<PAGE>
================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                  FORM 10-KSB/A
                                (AMENDMENT NO. 1)


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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

                         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: NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                          Common Stock, $.001 par value
                          -----------------------------
                                (Title of Class)

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 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 is not 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 had no revenues for its most recent fiscal year.

As of March 14, 2005, the aggregate market value of the voting stock of the
Registrant held by non-affiliates of the Registrant was $38,550,725.*

The number of shares of Common Stock, $.001 par value, outstanding on March 14,
2005, was 39,683,912.

* Excludes the Common Stock held by executive officers, directors and
stockholders whose ownership exceeds 5% of the Common Stock outstanding on March
14, 2005. The calculation does not reflect a determination that such persons are
affiliates for any other purposes.

================================================================================


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                                EXPLANATORY NOTE

         This Amendment No. 1 to the Annual Report on Form 10-KSB ("Form
10-KSB/A") is being filed to reflect the restatement of our consolidated
financial statements as of and for the year ended December 31, 2004 and for the
period from August 21, 1998 (date of inception) through December 31, 2004. The
Form 10-KSB of MicroIslet, Inc. (the "Company") for the fiscal year ended
December 31, 2004 was originally filed with the Securities and Exchange
Commission on March 30, 2005 (the "Original Filing"). On June 23, 2005, the
Company's audit committee determined, in consultation with management, that as a
result of the errors in the accounting treatment for warrants issued to settle
demands for payment made by certain parties who claimed to have rendered
services in connection with the Company's financing that closed in March 2004, a
restatement of the financial statements for the fiscal year ended December 31,
2004 and the first quarter of 2005 was required.

         This Form 10-KSB/A amends Part II, Item 6, Management's Discussion and
Analysis, and Part II, Item 7, Financial Statements, to reflect the restatement
discussed above. Additionally, this Form 10-KSB/A amends Part III, Item 9,
Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act and Part III, Item 11, Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder Matters, to
correct certain disclosures and supplement certain information.

         This Form 10-KSB/A sets forth the complete text of each item of Form
10-KSB listed above, and for convenience of the reader, also repeats the
complete text of each item of Form 10-KSB which has not been amended. This Form
10-KSB/A also includes as Exhibits 31.1, 31.2 and 32.1 new certifications by the
Chief Executive Officer and Chief Financial Officer.

         In order to explain the going concern qualification in the revised
audit opinion included herein, we have revised one risk factor and added one
note to the financial statements.

         In order to preserve the nature and character of the disclosures set
forth in such items as originally filed, this Form 10-KSB/A does not reflect
events occurring after the filing of the original Form 10-KSB on March 30, 2005,
except to reflect the restatement as described above. Accordingly, this Form
10-KSB/A should be read in conjunction with the Company's filings made
subsequent to the filing of the Original Filing, including any amendments to
those filings. In that regard, the Company will be amending its Form 10-QSB for
the quarter ended March 31, 2005, to reflect restated financial results and
other matters related to the restatement discussed above.

         Additional details regarding the restatement are presented in Note 13
to the Consolidated Financial Statements included in Part II, Item 7, Financial
Statements, and in Part II, Item 6, Management's Discussion and Analysis.



                                       -2-


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                                TABLE OF CONTENTS


                                                                            Page

                                     PART I

ITEM 1.   Business                                                             4
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 and Related Stockholder Matters            14
ITEM 6.   Management's Discussion and Analysis                                15
ITEM 7.   Financial Statements                                           32, F-1
ITEM 8.   Changes in and Disagreements with Accountants on
          Accounting and Financial Disclosure                                 32
ITEM 8A.  Controls and Procedures                                             32

                                    PART III

ITEM 9.   Directors, Executive Officers, Promoters and Control Persons;
          Compliance with Section 16(a) of the Exchange Act                   33
ITEM 10.  Executive Compensation                                              37
ITEM 11.  Security Ownership of Certain Beneficial Owners and
          Management and Related Stockholder Matters                          39
ITEM 12.  Certain Relationships and Related Transactions                      42
ITEM 13.  Exhibits                                                            43
ITEM 14.  Independent Auditors' Fees and Services                             47


                           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/A, 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.



                                      -3-


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                                     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. 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 introduce our products to the market.

PRODUCT

We intend to seek FDA approval for and bring to market 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 that have been 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 agreement 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, 2004, 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 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.

                                      -4-

<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 $15,000 during the fiscal year ended December
31, 2004 and $42,000 during the fiscal year ended December 31, 2003, 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 can
be included as part of the IND process for human clinical trials. The first
agreement calls for us to fund The Scripps Research Institute in the amount of
approximately $650,000 over a two year period ending in March 2005, and the
second for approximately $450,000 over a three year period ending in August
2007. We paid to The Scripps Research Institute approximately $434,000 during
the fiscal year ended December 31, 2004, and $215,000 during the fiscal year
ended December 31, 2003. We are currently in discussions with The Scripps
Research Institute to extend the first agreement beyond March 2005.

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 can be included as part of the
IND process 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. During the fiscal year ended December 31, 2004 we funded
$120,000 to the University of California, Davis.

INTELLECTUAL PROPERTY

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*
                          - Method of treating isolated pancreatic islet cells

6,365,385                 - Microencapsulated islet cells prepared according
  (granted 4/2/2002)           to claimed methods (above)
  (expires 3/22/2019)     - 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

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


                                      -5-


<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.

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 approximately seventeen employees working on this effort
with assistance from outside contractors. This research will use 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 to assist us
with transplantation surgery and subsequent monitoring in animal models.

Together with the University of Alberta, the University of California, Davis,
The Scripps Research Institute 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. 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 The Scripps Research Institute (TSRI)
showing interim results of transplants using our proprietary technology in
approximately 150 small animals. In the study, groups of streptozotocin-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.

     The preliminary data allow the following conclusions:

     o    Pig islet encapsulation technology we have developed preserves islet
          function and permits extended survival in an immunodeficient and
          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 pig islets in this model.

In August 2004 we received additional data from The Scripps Research Institute.
The additional data allow for the following additional conclusions:

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


                                      -6-


<PAGE>

     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.

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

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, 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), microencapsulated
          porcine islets.

Our total research and development expenses were approximately $2.9 million and
$1.5 million for 2004 and 2003.

PORCINE ISLET SUPPLY

Under the rules of the FDA, 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, and we believe this is the only facility that
can currently produce designated pathogen free pigs to the required
specification. We currently have a short-term supply agreement with the Mayo
facility. 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 preclinical xenotransplantation research for a term of six months,
extendable at our option for an additional three months. We have agreed to pay a
monthly fee over the term of the short-term supply agreement for the right to
receive these pigs. We will also be required to pay Mayo for its expenses of
harvesting the pancreas, should we ask the Mayo Foundation to perform such
harvesting for us. We believe the quantity of pigs that the Mayo Foundation has
agreed to supply will be sufficient to meet our needs during the term of the
short-term supply agreement. The Mayo Foundation has agreed that during the term
of the short-term supply agreement, it will not supply non-transgenic,
designated pathogen free pigs to any other company for research related to, or
use with respect to, the treatment of diabetes.

The short-term supply agreement also provides that we and the Mayo Foundation
will work together in good faith to agree upon a form of long-term supply
agreement for use in human clinical trials, which agreement would be for a term
of three years with our ability to extend for up to an additional four years,
for a total of seven years, on certain conditions. We believe that the Mayo
Foundation has the capacity to provide us with an adequate supply of donor
organs for our planned Phase I and Phase II clinical trials. Once we and the
Mayo Foundation agree on the form of long-term supply agreement, we will have
the right but not the obligation to enter into such agreement at any time during
the term of the short-term supply agreement. We have the right to terminate the
short-term supply agreement upon 30 days advance written notice. We or the Mayo
Foundation may also terminate the short-term supply agreement upon an uncured
material breach of the other party.


                                      -7-

<PAGE>

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.

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 US
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 there are no other products
currently available or in late stage clinical trials that can effectively cure
insulin dependent diabetes, we anticipate that this area 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 will not eliminate the need for frequent blood glucose
monitoring or 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; and

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


                                      -8-

<PAGE>

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.

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,
approval and oversight by an Institutional Review Board 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.

                                      -9-

<PAGE>

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, changes in the product
or manufacturing that have a substantial potential to adversely affect product
safety or effectiveness likewise require supplemental applications. These
supplemental applications may require the submission of clinical or
comparability data and must be approved 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:

     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.


                                      -10-


<PAGE>

     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 device-related deaths or serious injuries, and malfunctions the
recurrence of which would likely cause serious injury or death. Medical device
reports can result in agency action such as inspection, 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.

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 14, 2005, we had twenty-three full time employees. Seventeen of our
employees are engaged in research and development. We also maintain a Scientific
Advisory Board of outside consultants consisting of seven persons, all with
doctoral degrees. These consultants are:


                                      -11-


<PAGE>

MEMBER                                  AFFILIATIONS
------                                  ------------

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

Daniel R. Salomon, M.D.                 Associate Professor at The Scripps
Chairman of Scientific Advisory         Research Institute (TSRI) in the
Board                                   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.

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

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.

Riccardo Perfetti, MD, Ph.D.            Director of the Outpatient Diabetes and
                                        Weight Management Programs at
                                        Cedars-Sinai Medical Center. Director of
                                        the Endocrine Training Program, and the
                                        Diabetes Research Laboratory within the
                                        Division of Endocrinology, Diabetes and
                                        Metabolism at Cedars-Sinai. Assistant
                                        Professor In Residence with the
                                        Department of Medicine at the University
                                        of California, Los Angeles (UCLA),
                                        School of Medicine.

Tejal Desai, Ph.D.                      Associate Professor in Biomedical
                                        Engineering at Boston University and the
                                        Director of the Laboratory of
                                        Therapeutic Microtechnology.

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 11.4%, respectively, of
the outstanding shares at that time. The other executive officer of MicroIslet
of Delaware prior to the merger was Hartoun Hartounian, who served as its Chief
Operating Officer. Mr. Steel, Dr. Hartounian, Robert Anderson and James Gavin
made up the Board of Directors. Each of these individuals remains with our
company in the same or similar capacity. 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


                                      -12-

<PAGE>

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.

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 $302,770 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 $55,003 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 financings.

ITEM 2. PROPERTIES

We own no real property. We lease approximately 9,560 square feet of office and
laboratory space in San Diego, California at a current rental rate of
approximately $16,000 per month. The lease expires on February 28, 2008. This
facility is adequate for our current requirements. We also lease an additional
research and development facility in San Diego, California at a current rental
rate of $5,000 per month. The lease can be terminated at any time with sixty
days advance notice.


                                      -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 alleges 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 alleges that we made false statements concerning our
relationship with Duke University. The complaint seeks 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 seeks damages of three times the amount of plaintiff's injury, but
does 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. No trial date has been set. Although an
unfavorable outcome in this matter could have a material adverse effect on our
business, liquidity and financial position, we believe this claim is without
merit and we intend to vigorously defend the action.


We may from time to time become a party to legal proceedings arising in the
ordinary course of business. Other than the lawsuit described above, 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

None.

                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

                               MARKET INFORMATION

Our common stock has been traded on the American Stock Exchange (Amex) under the
trading symbol "MII" since June 1, 2004. Previously it had been traded on the
OTC Bulletin Board under the trading symbol "MIIS" from May 9, 2002 to May 31,
2004, and under the symbol "ALDI" from December 12, 2000 to May 8, 2002. The
following table sets forth the high and low prices for our common stock as
reported by various market makers for the fiscal years ended December 31, 2004
and 2003. The quotations reflect inter-dealer prices and may not reflect
adjustments for retail markups, markdowns, or commissions and may not reflect
actual transactions.

                                                    Bid Quotations
                                                    --------------
                                                   High         Low
                                                   ----         ---


2003
        First Quarter                             $2.39       $1.30
        Second Quarter                             1.50        0.37
        Third Quarter                              0.85        0.35
        Fourth Quarter                             0.45        0.89


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


                                      -14-

<PAGE>

On December 31, 2004, there were approximately 114 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.


ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

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 THAT 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.

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. As of December 31, 2004, we had an accumulated deficit of
approximately $21.6 million. We do not expect to produce revenues from
operations for the foreseeable future, so our revenues will be limited to
research grants we are able to obtain.


Our acquisition of MicroIslet of Delaware was completed on April 24, 2002. We
issued new shares of our common stock to the stockholders of MicroIslet of
Delaware in exchange for all the outstanding common stock and preferred stock of
MicroIslet of Delaware. The acquisition was accounted for as a reverse
acquisition because former stockholders of MicroIslet of Delaware owned a
majority of our outstanding stock subsequent to the acquisition. For accounting
purposes, MicroIslet of Delaware is deemed to have acquired ALD Services and
therefore all financial information presented in this report represents the
results of operations of MicroIslet of Delaware.

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 the efficacy of our approach in order to advance to subsequent
milestones.


In March 2004, we sold common stock for net cash proceeds of $12 million, which
we believe will be sufficient to fund our operations into early 2006.

RESTATEMENT

Subsequent to the issuance of our consolidated financial statements for the
fiscal year ended December 31, 2004, we determined that our previously issued
financial statements required restatement to correct our accounting for certain
warrants issued in settlement of demands for payment made by parties who claimed
to have rendered services in connection with our financing that closed in March
2004. In the previously issued financial statements, the fair value of these
warrants had been charged against the proceeds of the financing. Our management
has now determined that the value of the warrants should have been recorded as a
period expense in the first and second quarters of 2004 rather than as an offset
against the proceeds of the financing. As a result we have recorded $563,205 of
additional general and administrative expense in our consolidated statement of
operations for the year ended December 31, 2004.

                                       -15-

<PAGE>

We have also determined that the previously recorded non-cash expense for two
fully vested warrants issued to an investor relations consulting firm in January
2004 and June 2004 should have been amortized over the respective six-month
terms that services associated with such warrants were rendered, rather than on
the dates the warrants were granted. All such services were rendered during the
fiscal year ended December 31, 2004, so the correction of this error will not
affect the results of operations for the full 2004 fiscal year. This error did
however, result in restatement of the results of operations for each of the
quarters in 2004.

The restatement resulted in an increase in net loss and deficit accumulated
during the development stage of $541,554, and an increase of $0.01 in net loss
per share for the year ended December 31, 2004. Total assets, liabilities and
stockholders' equity for the year ended December 31, 2004 remained unchanged.
Refer to Note 13 of the consolidated financial statements for further details.


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:

GRANT REVENUE

We recognize grant revenue as qualifying research expenses are incurred.

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, 2004, 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. We plan to continue using the intrinsic value based method and
providing disclosure for the pro forma effect of using the fair value based
method to account for our stock-based compensation through December 31, 2005.


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). 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).

                                       -16-


<PAGE>

RESULTS OF OPERATIONS

Grant revenue for fiscal year 2003 was $255,857, consisting entirely of research
grants. We recognized no grant revenue for the year ended December 31, 2004. The
decrease reflects the completion of the funding available to us under the Small
Business Innovation Research (SBIR) grant from the National Institutes of Health
(NIH).


Total operating expenses were $6,624,605 in 2004 and $3,138,071 in 2003. The
increase in expenses was principally the result of personnel expenses due to the
increase in the number of employees as well as increased sponsored research
funding. Research and development expenses increased to $2,913,213 in 2004 from
$1,497,682 in 2003, reflecting increased headcount and spending for our
sponsored research and materials relating to testing of our technology in
animals. General and administrative expenses increased to $3,711,392 in 2004
from $1,640,389 in 2003. The increase was primarily related to higher investor
relations expense due to warrants and options issued to consultants, as well as
higher directors' and officers' insurance premiums and settlement costs incurred
related to the March 16, 2004 financing. We expect operating costs to increase
significantly in 2005 as discussed in our plan of operation below.


Interest income was $110,666 in 2004 and $3,600 in 2003. The increase in
interest income was due primarily to the corresponding increase in the levels of
cash and cash equivalents resulting from our March 2004 private placement and
increasing yields from our investments.


Our net loss was $6,518,460 or $0.17 per common share in 2004, and $3,039,817 or
$0.12 per common share in 2003. 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, 2004, our federal tax net operating loss and federal tax credit
carryforwards were $15,636,000 and $1,012,000, 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.


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, 2004, have netted approximately $19.9 million, and to a lesser
extent, through short term debt, grant funding and interest earned on cash and
cash equivalents. We have from time to time experienced significant strains on
our cash reserves, and during these times, we have curtailed non-essential
operations and extended payment terms with our trade creditors wherever
possible.

Our combined cash and cash equivalents totaled $8.8 million at December 31,
2004, an increase of $8.2 million from December 31, 2003. The primary source of
cash and cash equivalents for the year ended December 31, 2004 was the sale of
common stock and warrants in our March 2004 private placement and, to a lesser
extent, the exercise of stock options and warrants. The primary uses of cash and
cash equivalents during the year ended December 31, 2004 included $4.6 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 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.

                                       -17-


<PAGE>

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. Fusion Capital is committed to purchase the initial $12
million of our common stock through October 2005, if not extended by us for six
additional months. We may decrease this amount or terminate the agreement at any
time. If our stock price equals or exceeds $1.25 per share for five consecutive
trading days, we have the right to increase the daily purchase amount above
$20,000, provided that the sale price of our common stock remains at least
$1.25. The sale price per share to Fusion Capital is equal to the lesser of: the
lowest sale price of our common stock on the day of purchase by Fusion Capital,
or the average of the lowest three closing sale prices of our common stock
during the ten trading days prior to the date of purchase by Fusion Capital.
Fusion Capital has agreed that neither it nor any of its affiliates will engage
in any direct or indirect short-selling or hedging of our common stock during
any time prior to the termination of the common stock purchase agreement. We
have 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, we 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 has 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. An amended
registration statement registering the resale of shares by Fusion Capital was
declared effective by the SEC in June 2004.

Fusion Capital is not obligated to purchase any shares of our common stock
unless the purchase price under the common stock purchase agreement is at least
$0.50 per share. Under the agreement with Fusion Capital, we must satisfy
requirements that are a condition to Fusion Capital's obligation including but
not limited to: the continued effectiveness and availability of the registration
statement for the resale of the shares by Fusion Capital, continued listing of
our common stock on the American Stock Exchange, OTC Bulletin Board or another
recognized market or exchange, no failure of our transfer agent to issue stock
to Fusion Capital within five days of a purchase by Fusion Capital, no default
on any of our payment obligations in excess of $1,000,000, and no insolvency or
bankruptcy on our part. Consequently, the amount and timing of proceeds that we
will receive under the agreement, if any, is uncertain. As of December 31, 2004,
the Company has issued a total of 1,934,067 shares to Fusion Capital under this
agreement for net proceeds of approximately $1,060,000.

During the year ended December 31, 2004, we sold 415,094 shares of common stock
to Fusion Capital Fund II, LLC pursuant to the common stock purchase agreement.

OTHER FINANCINGS

In March 2004, we sold to a limited number of accredited investors 9,834,218
shares of common stock at a purchase price of $1.30 per share. In connection
with the financing we also issued to the investors five-year warrants to
purchase 4,917,120 shares at $1.00 per share. We paid placement fees to various
placement agents in the aggregate amount of $705,000, issued warrants to various
placement agents to purchase an aggregate of 738,038 common shares and issued
89,231 shares in lieu of cash commission to a placement agent who later became a
director of our company. The placement agent warrants have exercise prices of
$1.30 per share and expire between two to five years from the date of issuance.


Following completion of this financing, we received a demand from a purported
investor claiming that we had breached an agreement to sell $750,000 of
securities to the purported investor. In April 2004, we settled this demand and
a related claim by another investor through 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 has been
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. As of December 31, 2004, warrants for 150,000 shares
have been exercised and warrants for 150,000 shares have expired.

                                       -18-


<PAGE>

Also following completion of the private placement in March 2004, a placement
agent engaged by us claimed that it was entitled to payment of a cash
transaction fee and a warrant for services rendered in the private placement. In
September 2004, we 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 has been
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. As of December 31, 2004, 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 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, 2004, this warrant has not 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
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, 2004, 166,666 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 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 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 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, 2004, 20,000 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 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, 2004, this warrant has not been
exercised.

                                       -19-



<PAGE>

On April 12, 2004, the Company issued an option to an employee of a consulting
firm engaged by the Company to provide investor relations services. This option
to purchase 30,000 shares at $2.95 per share vests over two years and expires
ten years after the date of grant. In accordance with EITF 96-18, the fair value
of the option will be re-measured at the end of each reporting period and
changes in the estimated fair value will be recognized over the vesting period
of the option until the measurement date which has been defined as the
completion of performance.

We expect that our available cash and expected grant and interest income will be
sufficient to finance currently planned activities into early 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 $6.9 million. We believe however that the costs of remaining pre-clinical
studies and the preparation for human clinical trials could range from $5 to $10
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 $6.9 million we have budgeted for the next twelve months is divided into the
following categories:

Category                                         Estimated Cost
--------                                         --------------
Personnel............................................$2,711,000
Sponsored research.....................................$635,000
Outside consultants and services.......................$671,000
Supplies and materials...............................$1,364,000
Travel and entertainment...............................$186,000
Facilities.............................................$500,000
General and administrative.............................$872,000
Total................................................$6,939,000

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 initial pre-clinical studies will consist of cell transplantation studies
primarily involving small animals such as rats and mice and/or large animals
such as dogs or non-human primates. These studies will use non-encapsulated and
encapsulated animal islet cells. The encapsulated cells will be isolated and
encapsulated by us using our proprietary technology as well as any additional
processes, procedures or scientific advances we develop in our laboratory. This
work will be conducted by our research and development team at our facility with
assistance from outside contractors.

The transplantation surgery and subsequent monitoring is expected to take place
at one or more academic institutions with which we have relationships through
our Scientific Advisory Board. Together with these 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. 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>
                                            ESTIMATED TIME OF MILESTONE         ESTIMATED COST OF
MILESTONE                                            COMPLETION             ACHIEVING EACH MILESTONE
---------                                            ----------             ------------------------
<S>                                              <C>                           <C>
Ongoing optimization of viability and
functionality of encapsulated islets in          First Half of 2006            $1 to $1.4 million
vitro and in small animals
Testing viability and functionality of
encapsulated islets in vitro and in              Second Half of 2006             $3 to $4 million
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.

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>
                                                                    ESTIMATED TIME OF            ESTIMATED COST OF MILESTONE
                                                                        COMPLETION                 ACHIEVING EACH MILESTONE
MILESTONE                                                               ----------                 ------------------------
<S>                                                                  <C>                                <C>
COMPLETE FORMAL ANIMAL STUDIES IN ANTICIPATION OF FILING             2nd Half of 2006                   $6-10 Million
INVESTIGATIONAL 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           1st Half of 2006                    $2-3 Million
studies involve 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 ability to provide effective immunoisolation in
humans prior to clinical trials.

INITIATE PHASE I HUMAN CLINICAL TRIALS. Once the formal                     2007                            Unknown
controlled animal 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.
</TABLE>


                                      -21-


<PAGE>

<TABLE>
<S>                                                                    <C>                                  <C>
INITIATE PHASE II HUMAN CLINICAL TRIALS. The second phase                   2008                            Unknown
involves further 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                 2010                            Unknown
usually 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           2011 or later                        Unknown
FDA FOR 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.

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, are expected to result in substantial operating losses for the
foreseeable future.

We anticipate hiring approximately three additional employees in research and
development over the next twelve months.

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).


                                      -22-


<PAGE>

                                 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. OUR INDEPENDENT AUDITORS HAVE
RAISED 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 June 30, 2005, we have incurred total accumulated losses of
$25.5 million. We expect these losses to continue and it is uncertain when, if
ever, we will become profitable. These losses have resulted principally from
costs incurred in research and development and from general and administrative
costs associated with operations. We expect to incur increasing operating losses
in the future as a result of expenses associated with research and product
development as well as general and administrative costs. Even if we do achieve
profitability, we may not be able to sustain or increase profitability on a
quarterly or annual basis.


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.

Our current plans indicate we will need significant additional capital for
research and development before we have any anticipated revenue generating
products. The actual amount of funds that we will need will be determined by
many factors, some of which are beyond our control, and we may need funds sooner
than currently anticipated. These factors include:

     o    the extent to which we enter into licensing arrangements,
          collaborations or joint ventures;

     o    our progress with research and development;

     o    the costs and timing of obtaining new patent rights;

     o    the extent to which we acquire or license other technologies; and

     o    regulatory changes and competition and technological developments in
          the market.

Fusion Capital Fund II, LLC has agreed to provide us up to $24 million under a
common stock purchase agreement, of which approximately $22.9 million remains
available as of March 14, 2005. See "Management's Discussion and
Analysis--Liquidity and Capital Resources--Fusion Capital". However, the extent
we rely on Fusion Capital as a source of funding will depend on a number of
factors including, the prevailing market price of our common stock and the
factors listed above. For example, our continued access to financing under our
common stock purchase agreement with Fusion Capital requires the market price of
our common stock to remain above $0.50 per share and a registration statement
for the shares to be purchased by Fusion Capital to remain available. If
investment from Fusion Capital is unavailable or prohibitively expensive, we
will need to secure another source of funding, in order to satisfy our working
capital needs.

When we require additional funds, which may be above and beyond the funds we may
raise from Fusion Capital, 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 MAY NOT BE ABLE TO OBTAIN THE FULL $24 MILLION GROSS PROCEEDS UNDER OUR
COMMON STOCK PURCHASE AGREEMENT WITH FUSION CAPITAL.

We have the right to receive only $20,000 per trading day under the agreement
with Fusion Capital unless our stock price equals or exceeds $1.25, in which
case the daily amount may be increased under certain conditions as the price of
our common stock increases. At our recent stock price of $1.84, we have the
right to receive $50,000 per trading day. Fusion Capital will not have the right
or the obligation to purchase any shares of our common stock on any trading days
that the purchase price of our common stock under the purchase agreement would
be less than $0.50. We originally registered 6,000,000 purchase shares for sale
by Fusion Capital, 4,530,332 of which have not yet been issued. Depending on our
stock price and our utilization of the Fusion Capital commitment, we may be
limited in the amount of capital we raise from Fusion Capital unless we
authorize and register additional shares of common stock beyond the 5,058,866
shares currently registered, which we have the right but not the obligation to
do.

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 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 (other than Fusion
Capital under the common stock purchase agreement) are under any obligation to
continue to provide cash to meet our future liquidity needs.

WE ARE SUBJECT TO NEW CORPORATE GOVERNANCE AND INTERNAL CONTROLS 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 auditor reports on internal controls as part of our annual report
for the year ended December 31, 2006 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 cannot assure you that we will be able to fully comply
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.

We are a relatively new company and our technologies are still in the early
stages of development. We are currently working to develop our first product,
MicroIslet-P(TM). This product may not be successfully developed or
commercialized 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. Even if we develop our products for commercial use
and obtain all necessary regulatory approval, 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;

     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.

                                       -24-


<PAGE>

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

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 cannot be sure that we will 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.

                                       -25-


<PAGE>

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.

WE MAY NOT SUCCESSFULLY DEVELOP OR DERIVE REVENUES FROM OUR CELL THERAPY
PROGRAMS, AND IF WE DO NOT, YOUR INVESTMENT MAY DECLINE IN VALUE.

Our cell therapy programs are still in the early stages of development and may
not result in marketable products. We are directing our technology and
development focus primarily toward identifying processes and products that are
believed to produce optimal treatment for insulin-dependent diabetes. However,
these efforts may never generate revenue.

THE REGULATORY APPROVAL PROCESS IS EXPENSIVE, TIME CONSUMING AND UNCERTAIN.
FAILURE TO RECEIVE APPROVAL FOR COMMERCIALIZATION OF ANY POTENTIAL PRODUCT
DEVELOPED BY US OR OUR COLLABORATORS WOULD HAVE A NEGATIVE IMPACT ON OUR
BUSINESS AND YOUR INVESTMENT.

The FDA must approve any biological product before it can be marketed in the
United States. Biological products must also be approved by the regulatory
agencies of foreign governments before the product can be sold outside the U.S.
Before an investigational new drug application (IND) can be filed with the FDA,
the potential product must undergo preclinical laboratory tests, preclinical
studies in animals and formulation studies. Once the IND becomes effective,
adequate and well-controlled human clinical trials to establish the safety and
efficacy of the product are required. Commercialization of any therapeutic or
other product that we or our collaborators may develop depends upon successful
completion of these preclinical studies and clinical trials. Preclinical testing
and clinical development are long, expensive and uncertain processes and we do
not know whether we, or any of our collaborative partners, will be permitted to
undertake clinical trials of any potential products. It may take us or our
collaborative partners many years to complete any such testing, and failure can
occur at any stage of testing. Preliminary results of trials do not necessarily
predict final results, and acceptable results in early trials may not be
repeated in later trials. A number of companies in the pharmaceutical industry,
including biotechnology companies, have suffered significant setbacks in
advanced clinical trials, even after promising results in earlier trials. Delays
or rejections of potential products may be encountered based on changes in
regulatory policy for product approval during the period of product development
and regulatory agency review. Moreover, we or our collaborative partners may
decide to discontinue development of any or all of these projects at any time
for commercial, scientific or other reasons.

                                       -26-


<PAGE>

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. THESE AND OTHER 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.

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 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.

THE REIMBURSEMENT STATUS OF NEWLY APPROVED HEALTHCARE PRODUCTS AND TREATMENTS IS
UNCERTAIN AND FAILURE TO OBTAIN ADEQUATE REIMBURSEMENT COULD LIMIT OUR ABILITY
TO MARKET ANY PRODUCTS WE MAY DEVELOP AND DECREASE OUR ABILITY TO GENERATE
REVENUE.

There is significant uncertainty related to the reimbursement of newly approved
pharmaceutical products. Our ability and the ability of our collaborators to
commercialize products in both domestic and foreign markets will depend in part
on the reimbursements, if any, obtained from third-party payors such as
government health administration authorities, private health insurers, managed
care programs and other organizations. Third-party payors are increasingly
attempting to contain healthcare costs by limiting both coverage and the level
of reimbursement of new pharmaceutical products. Cost control initiatives could
decrease the price that we, or our collaborators, would receive for our products
and affect our ability to commercialize any products we may develop. If third
parties fail to provide adequate reimbursement for our products, consumers and
doctors may not choose to use our products, and we may not realize an acceptable
return on our investment in product development.

                                       -27-


<PAGE>

BECAUSE MANY OF OUR COMPETITORS HAVE SUBSTANTIALLY GREATER CAPITAL RESOURCES AND
MORE EXPERIENCE IN RESEARCH AND DEVELOPMENT, MANUFACTURING AND MARKETING THAN
US, WE MAY NOT SUCCEED IN DEVELOPING OUR PROPOSED PRODUCTS AND BRINGING THEM TO
MARKET IN A COST-EFFECTIVE, TIMELY MANNER.

We expect to compete with a broad range of organizations that are engaged in the
development and production of products, services and strategies to treat
diabetes. They include:

     o    biotechnology, pharmaceutical, chemical and other companies;

     o    academic and scientific institutions;

     o    governmental agencies; and

     o    public and private research organizations.

We are a development stage company engaged exclusively in research and
development. We have not yet completed the development of our first product and
have no revenue from operations. As a result, we may have difficulty competing
with larger, established biomedical and pharmaceutical companies. These
companies have much greater financial, technical, research, marketing, sales,
distribution, service and other resources than us. Moreover, they may offer
broader product lines, services and have greater name recognition than we do,
and may offer discounts as a competitive tactic. In addition, several early
stage companies are currently developing products that may compete with our
potential products. We anticipate strong competition from traditional and
alternate insulin delivery systems, such as inhalable insulin or insulin pumps.
We also expect to compete with other companies involved, like us, in the
implantation of cells. These cells may be derived from animals, embryonic or
adult stem cells, human cells or genetically altered cell lines.

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.

In addition to patent protection, we require our employees, consultants,
advisors and collaborators to execute confidentiality agreements. However, we
cannot guarantee that these agreements will 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.

                                       -28-


<PAGE>

OUR SUCCESS WILL DEPEND PARTLY ON OUR ABILITY TO OPERATE WITHOUT INFRINGING ON
OR MISAPPROPRIATING THE PROPRIETARY RIGHTS OF OTHERS.

We may be sued for infringing on the patent rights or misappropriating the
proprietary rights of others. 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.

IF WE LOSE OUR KEY SCIENTIFIC AND MANAGEMENT PERSONNEL, OUR PRODUCT DEVELOPMENT
AND COMMERCIALIZATION EFFORTS WOULD SUFFER.

Our performance is substantially dependent on the performance of our current
senior management, Board of Directors and key scientific and technical personnel
and advisers. The loss of the services of any member of our senior management,
Board of Directors, 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 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. Customers for any potential products
and regulatory agencies will require that we comply with current good
manufacturing practices that we may not be able to meet. We may not be able to
maintain acceptable quality standards if we ramp up production. 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. 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. This reliance could
reduce our gross margins and expose us to the risks inherent in relying on
others. 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.

WE HAVE NO MARKETING OR SALES STAFF, AND IF WE ARE UNABLE TO ENTER INTO
COLLABORATIONS WITH MARKETING PARTNERS OR IF WE ARE UNABLE TO DEVELOP OUR OWN
SALES AND MARKETING CAPABILITY, WE MAY NOT BE SUCCESSFUL IN COMMERCIALIZING OUR
PRODUCTS.

We currently have no sales, marketing or distribution capability. As a result,
we will depend on collaborations with third parties that have established
distribution systems and direct sales forces. To the extent that we enter into
co-promotion or other licensing arrangements, our revenues will depend upon the
efforts of third parties, over which we may have little or no control.

If we are unable to reach and maintain agreement with one or more pharmaceutical
companies or collaborators under acceptable terms, we may be required to market
our products directly. We may elect to establish our own specialized sales force
and marketing organization to market our products. In order to do this, we would
have to develop a marketing and sales force with technical expertise and with
supporting distribution capability. Developing a marketing and sales force is
expensive and time consuming and could delay a product launch. We may not be
able to develop this capacity, which would make us unable to commercialize our
products.

                                       -29-


<PAGE>

IF WE ARE SUBJECT TO PRODUCT LIABILITY CLAIMS AND HAVE NOT OBTAINED ADEQUATE
INSURANCE TO PROTECT AGAINST THESE CLAIMS, OUR FINANCIAL CONDITION WOULD SUFFER.

If we are able to launch commercially our products, we will face exposure to
product liability claims. 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 costs. There is also a risk that
third parties for which we have agreed to indemnify could incur liability.

Since we will conduct clinical trials on humans, we face the risk that the use
of our products will result in adverse effects. These risks will exist even for
products developed that may be cleared for commercial sale. We cannot predict
all of the possible harms or side effects that may result and, therefore, 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 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 controlled storage, use and
disposal of hazardous materials including biological hazardous materials. We are
subject to federal, state and local regulations governing the use, manufacture,
storage, handling and disposal of materials and waste products. Although we
believe that our safety procedures for handling and disposing of these hazardous
materials comply with the standards prescribed by law and regulation, the risk
of accidental contamination or injury from hazardous materials cannot be
completely eliminated. 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.

As of December 31, 2004, we have on file with the SEC effective registration
statements for a total of 20,940,421 shares for resale by investors and
investment-related service providers. In addition, we have on file with the SEC
a registration statement for 5,058,866 shares for resale by Fusion Capital. The
selling stockholders under our effective registration statements 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 also have other registration obligations that have not yet vested.

In addition, approximately 17.9 million shares of common stock issued to
stockholders of MicroIslet of Delaware in our business combination are available
for resale under Rule 144(k), without notice, volume or manner of sale
restrictions.

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 of shares by Fusion Capital and 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.


                                       -30-


<PAGE>

OUR STOCK IS THINLY TRADED, WHICH CAN LEAD TO PRICE VOLATILITY AND DIFFICULTY
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, 2004, the average daily trading volume of our
stock was approximately 102,800 shares and the shares traded as low as $0.60 and
as high as $3.59 per share. Both volume and price could also be subject to wide
fluctuations in response to various factors, many of which are beyond our
control, including:

     o    actual or anticipated variations in quarterly and annual operating
          results;

     o    announcements of technological innovations by us or our competitors;

     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
11,169,087 shares outstanding that have exercise prices at or below the recent
market price of our stock of $1.84 per share. We have options and warrants for
2,251,894 shares outstanding at prices above the current $1.84 market price, and
if the current 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.

CHANGES IN STOCK OPTION ACCOUNTING RULES MAY ADVERSELY AFFECT OUR REPORTED
OPERATING RESULTS PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES, OUR STOCK PRICE AND OUR EFFORTS IN RECRUITING ADDITIONAL EMPLOYEES
IN THE EMPLOYEE MARKETPLACE.

Development stage companies in general, and our company in particular, have a
history of depending upon and using broad based employee stock option programs
to hire, incentivize and retain employees in a competitive marketplace.
Currently, we include such expenses on a pro forma basis in the notes to our
annual financial statements in accordance with accounting principles generally
accepted in the United States, but we generally do not include stock option
expense for employee options in our reported financial statements. An accounting
standard setting body has recently adopted a new accounting standard that will
require us to record equity-based compensation expense for stock options and
employee stock purchase plan rights granted to employees based on the fair value
of the equity instrument at the time of grant. We will be required to record
these expenses beginning with the first quarter of the year ending December 31,
2006. The change in accounting rules may lead to a significant increase in our
reported losses which may negatively impact our future stock price. In addition,
this change in accounting rules could impact our ability to utilize broad based
employee stock plans to reward employees and could result in a competitive
disadvantage to us in the employee marketplace.

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 14, 2005, our executive officers, directors and their affiliates
beneficially own or control approximately 27.3% of the outstanding shares of our
common stock (after giving effect to the exercise of all options held by them
which are exercisable on or before May 14, 2005). 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.

                                       -31-


<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.

WE HAVE NOT, AND CURRENTLY DO NOT ANTICIPATE, PAYING DIVIDENDS ON OUR COMMON
STOCK.

We have never paid any dividends on our common stock and do not plan to pay
dividends on our common stock for the foreseeable future. We currently intend to
retain future earnings, if any, to finance operations, capital expenditures and
the expansion of our business.

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 Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of December 31, 2004. 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
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were not effective as of December 31, 2004
for the reasons described below.

      On June 23, 2005, subsequent to receipt of a comment letter from the
Securities and Exchange Commission, the Company's audit committee determined, in
consultation with management, that as a result of the errors in the accounting
treatment for warrants issued to settle demands for payment made by certain
parties who claimed to have rendered services in connection with the Company's
financing that closed in March 2004 and warrants issued to an investor relations
consulting firm in January 2004 and June 2004, a restatement of the financial
statements for each of the quarters and the fiscal year ended December 31, 2004
and the first quarter of 2005 was required. This correction resulted in the
restatement of the Company's consolidated financial statements for the fiscal
year ended December 31, 2004, which is reflected in this Annual Report on Form
10-KSB/A for the year ended December 31, 2004, and for the first quarter of
2005, which is reflected in the Quarterly Report on Form 10-QSB/A for that
period.

      After evaluating the nature of the deficiency and the resulting
restatement, the Company's Chief Executive Officer and Chief Financial Officer
concluded that a material weakness existed in the Company's internal control
over financial reporting at December 31, 2004.

Changes in Internal Control over Financial Reporting
----------------------------------------------------

      During the fourth quarter of fiscal 2004, there were no significant
changes in the Company's internal control over financial reporting that
materially affected or were reasonably likely to materially affect internal
control over financial reporting.

                                       -32-


<PAGE>

      As a result of the errors identified, management has adopted a policy and
procedure whereby financial management will formally research relevant
accounting literature relating to and, if necessary, retain the services of a
qualified certified public accountant, other than our independent auditor, to
assist us with respect to, the reporting of transactions that involve complex
and unusual accounting matters.


                                    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

The following table sets forth the names and ages as of December 31, 2004, 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.

NAME                                AGE       POSITION HELD AND TENURE
----                                ---       ------------------------

John F. Steel IV                    46        Chairman, Chief Executive Officer
                                              and Director

Hartoun Hartounian, Ph.D.           45        President, Chief Operating Officer
                                              and Director

William G. Kachioff                 39        Vice President, Finance and Chief
                                              Financial Officer

Myron A. Wick III                   61        Vice Chairman and Director

Robert W. Anderson, M.D.*           67        Director

Steven T. Frankel *                 61        Director

James R. Gavin III, M.D., Ph.D.*    59        Director

Cynthia Ekberg Tsai                 49        Director

* Member of the Audit,
Compensation and Nominating
and Governance Committees

SIGNIFICANT EMPLOYEES

Ronnda Bartel, Ph.D.                46        Executive Director of Biological
                                              Sciences

Mayank Patel                        35        Senior Director of Operations

Jain Krotz, Ph.D.                   43        Director of Delivery Sciences

Ingrid Stuiver, Ph.D                43        Director of Research

Dagmar Meissner                     39        Director of Process Research and
                                              Development

JOHN F. STEEL IV, CHAIRMAN AND CHIEF EXECUTIVE OFFICER. Mr. Steel joined us in
April 2002 as Chairman of the Board of Directors and Chief Executive Officer. In
January 1998, Mr. Steel founded MicroIslet of Delaware and has 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 received his
MBA degree with an emphasis in finance from the University of Southern
California and a Bachelor of Arts degree from Dartmouth College.

                                       -33-


<PAGE>

HARTOUN HARTOUNIAN, PH.D., PRESIDENT AND CHIEF OPERATING OFFICER. Dr. Hartounian
joined us in April 2002 and had served as President and Chief Operating Officer
of MicroIslet of Delaware from August 2000 to April 2002. Before joining
MicroIslet of Delaware, Dr. Hartounian served from July 1998 to August 2000 as
the Head of the Process Development at Kelco BioPolymers, one of the world's
largest producers of biopolymers and a unit of Pharmacia. From April 1994 to
June 1998, Dr. Hartounian served as the Associate Director of Process
Development at SkyePharma PLC (formerly known as Depotech), where he was
responsible for all aspects of process development, scale up and technology
transfer and was the key contributor in the commercialization of SkyePharma's
first product. Dr. Hartounian received his Ph.D. in Chemical Engineering from
the University of Delaware.

WILLIAM G. KACHIOFF, VICE PRESIDENT, FINANCE AND CHIEF FINANCIAL OFFICER. Mr.
Kachioff joined us in May 2002 as Vice President, Finance and Chief Financial
Officer. He had served previously as the acting Chief Financial Officer of
MicroIslet of Delaware on a consultant basis from February 2002 to April 2002.
>From November 1999 to November 2001, Mr. Kachioff served as Director of Finance
at Altus Medical, Inc., a manufacturer of innovative medical devices, where he
helped prepare that company for the successful commercial launch of its first
product and for an initial public offering of stock. From November 1998 to
November 1999, Mr. Kachioff was the Corporate Controller at Coulter
Pharmaceuticals, Inc., and from November 1996 to October 1998, Mr. Kachioff was
the Assistant Controller at Vivus, Inc. From September 1990 to November 1996, he
held a series of progressively responsible finance and accounting positions with
Abbott Laboratories. He was a senior auditor with Deloitte & Touche LLP from
August 1987 to August 1990. Mr. Kachioff received his B.S. in Management with
concentrations in Accounting and Information Systems from the State University
of New York at Buffalo and has been a Certified Public Accountant since 1989.

MYRON A. WICK III. Mr. Wick has been a director of our company since July 2004
and was appointed Vice Chairman in December 2004. 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 cofounder 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
an M.B.A. from Harvard University and B.A. from Yale University.

ROBERT W. ANDERSON, M.D. Dr. Anderson has been a director of our company 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. He
received an MBA degree from the Kellogg School of Management at Northwestern in
1994 and was appointed as the Chairman of the Department of Surgery at Duke in
the same year. Dr. Anderson received his B.S. degree in Engineering from Duke
University and was awarded the M.D. degree from Northwestern University.


STEVEN T. FRANKEL. Mr. Frankel was elected as director of MicroIslet in May
2002. Mr. Frankel has been Chief Executive Officer and President of Acon
Laboratories, Inc., a provider of rapid diagnostic healthcare 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
attended the Executive Program at Stanford University in 1989 and received his
B.A. in Philosophy from Clark University in 1964.



                                       -34-


<PAGE>

JAMES R. GAVIN III, M.D., PH.D. Dr. Gavin has been a director of our company
since April 2002 and was a director of MicroIslet of Delaware from March 2001 to
April 2002. Since July 2002, he has been the President of Atlanta Morehouse
School of Medicine. 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 and dLife, Inc. since 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. 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.
Dr. Gavin has received numerous civic and academic awards and honors.

CYNTHIA EKBERG TSAI. Ms. Tsai has been a director of our company since July
2004. Since 1995, Ms. Tsai has served as the Chairman and CEO of
HealthExpo, the largest consumer health entertainment event in the U.S. She also
has served since 1995 as general partner of MassTech Ventures, a venture
fund focusing on technology development at Massachusetts Institute of
Technology. She is a member of the Advisory Committee of the National Institute
of Health, the Board of Directors of the American Association for World Health
(the American segment of the World Health Organization), and the New York Board
of Directors for the Weizmann Institute of Science. Ms. Tsai is also a Fellow of
the Foreign Policy Association, a member of the Economic Club of New York, and a
member of the Board of the Institute for Global Finance at Pace University. In
2001, Ms. Tsai joined the Board of The White House Project. She began her career
in the financial services business with Merrill Lynch and Kidder Peabody in San
Diego. In May 2004, she was chosen to be recognized as one of the Leading Women
Entrepreneurs of the World by the STAR Group and she has been recognized by the
Harvard Business School Alumni Chapter in New York with an award for
entrepreneurship. Ms. Tsai has a B.A. in Psychology from the University of
Missouri.

SIGNIFICANT EMPLOYEES

RONNDA BARTEL, PH.D., EXECUTIVE DIRECTOR OF BIOLOGICAL RESEARCH. Prior to
joining MicroIslet in 2004, Dr. Bartel had 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
also participated in the first commercialization of tissue-engineered products
while holding both research and management positions at Advanced Tissue Sciences
from 1995 to 1998.  In addition, she had experience in drug
delivery research while a member of the research faculty at the University of
Kansas, Department of Pharmaceutical Chemistry and later as a senior scientist
in the Drug Delivery Department at the Becton Dickinson Research Center,
Research Triangle Park, North Carolina. 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. Prior to that, he worked at SkyePharma
PLC (formerly DepoTech) from May 1995 to January 1999 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 MBA in Operations Management and his B.S. in Chemical
Engineering from Rutgers University.

                                       -35-


<PAGE>

JAIN KROTZ, PH.D., DIRECTOR OF DELIVERY SCIENCES. Dr. Krotz joined MicroIslet in
September 2004 with over 10 years experience in commercial research and
development of implantable devices and in-vitro diagnostic products. Prior to
joining MicroIslet, she lead the development of platforms for microelectronic
DNA arrays at Nanogen, Inc. from 1998 to 2004. 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. Before joining MicroIslet of Delaware, 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, Dr. Stuiver
was a Sr. 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.

DAGMAR MEISSNER, DIRECTOR OF PROCESS RESEARCH AND DEVELOPMENT. Ms. Meissner
joined us in April 2002 and was the Director of Process Research and Development
at MicroIslet of Delaware. from January 2001 to April 2002. Prior to joining
MicroIslet of Delaware, Ms. Meissner was a Senior Scientist at Kelco BioPolymers
from September 1998 to December 2000. From December 1994 to June 1998, she
worked at SkyePharma PLC (formerly known as DepoTech) as a Senior Process
Engineer. From February 1992 to June 1994, she worked at Biogen, Inc., a
biotechnology company, as a Senior Process Associate. Ms. Meissner earned a
diploma in Chemical Engineering from a PolyTechnic Institute in Mannheim,
Germany and an M.S. degree in Chemical Engineering from Tufts University.

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, 2004, 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. Hartoun Hartounian and William G. Kachioff each
failed to file timely one Form 4 reporting two transactions, an option exercise
and a sale of common stock.

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 2004, was composed of Dr. Anderson, Mr.
Frankel and Dr. Gavin.


                                      -36-


<PAGE>

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 Directors are paid a retainer of $1,500 each month. During the fiscal year
ended December 31, 2004, 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, $9,000 to
Cynthia Tsai, and $9,000 to Myron A. Wick III.

In August 2004, Ms Tsai and Mr. Wick each received non-qualified options to
purchase 100,000 shares of common stock at an exercise price of $1.13 per share.
The options vest over 3 years and expire ten years after the date of grant.


COMPENSATION OF EXECUTIVE OFFICERS

The following table sets forth the annual and long-term compensation paid by our
company or MicroIslet of Delaware for services performed on our company's or
MicroIslet of Delaware's behalf for the three fiscal years ended December 31,
2004, with respect to those persons who served as the Chief Executive Officer
during the year ended December 31, 2004, and those executive officers who
received more than $100,000 in compensation for fiscal 2004.

<TABLE>
                                     Summary Compensation Table (1)
                                     ------------------------------

                                                                                         Long-Term
                                                          Annual Compensation          Compensation
                                                          -------------------           Securities
Name and Principal Position                      Year      Salary        Bonus      Underlying Options
- ---------------------------                      ----      ------        -----      ------------------
<S>                                              <C>      <C>          <C>                 <C>
John F. Steel IV, Chairman and Chief             2004     $168,000         -0-                 -0-
     Executive Officer (2)                       2003     $168,000      $2,000                 -0-
                                                 2002     $179,500         -0-                 -0-

Hartoun Hartounian, Ph.D., President             2004     $230,000     $90,000                 -0-
     and Chief Operating Officer (2)             2003     $234,230      $2,000             150,000
                                                 2002     $185,620         -0-              62,510

William G. Kachioff, Vice President,             2004     $165,000     $32,400                 -0-
     Finance and Chief Financial Officer (3)     2003     $150,000      $2,000             150,000
                                                 2002     $122,322      $5,000             262,500
</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 fair market value.

(2) Mr. Steel and Dr. Hartounian joined us in April 2002 with the completion of
the acquisition of MicroIslet of Delaware. Compensation in 2002 includes
compensation paid by us after the acquisition and compensation paid by
MicroIslet of Delaware prior to the acquisition.

(3) Mr. Kachioff joined us on a full-time basis in May 2002. Mr. Kachioff was a
consultant to MicroIslet of Delaware from February 2002 to April 2002, and
compensation shown includes consulting payments for that period.

There were no options granted to executive officers during 2004. 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, 2004, 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.


                                      -37-


<PAGE>

     The following table sets forth information concerning options exercised by
our named executive officers during the fiscal year ended December 31, 2004, and
unexercised options held by our named executive officers as of December 31,
2004.

<TABLE>
                      AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES

                                                                 NUMBER OF SECURITIES          VALUE OF UNEXERCISED IN THE
                                                                UNDERLYING UNEXERCISED              MONEY OPTIONS AT
                                 SHARES                           OPTIONS AT 12/31/04                  12/31/04(1)
                               ACQUIRED OR      VALUE         -----------------------------    -----------------------------
NAME                          EXERCISED (#)   REALIZED ($)    EXERCISABLE     UNEXERCISABLE    EXERCISABLE     UNEXERCISABLE
----                          -------------   ------------    -----------     -------------    -----------     -------------
<S>                              <C>            <C>             <C>                <C>          <C>                  <C>
John F. Steel IV                       -               -                -               -                -           -

Hartoun Hartounian, Ph.D.        250,000        $592,060        1,212,710               -       $1,110,697           -

William G. Kachioff              120,000        $253,925          278,611          13,889          $21,900           -
</TABLE>

(1) Represents the difference between the $1.28 closing selling price of our
    common stock on December 31, 2004 and the exercise price(s) of the named
    executive officer's options.


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

MicroIslet of Delaware entered into an agreement with Hartoun Hartounian dated
June 23, 2000, which agreement was assumed by us and amended effective January
30, 2004 and July 1, 2004. Under the agreement, as amended, we have the right to
terminate Dr. Hartounian's employment at any time and for any reason. If,
however, we do so without cause or if Dr. Hartounian terminates his agreement
for good reason, we must continue to pay salary for six months following
termination. Upon such termination, Dr. Hartounian will also be provided twelve
months to exercise his vested options. Dr. Hartounian must sign a waiver and
release of claims in order to receive these benefits. In addition, the agreement
as amended provides that Dr. Hartounian's initial grant of stock options for
1,250,200 shares will vest and become immediately exercisable upon a "change of
control" of our company, which generally means a merger, liquidation or sale of
all or substantially all of our stock or assets. Dr. Hartounian's base salary
was increased to $250,000 per year on July 1, 2004. Dr. Hartounian is also
eligible for a bonus of up to 40% of his base salary for the 2004 calendar year
based on performance goals approved by our compensation committee under our
performance cash bonus plan.

We entered into an agreement with William G. Kachioff dated May 1, 2002, which
agreement was amended effective January 30, 2004 and July 1, 2004. Under the
agreement, we have the right to terminate Mr. Kachioff's employment at any time
and for any reason. If, however, we do so without cause or if Mr. Kachioff
terminates his agreement for good reason, we must continue to pay salary for six
months following termination. Upon such termination, Mr. Kachioff will also be
provided twelve months to exercise his vested options. Mr. Kachioff must sign a
waiver and release of claims in order to receive these benefits. In addition,
the agreement provides that Mr. Kachioff's initial grant of stock options for
250,000 shares will vest and become immediately exercisable upon a "change of
control" of our company, which generally means a merger, liquidation or sale of
all or substantially all of our stock or assets. Mr. Kachioff's base salary was
increased to $180,000 per year on July 1, 2004. Mr. Kachioff is also eligible
for a bonus of up to 20% of his base salary for the 2004 calendar year based on
performance goals approved by our compensation committee under our performance
cash bonus plan.


                                      -38-


<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, 2004:

<TABLE>
                                                                                          NUMBER OF SECURITIES
                                                                                           REMAINING AVAILABLE
                                                                                           FOR FUTURE ISSUANCE
                                                                                              UNDER EQUITY
                                   NUMBER OF SECURITIES TO          WEIGHTED-AVERAGE       COMPENSATION PLANS
                                   BE ISSUED UPON EXERCISE          EXERCISE PRICE OF     (EXCLUDING SECURITIES
                                   OF OUTSTANDING OPTIONS,        OUTSTANDING OPTIONS,        REFLECTED IN
      PLAN CATEGORY                  WARRANTS AND RIGHTS           WARRANTS AND RIGHTS         COLUMN (A))
      -------------                  -------------------           -------------------         -----------
                                            (a)                            (b)                     (c)
<S>                                     <C>                               <C>                   <C>
Equity compensation plans
approved by security holders (1)        4,043,468 (2)                     $1.09                 1,427,871 (3)

Equity compensation plans not
approved by security holders            3,467,021 (4)                     $4.10                     --

Total                                   7,510,489                         $2.48                 1,427,871
</TABLE>

(1) Our Board of Directors adopted the MicroIslet of Delaware 2000 Stock Option
Plan on May 9, 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 Stock Option
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.

(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) The number of securities remaining available for future issuance under
equity compensation plans (excluding securities to be issued upon exercise of
outstanding options, warrants and rights) as of January 1, 2004 was 111,333.

(4) 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. Of
those, options representing 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 10.33, 10.34 and 10.35 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 10.32. 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 "Company Overview - History"
in Item 1. 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
10.37. 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 10.37, 10.39, 10.40, 10.41 and 10.42. Of those, warrants
representing 638,334 shares remain outstanding.


                                      -39-


<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 14, 2005, 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 of 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>
                                                        Number of Shares
Name and Address of Beneficial Owner (1)             Beneficially Owned (2)       Percent of Class (2)
----------------------------------------             ----------------------       --------------------
<S>                                                      <C>                               <C>

John F. Steel IV                                          8,983,251(3)                     22.6%

Richard Schoninger                                        3,190,850(4)                      8.0%
667 Madison Avenue
New York, NY 10021

Don and Bonnie Saunders Family Trust                      2,738,497(5)                      6.9%
900 E. Desert Inn Road, Apt. 521
Las Vegas, NV 89109

John J. Hagenbuch                                         3,819,852(6)                      9.5%
3673 Jackson Street
San Francisco, CA 94118

Hartoun Hartounian, Ph.D.                                 1,212,710(7)                      3.0%

William G. Kachioff                                         292,500(7)                      *

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

Steven T. Frankel                                           144,000(7)                      *

James R. Gavin III, M.D., Ph.D.                             190,648(7)                      *

Myron A. Wick III                                           373,654(7)(9)                   *

Cynthia Ekberg Tsai                                          25,000(7)                      *

All officers and directors as a group (8 in number)      11,412,411(8)                     27.3%

</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 39,683,931 shares outstanding on March 14, 2005, 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.

                                       -40-


<PAGE>


(5) Don and Bonnie Saunders are the trustees of the Don and Bonnie Saunders
Family Trust, and share voting and investment power over the 2,091,129 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
2,499,339 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.


(6) Includes 1,758,772 shares held by Jackson St. Partners, 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 14, 2005.


(8) Includes 2,188,968 shares subject to options and warrants exercisable within
60 days of March 14, 2005.

(9) Includes 211,025 shares of common stock beneficially owned by D-W
Investments, LLC, over which Mr. Wick possesses sole voting and investment
control, and 108,462 shares subject to warrants held by Mr. Wick that are
exercisable within 60 days of March 14, 2005. Also includes 25,000 shares that
are issuable upon exercise of options exercisable within 60 days of March 14,
2005, and 29,167 shares that D-W Investments has the right to purchase from John
F. Steel IV within 60 days of March 14, 2005.


CHANGES IN CONTROL

On February 22, 2005, Mr. John J. Hagenbuch, an affiliated partnership and an
affiliated trust, which we refer to collectively as the Hagenbuch holders, filed
a Schedule 13D with the Securities and Exchange Commission. In such Schedule
13D, Mr. Hagenbuch indicated that the Hagenbuch holders expected to deliver to
us a notice of nominations for directors and a proposal to amend our bylaws to
set a Board size of five directors. Presently, our bylaws permit the Board of
Directors to set the Board size at any number of directors, and our Board has
set the size at seven directors. The Hagenbuch holders indicated that they would
nominate Mr. Hagenbuch for one of the Board seats. Our bylaws provide that the
deadline for submitting such notice for action at our 2005 annual meeting of
stockholders is February 24, 2005, provided that the annual meeting date is not
advanced or delayed by more than 30 days from the anniversary date of the prior
year's annual meeting.

The Schedule 13D indicated that the Hagenbuch holders beneficially own 9.5% of
our outstanding common shares. The Hagenbuch holders also stated in such filing
that they had been in discussions with other stockholders who beneficially own
an aggregate of 38.5% of our outstanding common stock, and who the Hagenbuch
holders believed would agree to act together with the Hagenbuch holders,
although they had not yet so agreed. Mr. Hagenbuch is the brother-in-law of John
F. Steel IV, our Chairman and CEO, and the beneficial owner of approximately
22.6% of our outstanding common stock, and one of the beneficial owners
contacted by the Hagenbuch holders.

Our Board of Directors met on February 24, 2005 to discuss the Schedule 13D
filing by the Hagenbuch holders. In order to permit more time for our Board of
Directors and the nominating and governance committee of the Board to discuss
the Hagenbuch holders' proposals, our Board resolved to delay the date for the
2005 annual meeting of stockholders to a date more than thirty days after the
May 25, 2005 anniversary date of the annual meeting of stockholders held in
2004. The Board has not yet determined the date for the rescheduled meeting.

                                       -41-


<PAGE>

As a result of the delayed annual meeting date, the dates for which timely
notice may be received from a stockholder for nominations or other business to
be properly brought before the 2005 annual meeting will be no earlier than 120
days before the date of the rescheduled meeting, and no later than the later of
90 days before the date of the rescheduled meeting or 10 days after public
announcement of the meeting. We will disclose the dates for timely notice of
nominations and other business under our bylaws, and the deadline for submitting
a stockholder proposal for inclusion in our proxy statement and form of proxy
for the 2005 annual meeting pursuant to SEC Rule 14a-8, when we announce the
rescheduled annual meeting date.

On February 24, 2005, the Hagenbuch holders filed an amended Schedule 13D. Such
amendment indicates that Mr. Hagenbuch has had conversations with our Board
regarding the matters described in the initial Schedule 13D filing, and also
with stockholders beneficially owning (based on publicly available information)
approximately 41% of our outstanding common stock. The Hagenbuch holders state
in such amendment that as a result of these discussions, they are considering
the advisability of a larger Board. The amendment further indicates that Mr.
Hagenbuch is discussing with us appropriate nominees to the Board, which would
continue to include himself.

Since the original filing of the Schedule 13D by the Hagenbuch holders, our
nominating and governance committee has been engaging in dialog with Mr.
Hagenbuch concerning the size and composition of our Board. The nominating and
governance committee is currently considering an increase in our Board size to
nine directors, and the appointment of Mr. Hagenbuch and one other director, who
would be "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. The nominating and governance committee expects to make its
recommendations to the full Board in early April 2005, and the Board expects
shortly thereafter to determine a date for our 2005 annual meeting of
stockholders.

THE FOREGOING IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE A
SOLICITATION BY US OF A PROXY, CONSENT OR AUTHORIZATION FOR OR WITH RESPECT TO
THE 2005 ANNUAL MEETING OF STOCKHOLDERS. ANY SUCH SOLICITATION BY US WILL BE
MADE ONLY PURSUANT TO A PROXY STATEMENT AND OTHER SOLICITATION MATERIALS
COMPLYING WITH ALL APPLICABLE REQUIREMENTS OF SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934, AND THE RULES AND REGULATIONS PROMULGATED THEREUNDER.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In April 2003 and May 2003, we borrowed $300,000 and $200,000, respectively,
from a trust affiliated with Mr. John J. Hagenbuch, a significant beneficial
owner of our shares. The loans had an annual interest rate of 4.25%, with
principal and accrued interest originally due August 9, 2003 and September 9,
2003. As additional consideration for the loans, we issued to the lender two
ten-year warrants exercisable for 50,000 shares of common stock at an exercise
price of $1.49 and 50,000 shares of common stock at an exercise price of $0.85
per share.

On August 26, 2003, we reached agreement with Mr. Hagenbuch to extend the
maturity dates of the loans to December 7, 2003 and January 8, 2004,
respectively. As additional consideration for the loan extensions, we issued the
lender two ten-year warrants exercisable for an aggregate of 100,000 shares of
common stock at an exercise price of $0.50 per share.

On October 31, 2003, we reached agreement with Mr. Hagenbuch to cancel the notes
evidencing the loans in exchange for 1,022,200 shares and a warrant to purchase
408,880 shares at $1.00 per share. The two loans had a combined principal and
interest balance of $511,100. At the same time, Mr. Hagenbuch agreed to have his
trust purchase for cash 300,000 shares at $0.50 per share. Mr. Hagenbuch's trust
also received a warrant to purchase 120,000 shares at $1.00 per share in
connection with this purchase. As a result of these transactions, Mr. Hagenbuch
is now beneficial owner of approximately 9.6% of our outstanding stock.

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 five-year warrants 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 warrants to purchase 89,231 shares to Mr. Wick
for placement agent services received in connection with the financing. The
warrants have an exercise price of $1.30 per share and expire on March 16, 2006.
Mr. Wick joined our Board of Directors in July 2004.


                                      -42-


<PAGE>

ITEM 13. EXHIBITS

       Exhibit No.  Document Description
       -----------  --------------------

          2.1       Merger Agreement and Plan of Reorganization dated as of
                    April 22, 2002 by and among the Registrant, ALD Services
                    Merger Subsidiary, Inc. and MicroIslet of Delaware
                    (incorporated by reference to the Registrant's Current
                    Report on Form 8-K filed with the Commission on April 29,
                    2002).

          3.1       Articles of Incorporation of the Registrant (incorporated by
                    reference to the Registrant's Registration Statement on Form
                    10-SB filed with the Commission on August 13, 1999).

          3.2       Certificate of Amendment to the Articles of Incorporation of
                    the Registrant (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          3.3       Amended and Restated Bylaws of the Registrant (incorporated
                    by reference to the Registrant's Form 8-K filed with the
                    Commission on December 15, 2004).

          4.1       Specimen Common Stock Certificate (incorporated by reference
                    to the Registrant's Amendment No. 1 to Registration
                    Statement on Form SB-2 filed with the Commission on November
                    20, 2002).

          10.1      Amended and Restated 2000 Stock Option Plan of the
                    Registrant, as amended and restated January 30, 2004
                    (incorporated by reference to the Registrant's Form 10-KSB
                    filed with the Commission on March 30, 2004).*

          10.2      Form of Stock Option Grant Notice and Stock Option Agreement
                    under 2000 Stock Option Plan. (1)

          10.3      Investment Banking Agreement dated October 22, 2001 by and
                    between MicroIslet of Delaware and ASA Investment Company,
                    as amended (incorporated by reference to the Registrant's
                    Registration Statement on Form SB-2 filed with the
                    Commission on July 25, 2002).

          10.4      License and Sponsored Research Agreement dated September 15,
                    1998 by and between MicroIslet of Delaware and Duke
                    University (incorporated by reference to the Registrant's
                    Amendment No. 3 to Registration Statement on Form SB-2 filed
                    with the Commission on February 10, 2003).

          10.5      Amendment to License and Sponsored Research Agreement dated
                    February 5, 1999 by and between MicroIslet of Delaware and
                    Duke University (incorporated by reference to the
                    Registrant's Amendment No. 3 to Registration Statement on
                    Form SB-2 filed with the Commission on February 10, 2003).

          10.6      Research Service Agreement dated November 20, 2002 between
                    the Registrant and The Governors of the University of
                    Alberta (incorporated by reference to the Registrant's
                    Amendment No. 3 to Registration Statement on Form SB-2 filed
                    with the Commission on February 10, 2003).

          10.7      Research Funding and Option Agreement dated February 20,
                    2003 by and between the Registrant and the Scripps Research
                    Institute, a California nonprofit public benefit corporation
                    (incorporated by reference to the Registrant's Annual Report
                    on Form 10-KSB for the fiscal year ended December 31, 2002
                    filed on March 28, 2003).+


                                      -43-


<PAGE>

          10.8      Standard Industrial/Commercial Multi-Tenant Lease dated July
                    3, 2002 by and between the Registrant and Nancy Ridge
                    Technology Center, L.P. (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.9      Warrant Agreement (incorporated by reference to the
                    Registrant's Current Report on Form 8-K dated March 1, 2002
                    and filed with the Commission on March 6, 2002).

          10.10     Class A Warrant Certificate dated April 2, 2002, issued to
                    Donald G. Saunders (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.11     Class B Warrant Certificate dated April 2, 2002, issued to
                    Donald G. Saunders (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.12     Class A Warrant Certificate dated April 2, 2002, issued to
                    Thomas K. Russell (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.13     Class B Warrant Certificate dated April 2, 2002, issued to
                    Thomas K. Russell (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.14     Class A Warrant Certificate dated April 2, 2002, issued to
                    Mark C. Russell (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.15     Class B Warrant Certificate dated April 2, 2002, issued to
                    Mark C. Russell (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).

          10.16     Employment Agreement between MicroIslet of Delaware and
                    Hartoun Hartounian dated June 23, 2000 (incorporated by
                    reference to the Registrant's Form 10-KSB filed with the
                    Commission on March 30, 2004).*

          10.17     Amendment Agreement dated January 30, 2004 to Employment
                    Agreement between MicroIslet of Delaware and Hartoun
                    Hartounian dated June 23, 2000 (incorporated by reference to
                    the Registrant's Form 10-KSB filed with the Commission on
                    March 30, 2004).*

          10.18     Employment Agreement between the Registrant and William
                    Kachioff dated May 1, 2002 (incorporated by reference to the
                    Registrant's Annual Report on Form 10-KSB for the fiscal
                    year ended December 31, 2002 filed on March 28, 2003). *

          10.19     Amendment Agreement dated January 30, 2004 to Employment
                    Agreement between the Registrant and William Kachioff dated
                    May 1, 2002 (incorporated by reference to the Registrant's
                    Form 10-KSB filed with the Commission on March 30, 2004).*

          10.20     Common Stock Purchase Agreement, dated as of April 1, 2003
                    between the Registrant and Fusion Capital Fund II, LLC
                    (incorporated by reference to the Registrant's Current
                    Report on Form 8-K dated and filed on April 2, 2003).

          10.21     Registration Rights Agreement, dated as of April 1, 2003
                    between the Registrant and Fusion Capital Fund II, LLC
                    (incorporated by reference to the Registrant's Current
                    Report on Form 8-K dated and filed on April 2, 2003).


                                      -44-


<PAGE>

          10.22     120 Day Note, dated April 11, 2003 between the Registrant
                    and John J. Hagenbuch, Trustee U/D/T dated September 13,
                    1995 (incorporated by reference to Exhibit 10.18 to the
                    Registrant's Form SB-2 filed April 15, 2003).

          10.23     Warrant Agreement, dated April 11, 2003 between the
                    Registrant and John J. Hagenbuch, Trustee U/D/T dated
                    September 13, 1995 (incorporated by reference to Exhibit
                    10.19 to the Registrant's Form SB-2 filed April 15, 2003).

          10.24     120 Day Note, dated May 12, 2003 between the Registrant and
                    John J. Hagenbuch, Trustee U/D/T dated September 13, 1995
                    (incorporated by reference to Exhibit 10.1 to the
                    Registrant's Form 8-K filed May 13, 2003).

          10.25     Warrant Agreement, dated May 12, 2003 between the Registrant
                    and John J. Hagenbuch, Trustee U/D/T dated September 13,
                    1995 (incorporated by reference to Exhibit 10.2 to the
                    Registrant's Form 8-K filed May 13, 2003).

          10.26     Amendment to 120 Day note, dated August 26, 2003 between the
                    Registrant and John J. Hagenbuch, Trustee U/D/T dated
                    September 13,1995 (incorporated by reference to Exhibit 10.1
                    to the Registrant's Form 8-K filed August 28, 2003).

          10.27     Warrant Amendment, dated August 26, 2003 between the
                    Registrant and John J. Hagenbuch, Trustee U/D/T dated
                    September 13,1995 (incorporated by reference to Exhibit 10.2
                    to the Registrant's Form 8-K filed August 28, 2003).

          10.28     Amendment to 120 Day note, dated August 26, 2003 between the
                    Registrant and John J. Hagenbuch, Trustee U/D/T dated
                    September 13,1995 (incorporated by reference to Exhibit 10.3
                    to the Registrant's Form 8-K filed August 28, 2003).

          10.29     Warrant Amendment, dated August 26, 2003 between the
                    Registrant and John J. Hagenbuch, Trustee U/D/T dated
                    September 13,1995 (incorporated by reference to Exhibit 10.4
                    to the Registrant's Form 8-K filed August 28, 2003).

          10.30     Form of Stock Purchase Agreement (incorporated by reference
                    to Exhibit 10.1 to the Registrant's Form 8-K filed on
                    September 11, 2003).

          10.31     Amended and Restated Securities Purchase Agreement dated
                    October 31, 2003 between the Registrant and the purchasers
                    named therein (incorporated by reference to Exhibit 10.1 to
                    the Registrant's Form 8-K filed November 3, 2003).

          10.32     Form of Warrant dated October 31, 2003 (incorporated by
                    reference to Exhibit 10.2 to the Registrant's Form 8-K filed
                    November 3, 2003).

          10.33     Form of Special Stock Option used in connection with option
                    grants outside of Registrant's stock option plans
                    (incorporated by reference to the Registrant's Registration
                    Statement on Form S-8 filed September 26, 2003).

          10.34     Special Stock Option granted to Robert W. Anderson on
                    November 10, 2003 (incorporated by reference to the
                    Registrant's Form 10-KSB filed with the Commission on March
                    30, 2004).*

          10.35     Special Stock Option granted to James R. Gavin III on
                    November 10, 2003 (incorporated by reference to the
                    Registrant's Form 10-KSB filed with the Commission on March
                    30, 2004).*

          10.36     Special Stock Option granted to Steven T. Frankel on
                    November 10, 2003 (incorporated by reference to the
                    Registrant's Form 10-KSB filed with the Commission on March
                    30, 2004).*


                                      -45-


<PAGE>

          10.37     Form of Securities Purchase Agreement dated as of March 16,
                    2004 (incorporated by reference to the Registrant's Form
                    10-KSB filed with the Commission on March 30, 2004).

          10.38     Form of Warrant Agreement dated as of March 16, 2004
                    (incorporated by reference to the Registrant's Form 10-KSB
                    filed with the Commission on March 30, 2004).

          10.39     Table of Special Stock Options granted outside of
                    Registrant's Stock Option plans (1).*

          10.40     Warrant Agreement, dated January 30, 2004, between the
                    Registrant and Strategic Growth International, Inc.
                    (incorporated by reference to Exhibit 10.3 to the
                    Registrant's Form 10-QSB filed May 13, 2004).

          10.41     Warrant Agreement, dated April 1, 2004, between the
                    Registrant and BetaDynamics, LLC (incorporated by reference
                    to the Registrant's Form S-2 filed May 28, 2004).

          10.42     Warrant Agreement, dated April 1, 2004, between the
                    Registrant and SBI Brightline VII, LLC (incorporated by
                    reference to the Registrant's Form S-2 filed May 28, 2004).

          10.43     Warrant Agreement, dated May 25, 2004, between the
                    Registrant and Strategic Growth International, Inc.
                    (incorporated by reference to Exhibit 10.3 to the
                    Registrant's Form 10-QSB filed August 13, 2004).

          10.44     MicroIslet Inc. Executive Performance Cash Bonus Plan
                    (incorporated by reference to Exhibit 10.1 to the
                    Registrant's Form 10-QSB/A filed February 15, 2005).*

          10.45     Summary Sheet of Director and Executive Officer
                    Compensation.(1)*

          10.46     Short Term Supply Agreement dated February 23, 2005 between
                    the Registrant and Mayo Foundation for Medical Education and
                    Research (incorporated by reference to the Registrant's Form
                    8-K/A filed on March 29, 2005).+

          21.1      List of Subsidiaries (incorporated by reference to the
                    Registrant's Registration Statement on Form SB-2 filed with
                    the Commission on July 25, 2002).


          23.1      Consent of Deloitte & Touche LLP

          24.1      Power of Attorney (previously filed and included as part of
                    the signature page attached hereto).


          31.1      Certification of John F. Steel IV, 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 William G. Kachioff, 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. Section 1350, as adopted
                    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
                    executed by John F. Steel IV, Principal Executive Officer,
                    and William G. Kachioff, Principal Financial Officer


(1) Previously filed.
* Management contract or compensatory plan or arrangement.


+ 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.


                                      -46-


<PAGE>

ITEM 14. INDEPENDENT AUDITORS' FEES AND SERVICES

The following table summarizes the aggregate fees billed to the Company by
Deloitte & Touche LLP, our independent auditor, for the audit of our annual
financial statements for the years ended December 31, 2004 and December 31, 2003
and fees billed for other services rendered by Deloitte & Touche LLP during
those periods.

Type of Fee                          2004                   2003
-----------                          ----                   ----
Audit Fees (1)                     $ 92,950               $ 71,577
Audit Related Fees (2)                8,250                 29,140
Tax Fees (3)                          8,500                 10,560
Total                              $109,700               $111,277

(1) Fees for audit services billed in 2004 and 2003 consisted of professional
services rendered by Deloitte & Touche LLP for the audit of our annual financial
statements and review of financial statements included in our reports on Form
10-Q.

(2) Fees for audit-related services billed in 2004 and 2003 consisted of
financial accounting and reporting consultations performed by Deloitte & Touche
LLP.

(3) Fees for tax services billed in 2004 and 2003 consisted of professional
services rendered by Deloitte & Touche LLP for tax compliance. Tax compliance
services are services rendered based upon facts already in existence or
transactions that have already occurred to document, compute, and obtain
government approval for amounts to be included in tax filings and consisted of:
Federal, state, and local income tax return assistance.

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,
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. 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, 2004 and has
concluded that such services are compatible with such firm's independence.


                                      -47-


<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/ John F. Steel IV
                                           ------------------------------------
                                           John F. Steel IV
                                           Chairman and Chief Executive Officer
                                           (Principal Executive Officer)


                                       Date:  September 27, 2005


KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby severally constitutes and appoints John F. Steel IV, Hartoun
Hartounian and William Kachioff, and each of them, his or her true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution
for him or her and in his or her 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 or she 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 or her 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>
            Signature                             Title                               Date
            ---------                             -----                               ----
<S>                                  <C>                                         <C>
/s/ John F. Steel IV                 Chairman and Chief Executive                September 27, 2005
---------------------------------    Officer (Principal Executive Officer)
John F. Steel IV


/s/ William G. Kachioff              Vice President, Finance and Chief           September 27, 2005
---------------------------------    Financial Officer (Principal
William G. Kachioff                  Financial and Accounting Officer)


/s/ Hartoun Hartounian               President, Chief Operating Officer          September 27, 2005
---------------------------------    and Director
Hartoun Hartounian, Ph.D.


/s/ Robert W. Anderson               Director                                    September 27, 2005
---------------------------------
Robert W. Anderson, M.D.


/s/ James R. Gavin III               Director                                    September 27, 2005
---------------------------------
James R. Gavin III, M.D., Ph.D.


/s/ Steven T. Frankel                Director                                    September 27, 2005
---------------------------------
Steven T. Frankel


/s/ Cynthia Ekberg Tsai              Director                                    September 27, 2005
---------------------------------
Cynthia Ekberg Tsai


/s/ Myron A. Wick III                Director                                    September 27, 2005
---------------------------------
Myron A. Wick III


/s/ John J. Hagenbuch                Director                                    September 27, 2005
---------------------------------
John J. Hagenbuch


/s/ Bradley A. Geier                 Director                                    September 27, 2005
---------------------------------
Bradley A. Geier

</TABLE>


                                                  -48-


<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 (the "Company") as of December 31, 2004 and 2003, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended December 31, 2004 and 2003 and for the period from August 21,
1998 (date of inception) to December 31, 2004. 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, 2004 and 2003, and the results of their operations and their
cash flows for the years ended December 31, 2004 and 2003 and for the period
from August 21, 1998 (date of inception) to December 31, 2004 in conformity with
accounting principles generally accepted in the United States of America.

As discussed in Note 13 to the consolidated financial statements, the
accompanying consolidated financial statements for the year ended December 31,
2004 and the period from August 21, 1998 (date of inception) to December 31,
2004 have been restated.

We have not audited any financial statements of the Company for any period
subsequent to December 31, 2004. However, as discussed in Note 15 to the
financial statements, the Company has continued to incur operating losses
subsequent to December 31, 2004, and as of June 30, 2005, the Company's cash
position was $5.1 million. In addition, management has projected that cash on
hand will allow the Company to continue its operations until March 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 15. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.


/s/ Deloitte & Touche LLP


San Diego, California
March 25, 2005 (September 27, 2005 as to the effects of the restatement
discussed in Note 13 and the subsequent event as discussed in Note 15)


                                      F-1


<PAGE>

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


                                                                             December 31,      December 31,
                                                                                 2004              2003
                                                                            -------------     -------------
                                                                            (as restated
                                                                             See Note 13)
<S>                                                                         <C>               <C>
ASSETS

Current Assets:
     Cash and cash equivalents                                              $   8,777,364     $     529,877
     Grants receivable                                                                 --            16,242
     Prepaid expenses                                                             223,284            65,849
                                                                            -------------     -------------

                 Total current assets                                           9,000,648           611,968
                                                                            -------------     -------------

Property and equipment, net                                                       203,018           104,952
Patents, net                                                                       11,048            11,522
Deposits and other assets                                                          57,602            50,210
                                                                            -------------     -------------

                 Total assets                                               $   9,272,316     $     778,652
                                                                            =============     =============

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
     Research expenses due to stockholder                                   $          --     $     230,000
     Accounts payable and accrued expenses                                        393,270           181,458
                                                                            -------------     -------------

                 Total current liabilities                                        393,270           411,458
                                                                            -------------     -------------

Stockholders' Equity:
     Convertible preferred stock - $.001 par value: 10,000,000
        shares authorized; zero shares issued and outstanding
        at December 31, 2004 and December 31, 2003                                     --                --
     Common stock - $.001 par value: 100,000,000 shares authorized;
        39,646,846 and 28,143,699 shares issued and outstanding
        at December 31, 2004 and December 31, 2003, respectively                   39,647            28,144
     Additional paid-in capital                                                30,435,917        15,417,108
     Deficit accumulated during the development stage                         (21,596,518)      (15,078,058)
                                                                            -------------     -------------

                 Total stockholders' equity                                     8,879,046           367,194
                                                                            -------------     -------------

                 Total liabilities and stockholders' equity                 $   9,272,316     $     778,652
                                                                            =============     =============


                              See notes to consolidated financial statements.

                                                    F-2

<PAGE>

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


                                                                   Year Ended               August 21, 1998
                                                                  December 31,                     to
                                                         -------------------------------      December 31,
                                                              2004              2003              2004
                                                         -------------     -------------     -------------
                                                         (as restated                        (as restated
                                                          See Note 13)                        See Note 13)

Grant revenue                                            $          --     $     255,857     $     409,790

Expenses:
   Research and development expenses                         2,913,213         1,497,682        10,276,227
   General and administrative expenses                       3,711,392         1,640,389        11,712,287
                                                         -------------     -------------     -------------
       Operating expenses                                   (6,624,605)       (3,138,071)      (21,988,514)
                                                         -------------     -------------     -------------
       Loss from operations                                 (6,624,605)       (2,882,214)      (21,578,724)
                                                         -------------     -------------     -------------

Other income (expense):
   Interest income                                             110,666             3,600           164,549
   Interest and other expenses                                    (194)         (153,763)         (172,895)
   Other                                                        (4,327)           (7,440)           (9,448)
                                                         -------------     -------------     -------------
       Total other income (expense)                            106,145          (157,603)          (17,794)
                                                         -------------     -------------     -------------

    Net loss                                             $  (6,518,460)    $  (3,039,817)    $ (21,596,518)
                                                         =============     =============     =============

Basic and diluted net loss per share                     $        (.17)    $        (.12)    $       (1.00)
                                                         =============     =============     =============

Weighted average number of shares outstanding
   used in calculation                                      37,478,449        24,359,263        21,528,278


                              See notes to consolidated financial statements.

                                                    F-3


<PAGE>

                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2004

                                                                                          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-4


<PAGE>

                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2004


                                                                                          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-5


<PAGE>

                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2004


                                                                                          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-6

<PAGE>

                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
                              For the period August 21, 1998 (Date of Inception) to December 31, 2004


                                                                                          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
  (As restated, see Note 13)                                                                1,669,203                     1,669,203

Net loss (As restated,
  see Note 13)                                                                                            (6,518,460)    (6,518,460)
                               ------------  ------------  ------------   ------------   ------------   ------------   ------------

Balance, December 31, 2004
(As restated, see Note 13)               --  $         --    39,646,846   $     39,647   $ 30,435,917   $(21,596,518)  $  8,879,046
                               ============  ============  ============   ============   ============   ============   ============

                                           See notes to consolidated financial statements.


                                                                 F-7


<PAGE>

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


                                                                                               August 21, 1998
                                                              Year Ended        Year Ended            to
                                                             December 31,      December 31,      December 31,
                                                                 2004              2003              2004
                                                            -------------     -------------     -------------
                                                            (as restated                        (as restated
                                                             See Note 13)                        See Note 13)

Cash flows from operating activities:
   Net loss                                                 $  (6,518,460)    $  (3,039,817)    $ (21,596,518)
   Adjustments to reconcile net loss to net cash
     used in operating activities:
        Compensation paid with warrant                          1,669,203                --         5,146,926
        Interest paid with warrant                                     --           142,300           142,300
        In process research and development
          acquired for common stock                                    --                --         2,067,518
        Compensation paid with stock options                      354,478           253,717         2,491,435
        Depreciation and amortization                              50,731            45,314           157,641
        Loss on disposal of equipment                                  --             3,149            18,233
Changes in operating assets and liabilities:
   Deposits and other assets                                       (7,392)               --           (70,072)
   Grants receivable                                               16,242            18,805                --
   Prepaid expenses                                              (157,435)           44,620          (223,284)
   Deferred grant revenue                                              --           (40,352)               --
   Accounts payable and accrued expenses                          211,812           (23,885)          623,231
   Research expenses due to stockholder                          (230,000)               --                --
                                                            -------------     -------------     -------------

           Net cash used in operating activities               (4,610,821)       (2,596,148)      (11,242,590)
                                                            -------------     -------------     -------------

Cash flows from investing activities:
      Proceeds from sale of property and equipment                     --             1,000             1,000
      Purchases of property and equipment                        (148,323)          (16,867)         (408,470)
                                                            -------------     -------------     -------------

           Net cash used in investing activities                 (148,323)          (15,867)         (407,470)
                                                            -------------     -------------     -------------

Cash flows from financing activities:
   Loan from related parties                                           --           525,000           525,000
   Repayment of loan from related parties                              --           (25,000)          (25,000)
   Proceeds from sale of common stock                          13,006,631         1,828,197        19,740,924
   Proceeds from sale of preferred stock                               --                --           186,500
                                                            -------------     -------------     -------------

           Net cash provided by financing activities           13,006,631         2,328,197        20,427,424
                                                            -------------     -------------     -------------

           Net increase (decrease) in cash and cash
             equivalents                                        8,247,487          (283,819)        8,777,364

Cash and cash equivalents at beginning of period                  529,877           813,696                --
                                                            -------------     -------------     -------------

Cash and cash equivalents at end of period                  $   8,777,364     $     529,877     $   8,777,364
                                                            =============     =============     =============

Interest paid                                               $         194     $         364     $       8,302
Income taxes paid                                           $       1,575     $       3,445     $       1,130

Non-cash investing and financing activities:
   Conversion of loan from related parties to
      common stock                                          $          --     $     510,078     $     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     $     199,967     $     315,967
   Warrants issued in debt transaction                      $          --     $     142,300     $     142,300
   Compensation paid with warrant related to
      reverse merger                                        $          --     $          --     $   3,477,723
   Compensation expense related to options
      issued                                                $     354,478     $     193,691     $   2,491,435
   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

                               See notes to consolidated financial statements.

                                                     F-8
</TABLE>


<PAGE>

NOTES TO THE FINANCIAL STATEMENTS

NOTE 1.   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 to December 31, 2004, 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, 2004.


As shown in the financial statements, the Company incurred net losses of $6.5
million and $3.0 million for 2004 and 2003, respectively, and had an accumulated
deficit of $21.6 million as of December 31, 2004. As described in Note 7, on
March 16, 2004, the Company completed the sale of common stock for gross
proceeds of $12.8 million. The Company sold an aggregate of approximately 9.8
million shares for $1.30 per share. In connection with the financing, the
Company also issued to the investors five-year warrants to purchase an aggregate
of approximately 4.9 million shares at $1.00 per share. The Company expects to
incur substantial additional costs, including costs related to ongoing research
and development activities, preclinical studies and trials. The Company believes
that its existing funds will be sufficient to fund its operating expenses and
capital requirements into early 2006. The Company intends to raise additional
debt and/or equity financing to sustain its operations. 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. The Company intends 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 the Company's continued ability to obtain future funding, satisfactory
product development, regulatory approvals and market acceptance for the
Company's products.


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, since it has derived only
minimal revenues from its activities to date.

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.


                                      F-9


<PAGE>



Cash and cash equivalents
-------------------------

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


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. Repairs and maintenance are charged to expense as incurred.


Intangibles and Long-Lived Assets
---------------------------------

The Company's policy regarding long-lived assets is to review such long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. If the review indicates
that long-lived assets are not recoverable (i.e. the carrying amount is less
than the future projected undiscounted cash flows), their carrying amount is
reduced to fair value. The Company carries no goodwill on its books at either
December 31, 2004 or 2003. Further, during fiscal 2004 and 2003, the Company had
no material impairments of intangible assets, which consist primarily of
patents.

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

Research and development costs are charged to operations when incurred.

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

The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards ("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.


                                      F-10


<PAGE>

Stock-Based Compensation
------------------------


The Company accounts for employee stock-based compensation in accordance with
the intrinsic value method prescribed in Accounting Principles Board Opinion
(APB) No. 25 entitled "Accounting for Stock Issued to Employees," and related
interpretations. Accordingly, compensation cost for stock options is measured as
the excess, if any, of the fair value of the Company's stock at the date of
grant over the amount an employee must pay to acquire the stock amortized over
the vesting period. 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>
                                                                                     August 21, 1998
                                                                                     (Inception) to
                                                                                      December 31
                                                        2004             2003             2004
                                                    -------------    -------------    -------------
<S>                                                 <C>              <C>              <C>
Net loss, as reported                               $ (6,518,460)    $ (3,039,817)    $(21,596,518)


Add: Total stock-based compensation expense
   under APB No. 25. net of tax effect                     7,700          174,799          733,589

Deduct: Stock-based compensation expense
   determined under the fair value
   method for all awards, net of tax effect             (642,739)      (1,202,185)      (3,508,513)
                                                    -------------    -------------    -------------



Net loss, pro forma                                 $ (7,153,499)    $ (4,067,203)    $(24,371,442)
                                                    =============    =============    =============

Net loss per share, as reported:
      Basic and diluted                             $       (.17)    $       (.12)    $      (1.00)
                                                    =============    =============    =============

Net loss per share, pro forma:
      Basic and diluted                             $       (.19)    $       (.17)    $      (1.13)
                                                    =============    =============    =============
</TABLE>


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, 2004       Dec. 31, 2003
                                         -------------       -------------

Risk free interest rate                             3%                  3%
Dividend yield                                      --                  --
Volatility                                        120%                123%
Weighted average expected life                 5 years             8 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 its employee stock options.

Deferred charges for options granted to non-employees are determined in
accordance with SFAS No. 123 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.


                                      F-11

<PAGE>

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

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

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


In December 2004 the FASB issued SFAS No. 123 (revised 2004) "Share-Based
Payment," or SFAS No. 123(R). 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.


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

The Company maintains its cash balances in a financial institution and a money
market fund at the same institution. Cash balances at the institution are
insured by the Federal Deposit Insurance Corporation up to $100,000. Cash and
cash equivalents in the amount of $8,677,364 are uninsured at December 31, 2004.

NOTE 3.   COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS


                                                         2004           2003
                                                      ----------     ----------
Property and equipment:
-----------------------
Laboratory equipment                                  $  225,271     $  117,361
Computer equipment                                        65,231         41,078
Furniture and fixtures                                    40,356         24,096
Leasehold improvements                                    14,488         14,488
                                                      ----------     ----------
                                                      $  345,346     $  197,023

Less accumulated depreciation and amortization          (142,328)       (92,071)
                                                      ----------     ----------


                                                      $  203,018     $  104,952
                                                      ==========     ==========

Intangible assets:
------------------

Patents                                               $   13,892     $   13,892
Less accumulated amortization                             (2,844)        (2,370)
                                                      ----------     ----------

                                                      $   11,048     $   11,522
                                                      ==========     ==========

Accounts Payable and Other Accrued Liabilities:
-----------------------------------------------

Trade accounts payable                                $  116,465     $  155,568
Payroll related                                          215,754         12,605
Other                                                     61,051         13,285
                                                      ----------     ----------

                                                      $  393,270     $  181,458
                                                      ==========     ==========

NOTE 4.   LICENSE AGREEMENT


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 2004, 2003 or 2002.


                                      F-12

<PAGE>

NOTE 5.   COMMITMENTS

The Company has office and laboratory facilities under noncancelable operating
leases. Rent expense was $264,758 and $222,087 for the years ended December 31,
2004 and 2003, and $702,655 from August 21, 1998 (inception) to December 31,
2004. The following is a schedule of total future minimum lease payments under
all noncancelable operating leases:

     Year Ending December 31:
     ------------------------

             2005                         $   203,951
             2006                             183,024
             2007                             188,725
             2008                              31,825
                                          -----------

             TOTAL                        $   607,525
                                          ===========


NOTE 6.   MERGER OF MICROISLET OF DELAWARE AND A WHOLLY OWNED SUBSIDIARY OF ALD
          AND SALE OF SECURITIES (AS RESTATED)

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.



                                      F-13

<PAGE>

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 7. RELATED PARTIES /ISSUANCE OF WARRANTS

During 2003, the Company borrowed a total of $525,000 from two stockholders.
$500,000 of these loans plus $11,100 of accrued interest was converted to common
stock at $0.50 per share and $25,000 was repaid prior to December 31, 2003. In
relation to the borrowing of the $500,000, the Company issued the lender
ten-year warrants for a total of 200,000 shares of common stock, with exercise
prices ranging from $0.50 to $1.49. The Company recorded interest expense in
relation to the warrants in the amount of $142,300 during 2003. These warrants
have no registration rights. The Company accounted for these warrants using a
method that approximates the relative fair value method under APB Opinion No.
141. The related debt discount was amortized to interest expense over the term
of the debt until conversion to equity. The extension of the maturity date of
the notes represented a troubled debt restructuring under SFAS No. 15 and EITF
02-4. This extension and the subsequent extinguishment of the debt through
exchange for common stock did not result in a significant gain or loss.

In addition, during 2003, in relation to various equity financings, the Company
issued two-year warrants for 1,025,680 shares of registered common stock, with
exercise prices of $1.00, of which warrants for 64,800 shares were issued to the
placement agent. As of December 31, 2004, 40,000 of such warrants have been
exercised.

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 exercise prices of
$1.30 per share and expire between two to five years from the date of issuance.
As of December 31, 2004, 192,308 of the warrants issued to investors, and
160,000 of the placement agent warrants have been exercised.

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 has been 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 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 Statement of Financial Accounting Standards (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, 2004, 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 has been 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 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 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, 2004, 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 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, 2004, this warrant has not 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
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, 2004, 166,666 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 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 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 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, 2004, 20,000 shares of such warrant have been exercised.

                                      F-14

<PAGE>

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 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, 2004, this warrant has not been
exercised.

On April 12, 2004, the Company issued an option to an employee of a consulting
firm engaged by the Company to provide investor relations services. This option
to purchase 30,000 shares at $2.95 per share vests over two years and expires
ten years after the date of grant. In accordance with EITF 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.

The following table summarizes information with regard to outstanding warrants
issued in connection with equity and debt financings as of December 31, 2004:


<TABLE>
                                   NUMBER                                                    WEIGHTED AVERAGE
ISSUED IN CONNECTION WITH:       EXERCISABLE       EXERCISE PRICE       EXPIRATION DATE       EXERCISE PRICE
--------------------------       -----------       --------------       ---------------       --------------
<S>                              <C>                <C>                <C>                    <C>
Reverse merger                   1,500,000          $6.00-$12.00         July 31, 2007            $8.00

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

2004 private placement
     Investors                   4,724,812              $1.00           March 16, 2009            $1.00
     Placement Agents              578,038              $1.30           March 16, 2006-           $1.30
                                                                        March 16, 2009

Consulting services                638,334           $0.60-$1.65       January 30, 2009 -         $0.98
                                                                      September 27, 2009
                               ------------

            TOTAL                8,626,864
                               ============
</TABLE>

NOTE 8.   STOCKHOLDERS' EQUITY

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

In April 2003, the Company 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 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 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. Fusion Capital is committed to
purchase the initial $12 million of the Company's common stock through October
2005, if not extended by us for six additional months. The Company may decrease
this amount or terminate the agreement at any time. If the Company's stock price
equals or exceeds $1.25 per share for five consecutive trading days, the Company
has the right to increase the daily purchase amount above $20,000, provided that
the sale price of the Company's common stock remains at least $1.25 per share.
The sale price per share to Fusion Capital is 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 has agreed that neither it nor any of its affiliates
will 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 has 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 has 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. An amended registration statement registering the resale of
shares by Fusion Capital was declared effective by the SEC in June 2004.



                                      F-15

<PAGE>


Fusion Capital is not obligated to purchase any shares of the Company's common
stock unless the purchase price under the common stock purchase agreement is at
least $0.50 per share. Under the agreement with Fusion Capital, the Company must
satisfy requirements that are a condition to Fusion Capital's obligation
including but not limited to: the continued effectiveness and availability of
the registration statement for the resale of the shares by Fusion Capital,
continued listing of the Company's common stock on the American Stock Exchange,
OTC Bulletin Board or another recognized market or exchange, no failure of the
Company's transfer agent to issue stock to Fusion Capital within five days of a
purchase by Fusion Capital, no default on any of the Company's payment
obligations in excess of $1,000,000, and no insolvency or bankruptcy on the
Company's part. Consequently, the amount and timing of proceeds that the Company
will receive under the agreement, if any, is uncertain. As of December 31, 2004,
the Company has sold 1,432,599 shares to Fusion Capital under this agreement for
total proceeds of approximately $1,060,000.

During the years ended December 31, 2004 and 2003, the Company sold 415,094 and
1,017,505 shares of common stock, respectively, to Fusion Capital under this
agreement.


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.

Stock Splits
------------

Effective November 7, 2000, the Board of Directors authorized a 5-for-1 stock
split of the Company's $.001 par value common stock. As a result of the split,
3,876,640 additional shares were issued. All references in the accompanying
consolidated financial statements to the number of common shares and per-share
amounts have been restated to reflect the stock split. Effective October 18,
2001, the Board of Directors authorized a 3.1255-for-1 stock split of the
Company's $.001 par value common stock. As a result of the split, 11,843,483
additional shares were issued. All references in the accompanying consolidated
financial statements to the number of common shares and per-share amounts have
been restated to reflect the stock splits.

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

During 2000, the Company adopted a stock option plan for employees, outside
consultants and directors. There are currently 6,000,000 common shares
authorized under the plan. The 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 applies SFAS No. 123 and EITF 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, 2004 and 2003:
risk free interest rate of 3%; dividend yield of 0%; volatility of 120% in 2004
and 123% in 2003; expected life of 5 to 10 years; and market value of the
Company's common stock ranging from $1.28 to $2.80 in 2004 and from $0.45 to
$1.45 in 2003. Compensation cost charged to operations for options granted to
consultants performing advisory services was $222,941 in 2004, $78,919 in 2003
and $1,494,853 from August 21, 1998 (inception) to December 31, 2004.


                                      F-16


<PAGE>

The following summary presents the options granted, exercised, expired,
forfeited and outstanding at December 31, 2004 and 2003:

                                                           WEIGHTED
                                                           AVERAGE
                                            NUMBER OF      EXERCISE
                                             SHARES         PRICE
                                           ----------     ----------

Outstanding at January 1, 2003              3,433,667     $      .94

Granted                                       935,000     $      .53
Exercised                                     (30,000)           .40
Expired                                            --             --
Forfeited                                     (50,000)          1.29
                                           ----------

Outstanding at December 31, 2003            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
                                           ==========

The weighted average fair value of options granted during 2004 and 2003 was
$1.72 and $0.53, respectively. 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, 2004:

                                                     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         5.88          $0.29
 $0.30 - $0.80       1,058,180       1,038,805         7.95          $0.54
 $1.13 - $2.95       1,154,894         323,136         9.31          $1.83
 $4.40 - $5.00         391,000         356,222         7.37          $4.93

        Total        4,794,117       3,908,206         7.28          $1.10
                     =========       =========         ====          =====


NOTE 9.   EARNINGS PER SHARE

Basic and diluted net loss per share amounts are equivalent for the years ended
December 31, 2004 and 2003 as the inclusion of 13,420,981 and 7,014,347
potential common shares, respectively, in the number of shares used for the
diluted computation would be anti-dilutive.


                                      F-17


<PAGE>

NOTE 10.   INCOME TAXES

                                                      2004             2003
                                                  ------------     ------------
Deferred tax assets:
   Net operating loss carryforwards               $  6,362,000     $  3,918,000
   Stock-based compensation                            672,000          549,000
   Warrants                                          1,976,000        1,490,000
   Research and development credit                     940,000          800,000
   Accrual to cash                                      55,000          141,000
   Other                                                 2,000            4,000
                                                  ------------     ------------
                                                    10,007,000        6,902,000
Deferred tax liabilities:
   State taxes                                        (814,000)        (581,000)
   Other                                               (13,000)              --
                                                  ------------     ------------

Net deferred tax asset                               9,180,000        6,321,000
Less valuation allowance                            (9,180,000)      (6,321,000)
                                                  ------------     ------------

                                                  $        -0-     $        -0-
                                                  ============     ============

The net deferred tax asset has been fully reserved due to uncertainties as to
its realizability. The valuation allowance increased by $2,859,000 in 2004 and
$1,478,000 in 2003.

At December 31, 2004, approximately $116,000 of the valuation allowance for
deferred tax assets related to stock option deductions, which, when recognized,
will be allocated directly to additional paid-in capital.

The Company has not recorded income tax expense or benefit for the years ended
December 31, 2004 and 2003, and the period from August 21, 1998 (inception)
through December 31, 2004. The net deferred tax asset has been full reserved due
to uncertainties as to its realizability.

At December 31, 2004, the Company has net operating loss carryforwards of
approximately $29,685,000 for federal and state purposes. 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:

                                                      2004             2003
                                                  ------------     ------------


     Federal tax benefit at statutory rate        $  2,216,000     $  1,034,000
     State tax benefit, net                            438,000          163,000
     Increase in valuation allowance                (2,743,000)      (1,478,000)
     Research and development credit                    60,000          317,000
     Other permanent items                            (251,000)          20,000
     Stock-based compensation                          280,000          (56,000)
                                                  ------------     ------------


     Provision for income taxes                   $        -0-     $        -0-
                                                  ============     ============


NOTE 11.   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 2004 and 2003,
nor in any prior period since inception of the plan.



                                      F-18


<PAGE>

NOTE 12. SUBSEQUENT EVENT/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 alleges
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 alleges that the Company made false statements
concerning the Company's relationship with Duke University. The complaint seeks
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 seeks damages of three times the
amount of plaintiff's injury, but does 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. No trial
date has been set. Although an unfavorable outcome in this matter could have a
material adverse effect on the Company's business, liquidity and financial
position, the Company believes this claim is without merit and intends to
vigorously defend the action.

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

NOTE 13. RESTATEMENT

Subsequent to the issuance of the Company's consolidated financial statements
for the fiscal year ended December 31, 2004, the Company determined that the
fair value of certain warrants issued in settlement of demands for payment made
by certain parties who claimed to have rendered services in connection with the
financing that closed in March 2004 should have been charged to expense as a
cost of legal settlement. In the Company's previously issued financial
statements, the fair value of these warrants had been charged against the
proceeds of the financing. As a result, the accompanying consolidated financial
statements for the year ended December 31, 2004 and the period from August 21,
1998 (date of inception) to December 31, 2004 have been restated from the
amounts previously reported to correct the accounting for these warrants.

The Company has also determined that previously recorded non-cash expense for
two fully vested warrants issued to an investor relations consulting firm in
January 2004 and June 2004 should have been amortized over the respective
six-month terms that services associated with such warrants were rendered,
rather than on the dates the warrants were granted. All such services were
rendered during the fiscal year ended December 31, 2004, so the correction of
this error will not affect the results of operations for the full 2004 fiscal
year. However, this error resulted in restatement of the results of
operations for each of the quarters in 2004, as shown in Note 14.

<TABLE>
A summary of the significant effects of the restatement is as follows:

                                                                                                      For the period from
                                                          For the year ended                          August 21, 1998 to
                                                          December 31, 2004                           December 31, 2004
                                                    ------------------------------              ------------------------------
                                                    As Previously                               As Previously
                                                      Reported        As Restated                 Reported        As Restated
<S>                                                 <C>               <C>                       <C>               <C>
Total general and administrative expenses           $  3,169,838      $  3,711,392              $ 11,170,733      $ 11,712,287
Total operating expenses                            $  6,083,051      $  6,624,605              $ 21,446,960      $ 21,988,514
Net Loss                                            $ (5,976,906)     $ (6,518,460)             $(21,054,964)     $(21,596,518)
Basic and diluted net loss per share                $       (.16)     $       (.17)             $       (.98)     $      (1.00)

                                                    As of December 31, 2004:
Additional paid-in capital                          $ 29,894,363      $ 30,435,917
Deficit accumulated during the development stage    $(21,054,964)     $(21,596,518)
</TABLE>


                                                           F-19


<PAGE>


NOTE 14.   QUARTERLY FINANCIAL DATA (UNAUDITED)

As described in Note 14, the Company has restated its unaudited financial
statements for each of the quarters in 2004 to correct errors in the accounting
for certain equity transactions. A summary of the effects of this restatement is
shown in the following table of summarized quarterly financial results for 2004:

<TABLE>
2004 Quarter                                             First               Second              Third               Fourth
------------                                             -----               ------              -----               ------
<S>                                                   <C>                 <C>                 <C>                 <C>
Total general and administrative expenses,
  as previously reported                              $    594,069        $  1,548,763        $    430,826        $    596,180
Total general and administrative expenses,
  as restated                                         $  1,010,560        $  1,283,016        $    633,955        $    783,861

Total operating expenses, as previously
  reported                                            $  1,241,166        $  2,013,316        $  1,242,286        $  1,586,283
Total operating expenses, as restated                 $  1,657,657        $  1,747,569        $  1,445,415        $  1,773,964

Net loss, as previously reported                      $ (1,234,638)       $ (1,987,523)       $ (1,209,128)       $ (1,545,617)
Net loss, as restated                                 $ (1,651,129)       $ (1,721,776)       $ (1,412,257)       $ (1,733,298)

Basic and diluted net loss per share,
  as previously reported                              $       (.04)       $       (.05)       $       (.03)       $       (.04)
Basic and diluted net loss per share,
  as restated                                         $       (.05)       $       (.04)       $       (.04)       $       (.04)

Deficit accumulated during the development
  stage, as previously reported                       $(16,312,696)       $(18,300,219)       $(19,509,348)       $(21,054,964)
Deficit accumulated during the development
  stage, as restated                                  $(16,729,187)       $(18,450,963)       $(19,863,221)       $(21,596,518)

Additional paid-in-capital, as previously
  reported                                            $ 28,302,480        $ 29,662,771        $ 29,906,768        $ 29,894,363
Additional paid-in-capital, as restated               $ 28,339,129        $ 30,130,050        $ 30,443,263        $ 30,435,917
</TABLE>

Note 15.  Subsequent Event

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 continued to incur
operating losses subsequent to December 31, 2004, and as of June 30, 2005, the
Company's cash position was $5.1 million. Although the Company believes that its
existing funds will be sufficient to fund its operating expenses and capital
requirements through March 2006, the Company expects to incur substantial
additional costs, including costs related to ongoing research and development
activities, preclinical studies and trials. Future funding is subject to
continued agreement of a business plan by investors. In the event funding is not
obtained, the Company may be required to curtail operations. These factors among
others raise substantial doubt about whether the Company will be able to
continue as a going concern for a reasonable period of time.

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. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain successful operations. Management is
continuing its efforts to obtain additional funds so that the Company can meet
its obligations and sustain operations.

                                                              F-20