,094            415        499,587             --         500,002

Stock issued on exercise of
  employee stock options                 --          --        498,661            499        205,022             --         205,521

Stock issued on exercise
  of warrants                            --          --        665,943            666        541,736             --         542,402

Compensation expense
  related to options issued
  in exchange for services               --          --             --             --        354,478             --         354,478

Compensation expense
  related to warrants issued
  in exchange for services               --          --             --             --      1,669,203             --       1,669,203


Net loss                                 --          --             --             --             --     (6,518,460)     (6,518,460)
                               ------------   ---------   ------------   ------------   ------------   ------------    ------------

Balance, December 31, 2004               --   $      --     39,646,846   $     39,647   $ 30,435,917   $(21,596,518)   $  8,879,046
                               ============   =========   ============   ============   ============   ============    ============



                                                                                                                         (Continued)



                                           See notes to consolidated financial statements.

                                                                F-8




<PAGE>


                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                           Consolidated Statements of Stockholders' Equity
                               For the period August 21, 1998 (Date of Inception) to December 31, 2005

                                                                                       ADDITIONAL
                                   PREFERRED STOCK              COMMON STOCK             PAID-IN      ACCUMULATED
                                SHARES        AMOUNT        SHARES         AMOUNT        CAPITAL        DEFICIT          TOTAL
                              ------------   ---------   ------------   ------------   ------------   ------------    ------------

Balance, December 31, 2004              --   $      --     39,646,846   $     39,647   $ 30,435,917   $(21,596,518)   $  8,879,046
                              ============   =========   ============   ============   ============   ============    ============

Sale of common stock, net:
  December 23, 2005                     --          --      2,285,000          2,285      2,971,333             --       2,973,618

Common stock sold under
  agreement with Fusion
  Capital                               --          --         37,066             37         39,963             --          40,000

Stock issued on exercise o
  employee stock options                --          --            100             --             55             --              55

Stock issued on exercise
  of warrants                           --          --        576,149            576        533,495             --         534,071

Compensation expense
  related to options issued
  in exchange for services              --          --             --             --        110,988             --         110,988

Net loss                                --          --             --             --             --     (8,505,966)     (8,505,966)
                              ------------   ---------   ------------   ------------   ------------   ------------    ------------

Balance, December 31, 2005              --   $      --     42,545,161   $     42,545   $ 34,091,751   $(30,102,484)   $  4,031,812
                              ============   =========   ============   ============   ============   ============    ============


                                                                                                                         (Concluded)




                                           See notes to consolidated financial statements.


                                                                F-9



<PAGE>


                                               MICROISLET, INC.
                                         (A Development Stage Company)
                                     Consolidated Statements of Cash Flows

                                                                                                August 21, 1998
                                                                                             (Date of Inception)
                                                                 Year Ended       Year Ended          to
                                                                 December 31,    December 31,    December 31,
                                                                     2005           2004             2005
                                                                 ------------    ------------    ------------


Cash flows from operating activities:
     Net loss                                                    $ (8,505,966)   $ (6,518,460)   $(30,102,484)
     Adjustments to reconcile net loss to net cash
        used in operating activities:
          Warrant compensation expense                                     --       1,669,203       5,146,926
          Interest paid with warrant                                       --              --         142,300
          In process research and development
             acquired for common stock                                     --              --       2,067,518
          Compensation paid with stock options                        110,988         354,478       2,602,423
          Depreciation and amortization                                93,320          50,731         250,961
          Loss on disposal of equipment                                    --              --          18,233
Changes in operating assets and liabilities:
     Deposits and other assets                                          2,392          (7,392)        (67,680)
     Grant receivable                                                (102,971)             --        (102,971)
     Other receivables                                               (133,811)         16,242        (133,811)
     Prepaid expenses                                                  69,283        (157,435)       (154,001)
     Accounts payable and accrued expenses                            816,116         211,812       1,439,347
     Research expenses due to stockholder                                  --        (230,000)             --
                                                                 ------------    ------------    ------------

               Net cash used in operating activities               (7,650,649)     (4,610,821)    (18,893,239)
                                                                 ------------    ------------    ------------

Cash flows from investing activities:
     Proceeds from sale of property and equipment                          --              --           1,000
     Proceeds from property and equipment                            (142,876)       (148,323)       (551,346)
                                                                 ------------    ------------    ------------

               Net cash used in investing activities                 (142,876)       (148,323)       (550,346)
                                                                 ------------    ------------    ------------

Cash flows from financing activities:
     Payments made on capital lease obligation                        (12,737)             --         (12,737)
     Loan from related parties                                             --              --         525,000
     Repayment of loan from related parties                                --              --         (25,000)
     Proceeds from sale of common stock, net of offering costs      3,013,618      13,006,631      21,787,967
     Proceeds from exercise of stock options and warrants             534,126              --       1,500,701
     Proceeds from sale of preferred stock                                 --              --         186,500
                                                                 ------------    ------------    ------------

               Net cash provided by financing activities            3,535,007      13,006,631      23,962,431
                                                                 ------------    ------------    ------------

               Net (decrease) increase in cash and
                 cash equivalents                                  (4,258,518)      8,247,487       4,518,846

Cash and cash equivalents at beginning of period                    8,777,364         529,877              --
                                                                 ------------    ------------    ------------

Cash and cash equivalents at end of period                       $  4,518,846    $  8,777,364    $  4,518,846
                                                                 ============    ============    ============


                                                                                                   (Continued)


                                See notes to consolidated financial statements.

                                                     F-10




<PAGE>


                                              MICROISLET, INC.
                                       (A Development Stage Company)
                                   Consolidated Statements of Cash Flows

                                                                                            August 21, 1998
                                                                                          (Date of Inception)
                                                                Year Ended     Year Ended        to
                                                                December 31,   December 31,   December 31,
                                                                    2005          2004           2005
                                                                ------------   ------------   ------------


Supplemental disclosures of cash flow information:
Interest paid                                                   $      4,604   $        194   $     12,906
Income taxes paid                                               $      1,600   $      1,575   $      2,730


Supplemental disclosures of non-cash activities:
     Conversion of loan from related parties to common stock    $         --   $         --   $    510,078

In-process research and development
          acquired for common stock                             $         --   $         --   $  2,067,518
     Common stock issued as commission
          for offering of common stock                          $         --   $    116,000   $    315,967
     Warrants issued in debt transaction                        $         --   $         --   $    142,300
     Compensation paid with warrant related to reverse merger   $         --   $         --   $  3,477,723
     Compensation expense related to options issued             $    110,988   $    354,478   $  2,602,423
     Compensation expense related to warrants issued            $         --   $  1,669,203   $  5,146,926
     Common stock issued to founders                            $         --   $         --   $    (12,110)
     Shares issued pursuant to investment banking agreement     $         --   $         --   $   (200,000)
     Common stock issued related to reverse merger              $         --   $         --   $ 20,450,388
     Assets acquired under capital lease                        $    105,994   $         --   $    105,994




                              See notes to consolidated financial statements.

                                                   F-11
</TABLE>




<PAGE>


MICROISLET, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  DESCRIPTION OF BUSINESS AND GOING CONCERN

Description of Business
-----------------------

MicroIslet, Inc. ("MicroIslet" or the "Company") is engaged in the research,
development, and commercialization of patented technologies in the field of
transplantation therapy for patients with insulin-dependent diabetes. The
Company has not commenced planned principal operations and is considered to be
in the development stage. The Company intends to continue its research and
development efforts and, ultimately, to begin market introduction of its
products.

Prior to May 28, 2002, the Company was known as ALD Services, Inc. ("ALD"). The
merger of MicroIslet of Delaware, a Delaware corporation ("MicroIslet of
Delaware"), with a wholly-owned subsidiary of ALD was completed on April 24,
2002 (the "Merger"). The Merger was accounted for as a reverse acquisition
because former stockholders of MicroIslet of Delaware owned a majority of the
outstanding stock of ALD immediately subsequent to the Merger. Because the
Merger was treated as a reverse acquisition, the financial information from
inception includes the financial results of MicroIslet of Delaware from its
inception on August 21, 1998 ("Inception") to December 31, 2005, and the
financial results of the Company (which functions as a holding company after the
Merger) for the post-merger period from April 24, 2002 through December 31,
2005.

In October 2005, the Company was awarded a three year $1.7 million Phase II
Small Business Innovation Research ("SBIR") grant by the National Institutes of
Health ("NIH"), $153,000 of which had been awarded as of December 31, 2005. The
grant will be used to further develop the Company's islet cell transplantation
technology for treatment of insulin-dependent diabetes. Grant payments are
generally to be received shortly before or after the related qualifying
expenditures are incurred.

Going Concern
-------------

The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company has incurred net
losses of $8.5 million and $6.5 million and negative operating cash flows of
$7.7 million and $4.6 million for 2005 and 2004, respectively, and had an
accumulated deficit of $30.1 million as of December 31, 2005. As of that date,
the Company's cash position was $4.5 million. Management has projected that cash
on hand will only be sufficient to allow the Company to continue its operations
through the first half of 2006.

The Company's future cash requirements will depend on many factors, including
continued scientific progress in its research and development programs, the
scope and results of pre-clinical and clinical trials, the time and costs
involved in obtaining regulatory approvals, the costs involved in filing,
prosecuting and enforcing patents, competing technological and market
developments and the cost of product commercialization. The Company does not
expect to generate a positive cash flow from operations at least until the
commercial launch of its first product and possibly later given the expected
spending for research and development programs and the cost of commercializing
product candidates. Accordingly, the Company will require external financing to
sustain its operations, perhaps for a significant period of time. Management's
plans include raising additional debt and/or equity financing to sustain its
operations. In addition, the Company will continue to seek funding in the form
of grants for its scientific research.

The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
---------------------

The accompanying consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States of America.

The Company is an enterprise in the development stage as defined by Statement
No. 7 of the Financial Accounting Standards Board ("FASB"), since it has derived
only minimal revenues from its activities to date.

                                      F-12



<PAGE>

Use of Estimates
----------------

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

Cash and Cash Equivalents
-------------------------

The Company considers all highly liquid investments with an original maturity
date of three months or less from the date of purchase to be cash equivalents.

Concentration of Credit Risk
----------------------------

The Company has cash in a financial institution which is insured by the Federal
Deposit Insurance Corporation ("FDIC") up to $100,000. At December 31, 2005 and
2004, the Company had cash in excess of FDIC insured limits.

Property and Equipment
----------------------

Property and equipment is stated at cost. Depreciation is computed on the
straight-line method over the estimated useful asset lives, which range from
three to five years. Leased assets meeting certain capital lease criteria are
capitalized and the present value of the related lease payments is recorded as a
liability. Assets under capital lease arrangements are depreciated using the
straight-line method over their estimated useful lives or their related lease
term, whichever is shorter. Repairs and maintenance expenses are charged to
expense as incurred.

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

All long-lived assets are reviewed for potential impairment in value whenever
events or changes in circumstances indicate a carrying value of an asset may not
be recoverable under Statement of Financial Accounting Standards ("SFAS") No.
144, "Accounting for Impairment or Disposal of Long-lived Assets." Impairment is
determined by comparing future projected undiscounted cash flows to be generated
by the asset to its carrying value. If impairment is identified, a loss would be
recognized and reflected in current earnings, to the extent the carrying amount
of an asset exceeds its estimated fair value determined by the use of
appraisals, discounted cash flow analyses or comparable fair values of similar
assets.

Intangible Assets
-----------------

The Company accounts for intangible assets in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets". In accordance with SFAS No. 142, goodwill and other intangible assets
that have indefinite useful lives are not amortized; however, these assets are
reviewed at least annually for impairment. Intangible assets with finite lives
are to be amortized using a straight line method over the useful life of 17
years.

The Company carries no goodwill on its books for the years ended December 31,
2005 and 2004. Further, during fiscal years 2005 and 2004, the Company had no
material impairments of intangible assets, which consist of primarily patents.

Fair Value of Financial Instruments
-----------------------------------

At December 31, 2005 and 2004, the Company's financial instruments included cash
and cash equivalents, receivables, accounts payable, accrued expenses and
accrued compensation and payroll taxes. The carrying amount of cash and cash
equivalents, receivables, accounts payable, accrued expenses and accrued
compensation and payroll taxes approximates fair value due to the short-term
maturities of these instruments.

Grant Revenue
-------------

The Company recognizes grant revenue as qualifying research expenses per the
grant agreement are incurred.

                                      F-13



<PAGE>

Research and Development
------------------------

Research and development expenses consist of expenses incurred in performing
research and development activities including salaries and benefits, facilities
and other overhead expenses, contract services and other outside expenses.
Research and development costs are charged to operations when incurred.

Stock-based Compensation
------------------------

In December 2004, the FASB revised SFAS No. 123 ("SFAS No. 123(R)"),
"Share-Based Payment." SFAS No. 123(R) will require the Company to measure the
cost of all employee stock-based compensation awards based on the grant date
fair value of those awards and to record that cost as compensation expense over
the period during which the employee is required to perform service in exchange
for the award (generally over the vesting period of the award). Excess tax
benefits, as defined by SFAS No. 123(R), will be recognized as an addition to
common stock. On April 14, 2005, the U.S. Securities and Exchange Commission
("SEC") adopted a new rule amending the compliance dates for SFAS No. 123(R). In
accordance with the new rule, the accounting provisions of SFAS No. 123(R) will
be effective for the Company in the fiscal year starting January 1, 2006. The
SEC also issued Staff Accounting Bulletin No. 107 ("SAB No. 107"), which
provides interpretive guidance to assist issuers in their initial implementation
of SFAS No. 123(R).

The Company has not yet completed the process of determining how the guidance
regarding valuing share-based compensation as prescribed in SFAS No. 123(R) will
be applied to valuing share-based awards granted after the effective date and
the impact that the recognition of compensation expense related to such awards
will have on the Company's financial condition and results of operations.

Prior to the SFAS No. 123(R) effective date of January 1, 2006, the Company has
accounted for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board ("APB") Opinion No. 25 and related
interpretations for all periods presented. Accordingly, compensation costs for
stock options granted to employees and directors are measured as the excess, if
any, of the fair value of the Company's common stock at the date of the grant
over the amount the employee or director must pay to acquire the stock. The
Company applies the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation." Had the compensation cost for the Company's stock
option plans been determined based on the fair value at the grant dates for
awards under the plans consistent with the method of SFAS No. 123, the Company's
net loss and earnings per share on a pro forma basis would have been as follows:

<TABLE>
<S>       <C>
                                                                                     August 21, 1998
                                                                                   (Date of Inception) to
                                                                                        December 31
                                                            2005            2004            2005
                                                        ------------    ------------    ------------
Net loss attributable to common shareholders,
     as reported                                        $ (8,505,966)   $ (6,518,460)   $(30,102,484)

Add: Stock based employee compensation
     included in reported net loss attributable to
        common shareholders                                       --           7,700         733,589

Deduct: Stock-based employee compensation expense
   determined under the fair value
   method for all awards                                    (378,609)       (642,739)     (3,887,122)
                                                        ------------    ------------    ------------


Proforma net loss attributable to common shareholders   $ (8,884,575)   $ (7,153,499)   $(33,256,017)
                                                        ============    ============    ============

Net loss per share:
     Basic and diluted - as reported                    $       (.21)   $       (.17)   $      (1.25)
                                                        ============    ============    ============

     Basic and diluted - proforma                       $       (.22)   $       (.19)   $      (1.38)
                                                        ============    ============    ============
</TABLE>

                                      F-14



<PAGE>

The fair value of these options was estimated at the dates of grant using the
Black-Scholes option valuation model with the following weighted-average
assumptions:

                                                          YEAR ENDED
                                              ----------------------------------
                                              DEC. 31, 2005       DEC. 31, 2004
                                              -------------       -------------

Risk free interest rate                                  3%                  3%
Dividend yield                                         None                None
Volatility                                              77%                120%
Weighted average expected life                      5 years             5 years

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. The
Company's employee stock options have characteristics significantly different
from those of traded options, and changes in the subjective input assumptions
can materially affect the fair value estimate. In management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of the Company's employee stock options.

Deferred charges for options granted to non-employees (excluding directors) are
determined in accordance with SFAS No. 123 ("SFAS No. 123") "Share Based
Payment" and Emerging Issues Task Force ("EITF") No. 96-18, "Accounting for
Equity Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods and Services", as the fair value of the
consideration or the fair value of the equity instruments issued, whichever is
more reliably measured. Options granted to non-employees are periodically
remeasured as the underlying options vest or as services are performed, and the
related compensation expense is recorded over the vesting term or until
counterparty performance is complete, as applicable.

Income Taxes
------------

The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." In accordance with SFAS No. 109, the Company
records a valuation allowance against net deferred tax assets if, based upon the
available evidence, it is more likely than not that some or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax assets
is dependent upon the generation of future taxable income and when temporary
differences become deductible. The Company considers, among other available
information, uncertainties surrounding the recoverability of deferred tax
assets, scheduled reversals of deferred tax liabilities, projected future
taxable income, and other matters in making this assessment.

Segment Reporting
-----------------

The Company currently operates in a single operating segment. In addition,
financial results are prepared and reviewed by management as a single operating
segment. The Company continually evaluates its operating activities and the
method utilized by management to evaluate such activities and will report on a
segment basis if and when appropriate to do so.

New Accounting Pronouncements
-----------------------------

In December 2004, the FASB revised SFAS No. 123 ("SFAS No. 123(R)"),
"Share-Based Payment." As a result, the Company will be required, beginning in
the quarter ending March 31, 2006, to apply the fair value method as prescribed
in SFAS No. 123(R). Although the adoption of SFAS No. 123(R) could have a
material impact on the Company's financial position and results of operations,
the potential impact from adopting this statement has not been determined.

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets", which eliminates the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. SFAS No. 153 will be
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. Adoption of SFAS No. 153 did not significantly affect the
Company's financial condition or results of operations.

In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN No. 47"),
"Accounting for Conditional Asset Retirement Obligations." FIN No. 47 clarifies
that an entity must record a liability for a "conditional" asset retirement
obligation if the fair value of the obligation can be reasonably estimated. The
provision is effective no later than the end of fiscal years ending after
December 15, 2005. There is no current financial impact to the Company as a
result of FIN No. 47.

                                      F-15



<PAGE>

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." SFAS No. 154 establishes retrospective application as the required
method for reporting a change in accounting principle in the absence of explicit
transition requirements specific to the newly adopted accounting principle. SFAS
No. 154 also provides guidance for determining whether retrospective application
of a change in accounting principle is impracticable and for reporting a change
when retrospective application is impracticable. SFAS No. 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company does not expect the adoption of SFAS No.
154 to significantly affect the Company's financial condition or results of
operations.

In June 2005, the FASB ratified the consensus reached by the Task Force in EITF
No. 05-6. The Task Force reached a consensus that leasehold improvements that
are placed in service significantly after and not contemplated at or near the
beginning of the lease term should be amortized over the shorter of the useful
life of the assets or a term that includes required lease periods and renewals
that are deemed to be reasonably assured at the date of the leasehold
improvements are purchased. In addition, leasehold improvements acquired in a
business combination should be amortized over the shorter of the useful lives of
the assets or a term that includes required lease periods and renewals that are
deemed to be reasonably assured at the date of acquisition. EITF No. 05-6 is
effective for leasehold improvements (within the scope of this issue) that are
purchased or acquired in the reporting period beginning after June 29, 2005.
Adoption of EITF No. 05-6 did not affect the Company's financial condition or
results of operations.

NOTE 3. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

                                                          2005           2004
                                                        ---------     ---------
PROPERTY AND EQUIPMENT, NET:
Laboratory equipment                                    $ 446,745     $ 225,271
Computer equipment                                         70,298        65,231
Furniture and fixtures                                     62,685        40,356
Leasehold improvements                                     14,488        14,488
                                                        ---------     ---------
                                                        $ 594,216     $ 345,346

Less accumulated depreciation and amortization           (235,174)     (142,328)
                                                        ---------     ---------

                                                        $ 359,042     $ 203,018
                                                        =========     =========

Depreciation expense associated with property and equipment was $92,846 and
$50,257 for the years ended December 31, 2005 and 2004, respectively, and
$247,643 from Inception through December 31, 2005. At December 31, 2005 and
2004, assets acquired under capital leases totaled $105,994 and zero with
accumulated depreciation of $8,883 and zero, respectively. Depreciation of
assets acquired under the capital lease was $8,883 and zero for the years ended
December 31, 2005 and 2004, respectively.

PATENTS, NET:
Patents                                                 $  13,892     $  13,892
Less accumulated amortization                              (3,318)       (2,844)
                                                        ---------     ---------

                                                        $  10,574     $  11,048
                                                        =========     =========

Amortization expense related to amortizable intangible assets was $474 for
fiscal years 2005 and 2004 and $3,318 from Inception through December 31, 2005.
Based solely on the amortizable intangible assets as of December 31, 2005, the
estimated annual amortization expense of intangible assets for each of the next
five years is $474 and $8,204 thereafter. Actual amortization expense to be
reported in future periods could differ from these estimates as a result of
acquisitions, divestitures, asset impairments or abandonments, and other
relevant factors.

Accounts payable at December 31, 2005 include $90,000 severance due the former
Chief Financial Officer. Accrued liabilities at December 31, 2005 consist of
$438,647 related to the legal settlement accrual.

                                      F-16



<PAGE>

NOTE 4. LICENSE AND COLLABORATION AGREEMENTS

In September 1998, the Company entered into a license agreement with Duke
University ("Duke"). Under the terms of the agreement, the Company has the right
to develop and commercialize technology related to therapies for diabetes
developed and patented by Duke. The Company issued 344,586 shares of its common
stock to Duke upon the execution of the license agreement. The Company issued an
additional 344,586 shares to Duke upon issuance of the first patent involving
the technology, which occurred in October 2001. The Company is obligated to
issue an additional 344,586 shares to Duke upon approval of a licensed product.
The cost of the license rights is based on the fair value of the Company's stock
when earned by Duke and has been expensed as acquired in-process research and
development because the technology is in the early development stage and has no
foreseeable alternative future uses. The Company is obligated to pay Duke a
royalty of 5% of all proceeds generated by any future commercial products
derived from the licensed technology. The Company has also reimbursed Duke for
research costs related to developing the technology for commercial use. The
Company sponsored Duke's research in the amount of approximately $450,000 from
August 21, 1998 (inception) to December 31, 2001. The Company did not sponsor
any research during 2005, 2004, 2003 or 2002.

In November 2002 the Company began a two year collaboration with the University
of Alberta, Edmonton (Canada). This facility is assisting the Company with
transplantation surgery and subsequent monitoring in animal models. In November
2004 the terms of this arrangement were extended an additional two years. Under
the terms of the arrangement, the Company paid this facility approximately
$53,754 and $15,000 during the years ended December 31, 2005 and 2004,
respectively, and has agreed to pay this facility a maximum of $100,000 per year
based on services requested and provided as agreed upon from time to time.

The Company has also entered into two broad collaboration agreements in the area
of islet cell transplantation therapies for treatment of insulin-dependent
diabetes with The Scripps Research Institute ("TSRI"). Under the terms of these
agreements, the Company and TSRI are conducting preclinical studies utilizing
the Company's proprietary technologies. The first agreement entered into in
August 2004 calls for the Company to fund TSRI in the amount of approximately
$450,000 over a three year period. The second agreement entered into in July
2005 calls for the Company to fund approximately $610,000 over a two year
period. The Company paid TSRI approximately $367,160 and $434,000 during the
years ended December 31, 2005 and 2004, respectively.

In May 2004, the Company has also entered into a collaboration agreement with
the California National Primate Research Center at the University of California,
Davis, in the area of islet cell transplantation therapies for treatment of
insulin-dependent diabetes. In exchange for research services received, the
agreement calls for the Company to fund research in the amount of approximately
$1.3 million over a three year period ending May 2007. The Company paid to the
University of California, Davis, approximately $115,000 and $120,000 during the
years ended December 31, 2005 and 2004, respectively.


NOTE 5. COMMITMENTS

OPERATING LEASE COMMITMENTS. The Company has office and laboratory facilities
under non-cancelable operating leases. The Company leases approximately 12,000
square feet of office and laboratory space in San Diego, California at a current
rental rate of approximately $17,000 per month. The lease has scheduled rent
increases each year and expires on February 28, 2008.

Rent expense was $268,742 and $264,758 for the years ended December 31, 2005 and
2004, respectively, and $971,397 from August 21, 1998 (inception) to December
31, 2005. Future minimum rental payments under all non-cancelable operating
lease commitments as of December 31, 2005 are as follows:

         YEAR ENDING DECEMBER 31:

                  2006                                            $     250,353
                  2007                                                  256,143
                  2008                                                   43,064
                                                                  -------------

                  Total                                           $     549,560
                                                                  =============

                                      F-17



<PAGE>

CAPITAL LEASE COMMITMENTS. In August 2005, the Company acquired an equipment
system under a three-year capital lease obligation. This capital lease provides
the Company with the option at the expiration of the lease term to purchase the
system for a price of one dollar ($1.00). Future minimum payments under the
capital lease as of December 31, 2005 are as follows:

         YEAR ENDING DECEMBER 31:

                  2006                                            $      41,592
                  2007                                                   41,592
                  2008                                                   24,266
                                                                  -------------

                  Total                                                 107,450
                   Less amount representing interest                    (14,193)
                                                                  -------------
                   Present value of net lease payments                   93,257
                   Less current portion                                 (33,029)
                                                                  -------------
                   Long-term portion of obligation                $      60,228
                                                                  =============


NOTE 6. SIGNIFICANT CONTRACTS AND GRANTS

Mayo Long-term Supply Agreement
-------------------------------

In November 2005, the Company entered into a long-term strategic supply
agreement with the Mayo Foundation for Medical Education and Research ("Mayo")
under which Mayo will supply designated pathogen free pigs to the Company for
use in development of MicroIslet-P(TM). This agreement was the contemplated
long-term replacement of the Company's short-term supply agreement. Under the
terms of the new agreement, Mayo will supply MicroIslet substantially all of its
non-transgenic porcine islet production for a period of three to seven years.

Under the contract, regardless of the number of pigs ordered, the Company shall
pay Mayo a monthly fee of approximately $100,000 per month. Mayo can increase
the monthly fee at specific times throughout the contract limited by a CPI
calculation. The contract also limits the Company to the maximum purchase 20
pigs per month.

In addition to the monthly fee, the Company agreed to provide warrants to
purchase its common stock based on milestones in development such as
Investigational New Drug ("IND") date, Phase II clinical trials date, Phase III
clinical trials date, and New Drug Application ("NDA") date. Each milestone
earns Mayo a warrant to purchase 75,000 shares of the Company's common stock at
an exercise price of $1.90 per share. Each warrant has the expiration term of 10
years from the milestone date. These warrants have been accounted for in
accordance with EITF 96-18 "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Service". At December 31, 2005, the liability was determined to be contingent,
the lowest aggregate fair value of the warrants was determined to be zero, and
no expense was recorded. In each future period the Company will evaluate these
warrants and record an expense as necessary.

Government Grant Research
-------------------------

In October 2005, the Company was awarded a $1.7 million Phase II Small Business
Innovation Research ("SBIR") grant by the National Institute of Health ("NIH").
The balance remaining under the research grant as of December 31, 2005 was $1.5
million. The grant is being used to further development of the Company's islet
cell transplantation technology for the treatment of insulin-dependent diabetes.
The Phase II SBIR grant was awarded following peer review by the NIH of results
from the completion of Phase I grant for the same project.

                                      F-18



<PAGE>

NOTE 7. MERGER OF MICROISLET OF DELAWARE AND A WHOLLY OWNED SUBSIDIARY OF ALD
        AND SALE OF SECURITIES

On April 24, 2002, the Company consummated an integrated series of transactions
which resulted in the effective exchange of 3,913,018 shares of common stock for
net proceeds of $2.4 million. As a result, MicroIslet of Delaware became a
wholly owned subsidiary of ALD, which was previously a "public shell entity,"
through a reverse triangular merger among MicroIslet of Delaware, ALD and a
newly formed, wholly owned subsidiary of ALD (the "Merger"). For accounting
purposes, the Company was deemed to have issued 3,408,398 shares of common stock
(the "Merger Shares") in exchange for all of the outstanding equity securities
of ALD. ALD had no assets or liabilities at the time of the Merger.
Contemporaneous with the Merger, MicroIslet of Delaware closed a private
placement (the "Private Offering") in which it sold 504,620 shares of common
stock in exchange for approximately $2.4 million of net cash proceeds. The sale
of these common shares was subject to the terms of an Investment Banking
Agreement and a Private Placement Memorandum. The terms of the agreements
included specified minimum gross offering proceeds of $3 million, and a
requirement that MicroIslet of Delaware complete the aforementioned transaction
with a "public shell entity."

Two individuals who were affiliates of ALD were also then affiliates of ASA
Investment Company ("ASA"), which served as the placement agent for the Private
Offering. One of these individuals was ALD's former president and sole director
("ALD's President"), and the other individual was the beneficial owner of 76.9%
of the ALD's outstanding common stock prior to the Merger ("ALD's majority
stockholder"). Certain trusts affiliated with ALD's majority stockholder
subscribed for 175,000 MicroIslet of Delaware shares ($1,050,000 gross proceeds)
in the Private Offering. 52,500 of such shares ($315,000 gross proceeds) were
purchased by one of these trusts as a nominee for a company associated with
ALD's President and his brother, who was also then affiliated with ASA. ASA
received cash commissions equal to ten percent of the gross Private Offering
proceeds, and in connection with the Merger, received an investment banking fee
of $200,000 and 33,334 shares of common stock. Cash payments to ASA were
withheld from the gross offering proceeds distributed to the Company and have
been recorded as a direct reduction to the proceeds received by the Company in
the Private Offering. The Company was advised in May 2002 that ALD's majority
stockholder, ALD's President and his brother were no longer affiliated with ASA.

The Company believes that the Private Offering and the issuance of the Merger
Shares is a single capital raising activity that netted proceeds of
approximately $2.4 million. Because of the integrated nature of the transactions
described above, no expense has been recorded for either the Merger Shares or
the Private Offering shares deemed issued by the Company.

The Merger resulted in a change in control of ALD. The sole director resigned
effective upon the close of business on April 24, 2002, and was replaced by a
Board of Directors appointed by MicroIslet of Delaware.

After the Merger, the Company sold an additional 34,667 shares of common stock
at a price of $6.00 per share in private placements which raised net proceeds of
approximately $187,000. These shares were issued and sold on substantially
similar terms and conditions as the Private Offering described above and were
recorded in May and August 2002 upon receipt of confirming documentation. ASA
earned a commission of $20,800 in connection with these subsequent sales.

The Company agreed to file a registration statement with the Securities and
Exchange Commission to register for resale all of the shares sold through ASA in
private placements. The registration statement was filed July 25, 2002, and was
declared effective on February 14, 2003.

NOTE 8. RELATED PARTIES / ISSUANCE OF WARRANTS

In March 2004, the Company sold to certain accredited investors 9,834,218 shares
of common stock at a purchase price of $1.30 per share. In connection with the
financing, the Company also issued to the investors five-year warrants to
purchase 4,917,120 shares at $1.00 per share. The Company paid placement fees to
various placement agents as well as other issuance related costs in the
aggregate amounts of $705,000 and $320,793, respectively, issued warrants to
various placement agents to purchase an aggregate of 738,038 common shares and
agreed to issue to a certain placement agent, who later became a director of the
Company, 89,231 shares. The placement agent warrants have an exercise price of
$1.30 per share and expire between two to five years from the date of issuance.
As of December 31, 2005, 565,385 of the warrants issued to investors, and
203,072 of the placement agent warrants have been exercised.

                                      F-19



<PAGE>

Following completion of this financing, the Company received a demand from a
purported investor claiming that the Company had breached an agreement to sell
$750,000 of securities to the purported investor. On April 1, 2004, the Company
settled this demand and a related claim by another investor through the issuance
of two warrants to purchase 150,000 shares each at an exercise price of $1.30
per share. The warrants were exercisable until July 30, 2004. These warrants are
deemed issued in settlement of demands for payment made by certain parties in
connection with the financing. The estimated fair value of the warrants amounted
to $500,203, and was accrued as general and administrative expense in the first
quarter of 2004. The warrants were recorded upon issuance in satisfaction of the
liability in the second quarter of 2004. The grant date of April 1, 2004 was
used as the measurement date in accordance with EITF No. 96-18 as this is when
the Board of Directors approved the warrant for issuance and the settlement
commitment was made. The value of the warrant was expensed fully on March 31,
2004 in accordance with SFAS No. 5 "Accounting for Contingencies" as the warrant
amount was a legal contingency and both probable and reasonably estimable prior
to the issuance. The value of the warrants has been determined using the
Black-Scholes pricing model with the following weighted-average assumptions:
risk-free interest rate of 3%; no dividend yield; volatility of 131%; and
expected life of 4 months. As of December 31, 2005, warrants for 150,000 shares
have been exercised and warrants for 150,000 shares have expired.

Also following completion of the private placement in March 2004, a placement
agent engaged by the Company claimed that it was entitled to payment of a cash
transaction fee and a warrant for services rendered in the private placement.
Effective September 28, 2004, the Company settled this claim through the
issuance of a warrant to purchase 60,000 shares at an exercise price of $1.30
per share. The warrant is exercisable until September 27, 2009. The warrant is
deemed issued in settlement of demands for payment made by certain parties in
connection with the financing. The estimated fair value of the warrant amounted
to $63,002, and was accrued as general and administrative expense in the second
quarter of 2004. The warrants were recorded upon issuance in satisfaction of the
liability in the third quarter of 2004. The grant date of September 28, 2004 was
used as the measurement date in accordance with EITF No. 96-18 as this is when
the Board of Directors approved the warrant for issuance and the settlement
commitment was made. The value of the warrant was estimated and expensed fully
on June 30, 2004 in accordance with SFAS No. 5 as the warrant amount was a legal
contingency and both probable and reasonably estimable prior to the issuance.
The value of the warrant has been determined using the Black-Scholes pricing
model with the following weighted-average assumptions: risk-free interest rate
of 3%; no dividend yield; volatility of 123%; and expected life of 5 years. As
of December 31, 2005, this warrant has not been exercised.

In January 2004, the Company issued a warrant to an investor relations
consulting firm in consideration for investor relations consulting services
provided. The warrant is exercisable for 200,000 shares of common stock at an
exercise price of $0.60 per share and expires on January 30, 2009. The estimated
fair value of the warrant amounted to $216,649, and has been recorded as general
and administrative expense from the grant date through the end of the service
period which ended on June 15, 2004, using the straight line amortization
method. The grant date of January 30, 2004 was used as the measurement date in
accordance with EITF No. 96-18 as this is when the Board of Directors approved
the fully vested warrant for issuance, which was a specific provision for grant
as defined in the agreement. The value of the warrant has been determined using
the Black-Scholes pricing model with the following weighted-average assumptions:
risk-free interest rate of 3%; no dividend yield; volatility of 128%; and
expected life of 5 years. As of December 31, 2005, 100,000 shares of such
warrant have been exercised.

In May 2004, the Company issued an additional warrant to this investor relations
consulting firm in consideration for investor relations consulting services
provided. The warrant is exercisable for 200,000 shares of common stock at an
exercise price of $0.60 per share and expires on May 25, 2009. The estimated
fair value of the warrant amounted to $438,292 and has been recorded as general
and administrative expense from the grant date through the end of the service
period which ended on December 15, 2004, using the straight line amortization
method. June 15, 2004 was used as the measurement date in accordance with EITF
No. 96-18 as this is when the Board of Directors approved the fully vested award
for issuance, which was a specific provision for grant as defined in the
agreement. The value of the warrant has been determined using the Black-Scholes
pricing model with the following weighted- average assumptions: risk-free
interest rate of 3%; no dividend yield; volatility of 128%; and expected life of
5 years. As of December 31, 2005, 166,666 shares of such warrant have been
exercised.

                                      F-20



<PAGE>

In May 2004, the Company issued an additional warrant to this investor relations
consulting firm in consideration for the firm's services in connection with, and
which was contingent upon completion of, the March 2004 private placement. The
warrant is exercisable for 200,000 shares of common stock at an exercise price
of $0.75 per share and expires on May 25, 2009. On May 25, 2004 the Shareholders
of the Company authorized the additional shares required for exercise of the
warrants, and therefore May 25, 2004 was used as the measurement date in
accordance with EITF No. 96-18 as this is when warrant terms were specified and
a commitment was made. The estimated fair value of the warrant as measured on
this date amounted to $532,041 and has been recorded as issuance costs in
accordance with Staff Accounting Bulletin ("SAB") Topic 5-A whereby costs which
are direct and incremental to an offering of equity are offset against the
proceeds of that offering. The value of the warrant has been determined using
the Black-Scholes pricing model with the following weighted-average assumptions:
risk-free interest rate of 3%; no dividend yield; volatility of 128%; and
expected life of 5 years. As of December 31, 2005, 80,000 shares of such warrant
have been exercised.

On August 9, 2004, the Company issued a fully vested warrant to another investor
relations consulting firm in consideration for investor relations consulting
services provided pursuant to a contractual commitment on April 30, 2004. This
warrant to purchase 165,000 shares at $1.65 per share is exercisable at any time
until April 30, 2009. The fair value of the warrant on April 30, 2004 has been
recorded as general and administrative expense in the second quarter of 2004.
The contract date of April 30, 2004 was used as the measurement date in
accordance with EITF No. 96-18 as this is the date the commitment was made to
grant the fully vested warrant. The value of the warrant has been determined
using the Black-Scholes pricing model with the following weighted-average
assumptions: risk-free interest rate of 3%; no dividend yield; volatility of
131%; and expected life of 5 years. As of December 31, 2005, this warrant has
not been exercised.

On April 12, 2004, the Company issued options to two consultants who provide
scientific or investor relations services. These options to purchase 180,000
shares at $2.95 per share vest over two years and expire ten years after the
date of grant. In accordance with EITF No. 96-18, the fair value of the option
will be re-measured at the end of each reporting period and recognized over the
vesting period of the option until the measurement date which has been defined
as the completion of performance. At December 31, 2005, the fair value of these
options is $81,996.

In December 2005, the Company sold to certain accredited investors 2,284,999
shares of common stock at a purchase price of $1.50 per share. In connection
with the financing, the Company also issued to the investors five-year warrants
to purchase 1,142,500 shares at $1.65 per share. The Company paid placement fees
to two placement agents equal to 8% of the gross proceeds, or $274,200, and
issued warrants to the placement agents to purchase an aggregate of 91,400
common shares. The warrants issued to the placement agents have exercise prices
of $1.65 and $1.88 per share and expire on December 29, 2010. As of December 31,
2005, no such warrants have been exercised. The fair value of the warrants,
$85,112, has not been recorded as an adjustment to the financial statements as
it would have been both an increase and decrease to additional paid in capital.

As discussed more fully in Note 13, the Company's wholly owned subsidiary,
MicroIslet of Delaware, and John F. Steel IV, the Company's former Chairman and
Chief Executive Officer, were named as defendants in a lawsuit brought in the
Superior Court of California, County of Orange, by Donald Gallego. The Company
was obligated under its articles of incorporation, and MicroIslet of Delaware
was obligated under its bylaws, to advance expenses to Mr. Steel for his defense
of this lawsuit. Through December 31, 2005, the Company recorded expenses of
$189,606 associated with the payment of legal fees incurred by Mr. Steel in
defense of this action.

                                      F-21



<PAGE>

The following table summarizes information with regard to outstanding warrants
issued in connection with equity and debt financings as of December 31, 2005:

<TABLE>
<S>            <C>
                                   NUMBER           EXERCISE                                      WEIGHTED AVERAGE EXERCISE
ISSUED IN CONNECTION WITH:      OUTSTANDING          PRICE              EXPIRATION DATE                     PRICE
----------------------------   ---------------    ------------- --- -------------------------    -----------------------------

Reverse Merger                   1,500,000        $6.00-$12.00           July 31, 2007                      $8.00

                                                                    October 31, 2006-August
2003 Financings                  1,185,680        $0.50-$1.49               26, 2013                        $0.97

2004 Private Placement
    Investors                    4,351,735           $1.00               March 16, 2009                     $1.00
                                                                        March 16, 2006-
    Placement Agents              534,966            $1.30               March 16, 2009                     $1.30

                                                                          January 30,
Consulting Services               478,334         $0.60-$1.65       2009-September 27, 2009                 $1.09

2005 Private Placement
    Investors                    1,142,500           $1.65             December 29, 2010                    $1.65
    Placement Agents               91,400            $1.65             December 29, 2010                    $1.65
                               ---------------

                    TOTAL        9,284,615
                               ---------------
</TABLE>


NOTE 9. STOCKHOLDERS' EQUITY

Fusion Capital
--------------

In April 2003, the Company entered into a common stock purchase agreement with
Fusion Capital Fund II, LLC ("Fusion Capital") under which Fusion Capital
agreed, subject to certain conditions, to purchase on each trading day during
the term of the agreement $20,000 of the Company's common stock up to an
aggregate of $12.0 million. The common stock purchase agreement was amended in
May 2004 to, among other things, revise the daily purchase amount and give the
Company the option to increase the aggregate amount that may be purchased under
the agreement to $24 million and extend the term of the agreement. Fusion
Capital was committed to purchase the initial $12 million of the Company's
common stock through October 2005, if not extended by the Company for six
additional months. The Company could decrease this amount or terminate the
agreement at any time. If the Company's stock price equaled or exceeded $1.25
per share for five consecutive trading days, the Company had the right to
increase the daily purchase amount above $20,000, provided that the sale price
of the Company's common stock remained at least $1.25 per share. The sale price
per share to Fusion Capital was equal to the lesser of: the lowest sale price of
the Company's common stock on the day of purchase by Fusion Capital, or the
average of the lowest three closing sale prices of the Company's common stock
during the ten trading days prior to the date of purchase by Fusion Capital.
Fusion Capital agreed that neither it nor any of its affiliates would engage in
any direct or indirect short-selling or hedging of the Company's common stock
during any time prior to the termination of the common stock purchase agreement.
The Company agreed not to enter into any variable priced equity financings
during the term of the common stock purchase agreement without Fusion Capital's
consent. As compensation for its commitment and for expenses incurred, the
Company paid Fusion Capital $10,000 during the quarter ended June 30, 2003, and
issued to Fusion Capital in April 2003, 501,468 shares of common stock. Fusion
Capital agreed not to sell 491,468 of such shares until the earlier of October
2005, or the termination or a default under the common stock purchase agreement.

The Company terminated this agreement with Fusion Capital in December 2005.
During the years ended December 31, 2005 and 2004, the Company sold 37,066 and
415,094 shares of common stock to Fusion Capital pursuant to the common stock
purchase agreement, for gross proceeds of $40,000 and $500,000 respectively.

Convertible Preferred Stock
---------------------------

On April 24, 2002, each of the 82,888 shares of preferred stock outstanding was
converted into 15.6275 shares of common stock in connection with the Merger.

                                      F-22



<PAGE>

Stock Options
-------------

During 2000, the Company adopted the 2000 Stock Option Plan (the "2000 Plan")
for employees, outside consultants and directors. The 2000 Plan became
unavailable for new grants in November 2005, and at such time, a total of
6,000,000 common shares were authorized under the plan. The 2000 Plan allows for
incentive options with exercise prices of at least 100% of the fair market value
of the Company's common stock and nonqualified options with exercise prices of
at least 85% of the fair market value of the Company's common stock. All options
have a ten-year life and generally vest over a three-year period.

The Company's Board of Directors adopted the 2005 Equity Incentive Plan (the
"2005 Plan") in June 2005 and it became effective upon shareholder approval in
November 2005. A total of 2,000,000 new shares of the Company's common stock
have initially been reserved for issuance under the 2005 Plan. In addition, the
2005 Plan includes in its reserve shares of common stock available for issuance
under the 2000 Plan as of the date of the approval of the 2005 Plan. The reserve
will also include any shares currently subject to options under the 2000 Plan
that expire or become unexercisable for any reason without having been exercised
in full. The total 2005 Plan reserve cannot exceed 7,471,239 shares. All options
have a ten-year life and vest ratably over a three-year period.

The Company applies SFAS No. 123 and EITF No. 96-18 in accounting for stock
options granted to outside consultants and directors performing advisory
services. Compensation cost is recognized over the period over which the
services are received based on the fair value of the options at each balance
sheet date until the grantee's performance is complete. The fair value of these
options was estimated using the Black-Scholes pricing model with the following
weighted-average assumptions for the years ended December 31, 2005 and 2004:
risk free interest rate of 3%; dividend yield of 0%; volatility of 77% in 2005
and 120% in 2004; expected life of 5 to 10 years; and market value of the
Company's common stock ranging from $1.04 to $2.80 in 2005 and from $1.28 to
$2.80 in 2004. Compensation cost charged to operations for options granted to
consultants performing advisory services was $110,988 in 2005; $222,941 in 2004,
and $1,605,841 from August 21, 1998 (inception) to December 31, 2005.

The following summary presents the options granted, exercised, expired,
forfeited and outstanding at December 31, 2005 and 2004:

                                                                     Weighted
                                                                     Average
                                                     Number of       Exercise
                                                      Shares           Price
                                                   ------------     ----------
Outstanding at January 1, 2004                        4,288,667     $     .87

Granted                                               1,018,000     $    1.70
Exercised                                              (498,661)          .40
Expired                                                      --            --
Forfeited                                               (13,889)         2.14
                                                   ------------

Outstanding at December 31, 2004                       4,794,117     $   1.10
                                                   ------------

Granted                                                 295,000      $   1.96
Exercised                                                  (100)          .55
Expired                                                      --            --
Forfeited                                               (73,889)         1.13
                                                   ------------

Outstanding at December 31, 2005                      5,015,128      $   1.15
                                                   ============

The weighted average fair value of options granted during 2005 and 2004 was
$1.96 and $1.72, respectively. The Company had options for 4,345,063 shares
exercisable at December 31, 2005 with a weighted average of $1.15. The following
summary presents the exercise prices, number of options outstanding and
exercisable, and the remaining contractual lives of the Company's stock options
at December 31, 2005:

                                                     Weighted
                                                      Average      Weighted
                            Number of Shares         Remaining      Average
                     ----------------------------   Contractual    Exercise
Exercise Price        Outstanding     Exercisable      Life          Price
--------------        -----------     -----------   -----------    ---------
  $0.29 - $0.29        2,190,043        2,190,043       4.88          $0.29
  $0.30 - $0.80        1,058,080        1,058,080       6.95          $0.54
  $1.13 - $2.95        1,376,005          705,940       8.63          $1.90
  $4.40 - $5.00          391,000          391,000       6.36          $4.93
                     -----------      -----------

         Total         5,015,128        4,345,063       6.46          $1.15
                     ===========      ===========

                                      F-23



<PAGE>

NOTE 10. EARNINGS PER SHARE

Basic earnings per share is computed by dividing net income available for common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share is computed by dividing net income available
for common stockholders by the sum of the weighted-average number of common
shares outstanding for the period plus the assumed exercise of all dilutive
securities. Basic and diluted net loss per share amounts are equivalent for the
years ended December 31, 2005 and 2004. For the years ended December 31, 2005
and 2004, the effect of 14,299,742 and 13,420,981 potential common shares,
respectively, were not included in the earnings per share calculation as their
effect is antidilutive to the loss from continuing operations available for
common stockholders.

NOTE 11. INCOME TAXES

                                                     2005              2004
                                                 ------------      ------------
Deferred tax assets:
      Net operating loss carryforwards           $  9,732,000      $  6,362,000
      Stock-based compensation                        745,000           672,000
      Warrants                                      1,904,000         1,976,000
      Research and development credit               1,439,000           940,000
      Accrual to cash                                 320,000            55,000
      Other                                             2,000             2,000
                                                 ------------      ------------
                                                   14,142,000        10,007,000
Deferred tax liabilities:
      State taxes                                  (1,156,000)         (814,000)
      Other                                           (13,000)          (13,000)
                                                 ------------      ------------

Net deferred tax asset                             12,973,000         9,180,000
Less valuation allowance                          (12,973,000)       (9,180,000)
                                                 ------------      ------------

                                                 $         --      $         --
                                                 ============      ============

The net deferred tax asset has been fully reserved as the Company has determined
that it is unlikely to be realized. The valuation allowance increased by
$3,793,000 in 2005 and $2,859,000 in 2004.

The Company has not recorded income tax expense or benefit for the years ended
December 31, 2005 and 2004, and the period from August 21, 1998 (inception)
through December 31, 2005.

At December 31, 2005, the Company has net operating loss carryforwards of
approximately $22,723,000 and $22,694,000 for federal and state purposes,
respectively. The federal and state net operating loss carryforwards begin to
expire in 2019 and 2007, respectively.


The provision for income taxes differs from the amount using the statutory
federal income tax rate of 34% as follows:

                                                     2005              2004
                                                 ------------      ------------
      Federal tax benefit at statutory rate      $  2,892,000      $  2,216,000
      State tax benefit, net                          664,000           438,000
      Increase in valuation allowance              (3,793,000)       (2,743,000)
      Research and development credit                 244,000            60,000
      Other permanent items                            (5,000)         (251,000)
      Stock-based compensation                         (2,000)          280,000
                                                 ------------      ------------

      Provision for income taxes                 $         --      $         --
                                                 ============      ============


NOTE 12. EMPLOYEE SAVINGS PLAN

The Company has established an employee savings plan pursuant to Section 401(k)
of the Internal Revenue Code. The plan allows participating employees to deposit
into tax deferred investment accounts up to 60% of their salary, subject to
annual limits. The Company is not required to make matching contributions under
the plan, and did not make any such contributions in fiscal years 2005 and 2004,
nor in any prior period since inception of the plan.

                                      F-24



<PAGE>

NOTE 13. LEGAL PROCEEDINGS

In January 2005, MicroIslet of Delaware and the Company's Chairman and Chief
Executive Officer were named as defendants in a lawsuit brought in the Superior
Court of California, County of Orange, by Donald Gallego. The complaint alleged
breach of oral contract, fraud, racketeering, intentional infliction of
emotional distress, unfair business practices, conversion and other related
causes of action arising from an alleged oral agreement to pay Mr. Gallego a
commission in connection with fundraising activities between 2000 and 2002. The
racketeering cause of action alleged that the Company made false statements
concerning its relationship with Duke University. The complaint sought damages
of approximately $10.5 million plus pre-judgment interest, punitive and
exemplary damages and attorneys fees and costs. In connection with the
racketeering cause of action, the complaint sought damages of three times the
amount of plaintiff's injury, but did not allege the amount that the plaintiff
was injured. In March 2005, at the request of the Company, the action was
removed from the Orange County Superior Court to the United States District
Court for the Central District of California, and was subsequently transferred
to the United States District Court for the Southern District of California.

In November 2005, the Company entered into an agreement with Mr. Gallego to
settle this matter. The terms of the settlement were placed on the court record
before United States Magistrate Judge William McCurine, Jr. of the United States
District Court, Southern District of California. Any disputes that may arise in
connection with the final settlement documents or enforcement of the settlement
will be resolved by Judge McCurine. Any orders issued by Judge McCurine in this
regard will be final and binding on the parties.

In the settlement, the Company agreed to pay $50,000 cash and to issue 170,000
shares of common stock to Mr. Gallego. In addition, the Company agreed to file
with the Securities and Exchange Commission a registration statement for the
resale of these shares and an additional 150,000 shares owned by Mr. Gallego.
The Company recognized expense of $229,300 (net of insurance proceeds) and
reported this as part of General and Administrative expenses in the fourth
quarter of 2005. If the registration statement is not filed within thirty days
of the execution of a written settlement agreement, Mr. Gallego will be entitled
to liquidated damages equal to an additional 4,000 shares for the first month
following this thirty day period, and 8,000 shares per month for each month
thereafter, prorated on a daily basis. These liquidated damages began accruing
in February 2006. As of March 31, 2006, the registration statement has not been
filed. Mr. Gallego has agreed to deposit his shares into a brokerage account
with a broker selected by the Company, and limit his sales of these shares in
the public market to no more than 25,000 shares per week, unless the broker
indicates that more than 25,000 may be sold without materially affecting the
overall price of the Company's stock, in which case Mr. Gallego may sell up to
50,000 shares in any one week

A written settlement agreement setting forth the foregoing terms was executed in
January 2006.

The Company may from time to time become a party to legal proceedings arising in
the ordinary course of business. The Company is not currently a party to any
material pending litigation or other material legal proceeding, except as
discussed above.


NOTE 14. SUBSEQUENT EVENTS

In January 2006, Hartoun Hartounian, Ph.D., the Company's President and Chief
Operating Officer and a Director, gave notice of his intent to resign from his
positions with the Company, effective February 17, 2006. James R. Gavin III,
M.D., Ph.D., a member of the Board of Directors, was appointed as Interim
President and Chief Executive Officer in January 2006.

During January 2006, outstanding options were exercised for an aggregate of
56,111 shares at an exercise price of $1.13 per share.

During February 2006, outstanding options and warrants were exercised for an
aggregate of 1,310,729 shares at exercise prices ranging from $0.29 to $1.00 per
share.

During March 2006 outstanding options and warrants were exercised for an
aggregate of 203,577 shares at exercise prices ranging from $0.55 to $1.30 per
share.


                                      F-25