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

                                    FORM 10-K

                 [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                   For the fiscal year ended December 31, 2007

                                       or

               [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
            For the transition period from ___________ to ___________

                         Commission File Number 0-27035
                                                -------

                                MICROISLET, INC.
                 (Name of Small Business Issuer 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 under 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)

         Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]

         Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 [ ]

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (ss. 229.405 of this chapter) is not contained
herein, and will not 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-K or any amendment to this Form 10-K. [ ]

         Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer,"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated filer [ ]  Accelerated filer [ ]     Non-accelerated filer [ ]
    Smaller reporting company [X]                          (Do not check if a
                                                            smaller reporting
                                                                 company)

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

         The aggregate market value of the voting stock held by non-affiliates
of the registrant as of June 29, 2007, the last business day of the registrant's
second fiscal quarter, was approximately $16.8 million (based on the closing
price ($0.47 per share) reported on such date by the OTC Bulletin Board of the
registrant's common stock). Shares of common stock held by officers and
directors and holders of 5% or more of the outstanding common stock have been
excluded from the calculation of this amount because such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

         As of March 27, 2008, the number of outstanding shares of the
registrant's common stock was 54,574,426.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the proxy statement to be filed for our 2008 Annual Meeting of
Stockholders are incorporated herein by reference into Part III of this report.
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                                TABLE OF CONTENTS


                                                                            Page

                                     PART I

ITEM 1.            Business                                                    1
ITEM 1A.           Risk Factors                                               10
ITEM 1B.           Unresolved Staff Comments                                  24
ITEM 2.            Properties                                                 24
ITEM 3.            Legal Proceedings                                          24
ITEM 4.            Submission of Matters to a Vote of Security Holders        24

                                     PART II

ITEM 5.            Market for Registrant's Common Equity, Related
                   Stockholder Matters, and Issuer Purchases of Equity
                   Securities                                                 25

ITEM 6.            Selected Financial Data                                    26
ITEM 7.            Management's Discussion and Analysis of Results of
                   Operation and Financial Condition                          26
ITEM 7A.           Quantitative and Qualitative Disclosures About Market Risk 35
ITEM 8.            Financial Statements and Supplementary Data                35
ITEM 9.            Changes in and Disagreements with Accountants on
                   Accounting and Financial Disclosure                        35
ITEM 9A.           Controls and Procedures                                    35
ITEM 9A(T).        Controls and Procedures                                    35
ITEM 9B.           Other Information                                          36

                                    PART III

ITEM 10.           Directors, Executive Officers and Corporate Governance     38
ITEM 11.           Executive Compensation                                     38
ITEM 12.           Security Ownership of Certain Beneficial Owners and
                   Management and Related Stockholder Matters                 38
ITEM 13.           Certain Relationships and Related Transactions, and
                   Director Independence                                      38
ITEM 14.           Principal Accountant Fees and Services                     38

                                     PART IV

ITEM 15.           Exhibits and Financial Statement Schedules                 39

                           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 "Risk Factors" in Part I, Item 1A of this Form
10-K, which 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-K
with the Securities and Exchange Commission.

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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 conditions requiring cell-based replacement treatments,
with a focus on type 1, or insulin-dependent diabetes. Patented islet
transplantation technology, exclusively licensed from Duke University, along
with our own developments, constitute methods for isolating, culturing,
cryopreservation, and immuno-protection (microencapsulation) of islet cells. We
intend to continue our research and development efforts and, ultimately, to
introduce products to the market.

PRODUCTS

We intend to seek FDA approval for marketing in the U.S. a first product, called
MicroIslet-PTM. MicroIslet-PTM will be an injectable suspension of
microencapsulated porcine insulin-producing, pancreatic islet cells. We believe
that MicroIslet-PTM, a xenotransplantation (transplantation between different
species) product, has significantly more commercial potential than
human-to-human (allotransplantation) islet replacement approaches, due to the
high cost and inherently limited supply of human islets. In the past, we
researched the use of our technology for allotransplantation, and we may
continue such research for use in select patient populations. We refer to this
potential product as MicroIslet-HTM. Both of these product candidates are
intended for the treatment of insulin-dependent diabetes, and both are intended
to be administered into the patient's abdominal cavity, where the transplanted
islet cells will produce insulin in response to increases in blood glucose, much
like the patient's original pancreatic islet cells did prior to being destroyed
by disease.

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

LICENSE AND SPONSORED RESEARCH

We entered into a license agreement with Duke University in September 1998,
which was amended in February 1999. Pursuant to the license agreement we
sponsored research conducted by Duke from 1998 through 2001 in connection with
the isolation, culture, storage, and encapsulation of insulin-producing islet
cells from porcine sources to be used for transplantation in patients with
insulin-dependent diabetes. The research was conducted under the supervision of
Dr. Emmanuel C. Opara. Under the license agreement we agreed to pay Duke
University for all direct and indirect costs incurred in the performance of the
research. As of December 31, 2007, we had paid Duke approximately $496,000 for
its research efforts.

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

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

The agreement imposes on us an obligation to indemnify Duke, its officers,
employees, and agents against claims arising from our or any sub licensee'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

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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.

We have entered into a collaboration agreement in the area of islet cell
transplantation therapies for treatment of insulin-dependent diabetes with The
Scripps Research Institute (TSRI). Under the terms of the agreements, we and
TSRI are conducting preclinical studies utilizing our proprietary technologies.
We believe the completion of this work will set the stage for studies enabling
an Investigational New Drug application (IND) and may be included as part of the
IND process required by the FDA for human clinical trials. We paid to TSRI
approximately $229,000 and $596,000 during the years ended December 31, 2007 and
2006, respectively, and a total of $1.8 million since January 1, 2003.

We have entered into three collaboration agreements 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. The first agreement called for us to fund the University in the amount
of approximately $1.4 million over a three year period ended May 2007. A second
agreement amounting to approximately $181,000 called for additional primate
studies over a one-year period ended August 2007. Work under the agreements
continued past the end dates and through the remainder of 2007. A third
agreement was signed in March 2008 which included the additional, post contract
costs of the earlier contracts and specified activities to be performed through
July 2008. We paid to the University of California, Davis, approximately
$799,000 and $750,000 during the years ended December 31, 2007 and 2006,
respectively, and a total of $1.8 million from January 1, 2004 through December
31, 2007. Work related to these agreements is expected to be completed in the
third quarter of 2008 and to result in expenses for the first three quarters of
2008 of approximately $506,000.

Until November 2006, we also collaborated with the University of Alberta,
Edmonton (Canada). This facility assisted us with transplantation surgery and
subsequent monitoring in animal models. Under the terms of the arrangement we
paid the University approximately $54,000 during the year ended December 31,
2005 and $110,000 from January 1, 2002 to December 31, 2005. No payments were
made in 2007 and 2006.

INTELLECTUAL PROPERTY

Our team of scientists has developed new intellectual property in the areas of
islet cell processing, quantification, and encapsulation. While we keep a
portion of these advances as confidential trade secrets, we also have filed, and
will continue to file, patent applications with the U.S. Patent and Trademark
Office to protect our intellectual property as deemed appropriate.

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

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

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

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


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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 semi permeable membrane
                               - Microcapsule is comprised of alginate in
                                   combination with polylysine, polyornithine
                                   and combinations thereof
                               - Internal islet cell-containing core is
                                   comprised of alginate, gelled or not gelled
                               - Microcapsule is 50um to 2mm in diameter
                               - Microcapsule is incubated in physiologically
                                   acceptable salt to increase durability of the
                                   microcapsule
                               -   Physiological salt treatment of
                                   microencapsulated living islet cells
                                   results in not more than 10% increase by
                                   weight over one month at 37C and at least
                                   150% basal insulin secretion in response to
                                   16.7 mM glucose challenge in physiological
                                   solution at pH 7.4 after one month

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

RESEARCH AND DEVELOPMENT STRATEGY

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

We have sponsored research at TSRI, The California Regional Primate Center at
the University of California, Davis, and BioTox Sciences, and research continues
at all of these institutions except TSRI.

Together with our sponsored research partners, and possibly other collaborators,
we continue to obtain data relating to insulin levels, blood glucose control,
immune reactions, and any side effects associated with our islet transplantation
methods. We are collecting information on dose and duration of effect regarding
implanted cells in relevant diabetes models. We are also working on developing
approaches for the reduction or elimination of the need for the use of systemic
immunosuppressive drugs in islet cell transplant recipients. Through these
activities, we are hoping to further establish attractive safety and efficacy
parameters we have seen in our product candidates to date. Such parameters are
required for the support of our planned human clinical trials.

We have received data from TSRI showing results of transplants using our
proprietary technology in more than 500 small animals. Study groups of
streptozotocin-induced diabetic NOD/SCID, as well as groups of immunocompetent
mice, were transplanted with MicroIslet's microencapsulated porcine islet cells.
The transplanted capsules at various dosing levels were able to normalize blood
glucose (normoglycemia) levels in all animals within one week of
transplantation. These studies were conducted under the supervision of Dr.
Daniel R. Salomon of the Department of Molecular and Experimental Medicine at
TSRI.

In September 2005, we received additional data from TSRI showing interim results
of transplants using our proprietary technology in small animals. Experiments
were conducted using encapsulated porcine islets transplanted into the
peritoneums of diabetic rats. The goal of these studies was to demonstrate
increased islet function and graft survival time using a proprietary combination
of novel encapsulation formulations and treatment regimens. An analysis of the
results of these preclinical animal studies appears to demonstrate graft
survival in diabetic rats for greater than 70 days when encapsulated porcine
islets are transplanted into the peritoneal cavity. We believe that patients
treated with MicroIslet-P(TM) may require periodic transplantations of
additional islet cells. Accordingly, we have endeavored to demonstrate the
feasibility and safety of such re-transplantation by conducting
re-transplantation experiments in small animals. We have found that the
subsequent transplants were effective and well tolerated. In addition to
supporting the potential efficacy of our therapeutic approach, these results
demonstrate that the rodent model is an important tool for optimizing and
refining islet preparations and transplantation procedures.

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Additional preclinical studies have been performed in non-human primates. These
studies have demonstrated no signs of adverse effects to date. The animals have
demonstrated normal patterns of activity and periods of reduced insulin
requirements. In February 2006 we received data showing that minimally-invasive
transplantation of encapsulated porcine islets by intraperitoneal injection
resulted in significant and prolonged (greater than 30 days) improvement of
blood sugar with reduced insulin use in diabetic primates. Subsequent studies
with non-human primates have demonstrated evidence of graft function, with no
signs of adverse clinical effects, for periods up to approximately one year.
Moreover, animals have tolerated multiple transplantations into the peritoneum
without evidence of adverse effects. These results have been accomplished
without chronic immunosuppression. In addition, these results were obtained
through the use of our proprietary methods and encapsulation technologies, both
pre- and post-transplantation, which together significantly improved the
duration of islet function in the recipient animal. The encapsulation
formulation used in these studies was designed to effectively immunoisolate the
encapsulated islets, while preserving access to nutrients, oxygen, and transport
of low molecular weight entities. To date, our work in primates has provided a
basis upon which to design our future human studies, both with regard to
xenotransplantation using MicroIslet-P(TM) and allotransplantation using
MicroIslet-H(TM).

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 human clinical studies. These objectives are:

         o    Optimization of our proprietary microencapsulated porcine islet
              technology.

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

Once we are satisfied that we have adequately optimized our processes and have
received FDA clearance to proceed with human clinical trials, we expect to
undertake a two-stage strategy to validate the utility of this approach for
transplantation of porcine islets:

         o    Conduct a Phase I human clinical trial with MicroIslet-P(TM) , our
              microencapsulated porcine islet product.

         o    If the Phase I trial is successful, we intend to conduct a larger,
              Phase II and/or Phase II/III trial.

Our research and development expenses were approximately $6.4 and $7.1 million
for 2007 and 2006, respectively.

PORCINE ISLET SUPPLY

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

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

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

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We believe the quantity of pigs that FIOS has agreed to supply will be
sufficient to meet our needs during the initial term of the long-term supply
agreement. FIOS has agreed that during the period of the long-term supply
agreement it will not supply DPF pigs to any other company for research related
to, or use with respect to, the treatment of diabetes.

If this facility were to cease providing DPF pigs to us in sufficient
quantities, we would be required either to locate another facility which is able
to supply these 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
FIOS or any other facility which supplies DPF 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 DPF
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 U.S.
health care system more than $10,000 per year. We believe that the market will
support a price significantly higher than $10,000 per year for a product that
can effectively treat 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. Based upon publicly available information,
it appears that there are no other cell transplantation products currently
available, or in late stage clinical trials, that can effectively treat
insulin-dependent diabetes. Nevertheless, we anticipate that the development of
cell-based and other products that can better treat and manage this disease will
remain the focus of intense competition.

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

COMPETITORS

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

         o    Living Cell Technologies (LCT) - publicly traded Australian-based
              biotech company developing an alginate-encapsulated neo-natal
              porcine islet cell product, reported to be conducting a phase
              I/IIa clinical trial in Russia;

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

         o    Novocell - developer of a polyethylene glycol (PEG) coating
              technology for immunoisolation of islet cells (now focusing on
              stem cell technologies);

         o    Beta-Cell - developer of fetal islet cell products for
              transplantation;

         o    Amcyte - developer of encapsulated human islet cells;

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

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         o    Tissera (TSSR.OB) - developer of cell-based therapeutics for
              several diseases based on differentiated cells derived from human
              and porcine embryonic stem cells, including the pancreas for
              diabetes.

Most of our competitors are larger than we are and 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 which could compete with our products or render them
obsolete.

Recent Studies
--------------

There has been a significant amount of research activity in academic
institutions concerning the concept of using porcine islet cells for
transplantation in insulin-dependent diabetes. In 2006, a team at the University
of Minnesota published positive data on the use of porcine islets in conjunction
with immunosuppression to reverse diabetes in non-human primates. This
observation was followed by further work from a collaborative project between
scientists at the University of Alberta, Canada, and scientists at Emory
University School of Medicine. The results from the project appeared to
demonstrate that transplantation of fetal porcine islets, in conjunction with
immunosuppression, was able to effectively reverse diabetic conditions for a
period of months in non-human primates, further demonstrating the utility of
porcine islets for transplantation therapy.

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

SALES AND MARKETING

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

MANUFACTURING

We have contracted with Progenitor Cell Therapy, LLC (PCT) to perform the islet
isolation, encapsulation, testing, and packaging for the planned clinical
trials. These activities will be performed in dedicated suites at PCT's facility
in Mountain View, California. PCT has extensive experience in the processing,
manufacture, and distribution of cellular therapies for clinical trials. PCT
holds a California Drug Manufacturing License for the clinical trial manufacture
and distribution of cellular products and is registered with the FDA as a cell,
tissue, or cellular or tissue-based product facility. PCT will also distribute
the encapsulated islets in ready-to-use, sterile, single-use product infusion
bags.

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 conducted a pre-IND meeting with the FDA in
December 2007 in order to discuss manufacturing, preclinical, and clinical plans
for the xenotransplantation product, MicroIslet-P(TM). Both MicroIslet-P(TM) and
MicroIslet-H(TM) will be classified as combination biological and device
products by the FDA. The islets comprise the biological component and the
microencapsulation material comprises the device component. The FDA Center for
Biologics (CBER) has jurisdiction, meaning the MicroIslet-P(TM) product will be
reviewed primarily as a biological product.

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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 approval standards under the Federal Food,
Drug and Cosmetic Act, including good manufacturing practices regulations, good
laboratory practices, 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 the FDA.

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 with regard to a given disease. Before human clinical
trials may begin for new drugs and biologics, an IND application containing,
among other things, preclinical data, chemistry, manufacturing and control
information, an investigational plan, and clinical trial protocol must be
submitted to the FDA and approved.

PRE-IND PROCESS The pre-IND process involved submission by us of a compendium of
information to the FDA concerning our technology, our methods, and the
preliminary studies to support our desire to file an IND in the future. We posed
a number of questions to the agency regarding the adequacy of our work to date
to satisfy the requirements for an IND filing, and they provided guidance to us
and proposed additional work that would fulfill their requirements for product
safety and reliability. Their feedback included the request for additional
long-term preclinical in vivo data. As a result, we will complete the current
primate study and conduct a long-term study in diabetic mice. We are conducting
these preclinical studies with the guidance of highly experienced consultants,
including a former FDA Pharmacologist & Toxicologist. Due to the increased scope
of these safety studies, we expect the preclinical work required for IND
submission to be completed in the second half of 2008. Therefore, our target IND
submission date is the end of 2008, and we expect to initiate our human
xenotransplantation trial in either the fourth quarter of 2008 or the first
quarter of 2009.

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 with regard to a given disease. Before human clinical
trials may begin for new drugs and biologics, and an IND application containing,
among other things, preclinical data, chemistry, manufacturing and control
information, an investigative plan, must be submitted to the FDA. The Clinical
trials following approval of an IND will also require the approval and oversight
by an Institutional Review Board (IRB) to assure proper patient protection.
Clinical trials of certain medical devices generally require the same sort of
submission in the form of an application for an investigational device exemption
(IDE). We believe that the submission of an IND will be adequate for
MicroIslet-P(TM) or MicroIslet-H(TM), and that a separate IDE submission will
not be required for either product. Once a trial begins, changes to the
investigational product or study protocol may require prior approval before
implementation. There can be no assurance that submission of an IND application
or an IDE will result in the ability to commence clinical trials. In addition,
the FDA may place a clinical trial on hold or terminate it at any phase if,
among other reasons, it concludes that clinical subjects are being exposed to an
unacceptable health risk. Finally, pursuant to the FDA's Bioresearch Monitoring
(BIMO) program, the FDA conducts on-site inspections and data audits of the
conduct and reporting of all FDA-regulated research. The FDA's BIMO compliance
programs address inspections of non-clinical testing labs, clinical
investigators, clinical trial sponsors/monitors and IRBs.

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

         o    Phase I is conducted to evaluate the basic safety, metabolism, and
              pharmacology, and pharmacokinetics, and to identify potential side
              effects with escalating doses, the maximum tolerated dose of the
              experimental product in humans, and if possible, to begin to
              evaluate various routes, dosages, and schedules of product
              administration. These studies are often conducted in healthy
              subjects. Phase I trials are not intended to find early
              indications of effectiveness; however, it is not uncommon to
              evaluate these endpoints.

         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.

                                       7
<PAGE>

         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 Following our 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 Biologics License Application or 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 BLA approval, in addition to numerous
other FDA regulatory requirements applicable to drugs and biological products.
With certain exceptions, changes to the labeling of approved biological products
require approved supplemental applications. In addition, a supplemental
application is required to be submitted to the FDA for any change in the
product, production process, quality controls, equipment, facilities, or
responsible personnel that has a substantial potential to have an adverse effect
on the identity, strength, quality, purity, or potency of the product as may
relate to the safety or effectiveness of the product. These supplemental
applications may require the submission of clinical or comparability data and
require FDA approval before the product may be marketed as modified. The
approval process is lengthy, expensive, and uncertain.

LABELING AND ADVERTISING The nature of marketing claims that the FDA will permit
us to make in the labeling and advertising of our products will be limited to
those specified in an FDA approval. Claims exceeding those that are approved
will constitute a violation of the Federal Food, Drug, and Cosmetics Act. FDA
has primary responsibility for enforcing laws against false advertising and
promotion of prescription drug products. 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 February 29, 2008, we had 12 full time employees and two interns. Eight of
our employees and the two interns are engaged in research and development.

                                       8
<PAGE>

SCIENTIFIC ADVISORY BOARD

We also maintain a Scientific Advisory Board of six outside consultants, all
with doctoral degrees. These consultants are as follows:

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

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

David W. Scharp, M.D.                      Dr. Scharp trained and worked at
                                           Washington University School of
                                           Medicine, St. Louis, MO, as an
                                           academic surgeon and researcher in
                                           islet transplantation for nearly 30
                                           years, producing over 200
                                           publications with continuous NIH
                                           (National Institutes of Health) and
                                           JDRF (Juvenile Diabetes Research
                                           Foundation) funding and 13 patents to
                                           date.

John Logan, Ph.D.                          Dr. Logan is a Founder and serves as
                                           Chairman, President and CEO of FIOS
                                           Therapeutics Inc. (FIOS). Immediately
                                           prior to the formation of FIOS, Dr.
                                           Logan was a management consultant to
                                           the biotechnology industry and his
                                           major projects included work on the
                                           use of stem cells in cardiac disease,
                                           development of novel anti-virals for
                                           the treatment of HIV and as an
                                           advisor to Mayo Medical Ventures.
                                           Previous to that Dr. Logan was
                                           responsible for all of the activities
                                           of Nextran, Inc., a division of
                                           Baxter Healthcare. Nextran was
                                           focused on the development of
                                           genetically modified animals for use
                                           in xenotransplantation. As part of
                                           the activities of Nextran, Dr. Logan
                                           managed the world's first FDA cleared
                                           clinical trial of genetically
                                           modified organs for the treatment of
                                           patient's in fulminant hepatic
                                           failure. Before Nextran Dr. Logan was
                                           Chief Scientific Officer of DNX
                                           Corporation, the first commercial
                                           enterprise devoted to the development
                                           of biomedical and pharmaceutical
                                           applications of transgenic animal
                                           technology. Dr. Logan started his
                                           career in the biotechnology industry
                                           as a senior scientist at American
                                           Cyanamid Corporation. He holds a BSc
                                           (Hons) and PhD in biochemistry from
                                           the University of Glasgow and did
                                           post-doctoral training at Princeton
                                           University.

Christopher Marsh, M.D., F.A.C.S.          Dr. Marsh is the chief of the Organ
                                           Transplantation Service in the
                                           Division of General Surgery & Organ
                                           Transplantation and Co-Director of
                                           the Center for Organ and Cell
                                           Transplantation at Scripps Green
                                           Hospital. Previously, Dr. Marsh was


                                       9
<PAGE>

                                           associate professor of surgery and
                                           urology, Director of the Kidney/
                                           Pancreas Transplantation Program and
                                           associate head of the Division of
                                           Organ Transplantation at the
                                           University of Washington Medical
                                           Center in Seattle.

John Buse, M.D., Ph.D                      Dr. Buse is the President for
                                           Medicine and Science at the American
                                           Diabetes Association and a board
                                           member of the Carolinas Affiliate of
                                           the American Association of Clinical
                                           Endocrinologists. He has received
                                           numerous awards and honors, including
                                           citation in Best Doctors in America
                                           since 2001.

Miguel C. Riella, M.D., Ph.D., F.A.C.P.    Dr. Riella is Professor of Medicine
                                           at two institutions: the Evangelic
                                           School of Medicine and the Catholic
                                           University of Parana. He is Chief of
                                           Nephrology at the Evangelic
                                           University Hospital. Dr. Riella
                                           founded the Pro Renal Foundation of
                                           Brasil (www.pro-renal.org.br), a
                                           non-profit organization dedicated to
                                           patient assistance, education and
                                           research. More than 1800 patients are
                                           currently assisted by the Foundation.
                                           Dr. Riella is also the past president
                                           of the Brazilian Society of
                                           Nephrology and served on the Council
                                           of the International Society of
                                           Nephrology (ISN). He is a member of
                                           the Board of Directors of the
                                           International Federation of Kidney
                                           Foundations and will serves as the
                                           IFKF President for the period of
                                           2009-2011. Dr. Riella is a member of
                                           the National Academy of Medicine in
                                           Brazil.

                                           Recently, Dr. Riella established an
                                           Islet Cell Lab at the Catholic
                                           University and has performed the
                                           first islet cell transplant in humans
                                           in southern Brazil.


REPORTING AVAILABILITY

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

ITEM 1A. RISK FACTORS.

AN INVESTMENT IN OUR STOCK INVOLVES SIGNIFICANT RISKS. YOU SHOULD CAREFULLY
CONSIDER THE RISKS DESCRIBED BELOW, TOGETHER WITH ALL OF THE OTHER INFORMATION
IN THIS REPORT, BEFORE MAKING A DECISION TO INVEST IN OUR STOCK. IF ANY OF THESE
RISKS ACTUALLY OCCURS, OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION
AND PROSPECTS COULD SUFFER. AS A RESULT, THE TRADING PRICE OF OUR STOCK COULD
DECLINE AND YOU MAY LOSE PART OR ALL OF YOUR INVESTMENT.

OUR CURRENT CASH WILL FUND OUR BUSINESS AS CURRENTLY PLANNED ONLY THROUGH APRIL
2008. WE NEED ADDITIONAL FUNDING OR WE WILL BE FORCED TO CURTAIL OR CEASE
OPERATIONS.

                                       10
<PAGE>

We need immediate and substantial cash to continue our operations. We currently
have no funding commitments. Management has projected that cash on hand will be
sufficient to allow us to continue our operations only through April 2008, and
only if our promissory note holders with matured obligations do not seek to
enforce payment of such notes. We therefore will need additional funding, either
through equity or debt financings or partnering arrangements, or we will be
forced to curtail or cease operations. If we are forced to curtail or cease our
operations, even for a short time, we may lose the benefit of data gathered
during ongoing studies. If we later obtained sufficient capital to restart
operations, the costs and time to achieve our milestones could increase.

WE DO NOT HAVE SUFFICIENT CURRENT CASH TO REPAY THE PRINCIPAL AND ACCRUED
INTEREST DUE UNDER OUR OUTSTANDING PROMISSORY NOTES, SOME OF WHICH HAVE MATURED.

The unsecured subordinated promissory notes we issued to John J. Hagenbuch, our
former Chairman, and Peter Knobel, a significant stockholder of our company,
matured on January 12, 2008 and March 31, 2008, respectively. The aggregate
principal and accrued interest due under these notes as of March 31, 2008 was
$4.31million. Additionally, the unsecured subordinated promissory notes we
issued to the SMR 1996 Trust III in January 2008 and March 2008 mature in May
2008. The aggregate principal and accrued interest under these notes as of March
31, 2008 was $1.52 million. If the note holders determine to demand payment of
matured notes and we have insufficient cash to make the required payments, the
note holders could obtain a lien on our assets, including our intellectual
property, and upon obtaining a judgment, could force a sale of such assets for
their benefit. Under such circumstances, we may need to cease operations or file
for protection from claims of our creditors under the federal bankruptcy laws.

WE HAVE A HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT, AND WE ANTICIPATE
FUTURE LOSSES.

We have experienced significant operating losses in each period since our
inception. As of December 31, 2007, we have an accumulated deficit of $50.2
million. We expect continuing operating losses and it is uncertain when, if
ever, we will become profitable. Even if we do achieve profitability, we may not
be able to sustain or increase profitability on a quarterly or annual basis.

DUE TO OUR SIGNIFICANT OPERATING LOSSES, ACCUMULATED DEFICIT AND WORKING CAPITAL
DEFICIT, THERE IS SUBSTANTIAL DOUBT AS TO OUR ABILITY TO CONTINUE AS A GOING
CONCERN.

We anticipate that our existing funds will be sufficient to fund our operating
expenses and capital requirements only through April 2008. We expect to incur
substantial additional costs, including costs related to ongoing research and
development activities, preclinical studies and trials. These factors raise
substantial doubt about our ability to continue as a going concern. Our
independent registered public accounting firm has included in its report on our
2007 consolidated financial statements an explanatory paragraph expressing
substantial doubt regarding our ability to continue as a going concern.

IF WE CEASE TO CONTINUE AS A GOING CONCERN, DUE TO LACK OF FUNDING OR OTHERWISE,
YOU MAY LOSE YOUR ENTIRE INVESTMENT IN THE COMPANY.

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

When we require additional funds, general market conditions or the then-current
market price of our common stock may not support capital raising transactions
such as 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.

DEPENDING ON OUR METHOD OF RAISING FUNDS, NOW AND IN THE FUTURE, YOUR SHARES MAY
BE DILUTED.

If we raise additional funds by selling additional shares of our capital stock,
the ownership interest of our stockholders will be diluted.

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

                                       11
<PAGE>

During 2007, we completed a private placement of common stock and warrants for
aggregate gross proceeds of $1,000,000 with a related party, and borrowed an
additional $4,000,000, $3,000,000 of which was borrowed from our former Chairman
and $1,000,000 of which was borrowed from an existing shareholder. In the first
quarter of 2008, we borrowed an additional $1,500,000 from a related party and
may request to borrow an additional $1,000,000 from such person. For more
information about these transactions, see "Recent Debt and Equity Financings" in
Part II, Item 7 (Management's Discussion and Analysis of Results of Operation
and Financial Condition) of this report. We may not be able to obtain capital
from related persons in the future. None of the related persons referenced
above, nor any of our other officers, directors, or other stockholders, is under
any obligation to continue to provide cash to meet our future liquidity needs.

IF WE LOSE KEY PERSONNEL OR HAVE TO REDUCE OUR WORKFORCE (INCLUDING OUR KEY
SCIENTIFIC AND MANAGEMENT PERSONNEL), OUR PRODUCT DEVELOPMENT AND
COMMERCIALIZATION EFFORTS MAY NEVER RECOVER.

Our success is substantially dependent on the cooperation, retention and
performance of our key scientific and technical personnel and advisers. Our
scientific and technical staff is comprised of a small number of individuals,
and some of these individuals have worked with us for four or more years. If we
do not receive funding to continue our operations, we may have to significantly
reduce our workforce. Our future success would be dependent upon our ability to
hire back key personnel, which may not be possible, or upon our ability to
recruit and train replacement personnel, which could be time consuming, and may
not be possible in a reasonable time frame. The loss of the services of any of
our scientific or technical staff, for financial or other reasons, may therefore
significantly delay or prevent the achievement of product development and other
business objectives and could negatively or permanently impact our business,
operating results, and financial condition in the future.

COSTS RELATED TO COMPLIANCE WITH, OR OUR FAILURE TO COMPLY WITH, EXISTING AND
FUTURE INTERNAL CONTROL REPORTING REQUIREMENTS COULD ADVERSELY AFFECT OUR
BUSINESS.

In future periods, our independent registered public accounting firm will be
required to provide an opinion on the effectiveness of our internal control over
financial reporting in accordance with the requirements under Section 404 of
Sarbanes-Oxley Act of 2002. Preparing for such audit procedures may involve
substantial costs and take significant time to complete, which may distract our
officers, directors and employees from the operation of our business. Our audit
costs will also likely increase due to such procedures. If we fail to establish
and maintain effective internal control over financial reporting, we could be
unable to provide timely and accurate financial information.

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

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

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

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

We have exclusive worldwide rights to our technology for the isolation, culture,
storage, and encapsulation (microencapsulation) of insulin-producing islet cells
from porcine sources, through a license agreement with Duke University. Our
license generally may be terminated by Duke University if we fail to perform our
obligations, including obligations to conduct a research and development program
and develop the licensed products for commercialization. If terminated we would
lose the right to develop the licensed products, which would significantly harm
our business. The license agreement contemplates that once the research and


                                       12
<PAGE>

development program is completed, we and Duke University will agree upon
milestones toward commercialization of the licensed products. We will be
required to meet those agreed milestones, and if we fail to do so in a material
way, our license rights may become non-exclusive. If disputes arise in the
negotiation of those milestones, or once agreed upon, over the definition of
these requirements or whether we have satisfied the requirements in a timely
manner, or if any other obligations in the license agreement are disputed by
Duke University, the other party could terminate the agreement and we could lose
our rights to develop the licensed technology.

WE WILL REQUIRE A SUPPLY OF DESIGNATED PATHOGEN FREE PIGS IN ORDER TO COMMENCE
AND CONTINUE HUMAN CLINICAL TRIALS ON OUR MICROISLET P(TM) PRODUCT CANDIDATE. IF
WE CANNOT MAINTAIN 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 or DPF 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 DPF pigs for our preclinical research from FIOS Therapeutics, Inc. We
have not identified other suppliers in North America that can currently produce
DPF pigs to the required specification, although others may exist. If FIOS were
to cease providing DPF pigs to us in sufficient quantities, we would be required
either to locate another facility which is able to supply DPF pigs, which may
not be possible, or to construct and operate our own facility. FIOS will have
the right to terminate the supply agreement if we fail to meet our obligations
under the agreement, including payments of monthly fees. 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
FIOS or any other facility which supplies DPF 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 DPF
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/OR GENERATE REVENUE WILL SUFFER.

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

Collaborative agreements generally pose the following risks:

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

         o    collaborators may delay clinical trials, under-fund 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;

                                       13
<PAGE>

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

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

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

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

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

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

         o    obtaining regulatory approval to commence a clinical trial;

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

         o    manufacturing sufficient quantities of a product candidate;

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

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

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

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

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

         o    unforeseen safety issues; or

         o    lack of adequate funding to continue the clinical trial.

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

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

                                       14
<PAGE>

The clinical development, manufacturing, labeling, storage, record-keeping,
advertising, promotion, export, marketing, and distribution of any product
candidates we advance into clinical trials are subject to extensive regulation
by the FDA in the United States and by comparable governmental authorities in
foreign markets. In the United States, neither we nor our collaborators are
permitted to market our product candidates until we or our collaborators receive
approval of a Biologics License Application, or BLA, and/or a New Drug
Application, or NDA, from the FDA. The process of obtaining BLA approval,
particularly for novel and complex products like MicroIslet-P(TM) and
MicroIslet-H(TM), is expensive and often takes many years. Approval policies or
regulations may change. Our company has not previously filed a BLA or an NDA
with the FDA. This lack of experience may impede our ability to obtain FDA
approval in a timely manner, if at all, for our product candidates. The FDA or
any of the corresponding foreign regulatory bodies might delay, limit, or deny
approval of any product candidate of ours, and accordingly, delay, limit, or
prevent us from generating revenue from that product.

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

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

Undesirable side effects caused by MicroIslet-P(TM), MicroIslet-H(TM) or any
other product candidate we advance into clinical trials could interrupt, delay
or halt clinical trials and could result in the denial of regulatory approval by
the FDA or other regulatory authorities for any or all targeted indications.
This, in turn, could prevent us from commercializing these or any other product
candidate we advance into clinical trials.

Any one or a combination of these events could prevent us from achieving or
maintaining market acceptance of the affected product or could substantially
increase the costs and expenses of commercializing the product, which in turn
could delay or prevent us from generating significant revenues from the sale of
the product.

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

The FDA's accelerated approval process provides the opportunity for regulatory
approval based on surrogate, or substitute, endpoints that are reasonably likely
to predict clinical benefits. Drugs and biological products that are intended to
treat serious or life-threatening diseases and that either demonstrate an
improvement over available therapy or that provide therapy where none exists,
are eligible for this accelerated approval process. We may not successfully
complete clinical trials. Even if clinical trials were successfully completed,
there are no assurances that the FDA will accept a BLA on the basis of a single
study or review the BLA under the accelerated approval regulations. Failure to
obtain review on the basis of a single study or accelerated approval could
require us to complete additional and more extensive clinical trials, which
would be costly and time consuming and delay potential FDA approval for several
years. Even if we are able to obtain accelerated approval from the FDA, the FDA
still may not grant our product full approval for commercial sale. The FDA would
likely require that we conduct additional post-approval clinical studies as a
condition of any approval.

If a drug is intended for the treatment of a serious or life-threatening
condition and the drug demonstrates the potential to address an unmet medical
need for this condition, the drug sponsor may apply for FDA fast track
designation. In addition to the benefits of accelerated approval, fast track
designation may lead to designation for priority FDA review, which can be
completed in as short of a period as six months, and the ability to submit
portions of an application on a rolling basis, as they become available, for


                                       15
<PAGE>

required FDA review. Any fast track designation we may obtain may be withdrawn
by the FDA if the FDA believes that the designation is no longer supported by
data from our clinical development program or if a competitor's product is
approved for the indication we are seeking and our product is not determined to
offer any additional therapeutic advantage to that competitor's product. Any
fast track designation we may obtain will not guarantee that we will qualify for
or be able to take advantage of the priority review procedures following the
submission of a BLA. Additionally, if fast track designation were to be
withdrawn for any product for which we obtain such designation, our ability to
receive FDA approval could be delayed considerably.

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

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

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

         o    issue warning letters;

         o    impose civil or criminal penalties;

         o    withdraw regulatory approval;

         o    suspend any ongoing clinical trials;

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

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

         o    seize or detain products or require a product recall.

Moreover, in order to market any products outside of the United States, we and
our collaborators must establish and comply with numerous and varying regulatory
requirements of other countries regarding safety and efficacy. Approval
procedures vary among countries and can involve additional product testing and
additional administrative review periods. The time required to obtain approval
in other countries might differ from that required to obtain FDA approval. The
regulatory approval process in other countries may include all of the risks
described above regarding FDA approval in the United States. Regulatory approval
in one country does not ensure regulatory approval in another, but a failure or
delay in obtaining regulatory approval in one country may negatively impact the

                                       16
<PAGE>

regulatory process in others. Failure to obtain regulatory approval in other
countries or any delay or setback in obtaining such approval could have the same
adverse effects detailed above regarding FDA approval in the United States. As
described above, such effects include the risk that our product candidates may
not be approved for all indications requested, which could limit the uses of our
product candidates and adversely impact potential royalties and product sales,
and that such approval may be subject to limitations on the indicated uses for
which the product may be marketed or require costly, post-marketing follow-up
studies.

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

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

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

Other companies are currently conducting clinical trials involving the
transplantation of porcine cells into humans. The FDA requires lifelong
monitoring of all recipients of xenotransplantation products. 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.
Failure to comply with FDA guidelines may result in fines and civil penalties,
suspension of production, suspension or delay in product approval, product
seizure or recall, or withdrawal of product approval.

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

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

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

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

         o    the prevalence and severity of adverse side effects; and

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

                                       17
<PAGE>

If the health care community does not accept our products for any of the
foregoing reasons, our revenues from the sale of any approved product would be
significantly reduced.

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

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

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

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

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

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


                                       18
<PAGE>

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

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

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

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

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


                                       18
<PAGE>

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

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

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

WE WILL BE REQUIRED TO COMPLY WITH GOOD MANUFACTURING PRACTICE REQUIREMENTS, AND
OUR FAILURE TO DO SO MAY SUBJECT US TO FINES AND OTHER PENALTIES THAT WILL DELAY
OR PREVENT US FROM MARKETING AND SELLING OUR PRODUCTS.

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

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

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

                                       20
<PAGE>

         o    injury to our reputation;

         o    withdrawal of clinical trial participants;

         o    costs of related litigation;

         o    substantial monetary awards to patients or other claimants;

         o    decreased demand for our product candidates;

         o    loss of revenues; and

         o    the inability to commercialize our product candidates.

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

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

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

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

A SUBSTANTIAL NUMBER OF SHARES WE HAVE ISSUED IN EXEMPT TRANSACTIONS ARE, OR
WILL BE 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 issued in exempt
transactions, 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.

Investors that are not affiliates of our company and that purchased shares
directly from us or one of our affiliates may, after a six month holding period,
resell those shares into the open market without volume limitations under Rule
144, so long as we are providing current public information. Investors that are
affiliates of our company may also sell shares into the open market under Rule
144 subject to satisfying current public information, volume, manner of sale and
notice requirements. As of February 29, 2008, approximately 33.9 million shares
of our common stock were held by non-affiliates and approximately 20.7 million
shares were held by affiliates.

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

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

                                       21
<PAGE>

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, 2007, the average daily trading volume of our
stock was approximately 69,800 shares and the shares traded as low as $0.34 and
as high as $0.90 per share. On February 29, 2008, the closing price of our
common stock reported on the OTC Bulletin Board was $0.35. Both volume and price
could also be subject to wide fluctuations in response to the following:

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

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

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

         o    the timing and achievement of regulatory approvals or
              disapprovals;

         o    developments or disputes concerning patent or proprietary rights;
              and

         o    general market perception of biotechnology and pharmaceutical
              companies.

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

We have issued options and warrants to acquire common stock to our employees,
directors, consultants, and investors at various prices, some of which are or
may in the future be below the market price of our stock. If exercised, these
options and warrants will cause immediate and possibly substantial dilution to
our stockholders. We currently have options and warrants for approximately 0.8
million shares outstanding that have exercise prices at or below the recent
closing price of our stock on February 29, 2008 of $0.35 per share. We have
options and warrants for approximately 15.6 million shares outstanding at prices
above the recent $0.35 closing price, and if the market price increases, these
options and warrants could have a dilutive effect on stockholders if exercised.
Future options issued under our stock option plan may have further dilutive
effects.

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

As of February 29, 2008, our executive officers, directors and their affiliates
beneficially owned or controlled approximately 8.4% of the outstanding shares of
our common stock (after giving effect to the exercise of all options and
warrants held by them which are exercisable within sixty days of February 29,
2008). John F. Steel IV, our former Chairman and Chief Executive Officer
beneficially owns 16.4% of the outstanding shares of common stock, John J.
Hagenbuch beneficially owns 8.9%, Ronald Katz our Chairman beneficially owns
7.9%, and Richard Schoninger beneficially owns 6.2% of our outstanding common
stock (after giving effect to the exercise of all options and warrants held by
such person which are exercisable within sixty days of February 29, 2008).
Accordingly, a limited number of stockholders 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.

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

                                       22
<PAGE>

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 MAY ISSUE COMMON STOCK AS LIQUIDATED DAMAGES UNDER CERTAIN REGISTRATION
RIGHTS AGREEMENTS WHICH WILL DILUTE YOUR INVESTMENT IN OUR COMPANY.

In connection with private placements of common shares and warrants in December
2005 and August 2006, we are obligated to maintain registration statements
available for the resale of the common shares and the shares underlying the
warrants sold in these financings. In April 2007, we notified the December 2005
investors that the registration statement which registered their shares for
resale was no longer available, and accordingly, we became subject to liquidated
damages beginning on May 20, 2007. Upon filing of this annual report, we will
notify the August 2006 investors that the registration statement which
registered their shares for resale will no longer be available, and accordingly,
we expect to become subject to liquidated damages beginning at the end of April
2008.

With respect to each financing, the liquidated damages are equal to 0.0003 times
the purchase price of the securities the investors continue to own for each day
the registration statement is not available, other than securities that may be
resold under Rule 144 without restriction. We are permitted to pay any such
liquidated damages in cash or in shares of common stock at our election. If we
elect to issue shares, such shares are to be valued based on the volume weighted
average price of shares of common stock for the five trading days prior to the
date of issue. We are required to pay such damages no later than the first
trading day of each calendar month immediately following the month in which the
damages accrue.

Through December 31, 2007, liquidated damages of $143,000 had accrued, and we
discharged $132,000 of such obligation through the issuance of 267,684 shares of
common stock. Liquidated damages are expected to continue to accrue at
approximately $12,000 per month through April 2008, and at approximately $46,000
thereafter until we file and the SEC declares effective post-effective
amendments to the registration statements containing updated financial and other
information concerning our company. We intend to continue to pay such amounts by
issuing shares of our common stock.

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

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

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

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

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

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

In addition Chapter 78 of the Nevada Revised Statutes contains provisions that
may enable our board of directors to discourage, delay, or prevent a change in
our ownership or in our management. The combinations with interested
stockholders provisions of the Nevada Revised Statutes, subject to certain
exceptions, restrict the ability of our company to engage in any combination
with an interested stockholder for three years after the date a stockholder

                                       23
<PAGE>

becomes an interested stockholder, unless, prior to the stockholder becoming an
interested stockholder, our board of directors gave approval for the combination
or the acquisition of shares which caused the stockholder to become an
interested stockholder. If the combination or acquisition was not so approved
prior to the stockholder becoming an interested stockholder, the interested
stockholder may effect a combination after the three-year period only if either
the stockholder receives approval from a majority of the outstanding voting
shares, excluding shares beneficially owned by the interested stockholder or its
affiliates or associates, or the consideration to be paid by the interested
stockholder exceeds certain thresholds set forth in the statute. For purposes of
the foregoing provisions, "interested stockholder" means either a person, other
than our company or our subsidiaries, who directly or indirectly beneficially
owns 10% or more of the voting power of our outstanding voting shares, or one of
our affiliates or associates which at any time within three years immediately
before the date in question directly or indirectly beneficially owned 10% or
more of the voting power of our outstanding shares.

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

ITEM 1B. UNRESOLVED STAFF COMMENTS.

Not applicable.

ITEM 2.  PROPERTIES

We own no real property. We lease approximately 12,000 square feet of office and
laboratory space in San Diego, California at a current rental rate of
approximately $20,000 per month. The lease expires on February 28, 2009. This
facility is adequate for our current requirements.

ITEM 3.  LEGAL PROCEEDINGS

In January 2007, we received a demand letter from an attorney stating that he
represented shareholders who purchased approximately $3 million of common shares
at a price of $6 per share. The letter alleges that these shares were purchased
in 2002 and that we and certain former officers engaged in self-dealing,
potential fraud with respect to manipulation of the stock price, and diminution
of share value. Our insurance carriers have been notified of the demand letter
and as of March 31, 2008, no lawsuit has been filed by these shareholders.

On March 16, 2007, we and our wholly-owned subsidiary, MicroIslet, Inc., a
Delaware corporation (MicroIslet of Delaware); John F. Steel, IV, former
Chairman of the Board and Chief Executive Officer; Haro Hartounian, Ph.D.,
former President and Chief Operating Officer; and James R. Gavin, III, M.D.,
Ph.D., former President and Chief Executive Officer, filed a Declaratory Relief
Lawsuit ("DLR") in the United States District Court for the Southern District of
California in San Diego against the shareholders on whose behalf the demand
letter was sent. The DLR seeks a declaration from the court that we, MicroIslet
of Delaware, Mr. Steel, Dr. Hartounian and Dr. Gavin did not engage in conduct
entitling the shareholders to any relief under federal or state securities laws,
or otherwise. The DLR also seeks attorneys' fees and costs. We have not received
a response to the DLR, and we intend to dismiss the DLR without prejudice to our
ability to refile the action. No amounts have been accrued related to this
litigation.

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

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

Not applicable.


                                       24
<PAGE>

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
         ISSUER PURCHASES OF EQUITY SECURITIES

MARKET INFORMATION

Our common stock is currently traded on the OTC Bulletin Board under the symbol
"MIIS.OB." From June 1, 2004 through May 10, 2007, our common stock was traded
on the American Stock Exchange (AMEX) under the trading symbol "MII." The
trading market in our common stock on the OTC Bulletin Board is limited and
sporadic. Failure to develop or maintain an active trading market could
negatively affect the value of our shares and make it difficult for our
stockholders to sell their shares or recover any part of their investment in us.
The market price of our common stock may be highly volatile. The following table
sets forth, for our common stock for the periods indicated, the high and low
sale prices as reported by the American Stock Exchange and the OTC Bulletin
Board for the period from January 1, 2006, to December 31, 2007. The
over-the-counter market quotations reflect inter-dealer prices and may not
reflect adjustments for retail markups, markdowns, or commissions and may not
reflect actual transactions.

                                                Sale Price
                                ----------------------------------------
                                      2007                   2006
                                -----------------      -----------------
                                  High      Low          High      Low
                                -------   -------      -------   -------

     First Quarter              $  0.90   $  0.44      $  2.63   $  1.50
     Second Quarter                0.87      0.38         2.45      1.46
     Third Quarter                 0.70      0.34         2.09      1.39
     Fourth Quarter                0.67      0.40         1.94      0.72

HOLDERS

On February 29, 2008, there were approximately 110 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.

DIVIDEND POLICY

We have not paid any dividends to date and do not anticipate paying any
dividends on our common stock. Nevada and California law currently restrict our
ability to pay dividends as a result of our financial condition.

RECENT SALES OF UNREGISTERED SECURITIES

During the fiscal year ended December 31, 2007, the following securities were
sold without registration under the Securities Act and not previously reported
on Form 10-Q or Form 8-K:

On December 6, 2007, we issued an aggregate of 300,000 restricted stock units to
two individuals affiliated with our investor relations firm as partial
consideration for the firm's investor relations services. The restricted stock
units vest in equal monthly installments over one year beginning on the date of
issue, and settle via delivery of shares of common stock six months after
vesting, or upon a sooner change in control. The restricted stock units were
offered and sold without registration under the Securities Act of 1933 to
individuals who were by reason of their business or financial experience as an
investor relations professionals capable of evaluating the merits and risks of
an investment in the restricted stock units and of protecting their own
interests in connection with the acquisition of the restricted stock units, and
in reliance upon the exemption from registration in Section 4(2) of the
Securities Act. The restricted stock units and the shares issued upon settlement
thereof may not be offered or sold in the United States in the absence of an
effective registration statement or exemption from the registration requirements
under the Securities Act, and the shares issued upon settlement will bear an
appropriate restrictive legend.

                                       25
<PAGE>

During the quarter ended December 31, 2007, we incurred liquidated damages of
$132,000, which we discharged through the issuance of 267,684 shares of common
stock through December 31, 2007. See Note 11 to our consolidated financial
statements included in this report. These shares were offered and sold without
registration under the Securities Act to accredited investors in reliance upon
the exemption provided by Section 4(2) of the Securities Act and Rule 506 of
Regulation D thereunder, and may not be offered or sold in the United States in
the absence of an effective registration statement or exemption from the
registration requirements under the Securities Act. An appropriate legend has
been placed on the shares issued.

ITEM 6.  SELECTED FINANCIAL DATA.

Not applicable.

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATION AND
         FINANCIAL CONDITION

THE DISCUSSION IN THIS SECTION CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING
NATURE RELATING TO FUTURE EVENTS OR OUR FUTURE PERFORMANCE. WORDS SUCH AS
"ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," "MAY" AND SIMILAR
EXPRESSIONS OR VARIATIONS OF SUCH WORDS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS, BUT ARE NOT THE ONLY MEANS OF IDENTIFYING FORWARD-LOOKING
STATEMENTS. SUCH STATEMENTS ARE ONLY PREDICTIONS AND ACTUAL EVENTS OR RESULTS
MAY DIFFER MATERIALLY. IN EVALUATING SUCH STATEMENTS, WE URGE YOU TO CAREFULLY
CONSIDER VARIOUS FACTORS IDENTIFIED IN THIS REPORT, INCLUDING THOSE DISCUSSED
UNDER "RISK FACTORS" IN PART I, ITEM 1A OF THIS REPORT, 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 conditions requiring cell-based replacement treatments,
with a focus on type 1, or insulin-dependent diabetes. Patented islet
transplantation technology, exclusively licensed from Duke University, along
with our own developments, constitute methods for isolating, culturing,
cryopreservation, and immuno-protection (microencapsulation) of islet cells. We
intend to continue our research and development efforts and, ultimately, to
introduce products to the market. Currently, we have no products for sale and
are focused on research and development activities in preparation for clinical
activities.

Since inception, we have financed our operations through private sales of equity
securities. We have not generated revenues from sales of products, have had only
limited revenues from grants, and have had significant losses since inception.
We anticipate that we will incur substantial additional operating losses in
future years as we progress in our research and development programs. At
December 31, 2007, we had a deficit accumulated during the development stage of
approximately $50.2 million. We do not expect to produce revenues from product
sales for the foreseeable future so our revenues will be limited to research
grants we are able to obtain.

We need immediate and substantial cash to continue our operations. We currently
have no funding commitments. Management has projected that cash on hand will be
sufficient to allow us to continue our operations only through April 2008, and
only if our promissory note holders with matured obligations do not seek to
enforce payment of such notes. We therefore will need additional funding, either
through equity or debt financings or partnering arrangements, or we will be
forced to curtail or cease operations.

GOING CONCERN

The consolidated financial statements included elsewhere in this annual report
on Form 10-K have been prepared assuming we will continue as a going concern. We
incurred substantial operating losses and negative operating cash flows through
December 31, 2007, and as of that date our cash position was $353,000. We have
incurred net losses of $9.4 million and $10.7 million and negative operating
cash flows of $7.4 million and $9.5 million for the years ended December 31,
2007 and 2006, respectively. We also had a deficit accumulated during the


                                       26
<PAGE>

development stage of $50.2 million at December 31, 2007. As of that date, our
cash and cash equivalents were $353,000 and working capital deficit was $4.4
million, primarily reflecting $4.2 million of notes payable, including accrued
interest, which were due in January 2008 and March 2008 and are currently due on
demand. Currently, management has projected that cash on hand will be sufficient
to allow us to continue our operations only through April 2008. These matters
raise substantial doubt about our ability to continue as a going concern.
Management's plans in regard to these matters are described in Note 1 to our
consolidated financial statements. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

Our future cash requirements will depend on many factors, including continued
scientific progress in our research and development programs, the scope and
results of pre-clinical and clinical trials, the time and costs involved in
obtaining regulatory approvals, the costs involved in filing, prosecuting and
enforcing patents, competing technological and market developments, and the cost
of product commercialization. We do not expect to generate a positive cash flow
from operations at least until the commercial launch of our first product and
possibly later given the expected spending for research and development programs
and the cost of commercializing product candidates. Accordingly, we will require
external financing to sustain our operations, perhaps for a significant period
of time. Our plans include issuing additional debt and/or selling equity
securities to sustain our operations. In addition, we will continue to seek
funding in the form of grants for our scientific research. During 2007, we
completed two private placements of common stock and warrants for aggregate
gross proceeds of $2,045,000, and borrowed an additional $4,000,000, $3,000,000
of which was borrowed from our former Chairman and $1,000,000 of which was
borrowed from an existing shareholder. In the first quarter of 2008, we issued
two convertible notes to a related party pursuant to which we may request to
borrow up to $2,500,000 in the aggregate. We have completed short term
financings as part of a master purchase agreement dated January 25, 2008 with
amendment 1 dated March 17, 2008 and amendment 2 dated April 2, 2008. This
purchase agreement allows the Company to borrow up to $4.5 million. Under this
purchase agreement we have borrowed $1.0 million in January 2008, $500,000 in
March 2008 and $600,000 in April 2008 to fund our working capital needs. See
"Recent Debt and Equity Financings" below for more information about these
transactions.

If we secure funding and continue to operate as a going concern, our business
plan for the next twelve months is to demonstrate the safety and efficacy of our
product candidate in animal models and file an IND application with the Food and
Drug Administration for xenotransplantation clinical trials. It is necessary for
us to establish evidence of efficacy of our approach in order to advance to
subsequent milestones.

RECENT DEBT AND EQUITY FINANCINGS

JANUARY 2007 FINANCING

On January 12, 2007, John J. Hagenbuch, our former Chairman, lent us $2 million
under the terms of an unsecured subordinated promissory note. The note accrues
simple interest at the prime rate as published in the Wall Street Journal from
time to time. All outstanding principal and accrued interest under the note
became due on January 12, 2008.

In connection with this loan, we issued a 10-year detachable warrant to Mr.
Hagenbuch allowing for a purchase for cash of up to 500,000 shares of our common
stock at an exercise price of $1.00 per share. On May 10, 2007, this warrant was
amended to remove a condition to exercisability based on American Stock Exchange
approval, which approval was no longer required due to the removal of our common
stock from the American Stock Exchange. This warrant is now fully exercisable.

MAY 2007 FINANCING

On May 15, 2007, Mr. Hagenbuch lent us an additional $1 million under the terms
of an unsecured promissory note. The note accrues simple interest at the prime
rate as published in the Wall Street Journal from time to time. The terms of the
note restrict us from incurring senior indebtedness or pledging our intellectual
property. All outstanding principal and accrued interest under the note became
due on January 12, 2008.

                                       27
<PAGE>

In connection with this loan, we issued a 10-year detachable warrant to Mr.
Hagenbuch allowing for a purchase for cash of up to 250,000 shares of our common
stock at an exercise price of $0.75 per share.

JUNE 2007 FINANCING

In June 2007, we entered into a securities purchase agreement with certain
accredited investors pursuant to which we agreed to issue and sell 2,612,500
shares of our common stock for cash at a purchase price of $0.40 per share for
gross proceeds of $1,045,000. In connection with this financing, we issued
warrants to each investor, which are exercisable, commencing on the one-year
anniversary of the closing date until the six-year anniversary of the closing
date, for an aggregate of 1,306,250 shares of our common stock at an exercise
price of $0.60 per share. Also, we incurred legal fees in connection with the
financing of approximately $18,000, which were netted with the proceeds.
Pursuant to the securities purchase agreement, the purchasers of a majority of
the shares had the right to nominate up to four directors to serve on our board
of directors. The purchasers nominated the following four individuals to serve
on the board: Ronald Katz, Keith B. Hoffman, Ph.D., Jonathan R. T. Lakey, Ph.D.,
M.S.M., and Michael J. Andrews. Mr. Lakey resigned from the board in February
2008.

In connection with this financing, we entered into a registration rights
agreement pursuant to which we agreed to register for resale the shares of
common stock sold in the financing and the shares of common stock issuable upon
the exercise of the warrants on the next registration statement filed with the
SEC, relating to an offering for any of our equity securities, other than a
registration statement relating to equity securities to be issued solely in
connection with an acquisition of another entity, in an exchange offer for our
securities, or in connection with stock option or other employee benefit plans.
If the SEC requires us to omit some of the shares purchased in the financing or
upon exercise of the warrants in order for the offering to retain the status of
a secondary offering under SEC Rule 415, we are obligated to issue to each
holder as liquidated damages, a warrant exercisable from and after the date one
year after the closing date at an exercise price of $0.60 per share and expiring
on the date six years after the closing date, for a number of shares of our
common stock equal to 4% of the number of shares held by the holder which were
required to be omitted.

SEPTEMBER 2007 FINANCING

On September 20, 2007, Peter Knobel, an existing investor, lent us $1 million
under the terms of an unsecured subordinated promissory note. All outstanding
principal and daily compounded interest at a 10% annual interest rate is due on
March 31, 2008, or upon an "event of default," as defined in the agreement. We
may prepay the note at any time without penalty.

In connection with this loan, we issued Mr. Knobel a 5-year detachable warrant
allowing purchase for cash of up to 400,000 shares of our common stock at an
exercise price of $0.40 per share. The warrant is first exercisable on the one
year anniversary of the issue date, or upon any earlier merger or acquisition of
our company. In connection with this transaction, we entered into a registration
rights agreement pursuant to which we agreed to register for resale the shares
of common stock issuable upon exercise of the warrant on the next registration
statement we file with the SEC relating to an offering for any of our equity
securities, other than a registration statement relating to equity securities to
be issued solely in connection with an acquisition of another entity, in an
exchange offer for our securities, or in connection with stock option or other
employee benefit plans.

NOVEMBER 2007 FINANCING

On November 16, 2007, we entered into a securities purchase agreement with a
private trust, pursuant to which we agreed to issue and sell 2,352,941 shares of
our common stock for cash at a purchase price of $0.425 per share for gross
proceeds of $1,000,000. In connection with this financing, we issued a warrant
to the investor, which is exercisable, commencing on the earlier of the one-year
anniversary of the closing date or the date of any of certain fundamental
transactions involving our company (including a merger, a sale of substantially


                                       28
<PAGE>

all of our assets, the commencement of a tender or exchange offer or a
reclassification of our common stock) until the six-year anniversary of the
closing date, for an aggregate of 1,294,118 shares of our common stock at an
exercise price of $0.60 per share. Also, we incurred legal fees in connection
with the financing of approximately $26,000, which were netted with the
proceeds. Ronald Katz, our Chairman, serves as co-trustee of the trust. The
trust's beneficiaries are not affiliated with Mr. Katz.

Also in connection with this financing, we entered into a registration rights
agreement pursuant to which we agreed to register for resale the shares of
common stock sold in the financing and the shares of common stock issuable upon
the exercise of the warrants in the next registration statement filed with the
SEC relating to an offering for any of our equity securities, other than a
registration statement relating to equity securities to be issued solely in
connection with an acquisition of another entity, in an exchange offer for our
securities, or in connection with stock option or other employee benefit plans.
If the SEC requires us to omit some of the shares purchased in the financing or
upon exercise of the warrants in order for the offering to retain the status of
a secondary offering under SEC Rule 415, we will be obligated to issue to each
holder, as liquidated damages, a warrant exercisable beginning one year after
the closing date at an exercise price of $0.60 per share and expiring on the
date six years after the closing date, for a number of shares of our common
stock equal to 4% of the number of shares held by the holder which were required
to be omitted.

JANUARY 2008, MARCH 2008 AND APRIL 2008 FINANCINGS

On January 25, 2008, we entered into a securities purchase agreement with a
private trust. Ronald Katz, our Chairman, serves as co-trustee of the trust. The
trust's beneficiaries are not affiliated with Mr. Katz. The purchase agreement
permitted us to issue up to $2,000,000 in aggregate principal amount of
Subordinated Convertible Unsecured Revolving Promissory Notes due March 31, 2008
and warrants to purchase a number of shares of common stock equal to the
quotient of the aggregate funds advanced to us under the notes, divided by
$2.50. Each note accrues interest at the rate of 10% per annum until maturity
and 24% per annum thereafter. Interest is payable monthly in arrears, and may,
at our option, either be capitalized and added to the outstanding principal
balance of the note, or paid to the holder in cash. The holder of a note may, at
its option, convert all or a portion of the principal and accrued interest into
the securities sold in our next equity financing transaction in which we raise
at least $3 million, on the same terms as the securities purchased by the other
investors in the financing. Each warrant has an exercise price of $0.40 per
share and is exercisable for a period of five years, commencing on the earlier
of the one year anniversary of the grant and the occurrence of any specified
fundamental transaction involving our company. The holder may elect a cashless
exercise of the warrant under certain circumstances.

In connection with the purchase agreement, on January 25, 2008, we issued to the
trust (1) a note in the principal amount of $1,000,000 (January Note), and (2) a
warrant (January Warrant) to purchase a number of shares of common stock equal
to the quotient of the aggregate funds advanced to us under the January Note,
divided by $2.50, up to a maximum of 400,000 shares. The full $1,000,000 under
the January Note has been drawn down by us, and accordingly, the January Warrant
is exercisable for 400,000 shares.

Pursuant to the purchase agreement, on January 25, 2008, we also entered into a
registration rights agreement with the trust, pursuant to which we have agreed
to register for resale the shares of common stock issuable upon exercise of the
warrants issued pursuant to the purchase agreement on the next registration
statement we file with the SEC relating to an offering for any of our equity
securities, other than a registration statement relating to equity securities to
be issued solely in connection with an acquisition of another entity, in an
exchange offer for our securities, or in connection with stock option or other
employee benefit plans.

On March 17, 2008, we entered into a First Amendment to Securities Purchase
Agreement and Promissory Note with the trust. Pursuant to the amendment, the
maximum aggregate original principal amount of the notes issuable under the
purchase agreement was increased from $2,000,000 to $2,500,000, and the maturity
date of the notes was extended to May 31, 2008. The maturity date may be
accelerated by the trust upon the occurrence and during the continuance of an
event of default.

                                       29
<PAGE>

In connection with the amendment, on March 17, 2008, we issued to the trust (1)
a note in the principal amount of $1,500,000 (March Note), and (2) a warrant
(March Warrant), to purchase a number of shares of common stock equal to the
quotient of the aggregate funds advanced to us under the March Note, divided by
$2.50, up to a maximum of 600,000 shares. On that same date, the trust advanced
to us $500,000 under the terms of the March Note. Prior to the maturity of the
March Note, we may request additional advances from the trust, up to a total
aggregate principal amount of $1,500,000, which the trust may agree to make in
its sole discretion.

We entered into a Second Amendment to Securities Purchase Agreement with the
trust effective April 2, 2008. Pursuant to the amendment, the maximum aggregate
original principal amount of the notes issuable under the purchase agreement was
increased from $2,500,000 to $4,500,000.

In connection with this amendment, on April 2, 2008, we borrowed $500,000 from
one accredited investor unaffiliated with the trust or Mr. Katz and issued a
note under the purchase agreement in the original principal amount of $500,000.
On April 4, 2008, we borrowed an additional $100,000 from another accredited
investor unaffiliated with the trust or Mr. Katz on the same terms. The warrants
issued in connection with these notes are exercisable for 240,000 shares. The
terms and conditions of these notes and warrants are otherwise substantially
similar to the March Note and March Warrant.

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 which 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:

Share-Based Compensation
------------------------

Prior to January 1, 2006, we accounted for our share-based employee compensation
plans under the measurement and recognition provisions of Accounting Principles
Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," and
related Interpretations, as permitted by Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standards No. 123 (FAS 123),
"Accounting for Stock-Based Compensation." We recorded no share-based employee
compensation expense for options granted under our 2005 Equity Incentive Plan or
its predecessor plans prior to January 1, 2006, as all options granted under
those plans had exercise prices equal to the fair market value of our common
stock on the date of grant. In accordance with FAS 123 and FAS 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure," we disclosed our net
income or loss and net income or loss per share as if we had applied the fair
value-based method in measuring compensation expense for our share-based
incentive programs.

Effective January 1, 2006, we adopted the fair value recognition provisions of
FAS 123R, "Share-Based Payment," using the modified prospective transition
method. Under that transition method compensation expense that we recognize
beginning on that date includes: (a) compensation expense for all share-based
payments granted prior to, but not yet vested as of, January 1, 2006, based on
the grant date fair value estimated in accordance with the original provisions
of FAS 123, adjusted for estimated forfeitures, and (b) compensation expense for
all share-based payments granted on or after January 1, 2006, based on the grant
date fair value estimated in accordance with the provisions of FAS 123R. Results
for prior periods have not been restated for comparative purposes. At December
31, 2007, there was $1.2 million of total unrecognized compensation cost related
to non-vested share-based compensation arrangements granted under all equity
compensation plans. Total unrecognized compensation cost will be adjusted for
future changes in estimated forfeitures. We expect to recognize that cost over a
weighted average period of 1.9 years.

                                       30
<PAGE>

We estimate the fair value of options granted using the Black-Scholes option
valuation model and the assumptions shown in Note 2 to the consolidated
financial statements included in this report. We estimate the expected term of
options granted based on the history of grants and exercises in our option
database along with the term of the options reported by a peer group consisting
of early-stage pharmaceutical companies with market capitalizations below $300
million. We estimate the volatility of our common stock at the date of grant
based on historical trading of our common stock. We base the risk-free interest
rate that we use in the Black-Scholes option valuation model on the implied
yield in effect at the time of option grant on U.S. Treasury zero-coupon issues
with equivalent remaining terms. We have never paid a cash dividend on our
common stock and we do not anticipate paying any cash dividends in the
foreseeable future. Consequently, we use an expected dividend yield of zero in
the Black-Scholes option valuation model. We use historical data of our company
and the peer group to estimate pre-vesting option forfeitures and record
share-based compensation expense only for those awards that are expected to
vest. For all options we amortize the fair value on a straight-line basis. All
options are amortized over the requisite service periods of the awards, which
are generally the vesting periods. We may elect to use different assumptions
under the Black-Scholes option valuation model in the future, which could
materially affect our net income or loss and net income or loss per share.

RESULTS OF OPERATIONS

Grant revenue for the years 2007 and 2006 was $742,000 and $631,000,
respectively, and is derived from a three year $1.7 million Phase II Small
Business Innovation Research (SBIR) grant by the National Institutes of Health
(NIH). The grant will be used to further develop our islet cell transplantation
technology for treatment of insulin-dependent diabetes.

General and administrative expenses decreased by $1,166,000 to $3,161,000 in
2007 compared to $4,327,000 in 2006. The decreases included:

         o    decreased investor relations expense ($103,000) resulting from the
              expiration of our contract with an investor relations firm in
              March 2007 and the delay until November 2007 in executing a
              contract with a new firm;

         o    decreased directors' fees ($75,000) due to the waiver by all
              directors of unpaid fees and future fees in June 2007;

         o    decreased share-based compensation expense under FAS 123R
              ($518,000) due to reduced headcount;

         o    reduced compensation expense associated with the Chief Executive
              Officer position ($293,000); and

         o    decreases in legal expenses ($21,000), office supplies ($12,000)
              and insurance ($15,000).

         o    These decreases were offset by non-cash expenses for stock
              issuances to certain stockholders in satisfaction of contractual
              liquidated damages associated with the unavailability of a
              registration statement ($132,000).

Research and development expenses decreased $680,000 to $6,408,000 in 2007, from
$7,088,000 in 2006. These decreases included:

         o    decreased share-based compensation expense under FAS 123R
              ($517,000);

         o    reduced lab operations expense due to increased outsourcing
              ($461,000);

         o    reduced repair and maintenance due to outsourcing ($19,000); and

         o    reduced salary and benefits ($721,000) resulting from an decrease
              in headcount;

         o    These decreases were offset by outsourcing and expanded research
              collaboration costs with Progenitor Cell Therapy, The Scripps
              Research Institute, UC Davis and FIOS Therapeutics, Inc.
              ($888,000)

                                       31
<PAGE>

Interest income was $60,000 in 2007 and $133,000 in 2006. The decrease in
interest income was due primarily to the lower levels of cash and cash
equivalents throughout the year compared to the previous year.

Interest expense was $665,000 in 2007 and $8,000 in 2006. The increase in
interest expense was attributable to the three short term notes payable that we
entered into during the year ended December 31, 2007. See "Recent Debt and
Equity Financings" above for more information about these notes.

Our net loss was $9,434,000 or $0.18 per common share in 2007, and $10,663,000
or $0.23 per common share in 2006. 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, 2007, our federal tax net operating loss and federal tax credit
carry forwards were $42.9 million and $1,024,000, respectively, which will begin
to expire in 2019, if not utilized. Our ability to utilize our net operating
loss and tax credit carry forwards may become subject to limitation in the event
of a change in ownership.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations since inception primarily through private sales
of equity securities, which, from inception through December 31, 2007, have
netted approximately $27.5 million, and to a lesser extent, through short-term
debt, grant funding, and interest earned on short-term investments.

Our combined cash and cash equivalents totaled $353,000 at December 31, 2007, a
decrease of $1.5 million from December 31, 2006. The primary uses of cash and
cash equivalents during the year ended December 31, 2007, included $7.4 million
to finance our operations - principally employee costs, lab supplies,
collaboration research, and working capital requirements. The sources of cash
during the year ended December 31, 2007, were sales of common stock and
warrants, sales of short term notes payable to related persons, and grant
payments.

During 2007, we completed two private placements of common stock and warrants
for aggregate gross proceeds of $2,045,000, and borrowed an additional
$4,000,000, $3,000,000 of which was borrowed from our former Chairman and
$1,000,000 of which was borrowed from an existing shareholder, to fund working
capital needs. In the first quarter of 2008, we issued two convertible notes to
a related party pursuant to which we may request to borrow up to $2,500,000 in
the aggregate. See "Recent Debt and Equity Financings" above for more
information about these transactions.

As stated above, future cash requirements will depend on many factors. 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 "Risk Factors" in Part I, Item 1A of this
report.

As described in the overview above, we expect that our available cash and
expected grant and interest income will be sufficient to finance currently
planned activities only through April 2008.

We will also need additional funds or a collaborative partner, or both, to
finance the clinical development activities of our product candidates. 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 the entire 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 effect on our business. See "Risk Factors" in Part I, Item 1A
of this report.

                                       32
<PAGE>

PLAN OF OPERATION

We have budgeted our total cash costs for our operations for the next 12 months
(ending March 31, 2009) at approximately $15.4 million. We believe however that
the costs of remaining pre-clinical studies and Phase I/II xenotransplantation
trials could range from $16 to $18 million as further explained in the milestone
table below. The actual amount of funds required during the next 12 months, and
the amount required to complete initial pre-clinical studies and Phase I/II
xenotransplantation trials, 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 $15.4 million we have budgeted for the 12 months is divided into the
following categories:

Category                                             Estimated Cost
--------                                             --------------
Personnel .....................................      $    2,330,000
Equipment .....................................              30,000
Outside consultants and services ..............           6,600,000
Supplies and materials ........................             560,000
Travel ........................................             480,000

Facilities ....................................             320,000
General & administrative ......................             590,000
Retirement of short term notes payable and
liabilities to related persons ................           4,500,000
                                                     --------------
Total .........................................      $   15,410,000
                                                     ==============

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

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

We have sponsored research at TSRI, The California Regional Primate Center at
the University of California, Davis, and BioTox Sciences, and research continues
at all such institutions except TRSI.

Together with our sponsored research partners, and possibly other collaborators,
we continue to obtain data relating to insulin levels, blood glucose control,
immune reactions, and any side effects associated with our islet transplantation
methods. We are collecting information on dose and duration of effect regarding
implanted cells in relevant diabetes models. We are also working on developing
approaches for the reduction or elimination of the need for the use of systemic
immunosuppressive drugs in islet cell transplant recipients. Through these
activities, we are hoping to further establish attractive safety and efficacy
parameters we have seen in our product candidates to date. Such parameters are
required for the support of our planned human clinical trials.

In December 2007, we presented data to the Food and Drug Administration during a
pre-investigational new drug meeting regarding our planned clinical
xenotransplantation trials. At that meeting, we disclosed that we have achieved
evidence of graft function after 12 months in diabetic non-human primates. These
findings revealed that, on average, glucose levels were lowered more than 30%,
while insulin dose requirements fell by 50% as compared to time periods prior to
the experimental intraperitoneal transplantation of the encapsulated porcine
islets. More importantly, these results were achieved with transient
immunosuppression treatments, followed by the elimination of immunosuppression
35-40 days after each transplant procedure. We believe this is the first
demonstration of prolonged graft function in the peritoneal site without the use
of prolonged immune suppression. These studies were designed to establish
evidence of continued graft function and efficacy of immunoisolation, rather
than the achievement of an insulin-free condition in these diabetic animals.
Thus, while optimization of this approach is yet to be determined, the
feasibility of this intervention as a treatment strategy for insulin-deficient
diabetes has been demonstrated.

                                       33
<PAGE>

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

The initial patient population that we are targeting in our business strategy
are the thousands of persons who have received kidney transplants due to renal
malfunction from poorly controlled diabetes. The scientific literature suggests
that the requirements of these patients are not being met by a kidney transplant
alone. In cases where a pancreas transplant or islet cell transplants have been
available for such patients, they have had significantly improved kidney graft
survival and improved overall survival. A clear limitation has been that
sufficient amounts of islet cells, in a form that can be delivered safely and in
a reproducible fashion, are not readily available.

The following chart is a summary of the significant milestones we believe 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 MicroIslet-P(TM), product candidate. We do not
presently have a budget or timetable for the development of our MicroIslet-H(TM)
product. 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. The chart also includes
the estimated cost of achieving each milestone.

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

FILE IND APPLICATION FOR XENOTRANSPLANTATION CLINICAL TRIALS.  We will be    3/4Q2008              $7-8 Million
conducting activities in order to meet FDA requirements to establish the
porcine islet donor pig facility and the islet processing and
microencapsulation facility.  QC/QA, GMP and GLP validation studies will
be needed to support this IND.

INITIATE PHASE I/II XENOTRANSPLANTATION CLINICAL TRIALS. Once the IND for    1Q2010                $9-10 Million
xenotransplantation clinical trials is active, we plan to begin clinical
trials administering microencapsulated porcine islets to evaluate the
safety and preliminary efficacy of these islets in type 1 diabetes
patients with kidney transplants.  Whether additional Phase I/II trials
will be needed will be based on the results of the initial trial and
additional discussions with the FDA.  During these trials, we will
evaluate whether our product candidate may qualify for an orphan drug
designation under the Orphan Drug Act.  If our candidate receives an
orphan drug designation, we will be eligible for seven years of market
exclusivity following the approval of the product by the FDA, tax
benefits, and special research subsidies and funding.

INITIATE PHASE III HUMAN CLINICAL TRIALS. The design of these studies will   2010                  Unknown
be based on the results of the completed xenotransplantation clinical
trial(s) and future discussions with the FDA.  These studies test 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.  While the scope of these
trials is larger, it is not expected that the trial design will mimic the
randomized, double-blind design of trials for chemical drugs which
typically include hundreds, even thousands, of patients.

COMPLETE HUMAN CLINICAL TRIALS AND SUBMIT OUR PRODUCT TO THE FDA FOR         2010 - 2011           Unknown
APPROVAL.  Once the clinical investigations are complete we intend to
submit a marketing application to the FDA including all of our clinical,
preclinical, and manufacturing data.  The type marketing application that
will be submitted for MicroIslet-P ((TM)) is called a biologics license
application (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.

BEGIN TO MANUFACTURE, MARKET AND SELL OUR PRODUCT(S) TO BROADER CLINICAL     2011                  Unknown
MARKET.
</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.

                                       34
<PAGE>

We have not at this time identified any source of revenue from operations until
MicroIslet-P(TM) 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, will result in substantial operating losses for the
foreseeable future.

We expect to add additional employees and collaborators as they become
necessary.

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).

NEW ACCOUNTING PRONOUNCEMENTS

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not applicable.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements required by this Item 8 begin on page F-1
and are located following the signature page and officer certifications.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

Not applicable.

ITEM 9A(T) CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Our management, with the participation of our Chief Executive Officer and Acting
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures, as such term is defined in Rules 13(a)-15(e) and
15(d)-15(e) under the Securities Exchange Act of 1934, as amended, as of
December 31, 2007. Our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the rules and forms of the SEC, and that such
information is accumulated and communicated to our management, including the
Chief Executive Officer and Acting Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure. Based on that evaluation,
the Chief Executive Officer and Acting Chief Financial Officer concluded that
our disclosure controls and procedures were effective as of December 31, 2007.

MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

                                       35
<PAGE>

Our management, including our Chief Executive Officer and Acting Chief Financial
Officer, is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act. Our internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of our financial statements for
external reporting purposes in accordance with U.S. generally accepted
accounting principles (GAAP). Internal control over financial reporting includes
those policies and procedures that: (i) pertain to the maintenance of records
that in reasonable detail accurately and fairly reflect the transactions and
dispositions of our assets; (ii) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in
accordance with GAAP, and that receipts and expenditures of the company are
being made only in accordance with authorizations of our management and
directors; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of our assets that
could have a material effect on the financial statements.

 Management (with the participation of our Chief Executive Officer and Acting
Chief Financial Officer) conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework in INTERNAL
CONTROL -- INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this evaluation, management
concluded that our internal control over financial reporting was effective as of
December 31, 2007. Management has reviewed the results of their assessment with
our Audit Committee.

This annual report does not include an attestation report of our independent
registered public accounting firm regarding internal control over financial
reporting. Management's report was not subject to attestation by our independent
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit us to provide only management's report in
this Annual Report.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There have been no changes in the Company's internal control over financial
reporting during the fourth quarter of 2007 that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.

ITEM 9B. OTHER INFORMATION

EMPLOYMENT AGREEMENT WITH DR LAKEY

On September 4, 2007, we entered into an employment agreement with Jonathan
Lakey, Ph.D, M.S.M., our former President and Chief Scientific Officer. Prior to
his appointment, Dr. Lakey served as a member of our Scientific Advisory Board.
The employment agreement with Dr. Lakey contained the following terms:

         o    Dr. Lakey earned a base salary of $250,000 per year.

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

         o    Dr. Lakey was an at-will employee and either we or Dr. Lakey could
              terminate employment at any time.

         o    Dr. Lakey was reimbursed for reasonable expenses incurred under
              the agreement, including travel between San Diego and Dr. Lakey's
              primary residence in Edmonton, Alberta Canada, and housing and
              automobile expenses in San Diego of up to $2,900 per month.

         o    Dr. Lakey was entitled to all benefits including vacation, health
              and disability benefits, for which he was eligible under the terms
              and conditions of our standard benefit plans provided generally to
              senior level executives.

                                       36
<PAGE>

Dr. Lakey also received an option to purchase 400,000 shares of our common stock
under our 2005 Equity Incentive Plan at an exercise price per share of $0.57,
which was the closing price of our common stock as reported on the OTC Bulletin
Board on that date. The option had a ten year life subject to continuing service
to our company. The option vested as to 25% of the shares immediately when
granted and as to an additional 25% on each of the first, second, and third
anniversaries of the date of grant, subject to Dr. Lakey's continuing to serve
as our President and Chief Scientific Officer.

On January 25, 2008, Dr. Lakey was released from his position as President and
Chief Scientific Officer, at which time his employment agreement with us
terminated.

On February 28, 2008, Dr. Lakey resigned from our board of directors, at which
time his option ceased vesting. The option will expire unless exercised prior to
May 28, 2008.

This disclosure is provided in lieu of disclosure under Item 5.02(e) of Form
8-K.

                                       37
<PAGE>


                                    PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

The information required by this item will be contained in our proxy statement
to be filed for our 2008 Annual Meeting of Stockholders and is incorporated
herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item will be contained in our proxy statement
to be filed for our 2008 Annual Meeting of Stockholders and is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
         RELATED STOCKHOLDER MATTERS

The information required by this item will be contained in our proxy statement
to be filed for our 2008 Annual Meeting of Stockholders and is incorporated
herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
         INDEPENDENCE

The information required by this item will be contained in our proxy statement
to be filed for our 2008 Annual Meeting of Stockholders and is incorporated
herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item will be contained in our proxy statement
to be filed for our 2008 Annual Meeting of Stockholders and is incorporated
herein by reference.


                                       38
<PAGE>

                                     PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) CONSOLIDATED FINANCIAL STATEMENTS.

The following documents are filed in Part II, Item 8 of this annual report on
Form 10-K:

         Reports of Independent Registered Public Accounting Firms
         Consolidated Balance Sheets
         Consolidated Statements of Operations
         Consolidated Statements of Stockholders' Equity
         Consolidated Statements of Cash Flows
         Notes to the Consolidated Financial Statements

(a)(2) FINANCIAL STATEMENT SCHEDULES.

All schedules have been omitted as they are not required, not applicable, or the
required information is otherwise included. (a)(3) EXHIBITS.

<TABLE>
<S>     <C>
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
                                                   Filed        Incorporated                                Exhibit
Exhibit No.  Description                           Herewith     by Reference    Form         Date Filed     No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.1          Articles of Incorporation                                X         10-SB        Aug. 13, 1999  3.(a)
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.2          Certificate of Amendment to the                          X         SB-2         July 25, 2002  3.2
             Articles of Incorporation
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.3          Certificate of Amendment to the                          X         8-A12B       May 27, 2004   3.1C
             Articles of Incorporation
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
3.4          Amended and Restated Bylaws                              X         10-KSB       April 6, 2006  3.3
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
4.1          Specimen Common Stock Certificate                        X         SB-2/A       Nov. 20, 2002  4.1
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.1         Amended and Restated 2000 Stock                          X         10-KSB       March 30,      10.1
             Option Plan, as amended and                                                     2004
             restated January 30, 2004*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.2         Form of Stock Option Grant Notice                        X         10-KSB       March 30,      10.2
             and Stock Option Agreement under                                                2005
             2000 Stock Option Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.3         License and Sponsored Research                           X         SB-2/A       Feb. 10, 2003  10.3
             Agreement dated September 15, 1998,
             between MicroIslet of Delaware and
             Duke University
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.4         Amendment to License and Sponsored                       X         SB-2/A       Feb. 10, 2003  10.14
             Research Agreement dated February
             5, 1999, between MicroIslet of
             Delaware and Duke University
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.5         Research Funding and Option                              X         10-KSB       March 28,      10.6
             Agreement dated February 20, 2003,                                              2003
             between MicroIslet, Inc. and the
             Scripps Research Institute, a
             California nonprofit public benefit
             corporation +
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.6         Standard Industrial/Commercial                           X         SB-2         July 25, 2002  10.6
             Multi-Tenant Lease dated July 3,
             2002, between MicroIslet, Inc. and
             Nancy Ridge Technology Center, L.P.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.7         First Amendment dated February 17,                       X         8-K          Feb. 24, 2005  99.1
             2005, to the Lease dated July 3,
             2002 between MicroIslet, Inc. and
             Nancy Ridge Technology Center, L.P.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------


                                       39
<PAGE>

------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
                                                   Filed        Incorporated                                Exhibit
Exhibit No.  Description                           Herewith     by Reference    Form         Date Filed     No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.8         Warrant Agreement, dated April 11,                       X         SB-2         April 15,      10.19
             2003, between MicroIslet, Inc. and                                              2003
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.9         Warrant Agreement, dated May 12,                         X         8-K          May 13, 2003   10.2
             2003 between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.10        Warrant Amendment, dated August 26,                      X         8-K          Aug. 28, 2003  10.2
             2003, between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.11        Warrant Amendment, dated August 26,                      X         8-K          Aug. 28, 2003  10.4
             2003, between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 1995
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.12        Form of Warrant dated October 31,                        X         8-K          Nov. 3, 2003   10.2
             2003
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.13        Form of Special Stock Option used                        X         S-8          Sept. 26,      99.2
             in connection with option grants                                                2003
             outside of MicroIslet, Inc.'s stock
             option plans*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.14        Special Stock Option granted to                          X         10-KSB       March 30,      10.34
             Robert W. Anderson on November 10,                                              2004
             2003*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.15        Special Stock Option granted to                          X         10-KSB       March 30,      10.36
             Steven T. Frankel on November 10,                                               2004
             2003*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.16        Form of Securities Purchase                              X         10-KSB       March 30,      10.37
             Agreement dated as of March 16, 2004                                            2004
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.17        Form of Warrant Agreement dated as                       X         10-KSB       March 30,      10.38
             of March 16, 2004                                                               2004
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.18        Warrant Agreement, dated January                         X         10-QSB       May 13, 2004   10.3
             30, 2004, between MicroIslet, Inc.
             and Strategic Growth International,
             Inc.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.19        Warrant Agreement, dated May 25,                         X         10-QSB       Aug. 13, 2004  10.3
             2004, between MicroIslet, Inc. and
             Strategic Growth International, Inc.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.20        Amended and Restated MicroIslet,                         X         S-8          Apr. 6, 2007   4.2
             Inc. 2005 Equity Incentive Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.21        Form of Stock Option Grant Notice          X
             and Stock Option Agreement under
             2005 Equity Incentive Plan (revised
             December 2007)*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.22        Form of Stock Award Agreement under                      X         8-K          Jan. 19, 2006  99.2
             2005 Equity Incentive Plan*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.23        System lease dated August 23, 2005,                      X         10QSB        Nov. 14, 2005  10.1
             between MicroIslet, Inc. and
             Beckman Coulter Corporation
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------


                                       40
<PAGE>

------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
                                                   Filed        Incorporated                                Exhibit
Exhibit No.  Description                           Herewith     by Reference    Form         Date Filed     No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.24        Securities Purchase Agreement dated                      X         8-K          Dec. 27, 2005  99.1
             as of December 23, 2005, between
             MicroIslet, Inc. and certain
             purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.25        Registration Rights Agreement dated                      X         8-K          Dec. 27, 2005  99.2
             as of December 23, 2005, between
             MicroIslet, Inc. and certain
             investors
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.26        Form of Warrant dated December 23,                       X         8-K          Dec. 27, 2005  99.3
             2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.27        Long Term Supply Agreement dated                         X         8-K/A        Jan. 1, 2006   99.2
             November 15, 2005, between
             MicroIslet, Inc. and Mayo
             Foundation for Medical Education
             and Research +
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.28        Professional Services Agreement                          X         8-K          Jan. 19, 2006  99.3
             dated January 18, 2006, between
             MicroIslet, Inc. and Resources
             Connection, LLC*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.29        Securities Purchase Agreement dated                      X         8-K          August 1,      99.1
             July 27, 2006, among MicroIslet,                                                2006
             Inc. and certain purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.30        Amendment dated December 7, 2006 to                      X         8-K          December 12,   99.1
             Securities Purchase Agreement dated                                             2006
             July 27, 2006, among MicroIslet,
             Inc. and certain purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.31        Registration Rights Agreement dated                      X         8-K          August 1,      99.2
             July 27, 2006, among MicroIslet,                                                2006
             Inc. and certain investors
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.32        Form of Warrant dated July 27, 2006                      X         8-K          August 1,      99.3
                                                                                             2006
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.33        Unsecured Subordinated Promissory                        X         8-K          January 17,    99.1
             Note dated January 12, 2007, issued                                             2007
             by MicroIslet, Inc. to John J.
             Hagenbuch, Trustee U/D/T dated
             September 13, 2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.34        Warrant Agreement dated January 12,                      X         8-K          January 12,    99.2
             2007, between MicroIslet, Inc. and                                              2007
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.35        Unsecured Promissory Note dated May                      X         8-K          May 15, 2007   99.1
             15, 2007, issued by MicroIslet,
             Inc. to John J. Hagenbuch, Trustee
             U/D/T dated September 13, 2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.36        Warrant Agreement dated May 15,                          X         8-K          May 15, 2007   99.2
             2007, between MicroIslet, Inc. and
             John J. Hagenbuch, Trustee U/D/T
             dated September 13, 2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------


                                       41
<PAGE>

------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
                                                   Filed        Incorporated                                Exhibit
Exhibit No.  Description                           Herewith     by Reference    Form         Date Filed     No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.37        Amendment to Warrant Agreement                           X         8-K          May 15, 2007   99.3
             dated May 10, 2007, for the benefit
             of John J. Hagenbuch, Trustee U/D/T
             dated September 13, 2005
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.38        Securities Purchase Agreement dated                      X         8-K          June 21, 2007  99.1
             June 20, 2007, among MicroIslet,
             Inc. and certain purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.39        Registration Rights Agreement dated                      X         8-K          June 21, 2007  99.2
             June 20, 2007, among MicroIslet,
             Inc. and certain investors
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.40        Form of Warrant dated June 20, 2007                      X         8-K          June 21, 2007  99.3
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.41        Summary of Certain Compensation                          X         10QSB        Aug. 20, 2007  10.6
             Arrangements
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.42        Unsecured Subordinated Convertible                       X         8-K          Sept. 21,      99.1
             Promissory Note dated September 20,                                             2007
             2007, issued by MicroIslet, Inc. to
             Peter Knobel
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.43        Warrant Agreement dated September                        X         8-K          Sept. 21,      99.2
             20, 2007, between MicroIslet, Inc.                                              2007
             and Peter Knobel
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.44        Registration Rights Agreement dated                      X         8-K          Sept. 21,      99.3
             September 20, 2007, between                                                     2007
             MicroIslet, Inc. and Peter Knobel
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.45        Employment Agreement dated                               X         10QSB        Nov. 19, 2007  10.4
             September 4, 2007, between
             MicroIslet, Inc. and Jonathan R. T.
             Lakey, Ph.D., M.S.M.*
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.46        Services Agreement dated September                       X         10QSB        Nov. 19, 2007  10.5
             1, 2007, between MicroIslet, Inc.
             and Progenitor Cell Therapy, LLC.+
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.47        Securities Purchase Agreement dated        X
             November 16, 2007, between
             MicroIslet, Inc. and SMR 1996 Trust
             III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.48        Registration Rights Agreement dated        X
             November 16, 2007, between
             MicroIslet, Inc. and SMR 1996 Trust
             III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.49        Form of Warrant dated November 16,         X
             2007, issued to SMR 1996 Trust III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.50        Securities Purchase Agreement dated                      X         8-K          Jan. 31, 2008  99.1
             January 24, 2008, among MicroIslet,
             Inc. and certain purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.51        Subordinated Convertible Unsecured                       X         8-K          Jan. 31, 2008  99.2
             Revolving Promissory Note dated
             January 25, 2008, issued to SMR
             1996 Trust III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.52        Form of Warrant dated January 25,                        X         8-K          Jan. 31, 2008  99.3
             2008
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.53        Registration Rights Agreement dated                      X         8-K          Jan. 31, 2008  99.4
             January 24, 2008, among MicroIslet,
             Inc. and certain purchasers
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------

                                       42
<PAGE>

------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
                                                   Filed        Incorporated                                Exhibit
Exhibit No.  Description                           Herewith     by Reference    Form         Date Filed     No.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.54        First Amendment to Securities                            X         8-K          Mar. 21, 2008  99.1
             Purchase Agreement and Promissory
             Note dated March 17, 2008, between
             MicroIslet, Inc. and SMRH 1996
             Trust III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.55        Subordinated Convertible Unsecured                       X         8-K          Mar. 21, 2008  99.2
             Revolving Promissory Note dated
             March 17, 2008, issued to SMR 1996
             Trust III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.56        Warrant dated March 17, 2008,                            X         8-K          Mar. 21, 2008  99.3
             issued to SMR 1996 Trust III
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
10.57        Letter agreement dated October 8,          X
             2007 between MicroIslet, Inc. and
             Amaresh Basu, Ph.D *
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
16.1         Letter from Deloitte & Touche LLP,                       X         8-K          July 24, 2007  16.1
             Independent Registered Public
             Accounting Firm.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
21.1         List of Subsidiaries of MicroIslet,                      X         SB-2         July 25, 2002  21.1
             Inc.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
23.1         Consent of  KMJ Corbin & Company           X
             LLP, Independent Registered Public
             Accounting Firm.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
23.2         Consent of  Deloitte & Touche LLP,         X
             Independent Registered Public
             Accounting Firm.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
24.1         Power of Attorney (included as a           X
             part of the signature page attached
             hereto)
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
31.1         Certification of Michael J.                X
             Andrews, Principal Executive and
             Financial Officer, pursuant to Rule
             13a-14(a) or 15d-14(a) of the
             Securities Exchange Act of 1934, as
             adopted pursuant to Section 302 of
             the Sarbanes-Oxley Act of 2002.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
32.1         Certificate pursuant to 18 U.S.C.          X
             Section 1350, as adopted pursuant
             to Section 906 of the
             Sarbanes-Oxley Act of 2002,
             executed by Michael J. Andrews,
             Principal Executive and Financial
             Officer.
------------ ------------------------------------- ------------ --------------- ------------ -------------- -----------
</TABLE>
+ Confidential treatment has been requested with respect to certain portions of
this exhibit. Omitted portions have been filed separately with the Securities
and Exchange Commission.

*Management contract or compensatory plan or arrangement.


                                       43
<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/ Michael Andrews                              Date:    April 11, 2008
      -------------------
Michael Andrews
Chief Executive Officer and Acting Chief Financial Officer
(Principal Executive Officer and Principal Financial and Accounting Officer)

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

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

Signature                                  Title                      Date
---------                                  -----                      ----

/s/ Michael Andrews           Chief Executive Officer,           April 11, 2008
----------------------------  Acting Chief Financial Officer
Michael Andrews               and Director (Principal Executive
                              Officer and Principal Financial
                              and Accounting Officer)

/s/ Ronald Katz               Chairman and Director              April 11, 2008
----------------------------
Ronald Katz

/s/ Robert W. Anderson        Director                           April 11, 2008
----------------------------
Robert W. Anderson, M.D.

/s/ Steven T. Frankel         Director                           April 11, 2008
----------------------------
Steven T. Frankel

                              Director
----------------------------
Keith Hoffman, Ph.D

/s/ Barry Ritholtz            Director                           April 11, 2008
----------------------------
Barry Ritholtz

                                       44
<PAGE>

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            Page


            Report of Independent Registered Public Accounting Firm          F-2
            Report of Independent Registered Public Accounting Firm          F-3

                   CONSOLIDATED FINANCIAL STATEMENTS

            Consolidated Balance Sheets                                      F-4
            Consolidated Statements of Operations                            F-5
            Consolidated Statements of Stockholders' Equity (Deficit)        F-6
            Consolidated Statements of Cash Flows                           F-12
            Notes to Consolidated Financial Statements                      F-14


                                      F-1
<PAGE>


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders of


MicroIslet, Inc.


San Diego, California


We have audited the accompanying consolidated balance sheet of MicroIslet, Inc.
and subsidiary, a development stage company (the "Company"), as of December 31,
2007, and the related consolidated statements of operations, stockholders'
equity (deficit), and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit. We did not audit the cumulative data from August
21, 1998 (inception) to December 31, 2006 in the consolidated statements of
operations, stockholders' equity (deficit) and cash flows, which was audited by
other auditors whose report, dated April 2, 2007, expressing an unqualified
opinion (which report includes an explanatory paragraph related to the
uncertainty of the Company's ability to continue as a going concern) has been
furnished to us. The consolidated financial statements for the period from
August 21, 1998 (inception) to December 31, 2006 reflect total revenues and net
loss of $1,194,000 and $40,765,000, respectively, of the related totals. Our
opinion, insofar as it relates to the amounts included for the cumulative data
from August 21, 1998 (inception) to December 31, 2006 is based solely on the
report of other auditors.

We conducted our audit 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
consolidated 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 consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement presentation. We believe
that our audit provides a reasonable basis for our opinion.

In our opinion, based on our audit and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of MicroIslet, Inc. and
subsidiary, as of December 31, 2007, and the results of their operations and
their cash flows for the year then ended and for the cumulative period from
August 21, 1998 (inception) to December 31, 2007 in conformity with accounting
principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As more fully described in
Note 1, the Company has incurred recurring losses and negative cash flows from
operations since inception and has a working capital deficit of $4,396,000 and a
cash balance of $353,000 at December 31, 2007. Management has estimated that
cash on hand will be sufficient to allow the Company to continue its operations
only into the second quarter of 2008. These matters raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amount
or classification of liabilities that may result from the outcome of the
uncertainty.



/s/ KMJ Corbin & Company LLP


Irvine, California

April 10, 2008


                                      F-2
<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 sheet of MicroIslet, Inc.
and subsidiary, a development stage company, (the "Company") as of December
31,2006, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the year then ended, and for the period from August
21, 1998 (date of inception) to December 31, 2006 (not presented herein). 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, 2006, and the results of their operations and their cash flows
for the year then ended and for the period from August 21, 1998 (date of
inception) to December 31, 2006 in conformity with accounting principles
generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 123(R), SHARE-BASED
PAYMENT, effective January 1, 2006.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred substantial operating losses and
negative operating cash flows through December 31, 2006, and as of that date the
Company's cash position was $1.8 million. Management has estimated that cash on
hand will be sufficient to allow the Company to continue its operations only
into the second quarter of 2007. These matters raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.



/s/ Deloitte & Touche LLP


San Diego, California

April 2, 2007


                                      F-3
<PAGE>

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

                                                                                December 31,       December 31,
                                                                                    2007               2006
                                                                                ------------       ------------
ASSETS

Current Assets:
            Cash and cash equivalents                                           $    353,000       $  1,847,000
            Grant receivables                                                         79,000                 --
            Other receivables                                                         52,000              5,000
            Prepaid expenses                                                         120,000            438,000
            Other current assets                                                       4,000             64,000
                                                                                ------------       ------------

                     Total current assets                                            608,000          2,354,000

            Property and equipment, net                                              205,000            295,000
            Patents, net                                                              41,000             17,000
            Deposits and other assets                                                 50,000             51,000
                                                                                ------------       ------------

                     Total assets                                               $    904,000       $  2,717,000
                                                                                ============       ============

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current Liabilities:
            Accounts payable                                                    $    508,000       $    292,000
            Accrued payroll                                                           25,000             79,000
            Accrued legal and other expenses                                         288,000            101,000
            Current portion of capital lease obligation                               23,000             36,000
            Loans from related parties (including accrued interest
               of $235,000), net of unamortized discount of $75,000                4,160,000                 --
                                                                                ------------       ------------

                     Total current liabilities                                     5,004,000            508,000

Capital lease obligation - net of current portion                                         --             25,000
                                                                                ------------       ------------

                     Total liabilities                                             5,004,000            533,000
                                                                                ------------       ------------

Commitments and contingencies

Stockholders' Equity (Deficit):
            Convertible preferred stock - $.001 par value: 10,000,000
                shares authorized; no shares issued and outstanding
                at December 31, 2007 and 2006                                             --                 --
            Common stock - $.001 par value:  100,000,000 shares authorized
                54,574,426 and 49,341,301 shares issued and outstanding
                at December 31, 2007 and 2006, respectively                           55,000             49,000
            Additional paid-in capital                                            46,044,000         42,900,000
            Deficit accumulated during the development stage                     (50,199,000)       (40,765,000)
                                                                                ------------       ------------

                     Total stockholders' equity (deficit)                         (4,100,000)         2,184,000
                                                                                ------------       ------------

                     Total liabilities and stockholders' equity (deficit)       $    904,000       $  2,717,000
                                                                                ============       ============

                 See notes to consolidated financial statements.

                                      F-4
<PAGE>

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


                                                                                               August 21, 1998
                                                                    Year Ended               (Date of Inception)
                                                                    December 31,                     to
                                                              2007              2006          December 31, 2007
                                                          ------------       ------------       ------------

Grant revenue                                             $    742,000       $    631,000       $  1,936,000
                                                          ------------       ------------       ------------

Expenses:
           Research and development expenses                 6,408,000          7,088,000         29,410,000
           General and administrative expenses               3,161,000          4,327,000         22,354,000
                                                          ------------       ------------       ------------
                   Operating expenses                       (9,569,000)       (11,415,000)       (51,764,000)
                                                          ------------       ------------       ------------
                   Loss from operations                     (8,827,000)       (10,784,000)       (49,828,000)
                                                          ------------       ------------       ------------

Other income (expense):
           Interest income                                      60,000            133,000            507,000
           Interest expense                                   (665,000)            (8,000)          (851,000)
           Other                                                (2,000)            (4,000)           (27,000)
                                                          ------------       ------------       ------------
                   Total other income (expense), net          (607,000)           121,000           (371,000)
                                                          ------------       ------------       ------------

                   Net loss                               $ (9,434,000)      $(10,663,000)      $(50,199,000)
                                                          ============       ============       ============

Basic and diluted net loss per share                      $      (0.18)      $      (0.23)      $      (1.71)
                                                          ============       ============       ============

Weighted average number of shares outstanding -
           basic and diluted                                51,068,626         46,439,402         29,385,483

                      See notes to consolidated financial statements.


                                           F-5
<PAGE>

                                               MICROISLET, INC.
                                         (A Development Stage Company)
                           Consolidated Statements of Stockholders' Equity (Deficit)
                    For the period August 21, 1998 (Date of Inception) to December 31, 2007

                                                                                       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   $     13,000   $    (12,000)             --    $      1,000
Stock issued pursuant to
  license agreement,
  September 15, 1998                    --         --        344,586             --             --              --              --
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 1998              --         --     12,938,789         13,000        (12,000)             --           1,000

Sale of preferred stock,
  net:
  May 4, 1999                       82,888         --             --             --        186,000              --         186,000

Net loss                                --         --             --             --             --         (73,000)        (73,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 1999          82,888         --     12,938,789         13,000        174,000         (73,000)        114,000

Sale of common stock, net:
  January 20, 2000                      --         --      1,706,679          2,000        498,000              --         500,000
  January 24, 2000                      --         --        500,080             --             --              --              --

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

Compensation expense
  related to options
  issued in exchange
  for services                          --         --             --             --        211,000              --         211,000

Net loss                                --         --             --             --             --        (965,000)       (965,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2000          82,888    $    --     15,145,548   $     15,000   $  1,383,000    $ (1,038,000)   $    360,000

                                                                                                                       (Continued)
                                See notes to consolidated financial statements.


                                                     F-6
<PAGE>
                                               MICROISLET, INC.
                                         (A Development Stage Company)
                           Consolidated Statements of Stockholders' Equity (Deficit)
                    For the period August 21, 1998 (Date of Inception) to December 31, 2007

                                                                                       ADDITIONAL
                                  PREFERRED STOCK              COMMON STOCK             PAID-IN        ACCUMULATED
                                 SHARES       AMOUNT       SHARES         AMOUNT        CAPITAL          DEFICIT         TOTAL
                              ------------    -------   ------------   ------------   ------------    ------------    ------------
Balance, December 31, 2000          82,888    $    --     15,145,548   $     15,000   $  1,383,000    $ (1,038,000)   $    360,000

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

Stock issued pursuant to
  license agreement,
  October 16, 2001                      --         --        344,586          1,000      2,067,000              --       2,068,000

Compensation expense
  related to options
  issued in exchange
  for services                          --         --             --             --      1,341,000              --       1,341,000

Net loss                                --         --             --             --             --      (4,894,000)     (4,894,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2001          82,888         --     17,415,575         18,000      6,276,000      (5,932,000)        362,000

Sale of common stock, net:
  April 24, 2002                        --         --        504,620          1,000      2,430,000              --       2,431,000
  May 13, 2002                          --         --         10,000             --         54,000              --          54,000
  May 15, 2002                          --         --          8,333             --         45,000              --          45,000
  August 31, 2002                       --         --         16,334             --         88,000              --          88,000

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)        --      1,295,332          1,000         (1,000)             --              --

Issuance of shares in
  merger with ALD
  Services, Inc.                        --         --      3,408,398          3,000         (3,000)             --              --

Reverse merger warrant
  expense                               --         --             --             --      3,478,000              --       3,478,000

Compensation expense
  related to options
  issued in exchange
  for services                          --         --             --             --        331,000              --         331,000

Net loss                                --         --             --             --             --      (6,106,000)     (6,106,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2002              --    $    --     22,658,592   $     23,000   $ 12,498,000    $(12,038,000)   $    483,000

                                                                                                                        (Continued)
                                See notes to consolidated financial statements.


                                                     F-7
<PAGE>

                                               MICROISLET, INC.
                                         (A Development Stage Company)
                           Consolidated Statements of Stockholders' Equity (Deficit)
                    For the period August 21, 1998 (Date of Inception) to December 31, 2007

                                                                                       ADDITIONAL
                                  PREFERRED STOCK              COMMON STOCK             PAID-IN        ACCUMULATED
                                 SHARES       AMOUNT       SHARES         AMOUNT        CAPITAL          DEFICIT         TOTAL
                              ------------    -------   ------------   ------------   ------------    ------------    ------------
Balance, December 31, 2002              --    $    --     22,658,592   $     23,000   $ 12,498,000    $(12,038,000)   $    483,000

Sale of common stock, net:
  June 26, 2003                         --         --        500,000             --        250,000              --         250,000
  September 4, 2003                     --         --      1,000,600          1,000        399,000              --         400,000
  October 31, 2003                      --         --      1,080,000          1,000        469,000              --         470,000

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

Common stock sold under
  agreement with Fusion
  Capital, net                          --         --      1,017,505          1,000        534,000              --         535,000

Common stock issued
  under Agreement with
  Fusion  Capital as
  issuance cost                         --         --        501,468          1,000         (1,000)             --              --

Compensation expense
  related to options
  issued in exchange
  for services                          --         --             --             --        254,000              --         254,000

Common stock issued in
  conversion of related
  party debt                            --         --      1,022,200          1,000        510,000              --         511,000

Stock issued on exercise
  of employee stock
  options                               --         --         30,000             --         12,000              --          12,000

Warrants issued in
  relation to related
  party debt                            --         --             --             --        142,000              --         142,000

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

Net loss                                --         --             --             --             --      (3,040,000)     (3,040,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2003              --    $    --     28,143,699   $     28,000   $ 15,417,000    $(15,078,000)   $    367,000

                                                                                                                        (Continued)
                                See notes to consolidated financial statements.


                                                     F-8
<PAGE>

                                               MICROISLET, INC.
                                         (A Development Stage Company)
                           Consolidated Statements of Stockholders' Equity (Deficit)
                    For the period August 21, 1998 (Date of Inception) to December 31, 2007

                                                                                       ADDITIONAL
                                  PREFERRED STOCK              COMMON STOCK             PAID-IN        ACCUMULATED
                                 SHARES       AMOUNT       SHARES         AMOUNT        CAPITAL          DEFICIT         TOTAL
                              ------------    -------   ------------   ------------   ------------    ------------    ------------
Balance, December 31, 2003              --    $    --     28,143,699   $     28,000   $ 15,417,000    $(15,078,000)   $    367,000

Sale of common stock, net:
  March 16, 2004                        --         --      9,923,449         10,000     11,749,000              --      11,759,000

Common stock sold under
  agreement with Fusion
  Capital                               --         --        415,094             --        500,000              --         500,000

Stock issued on exercise
  of employee stock
  options                               --         --        498,661          1,000        205,000              --         206,000

Stock issued on exercise
  of warrants                           --         --        665,943          1,000        542,000              --         543,000

Compensation expense
  related to options
  issued in exchange for
  services                              --         --             --             --        354,000              --         354,000

Compensation expense
  related to warrants
  issued in exchange for
  services                              --         --             --             --      1,669,000              --       1,669,000

Net loss                                --         --             --             --             --      (6,518,000)     (6,518,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2004              --         --     39,646,846         40,000     30,436,000     (21,596,000)      8,880,000

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

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

Stock issued on exercise
  of employee stock
  options                               --         --            100             --             --              --              --

Stock issued on exercise
  of warrants                           --         --        576,149             --        534,000              --         534,000

Compensation expense
  related to options
  issued in exchange
  for services                          --         --             --             --        111,000              --         111,000

Net loss                                --         --             --             --             --      (8,506,000)     (8,506,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2005              --    $    --     42,545,161   $     42,000   $ 34,092,000    $(30,102,000)   $  4,032,000

                                                                                                                        (Continued)
                                See notes to consolidated financial statements.


                                      F-9
<PAGE>

                                               MICROISLET, INC.
                                         (A Development Stage Company)
                           Consolidated Statements of Stockholders' Equity (Deficit)
                    For the period August 21, 1998 (Date of Inception) to December 31, 2007

                                                                                       ADDITIONAL
                                  PREFERRED STOCK              COMMON STOCK             PAID-IN        ACCUMULATED
                                 SHARES       AMOUNT       SHARES         AMOUNT        CAPITAL          DEFICIT         TOTAL
                              ------------    -------   ------------   ------------   ------------    ------------    ------------
Balance, December 31, 2005              --    $    --     42,545,161   $     42,000   $ 34,092,000    $(30,102,000)   $  4,032,000

Sale of common stock, net:
  August 4, 2006                        --         --      2,172,720          2,000      3,103,000              --       3,105,000

Sale of common stock,
  related parties and
  affiliates, net:
  August 4, 2006                        --         --        379,341             --        607,000              --         607,000

Stock issued for legal
  settlement                            --         --        190,000             --        344,000              --         344,000

Stock issued for late
  registration                          --         --         56,899             --        106,000              --         106,000

Stock issued on exercise
  of employee stock
  options                               --         --      1,397,217          2,000        538,000              --         540,000

Stock issued on exercise
  of non-employee
  stock options                         --         --         93,766             --         55,000              --          55,000

Stock issued on exercise
  of warrants                           --         --      2,506,197          3,000      2,564,000              --       2,567,000

Share-based
  compensation expense                  --         --             --             --      1,491,000              --       1,491,000

Net loss                                --         --             --             --             --     (10,663,000)    (10,663,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2006              --    $    --     49,341,301   $     49,000   $ 42,900,000    $(40,765,000)   $  2,184,000

                                                                                                                        (Continued)
                                See notes to consolidated financial statements.


                                                     F-10
<PAGE>

                                               MICROISLET, INC.
                                         (A Development Stage Company)
                           Consolidated Statements of Stockholders' Equity (Deficit)
                    For the period August 21, 1998 (Date of Inception) to December 31, 2007

                                                                                       ADDITIONAL
                                  PREFERRED STOCK              COMMON STOCK             PAID-IN        ACCUMULATED
                                 SHARES       AMOUNT       SHARES         AMOUNT        CAPITAL          DEFICIT         TOTAL
                              ------------    -------   ------------   ------------   ------------    ------------    ------------
Balance, December 31, 2006              --    $    --     49,341,301   $     49,000   $ 42,900,000    $(40,765,000)   $  2,184,000

Estimated relative fair
  value of warrants
  granted in connection
  with related parties
  notes payable                         --         --             --             --        499,000              --         499,000

Sale of common stock,
  related parties and
  affiliates, net:
  June 20,  2007 (price
  per unit $0.40)(1)                    --         --      2,612,500          3,000      1,024,000              --       1,027,000

November 16, 2007 (price
  per unit $0.425)(1)                   --         --      2,352,941          2,000        972,000              --         974,000

Stock issued for late
  registration                          --         --        267,684          1,000        131,000              --         132,000

Share-based
  compensation expense                  --         --             --             --        518,000              --         518,000

Net loss                                --         --             --             --             --      (9,434,000)     (9,434,000)
                              ------------    -------   ------------   ------------   ------------    ------------    ------------

Balance, December 31, 2007              --    $    --     54,574,426   $     55,000   $ 46,044,000    $(50,199,000)   $ (4,100,000)
                              ============    =======   ============   ============   ============    ============    ============

                                                                                                                        (Concluded)

(1) A unit consists of 1 share of common stock and a warrant to purchase 1/2
share of common stock (warrants may only be exercised in whole numbers of
shares).

                                See notes to consolidated financial statements.


                                                     F-11
<PAGE>

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

                                                                                                 August 21, 1998
                                                                          Year Ended                (Date of
                                                                          December 31,            Inception) to
                                                                      2007           2006       December 31, 2007
                                                                  ------------    ------------    ------------
Cash flows from operating activities:
      Net loss                                                    $ (9,434,000)   $(10,663,000)   $(50,199,000)
      Adjustments to reconcile net loss to net cash
        used in operating activities:
            Warrant compensation expense                                    --              --       5,147,000
            Interest paid with warrant                                      --              --         142,000
            Amortization of related parties loan discount              424,000              --         424,000
            In process research and development
              acquired for common stock                                     --              --       2,068,000
            Legal settlement paid with common stock                         --          40,000          40,000
            Late registration damages paid with shares of stock        132,000         106,000         238,000
            Share-based compensation                                   518,000       1,491,000       4,612,000
            Depreciation and amortization                              105,000         111,000         467,000
            Loss on disposal of equipment                                   --              --          18,000
Changes in operating assets and liabilities:
      Grant receivables                                                (79,000)        103,000         (79,000)
      Other receivables                                                (47,000)        129,000         (52,000)
      Prepaid expenses                                                 318,000        (285,000)       (121,000)
      Other current assets                                              60,000         (64,000)         (4,000)
      Deposits and other assets                                          1,000           5,000         (62,000)
      Accounts payable and accrued expenses                            349,000        (432,000)      1,356,000
      Accrued interest on related parties loans                        235,000              --         235,000
                                                                  ------------    ------------    ------------

            Net cash used in operating activities                   (7,418,000)     (9,459,000)    (35,770,000)
                                                                  ------------    ------------    ------------
Cash flows from investing activities:
      Proceeds from sale of property and equipment                          --              --           1,000
      Purchases of property and equipment                              (14,000)        (47,000)       (612,000)
      Patent costs                                                     (25,000)         (7,000)        (32,000)
                                                                  ------------    ------------    ------------
            Net cash used in investing activities                      (39,000)        (54,000)       (643,000)
                                                                  ------------    ------------    ------------
Cash flows from financing activities:
      Payments on capital lease obligation                             (38,000)        (33,000)        (84,000)
      Loans from related parties                                     4,000,000              --       4,525,000
      Repayment of loan from related parties                                --              --         (25,000)
      Proceeds from sale of common stock, net of offering costs      2,001,000       3,712,000      27,501,000
      Proceeds from exercise of stock options and warrants                  --       3,162,000       4,663,000
      Proceeds from sale of preferred stock                                 --              --         186,000
                                                                  ------------    ------------    ------------

            Net cash provided by financing activities                5,963,000       6,841,000      36,766,000
                                                                  ------------    ------------    ------------
            Net (decrease) increase in cash and cash equivalents    (1,494,000)     (2,672,000)        353,000
Cash and cash equivalents at beginning of period                     1,847,000       4,519,000              --
                                                                  ------------    ------------    ------------
Cash and cash equivalents at end of period                        $    353,000    $  1,847,000    $    353,000
                                                                  ============    ============    ============

                                                                                                    (Continued)

                           See notes to consolidated financial statements.


                                                F-12
<PAGE>

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

                                                                                                 August 21, 1998
                                                                          Year Ended                (Date of
                                                                          December 31,            Inception) to
                                                                      2007           2006       December 31, 2007
                                                                  ------------    ------------    ------------
Supplemental disclosure of cash flow information:
Interest paid                                                     $      7,000    $      8,000    $     21,000
Income taxes paid                                                 $      2,000    $      2,000    $     13,000

Supplemental disclosures of non-cash investing
  and financing activities:
      Common stock issued in relation to legal settlement         $         --    $    304,000    $    304,000
      Conversion of loan from related party to stock              $         --    $         --    $    510,000
      In-process research and development acquired for
        common stock                                              $         --    $         --    $  2,068,000
      Common stock issued as commission for offering of
        common stock                                              $         --    $         --    $    316,000
      Estimated relative fair value of warrants issued
        in connection with related parties notes payable          $    499,000    $         --    $    641,000
      Compensation paid with warrant related to reverse merger    $         --    $         --    $  3,478,000
      Common stock issued to founders                             $         --    $         --    $    (12,000)
      Shares issued pursuant to investment banking agreement      $         --    $         --    $   (200,000)
      Common stock issued related to reverse merger               $         --    $         --    $ 20,450,000
      Assets acquired under capital lease                         $         --    $         --    $    106,000


                           See notes to consolidated financial statements.


                                                F-13
</TABLE>
<PAGE>

                                MICROISLET, INC.
                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  DESCRIPTION OF BUSINESS AND GOING CONCERN

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

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

Prior to May 28, 2002, the Company was known as ALD Services, Inc. ("ALD"). The
merger of MicroIslet of Delaware , Inc., a Delaware corporation ("MicroIslet of
Delaware"), with a wholly-owned subsidiary of ALD was completed on April 24,
2002 (the "Merger"). The Merger was accounted for as a reverse acquisition
because former stockholders of MicroIslet of Delaware owned a majority of the
outstanding stock of ALD immediately subsequent to the Merger. Because the
Merger was treated as a reverse acquisition, the financial information from
inception includes the financial results of MicroIslet of Delaware from its
inception on August 21, 1998 ("Inception") to December 31, 2007, 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,
2007.

In October 2005, the Company was awarded a $1.7 million Phase II Small Business
Innovation Research ("SBIR") grant by the National Institute of Health ("NIH").
The balance remaining under the research grant as of December 31, 2007, was
approximately $74,000. The grant is being used to further development of the
Company's islet cell transplantation technology for the treatment of
insulin-dependent diabetes. The Phase II SBIR grant was awarded following peer
review by the NIH of results from the completion of the Phase I grant for the
same project.

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

The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. The Company has incurred
substantial operating losses and negative operating cash flows through December
31, 2007, and as of December 31, 2007 and 2006 the Company's cash position was
$353,000 and $1,847,000, respectively. The Company has incurred net losses of
$9.4 million and $10.7 million and negative operating cash flows of $7.4 million
and $9.5 million for the years ended December 31, 2007 and 2006, respectively.
The Company also had a deficit accumulated during the development stage of $50.2
million at December 31, 2007. As of that date, the Company had negative working
capital of $4.4 million, primarily reflecting $4.2 million of notes payable,
including accrued interest, which matured in January 2008 and March 2008 and are
currently due on demand. Currently, management has projected that cash on hand,
including cash that may be borrowed under the convertible notes issued in the
first quarter of 2008, will be sufficient to allow the Company to continue its
operations only into April 2008. 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 described below. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.

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's


                                      F-14
<PAGE>

plans include raising additional debt and/or equity financing to sustain its
operations. In addition, the Company will continue to seek funding in the form
of grants for its scientific research. During 2007, the Company completed two
private placements of common stock and warrants for aggregate gross proceeds of
$2,045,000, and borrowed an additional $4,000,000 from related parties. See
Notes 8 and 9 to the consolidated financial statements for more information
about these transactions. In the first quarter of 2008, the Company issued two
convertible notes to a related party pursuant to which the Company may request
to borrow up to $2,500,000 in the aggregate. We have completed short term
financings as part of a master purchase agreement dated January 25, 2008 with
amendment 1 dated March 17, 2008 and amendment 2 dated April 2, 2008. This
purchase agreement allows the Company to borrow up to $4.5 million. Under this
purchase agreement we have borrowed $1.0 million in January 2008, $500,000 in
March 2008 and $600,000 in April 2008 to fund our working capital needs. See
Note 17 to the consolidated financial statements for more information about
these notes.

If the Company secures funding and continues to operate as a going concern, its
business plan for the next twelve months is to demonstrate the safety and
efficacy of its product candidate in animal models and to file an IND
application with the Food and Drug Administration for xenotransplantation
clinical trials. It is necessary for the Company to establish evidence of
efficacy of its approach in order to advance to subsequent milestones.

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's planned principal operations have not yet commenced. Accordingly,
the Company's activities have been accounted for as those of a development stage
enterprise as defined in Statement of Financial Accounting Standards ("SFAS")
No. 7, "Accounting and Reporting by Development Stage Enterprises." All losses
since inception have been considered as part of the Company's development stage
activities.

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. Significant estimates include the
collectibility of receivables, the recoverability of long-lived assets, the
valuation of common stock, warrants and stock options and the valuation of
deferred tax assets. Actual results could differ from those estimates.

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

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

Concentration of credit risk
----------------------------

The Company has cash in a financial institution which is insured by the Federal
Deposit Insurance Corporation ("FDIC") up to $100,000. At December 31, 2007, the
Company had cash balances of $332,000 in excess of FDIC insured limits. The
Company maintains its cash balances at a credit-worthy financial institution and
management believes the risk of loss of cash balances in excess of the insured
limit to be low.



                                      F-15
<PAGE>

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 seven years. Leased assets meeting certain capital lease criteria are
capitalized and the present value of the related lease payments is recorded as a
liability. Assets under capital lease arrangements are depreciated using the
straight-line method over their estimated useful lives or their related lease
term, whichever is shorter. Repairs and maintenance expenses are charged to
expense as incurred.

Impairment of long-lived assets
-------------------------------

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

Intangible assets
-----------------

The Company accounts for intangible assets in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets." In accordance with SFAS No. 142,
goodwill and other intangible assets that have indefinite useful lives are not
amortized; however, these assets are reviewed at least annually for impairment.
Intangible assets with finite lives are amortized using a straight -line method
over the useful life of 17 years. The Company carries no goodwill on its books
for the years ended December 31, 2007 and 2006. Further, during fiscal years
2007 and 2006, the Company had no material impairments of intangible assets,
which consist of patents.

Fair value of financial instruments
-----------------------------------

At December 31, 2007 and 2006, the Company's financial instruments included cash
and cash equivalents, receivables, accounts payable, accrued expenses and
accrued compensation and payroll taxes and loans from related parties. The
carrying amount of cash and cash equivalents, receivables, accounts payable,
accrued expenses and accrued compensation and payroll taxes and loans from
related parties approximates fair value due to the short-term maturities of
these instruments.

Grant revenue
-------------

Grant revenue consists of amounts earned under research grants with the National
Institute of Health. The Company's federal government grants provide for the
reimbursement of qualified expenses for research and development as defined
under the terms of each grant. Revenue under the grants is recognized when the
related qualified research and development expenses are incurred up to the limit
of the approval funding amounts. Grant receivables reflect amounts of qualified
research and development expenses incurred under research grants, which have not
yet been reimbursed to the Company.

Research and development
------------------------

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

                                      F-16
<PAGE>

Share-based compensation
------------------------

In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R ("SFAS 123R"), "Share-Based Payment," which establishes accounting for
share-based awards exchanged for employee services and requires companies to
expense the estimated fair value of these awards over the requisite employee
service period. In March 2005, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS 123R. The Company
has applied the provisions of SAB 107 in its adoption of SFAS 123R. On April 14,
2005, the SEC adopted a new rule amending the effective date for SFAS 123R. The
Company implemented SFAS 123R on January 1, 2006.

Under SFAS 123R, share-based compensation cost is measured at the grant date,
based on the estimated fair value of the award, and is recognized as expense
over the employee's requisite service period. As of December 31, 2007, there are
8,471,239 shares authorized for awards of equity share options in the 2005
Equity Incentive Plan ("2005 Plan"). The Company has no awards with market or
performance conditions. All options granted under the 2005 Plan through December
31, 2007, have exercise prices equal to the fair market value of the Company's
stock on the date of grant. Options granted under the 2005 Plan typically vest
over three years based on continued service and have a ten-year term. Shares
issued upon option exercise are newly issued shares since the Company has no
treasury shares. The Company adopted the provisions of SFAS 123R on January 1,
2006, the first day of the Company's fiscal year 2006, using a modified
prospective application, which provides for certain changes to the method for
valuing share-based compensation. Under the modified prospective application,
prior periods are not revised for comparative purposes. The valuation provisions
of SFAS 123R apply to new awards and to awards that are outstanding on the
effective date and subsequently modified or cancelled. Estimated compensation
expense for awards outstanding at the effective date will be recognized over the
remaining service period using the compensation cost calculated for pro forma
disclosure purposes under FASB Statement No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), as modified by SFAS 123R to include estimated
forfeitures and expected future volatility rates.

Prior to January 1, 2006, the Company accounted its share-based employee
compensation plans under the intrinsic value measurement and recognition
provisions of Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting
for Stock Issued to Employees," and related Interpretations, as permitted by
SFAS 123. Accordingly, the Company recorded no share-based employee compensation
expense for options granted under the 2005 Plan or its predecessor plans prior
to January 1, 2006, as substantially all options granted under those plans had
exercise prices equal to the fair market value of the Company's common stock on
the date of grant. Results for prior periods have not been restated for
comparative purposes.

On November 10, 2005, the FASB issued FASB Staff Position No. SFAS 123R-3,
"Transition Election Related to Accounting for Tax Effects of Share-Based
Payment Awards" ("SFAS 123R-3"). The Company has elected to adopt the
alternative transition method provided in SFAS 123R-3. The alternative
transition method includes a simplified method to establish the beginning
balance of the additional paid-in capital pool ("APIC pool") related to the tax
effects of employee share-based compensation, which is available to absorb tax
deficiencies recognized subsequent to the adoption of SFAS 123R.

The Company has been operating at a loss since inception. The Company has a net
operating loss carry forward and has provided for a full valuation allowance
against its deferred income tax assets recorded as of December 31, 2007. Since
the Company does not have sufficient taxable income in the year ended December
31, 2007, no deferred income tax assets and deferred income tax benefits were
recorded for the stock options that were granted in the year and that ordinarily
would have resulted in a future tax deduction. In accordance with SFAS 123R,
since the Company has a net operating loss carry forward, a tax benefit and a
credit to common stock for the excess deduction would not be recognized until
that deduction reduces taxes payable.

                                      F-17
<PAGE>

Total compensation expense related to all of the Company's share-based awards
recognized under SFAS 123R, for the years ended December 31, 2007 and 2006, was
comprised of the following:
<TABLE>
<S> <C>
                                                               2007            2006
                                                            -----------    -----------
         Research and development                           $   117,000    $   597,000
         General and administrative                             401,000        865,000
                                                            -----------    -----------
            Share-based compensation expense before taxes       518,000      1,462,000
         Related income tax benefits                                 --             --
                                                            -----------    -----------
            Share-based compensation expense                $   518,000    $ 1,462,000
                                                            ===========    ===========
         Net share-based compensation expense per common
           share -- basic and diluted                       $     (0.01)   $     (0.03)
                                                            ===========    ===========
</TABLE>

As of December 31, 2007, there was $1.2 million of total unrecognized
compensation cost related to non-vested share-based compensation arrangements
granted under all equity compensation plans. The Company expects to recognize
that cost over a weighted average period of 1.9 years.

The Company accounts for certain stock options granted to non-employees in
accordance with Emerging Issues Task Force No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services," ("EITF 96-18"). Under EITF 96-18,
the Company determines the fair value of the stock options granted as either the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measurable. Compensation expense
recorded under EITF 96-18 in 2007 and 2006 was $0 and $29,000 respectively.

Determining fair value
----------------------

VALUATION AND AMORTIZATION METHOD. The Company estimates the fair value of stock
options granted using the Black-Scholes option valuation model and a single
option award approach. All options are amortized on a straight-line basis over
the requisite service periods of the awards, which are generally the vesting
periods.

EXPECTED TERM. The expected term of options granted represents the period of
time that they are expected to be outstanding. The Company estimates the
expected term of options granted based on the history of grants and exercises in
its option database along with the term of the options reported by a peer group
consisting of early-stage pharmaceutical companies with market capitalizations
below $300 million. The Company has examined its historical pattern of option
exercises in an effort to determine if there were any discernable patterns of
activity based on two distinct groups of option recipients: (1) employees other
than senior management and (2) directors and senior management. Although the
amount of data on these two groups was limited, results of the analysis indicate
distinct and typical behavior patterns between the two groups. Therefore, the
Company is using the applicable term for each group in its valuation.

EXPECTED VOLATILITY. Since the Company and its peer group do not have stock
options that are publicly traded, the Company estimates the volatility based on
historical trading of the Company's common stock. Based on SAB 107, the
volatility of the Company's common stock should be measured over the expected
term of the options. The Company has been publicly traded since January 2002,
but management has concluded that its stock price volatility prior to April 2004
was not representative of the current market for the Company's securities.
Consequently, the Company measured its historical volatility for the period from
April 2004 through the issue date of the options. The Company also considered
the historical volatilities of the peer group, which are similar to the
Company's. Because of the risks inherent in the Company's business model, the
Company expects the future volatility of its share price over the expected term
to continue near historic averages.

                                      F-18
<PAGE>

RISK-FREE INTEREST RATE. The Company bases the risk-free interest rate used in
the Black-Scholes option valuation model on the implied yield in effect at the
time of option grant on U.S. Treasury zero-coupon issues with equivalent
remaining terms.

DIVIDENDS. The Company has never paid a cash dividend on its common stock and
does not anticipate paying any cash dividends in the foreseeable future.
Consequently, the Company uses an expected dividend yield of zero in the
Black-Scholes option valuation model.

FORFEITURES. The Company uses historical data of the Company and the peer group
to estimate pre-vesting option forfeitures. The Company's estimate uses a
combination of historical forfeiture rates found in the peer group, historical
rates found at the Company, and the Company's measured turnover rates for
employees and directors/senior management. As required by SFAS 123R, the Company
records share-based compensation expense only for those awards that are expected
to vest. Previously, under SFAS 123, the Company recognized the effect of
forfeitures when they occurred.

The Company used the following weighted average assumptions to estimate the fair
value of employee options granted for the years ended December 31, 2007 and
2006:
                                                        Year Ended December 31,
                                                        -----------------------
                                                         2007           2006
                                                        ---------     ---------
Average expected term (years)                            5.50          3.96
Expected volatility                                        80  %         77  %
Risk-free interest rate                                  4.61  %       4.41  %
Expected dividend yield                                     0  %          0  %
Average forfeiture rate                                     5  %          7  %

Modifications
-------------

Certain options granted to the Company's former President and COO were modified
as part of a separation agreement entered into in February 2006. The
modification extended the exercise date for each outstanding fully vested option
held by the former executive to December 31, 2006. In connection with this
modification, the Company recorded compensation expense of $43,000 during the
first quarter of 2006. This amount was calculated as the excess of the fair
value of the modified options immediately after the modification over the fair
value of such options immediately prior to the modification, in accordance with
provisions of SFAS 123R. The fair value of the modified options was calculated
using an assumed forfeiture rate of 0%, expected volatility of 88% and an
average expected term of 10.5 months. The intrinsic value of these options after
the modification was $2.1 million.

Income taxes
------------

The Company accounts for income taxes in accordance with SFAS No. 109 ("SFAS
109"), "Accounting for Income Taxes". In accordance with SFAS 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.

In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN 48"). FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
entity's financial statements in accordance with SFAS 109 and prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. Additionally, FIN 48 provides guidance on subsequent derecognition
of tax positions, financial statement classification, recognition of interest
and penalties, accounting in interim periods, and disclosure and transition
requirements.

                                      F-19
<PAGE>

The Company adopted the provisions of FIN 48 on January 1, 2007, see Note 14 for
additional information.

Segment reporting
-----------------

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

New accounting pronouncements
-----------------------------

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"), which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
SFAS 157 applies to other accounting pronouncements that require or permit fair
value measurements. The new guidance is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and for interim
periods within those fiscal years. The Company is currently evaluating the
requirements of SFAS 157; however, the Company does not believe that its
adoption will have a material effect on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Option for Financial Assets and Financial Liabilities - Including an Amendment
of FASB Statement No. 115" ("SFAS 159"). SFAS 159 provides companies with an
option to report selected financial assets and liabilities at fair value. SFAS
159's objectives are to reduce both complexity in accounting for financial
instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. SFAS 159 is effective as of the beginning of an
entity's first fiscal year beginning after November 15, 2007. The Company is
currently evaluating the potential impact, if any, that the adoption of SFAS 159
will have on its consolidated financial statements.

In December 2006, the FASB issued FASB Staff Position ("FSP") EITF 00-19-2,
"Accounting for Registration Payment Arrangements." This FSP specifies that the
contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, should be separately recognized and measured in accordance with SFAS
No. 5. The FSP further clarifies that a financial instrument subject to a
registration payment arrangement should be accounted for in accordance with
other applicable GAAP without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement. This FSP amends
various authoritative literature notably SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity," and FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." This FSP is effective immediately for registration payment arrangements
and the financial instruments subject to those arrangements that are entered
into or modified subsequent to December 21, 2006. For registration payment
arrangements and financial instruments subject to those arrangements that were
entered into prior to December 21, 2006, the guidance in the FSP is effective
for financial statements issued for fiscal years beginning after December 15,
2006, and interim periods within those fiscal years. The Company believes that
it is properly accounting for its registration rights agreements in accordance
with this FSP (see Notes 8, 9 and 11).

In June 2007, the FASB ratified EITF No. 07-3, "Accounting for Nonrefundable
Advance Payments for Goods or Services to Be Used in Future Research and
Development Activities" ("EITF 07-3"). EITF 07-3 requires non-refundable advance
payments for goods and services to be used in future research and development
activities to be recorded as an asset and the payments to be expensed when the
research and development activities are performed. EITF No. 07-3 is effective
for fiscal years beginning after December 15, 2007. This standard is not
expected to have a material impact on the Company's future consolidated
financial statements.

                                      F-20
<PAGE>

In December 2007, the FASB ratified EITF No. 07-1, "Accounting for Collaborative
Agreements" ("EITF No. 07-1"). EITF 07-1 provides guidance regarding financial
statement presentation and disclosure of collaborative arrangements, as defined,
which includes arrangements the Company has entered into regarding development
and commercialization of products and product candidates. EITF No. 07-1 is
effective for the Company as of January 1, 2009, and its adoption is not
expected to have a material impact on its consolidated results of operations or
financial position.

In February 2008, the FASB issued FSP 157-1, "Application of FASB Statement No.
157 to FASB Statement No. 13 and Its Related Interpretive Accounting
Pronouncements That Address Leasing Transactions" ("FSP 157-1"), FSP 157-2,
"Effective Date of FASB Statement No. 157" ("FSP 157-2"). FSP 157-1 removes
leasing from the scope of SFAS No. 157. FSP 157-2 delays the effective date of
SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except for
items that are recognized or disclosed at fair value at least once a year, to
fiscal years beginning after November 15, 2008, and for interim periods within
those fiscal years.

NOTE 3.  COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

Prepaid expenses at December 31, 2007 primarily consist of advance payments for
research services, most of which will be used in the first quarter of 2008.
Prepaid expenses at December 31, 2006 primarily consist of advance payments for
research services, all of which were used in the first quarter of 2007.

                                                          2007           2006
                                                        ---------     ---------
Property and Equipment, net:
----------------------------
Laboratory equipment                                    $ 493,000     $ 484,000
Computer equipment                                         78,000        76,000
Furniture and fixtures                                     70,000        67,000
Leasehold improvements                                     14,000        14,000
                                                        ---------     ---------
                                                          655,000       641,000
Less accumulated depreciation and amortization           (450,000)     (346,000)
                                                        ---------     ---------
                                                        $ 205,000     $ 295,000
                                                        =========     =========

Depreciation expense associated with property and equipment was $104,000 and
$110,000 for the years ended December 31, 2007 and 2006, respectively, and
$462,000 from Inception through December 31, 2007. At December 31, 2007 and
2006, assets acquired under capital leases totaled $106,000 for both years with
accumulated depreciation of $51,000 and $30,000, respectively. Depreciation of
assets acquired under the capital lease was $21,000 and $21,000 for the years
ended December 31, 2007 and 2006, respectively.

                                                        2007             2006
                                                      --------         --------
Patents, net:
-------------
Patents                                               $ 46,000         $ 21,000

Less accumulated  amortization                          (5,000)          (4,000)
                                                      --------         --------
                                                      $ 41,000         $ 17,000
                                                      ========         ========

Amortization expense related to amortizable intangible assets was $1,000 and
$1,000 for fiscal years 2007 and 2006 and $5,000 from inception through December
31, 2007. Based solely on the amortizable intangible assets as of December 31,
2007, the estimated annual amortization expense of intangible assets for each of
the next five years is $1,000 and $6,000 thereafter. The remaining $30,000
pertains to expenses associated with the Company's pending patent applications.
There is no guarantee that these patents will be issued. If any of these patents
are issued in the future they will be amortized over a 20 year period. If the
patents are denied or abandoned at a future date, the costs associated with the
patent will be immediately expensed. Actual amortization expense to be reported
in future periods could differ from these estimates as a result of acquisitions,
divestitures, asset impairments or abandonments, and other relevant factors.

                                      F-21
<PAGE>

NOTE 4.  LICENSE AND COLLABORATION AGREEMENTS

DUKE UNIVERSITY

The Company entered into a license agreement with Duke University ("Duke") in
September 1998, which was amended in February 1999. Pursuant to the license
agreement, the Company 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. Under the license
agreement, the Company agreed to pay Duke University for all direct and indirect
costs incurred in the performance of the research. As of December 31, 2007, the
Company had paid Duke approximately $496,000 for its research efforts and
recorded such amounts as research and development expenses in the accompanying
consolidated statements of operations.

The license agreement gives the Company the exclusive, worldwide
commercialization rights to any product in any field of use developed under the
Company's sponsorship, with the right to sublicense. 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. In the event the Company is
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, the Company issued 344,586 shares
of the Company's common stock to Duke upon the execution of the agreement. The
Company issued an additional 344,586 shares to Duke upon its issuance of the
first patent involving the technology 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 common 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 agreement imposes on the Company an obligation to indemnify Duke, its
officers, employees, and agents against claims arising from the Company's or any
sub licensee'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 the Company 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 the Company does not exploit on the Company's own. If the
Company fails to meet these obligations, Duke may reduce the license to a
non-exclusive one. Moreover, if the Company fails to meet the Company's
obligations under the agreement, including the Company's payment obligations,
and fails to remedy the Company's 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 the Company by Duke has
expired.

THE SCRIPPS RESEARCH INSTITUTE

The Company has entered into a collaboration agreement in the area of islet cell
transplantation therapies for treatment of insulin-dependent diabetes with The
Scripps Research Institute ("TSRI"). Under the terms of the agreements, the
Company and TSRI are conducting preclinical studies utilizing the Company's
proprietary technologies. The Company paid to TSRI approximately $229,000 and
$596,000 during the years ended December 31, 2007 and 2006, respectively, and a
total of $1.8 million since January 1, 2003. These expenses were recorded as
research and development expenses in the accompanying consolidated statements of
operations.

                                      F-22
<PAGE>

CALIFORNIA NATIONAL PRIMATE RESEARCH CENTER AT UNIVERSITY OF CALIFORNIA, DAVIS

The Company has entered into three collaboration agreements 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. The first agreement called for the Company to fund the university in
the amount of approximately $1.4 million over a three year period ended May
2007. A second agreement amounting to approximately $181,000 called for
additional primate studies over a one-year period ended August 2007. Work under
the agreements continued past the end dates and through the remainder of 2007. A
third agreement was signed in March 2008 that included the additional, post
contract costs of the earlier contracts and specified activities to be performed
through July 2008. The Company paid to the University of California, Davis,
approximately $799,000 and $750,000 during the years ended December 31, 2007 and
2006, respectively, and a total of $1.8 million from January 1, 2004 through
December 31, 2007. These expenses were recorded as research and development
expenses in the accompanying consolidated statements of operations.


NOTE 5.  COMMITMENTS

OPERATING LEASE COMMITMENTS. The Company leases office and laboratory facilities
under non-cancelable operating leases. The Company leases approximately 12,000
square feet of office and laboratory space in San Diego, California at a current
rental rate of approximately $20,000 per month. The lease expires on February
28, 2009.

Rent expense was $223,000 and $254,000 for the years ended December 31, 2007 and
2006, respectively, and $1,470,000 from August 21, 1998 (inception) to December
31, 2007. The Company received rent under a sub-lease to the aforementioned
lease for the fiscal year ended December 31, 2007 of $10,500. The future minimum
rental receipts of this sub-lease, which expired on February 29, 2008, were
$6,000. Future minimum rental payments under all non-cancelable operating lease
commitments as of December 31, 2007 are as follows:

Year Ending December 31:
------------------------
         2008                                                           $237,000
         2009                                                             38,000
                                                                        --------
         Total                                                          $275,000
                                                                        ========

CAPITAL LEASE COMMITMENTS. In August 2005, the Company acquired an equipment
system under a three-year capital lease obligation. This capital lease provides
the Company with the option at the expiration of the lease term to purchase the
system for a price of $1.00. Future minimum payments under the capital lease as
of December 31, 2007 are as follows:

Year Ending December 31:
------------------------
      2008                                                             $ 24,000
                                                                       --------
      Less amount representing interest                                  (1,000)
                                                                       --------
      Present value of net lease payments                                23,000
      Less current portion                                              (23,000)
                                                                       --------
      Long-term portion of obligation                                  $     --
                                                                       ========

NOTE 6.  SIGNIFICANT CONTRACTS AND GRANTS

FIOS Long-term supply agreement
-------------------------------

In November 2005, the Company entered into a long-term strategic supply
agreement with the Mayo Foundation for Medical Education and Research, which
agreement has been assumed by FIOS Therapeutics, Inc. ("FIOS"). Under the
agreement, FIOS will supply designated pathogen free pigs to the Company for use
in development of MicroIslet-P(TM). Under the terms of the agreement, FIOS will
supply MicroIslet substantially all of its non-transgenic porcine islet
production for a period of three to seven years.

                                      F-23
<PAGE>

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

In addition to the monthly fee, the Company agreed to grant to FIOS a warrant to
purchase 75,000 shares of its common stock upon the occurrence of each of the
following events: (i) active Investigational New Drug application for a product
using designated pathogen free pigs, (ii) approval to start a Phase II clinical
trial using designated pathogen free pigs, (iii) approval to start a Phase III
clinical trial using designated pathogen free pigs, and (iv) New Drug
Application/Biologics License Application approval for a product using
designated pathogen free pigs. Each warrant will have an exercise price of $1.90
per share and will be exercisable for 10 years following the date of issuance.
These warrants have been accounted for in accordance with EITF 96-18. At
December 31, 2007 and 2006, the liability was determined to be contingent, the
lowest aggregate fair value of the warrants was determined to be zero, and no
expense was recorded. In each future period the Company will evaluate these
warrants and record an expense as necessary.

Government grant research
-------------------------

In October 2005, the Company was awarded a $1.7 million Phase II SBIR grant by
the NIH (see Note 1). Revenue for this grant for the years ended December 31,
2007 and 2006, was $742,000 and $631,000, respectively, and the accumulated to
date revenue for this grant since inception is $1,624,000. The balance remaining
under the research grant as of December 31, 2007 and 2006 was $74,000 and
$816,000, respectively.

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

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

Two individuals who were affiliates of ALD were also then affiliates of ASA
Investment Company ("ASA"), which served as the placement agent for the Private
Offering. One of these individuals was ALD's former president and sole director
("ALD's President"), and the other individual was the beneficial owner of 76.9%
of the ALD's outstanding common stock prior to the Merger ("ALD's majority
stockholder"). Certain trusts affiliated with ALD's majority stockholder
subscribed for 175,000 MicroIslet of Delaware shares ($1.1 million 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.

                                      F-24
<PAGE>

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

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

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

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

NOTE 8.  LOAN FINANCINGS

JANUARY 2007 FINANCING

On January 12, 2007, John J. Hagenbuch, the Company's former Chairman, lent the
Company $2 million under the terms of an unsecured subordinated promissory note.
The note accrues simple interest at the prime rate as published in the Wall
Street Journal from time to time. All outstanding principal and accrued interest
under the note became due on January 12, 2008 and is now due on demand.

In connection with this loan, the Company issued a 10-year detachable warrant to
Mr. Hagenbuch allowing for a purchase for cash of up to 500,000 shares of stock
at an exercise price of $1.00 per share. On May 10, 2007, this warrant was
amended to remove a condition to exercisability based on American Stock Exchange
approval, which approval was no longer required due to the removal of the
Company's common stock from the American Stock Exchange. Such warrant is now
fully exercisable. Mr. Hagenbuch is currently the beneficial owner of
approximately 9.0% of the Company's common stock, including this warrant and the
warrant described below.

In accordance with Accounting Principles Board Opinion No. 14 ("APB No. 14"),
"Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,"
the Company has allocated the proceeds from the note into debt and equity
components, based on the relative fair values of each instrument. The fair value
of the warrant was estimated to be $268,000, which was determined by the Company
using the Black-Scholes pricing model using an expected life of 10 years, a
volatility rate of 80%, and a risk-free interest rate of 4.765%. The amount
allocated to the warrant resulting from the relative fair value allocation of
the proceeds between the debt and warrant was accounted for as additional
paid-in capital and a corresponding debt discount.

MAY 2007 FINANCING

On May 15, 2007, Mr. Hagenbuch lent the Company an additional $1 million under
the terms of an unsecured promissory note. The note accrues simple interest at
the prime rate as published in the Wall Street Journal from time to time. The
terms of the note restrict the Company from incurring senior indebtedness or
pledging its intellectual property. All outstanding principal and accrued
interest under the note became due on January 12, 2008 and is now due on demand.

In connection with this loan, the Company issued a 10-year detachable warrant to
Mr. Hagenbuch allowing for a purchase for cash of up to 250,000 shares of stock
at an exercise price of $0.75 per share. Mr. Hagenbuch is the beneficial owner
of approximately 9.0% of the Company's common stock, including this warrant.

                                      F-25
<PAGE>

In accordance with APB No. 14, the Company has allocated the proceeds from the
note into debt and equity components, based on the relative fair values of each
instrument. The relative fair value of the warrant was estimated to be $94,000,
which was determined by the Company using the Black-Scholes pricing model using
an expected life of 10 years, a volatility rate of 80%, and a risk-free interest
rate of 4.71%. The amount allocated to the warrant resulting from the relative
fair value allocation of the proceeds between the debt and warrant was accounted
for as additional paid-in capital and a corresponding debt discount.

SEPTEMBER 2007 FINANCING

On September 20, 2007, Peter Knobel, an existing investor, lent the Company $1
million under the terms of an unsecured subordinated promissory note. All
outstanding principal and monthly compounded interest at a 10% annual interest
rate was due on March 31, 2008 and is now due on demand. The interest rate
increased to 24% following maturity.

In connection with this loan, the Company issued Mr. Knobel a 5-year detachable
warrant allowing for a purchase for cash of up to 400,000 shares of stock at an
exercise price of $0.40 per share. The warrant is first exercisable on the one
year anniversary of the issue date, or upon any earlier merger or acquisition of
the Company. In connection with this transaction, the Company entered into a
registration rights agreement pursuant to which it agreed to register for resale
the shares of common stock issuable upon exercise of the warrant on the next
registration statement it files with the SEC, relating to an offering for any of
its equity securities, other than a registration statement relating to equity
securities to be issued solely in connection with an acquisition of another
entity, in an exchange offer for its securities, or in connection with stock
option or other employee benefit plans.

In accordance with APB No. 14, the Company has allocated the proceeds from the
note into debt and equity components, based on the relative fair values of each
instrument. The relative fair value of the warrant was estimated to be $137,000,
which was determined by the Company using the Black-Scholes pricing model using
an expected life of 5 years, a volatility rate of 80%, and a risk-free interest
rate of 4.35%. The amount allocated to the warrant resulting from the relative
fair value allocation of the proceeds between the debt and warrant was accounted
for as additional paid-in capital and a corresponding debt discount.


The Company is amortizing the debt discounts over the terms of the related debt
instruments using the straight-line method (which approximates the effective
interest method). During the year ended December 31, 2007 and from inception
through December 31, 2007, the Company amortized $424,000 related to the debt
discounts, which is recorded as interest expense in the accompanying
consolidated statements of operations.

Total interest expense (including amortization of debt discounts) related to the
loans from related parties was $658,000 for the year ended December 31, 2007 and
from inception through December 31, 2007.

NOTE 9.  EQUITY FINANCINGS

DECEMBER 2005 FINANCING

In December 2005, the Company sold to certain accredited investors 2,285,000
shares of common stock at a purchase price of $1.50 per share. In connection
with the financing, the Company also issued to the investors five-year warrants
to purchase 1,142,500 shares at $1.65 per share. The Company paid placement fees
to two placement agents equal to 8% of the gross proceeds, or $274,200, and
issued warrants to the placement agents to purchase an aggregate of 91,400
common shares. The warrants issued to the placement agents have exercise prices
of $1.65 and $1.88 per share and expire on December 29, 2010. The fair value of
the warrants, $85,000, has not been recorded as an adjustment to the financial
statements as it would have been both an increase and decrease to additional
paid-in capital.

                                      F-26
<PAGE>

AUGUST 2006 FINANCING

In the August 2006 private placement, 379,341 shares were purchased by
directors, officers, employees, or consultants of the Company, or affiliates of
such persons at a price of $1.67 per share. In connection with this placement,
the Company issued warrants to each investor. These related parties and
affiliates received warrants for an aggregate of 208,638 shares of common stock
at an exercise price of $1.67 per share. These warrants will be exercisable from
February 3, 2007 to August 3, 2011.

JUNE 2007 FINANCING

In June 2007, the Company entered into a securities purchase agreement with
certain accredited investors, pursuant to which the Company agreed to issue and
sell 2,612,500 shares of its common stock for cash at a purchase price of $0.40
per share for gross proceeds of $1,045,000. In connection with this financing,
the Company issued warrants to each investor, which are exercisable, commencing
on the one-year anniversary of the closing date until the six-year anniversary
of the closing date, for an aggregate of 1,306,250 shares of the Company's
common stock at an exercise price of $0.60 per share. Also, the Company incurred
legal fees in connection with the financing of approximately $18,000, which were
netted with the proceeds. The fair value of the warrants issued has not been
recorded in the financial statements as it would have been both an increase and
decrease to additional paid-in capital. Pursuant to the securities purchase
agreement, the purchasers of a majority of the shares had the right to nominate
up to four directors to serve on the Company's board of directors. The
purchasers nominated the following four individuals who now serve on the board:
Ronald Katz, Keith B. Hoffman, Ph.D., Jonathan R. T. Lakey, Ph.D., M.S.M., and
Michael J. Andrews. Dr. Lakey has since resigned from the board of directors.

In connection with this financing, the Company entered into a registration
rights agreement pursuant to which the Company agreed to register for resale the
shares of common stock sold in the financing and the shares of common stock
issuable upon the exercise of the warrants on the next registration statement
filed with the SEC, relating to an offering for any of the Company's equity
securities, other than a registration statement relating to equity securities to
be issued solely in connection with an acquisition of another entity, in an
exchange offer for the Company's securities, or in connection with stock option
or other employee benefit plans. If the SEC requires the Company to omit some of
the shares purchased in the financing or upon exercise of the warrants in order
for the offering to retain the status of a secondary offering under SEC Rule
415, the Company is obligated to issue to each holder as liquidated damages, a
warrant exercisable from and after the date one year after the closing date at
an exercise price of $0.60 per share and expiring on the date six years after
the closing date, for a number of shares of its common stock equal to 4% of the
number of shares held by the holder which were required to be omitted. At
December 31, 2007, the Company has not accrued for any liquidated damages
related to this registration rights agreement.

NOVEMBER 2007 FINANCING

On November 16, 2007, the Company entered into a securities purchase agreement
with a private trust, pursuant to which the Company agreed to issue and sell
2,352,941 shares of its common stock for cash at a purchase price of $0.425 per
share for gross proceeds of $1,000,000. In connection with this financing, the
Company issued a warrant to the investor, which is exercisable, commencing on
the earlier of the one-year anniversary of the closing date or the date of any
of certain fundamental transactions involving the Company (including a merger, a
sale of substantially all of the Company's assets, the commencement of a tender
or exchange offer or a reclassification of the Company's common stock) until the
six-year anniversary of the closing date, for an aggregate of 1,294,118 shares
of the Company's common stock at an exercise price of $0.60 per share. Also, the
Company incurred legal fees in connection with the financing of approximately
$26,000, which were netted with the proceeds. The fair value of the warrants
issued has not been recorded in the financial statements as it would have been
both an increase and decrease to additional paid-in capital. The Company's
Chairman serves as co-trustee of the trust. The trust's beneficiaries are not
affiliated with the Chairman.

                                      F-27
<PAGE>

Also in connection with this financing, the Company entered into a registration
rights agreement pursuant to which the Company agreed to register for resale the
shares of common stock sold in the financing and the shares of common stock
issuable upon the exercise of the warrants in the next registration statement
filed with the SEC, relating to an offering for any of the Company's equity
securities, other than a registration statement relating to equity securities to
be issued solely in connection with an acquisition of another entity, in an
exchange offer for the Company's securities, or in connection with stock option
or other employee benefit plans. If the SEC requires the Company to omit some of
the shares purchased in the financing or upon exercise of the warrants in order
for the offering to retain the status of a secondary offering under SEC Rule
415, the Company will be obligated to issue to each holder, as liquidated
damages, a warrant exercisable beginning one year after the closing date at an
exercise price of $0.60 per share and expiring on the date six years after the
closing date, for a number of shares of its common stock equal to 4% of the
number of shares held by the holder which were required to be omitted. At
December 31, 2007, the Company has not accrued for any liquidated damages
related to this registration rights agreement.

NOTE 10. RELATED PARTY TRANSACTIONS

See "December 2005 Financing" "August 2006 Financing" "January 2007 Financing,"
"May 2007 Financing" and "September 2007 Financing" in Note 8 of the
consolidated financial statements; "June 2007 Financing" and "November 2007
Financing" in Note 9 of the consolidated financial statements; and "January
2008, March 2008 and April 2008 Financings" in Note 17 of the consolidated
financial statements.

NOTE 11. LIQUIDATED DAMAGES TO INVESTORS

DECEMBER 2005 FINANCING

In connection with a private placement of common shares and warrants in December
2005, the Company is obligated to maintain a registration statement available
for the resale of the common shares and the shares underlying the warrants sold
in such financing. In April 2007, the Company notified the investors that the
registration statement which registered such shares for resale was no longer
available, and accordingly, the Company became subject to liquidated damages
beginning on May 20, 2007. The liquidated damages are equal to 0.0003 times the
purchase price of the securities the investors continue to own for each day the
registration statement is not available, other than securities that may be
resold under Rule 144 without restriction. The Company is permitted to pay any
such liquidated damages in cash or in shares of common stock at its election. If
the Company elects to issue shares, such shares are to be valued based on the
volume weighted average price of shares of common stock for the five trading
days prior to the date of issue. The Company is required to pay such damages no
later than the first trading day of each calendar month immediately following
the month in which the damages accrue.

In March 2006, a committee of the Board of Directors resolved to pay these
liquidated damages in shares, and to issue the shares in payment of those
damages as of the first trading day of each calendar month immediately following
the month in which the damages accrue, using the valuation formula described
above. Through December 31, 2007, liquidated damages of $143,000 had accrued,
and the Company discharged $132,000 of such obligation through the issuance of
267,684 shares of common stock in 2007. 30,192 of these shares were issued to
the Company's Chairman who was an investor in the financing. Liquidated damages
decreased approximately $8,000 per month in January 2008 as a result of shares
sold in the financing and held by non-affiliates being eligible for sale without
volume restrictions under Rule 144. Liquidated damages on all outstanding
warrants issued in the December 2005 financing, and on shares held by the
Company's Chairman and the holder of the promissory note issued in September
2007 will continue to accrue at approximately $12,000 per month until the
Company files and the SEC declares effective a post-effective amendment to the
registration statement containing updated financial and other information
concerning our company. The Company intends to continue to pay such amounts by
issuing shares of its common stock.


                                      F-28
<PAGE>

AUGUST 2006 FINANCING

In connection with a private placement of common shares and warrants in August
2006, the Company is obligated to maintain a registration statement available
for the resale of the common shares and the shares underlying the warrants sold
in such financing. Upon filing of the Company's annual report on Form 10-K for
the fiscal year ended December 31, 2007, the Company will notify the August 2006
investors that the registration statement which registered their shares for
resale will no longer be available, and accordingly, the Company expects to
become subject to liquidated damages beginning at the end of April 2008. The
liquidated damages are equal to 0.0003 times the purchase price of the
securities the investors continue to own for each day the registration statement
is not available, other than securities that may be resold under Rule 144
without restriction. The Company is permitted to pay any such liquidated damages
in cash or in shares of common stock at its election. If the Company elects to
issue shares, such shares are to be valued based on the volume weighted average
price of shares of common stock for the five trading days prior to the date of
issue. The Company is required to pay such damages no later than the first
trading day of each calendar month immediately following the month in which the
damages accrue.

NOTE 12. STOCKHOLDERS' EQUITY

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

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

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

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.

December 2005 Financing
-----------------------
The Company issued, in fiscal year ended December 31, 2007 and 2006, 267,684 and
56,899 shares of common stock respectively, in satisfaction of liquidated
damages owed to the purchasers in the Company's December 2005 financing for
failure to timely file and have declared effective by the SEC, a registration
statement covering the resale of the shares of common stock sold in the

                                      F-29
<PAGE>

financing and the shares of common stock issuable upon the exercise of the
warrants issued to the purchasers. The Company recorded $132,000 and $106,000 of
expense, in the fiscal years ended December 31, 2007 and 2006, respectively,
associated with the liquidated damages shares which is classified as general and
administrative expenses in the accompanying consolidated statements of
operations (see Note 11).

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

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

The Company's Board of Directors adopted the 2005 Plan in June 2005 and it
became effective upon shareholder approval in November 2005. A total of
3,000,000 new shares of the Company's common stock have been reserved for
issuance under the 2005 Plan (the original 2,000,000 plus an additional
1,000,000 approved by shareholders on November 14, 2006). In addition, the 2005
Plan includes in its reserve shares of common stock available for issuance under
the 2000 Plan as of the date of the approval of the 2005 Plan. The reserve will
also include any shares currently subject to options under the 2000 Plan that
expire or become unexercisable for any reason without having been exercised in
full. The total 2005 Plan reserve cannot exceed 8,471,239 shares. All options
have a ten-year life and vest ratably over a three-year period.

The Company applies SFAS No. 123 and EITF No. 96-18 in accounting for stock
options granted to outside consultants and directors performing advisory
services. Compensation cost is recognized over the period over which the
services are received based on the fair value of the options at each balance
sheet date until the grantee's performance is complete. Compensation cost
charged to operations for options granted to consultants performing advisory
services was $29,000 in 2006, and $1,635,000 from August 21, 1998 (inception) to
December 31, 2007. The fair value of these options was estimated using the
Black-Scholes pricing model with the following weighted-average assumptions for
the year ended December 31, 2006: risk free interest rate of 4.80%; dividend
yield of 0%; volatility of 77%, forfeiture rate of 7%, expected life of 5 to 10
years. There were no options issued to consultants during 2007.

The following summary presents the options granted, exercised, expired,
forfeited and outstanding as of and for the years ended December 31, 2007 and
2006:
<TABLE>
<S>     <C>
                                                                             Weighted
                                                                Weighted     Average
                                                                Average     Remaining    Aggregate
                                                   Number of    Exercise   Contractual   Intrinsic
                                                    Shares       Price        Life        Value
                                                  ----------    --------   ----------   ----------
Outstanding at December 31, 2005                   5,015,128    $   1.15
Granted                                            1,947,000        2.15
Exercised                                         (1,490,983)       0.40
Forfeited and expired                             (1,080,904)       2.32
                                                  ----------    --------
Outstanding at December 31, 2006                   4,390,241        1.56
Granted                                            4,642,633        0.54
Exercised                                                 --          --
Forfeited and expired                             (3,557,875)       1.66
                                                  ----------    --------
Outstanding at December 31, 2007                   5,474,999    $   0.63         8.30   $  180,000
                                                  ==========    ========   ==========   ==========
Vested or expected to vest at December 31, 2007    5,295,491    $   0.64         8.25   $  180,000
                                                  ==========    ========   ==========   ==========
Exercisable at December 31, 2007                   1,884,857    $   0.78         5.48   $  171,000
                                                  ==========    ========   ==========   ==========
</TABLE>

                                      F-30
<PAGE>

The weighted average grant date fair value of options granted during 2007 and
2006 was $0.38 and $2.15, respectively. The total intrinsic value of options
exercised during 2007 and 2006 was $0 and $2,138,000, respectively. The total
fair value of shares vested during the years ended December 31, 2007 and 2006
was $518,000 and $832,000 respectively.

The Company had options for 1,884,857 shares exercisable at December 31, 2007
with a weighted average exercise price of $0.78. 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, 2007:


                                      OPTIONS OUTSTANDING
                          -------------------------------------------
                                           Weighted          Weighted
                           Number of       Average           Average
                            Shares         Remaining         Exercise
Exercise Price:           Outstanding   Contractual Life      Price
---------------           -----------   ----------------    ---------
$0.29-$0.80                5,217,959         8.41           $  0.51
$1.13-$2.35                  116,156         7.85           $  1.59
$2.95-$5.00                  140,884         4.52           $  4.32
                          -----------
TOTAL                      5,474,999         8.30           $  0.63
                          ===========

                                OPTIONS EXERCISABLE
                          ------------------------------
                                               Weighted
                                               Average
                          Number of Shares     Exercise
Exercise Price:             Exercisable         Price
---------------           ----------------   -----------
$0.29-$0.80                  1,656,401         $ 0.44
$1.13-$2.35                     87,572         $ 1.54
$2.95-$5.00                    140,884         $ 4.32
                          ----------------
TOTAL                        1,884,857         $ 0.78
                          ================

Warrants
--------

The following table summarizes information with regard to outstanding warrants
issued in connection with equity and debt financings
as of December 31, 2007:

<TABLE>
<S>     <C>
                                            Number                                               Weighted Average
Issued in Connection With:                Outstanding     Exercise Price   Expiration Date        Exercise Price
--------------------------------------    ------------    --------------   -------------------   ----------------
                                                                           April 11, 2013 -
2003 Financings                               200,000     $0.50 - $1.49    August 26, 2013            $0.84
2004 Private Placement:
  Investors                                 3,220,965     $1.00            March 16, 2009             $1.00
  Placement Agents                             28,450     $1.30            March 16, 2009             $1.30
                                                                           April 30, 2009 -
Consulting Services                           362,334     $0.60 - $1.65    September 27, 2009         $1.22
2005 Private Placement:
  Investors                                 1,142,500     $1.65            December 29, 2010          $1.65
  Placement Agents                             91,400     $1.65 - $1.88    December 29, 2010          $1.72
2006 Private Placement                      1,403,634     $1.65 - $1.67    August 3, 2011             $1.65
January 2007 Note Payable                     500,000     $1.00            January 12, 2017           $1.00
May 2007 Note Payable                         250,000     $0.75            May 19, 2017               $0.75
June 2007 Private Placement                 1,306,250     $0.60            June 20, 2013              $0.60
September 2007 Note Payable                   400,000     $0.40            September 20, 2012         $0.40
November 2007 Private Placement             1,294,118     $0.60            November 16, 2013          $0.60
                                          ------------                                           ----------------
Total                                      10,199,651                                                 $1.02
                                          ============                                           ================
</TABLE>

                                      F-31
<PAGE>

The following summary presents the warrants granted, exercised, expired,
forfeited and outstanding as of and for the years ended December 31, 2007 and
2006:
                                         2007                     2006
                               -----------------------   -----------------------
                                              Weighted                  Weighted
                                              Average                   Average
                                              Exercise                  Exercise
                                 Warrants      Price       Warrants      Price
                               -----------    --------   -----------    --------
Outstanding at January 1,        8,130,052    $   2.52     9,284,615    $   2.24
Granted                          3,750,368        0.57     1,403,634        1.65
Exercised                               --          --    (2,506,197)       1.02
Forfeited and expired           (1,680,769)       7.28       (52,000)       1.00
                               -----------    --------   -----------    --------
Outstanding at December 31,     10,199,651    $   1.02     8,130,052    $   2.52
                               ===========    =====---   ===========    ========


NOTE 13. EARNINGS PER SHARE

Loss per share has been calculated based upon the weighted average shares
outstanding. Basic and diluted net loss per share amounts are equivalent for the
years ended December 31, 2007 and 2006, as the inclusion of 1,177,297 and
12,520,293 potential common shares, respectively, in the number of shares used
for the diluted computation would be anti-dilutive.

NOTE 14. INCOME TAXES

                                                     2007             2006
                                                 ------------      ------------
Deferred tax assets:
      Net operating loss carry forwards          $ 18,329,000      $ 14,891,000
      Stock-based compensation                      1,107,000           835,000
      Warrants                                      1,806,000         1,806,000
      Research and development credit               2,247,000         1,790,000
      Accrual to cash                                 344,000            12,000
      Other                                             3,000             3,000
                                                 ------------      ------------
                                                   23,836,000        19,337,000
Deferred tax liabilities:
      State taxes                                  (1,906,000)       (1,554,000)
      Other                                           (54,000)          (33,000)
                                                 ------------      ------------
Net deferred tax asset                             21,876,000        17,750,000
Less valuation allowance                          (21,876,000)      (17,750,000)
                                                 ------------      ------------
                                                 $         --      $         --
                                                 ============      ============

SFAS No. 109, "Accounting for Income Taxes", requires that a valuation allowance
be established when it is more likely than not that its net deferred tax asset
will not be realized. In determining whether a valuation allowance is required,
a company must take into account all positive and negative evidence with regard
to the utilization of a deferred tax asset. SFAS No. 109 further states that it
is difficult to conclude that a valuation allowance is not needed when there is
negative evidence such as cumulative losses in recent years. As of December 31,
2007 and 2006, the valuation allowance for the deferred tax assets totaled
$21,876,000 and $17,750,000, respectively. For the years ended December 31, 2007
and 2006, the net change in the valuation allowance was $4,126,000 (increase)
and $4,777,000 (increase), respectively.

The Company plans to continue to provide a full valuation allowance on future
tax benefits until it can sustain an appropriate level of profitability and
until such time, the Company would not expect to recognize any significant tax
benefits in its future results of operations.

                                      F-32
<PAGE>

As of December 31, 2007, the Company had net operating loss carry forwards for
federal and state income tax purposes of approximately $42,948,000 and
$42,068,000, respectively. The federal net operating loss carry forwards begin
to expire in 2019 and the state net operating loss carry forwards began to
expire in 2007. As of December 31, 2007, the Company had research and
development credits carry forwards for federal and state income tax purposes of
approximately $1,024,000 and $1,223,000, respectively. The federal research
credit carry forward begins to expire in 2019. The state research credit carry
forward is available indefinitely. A portion of the net operating loss carry
forwards as of December 31, 2007 includes amounts related to stock option
deductions. Under SFAS 123R, any excess tax benefits from share-based
compensation are only realized when income taxes payable is reduced, with the
corresponding credit posted to additional paid-in capital.

The utilization of net operating loss and credit carry forwards may be limited
under the provisions of the Internal Revenue Code section 382/383 and similar
state provisions due to the change in ownership.

The Company is required to file federal and state income tax returns in the
United States.

Prior to January 1, 2007, the Company analyzed and determined no accrual was
required for uncertain tax positions based upon SFAS No. 5, ACCOUNTING FOR
CONTINGENCIES, which requires the Company to accrue for the estimated additional
amount of taxes for the uncertain tax positions if it was probable the Company
would be required to pay such additional taxes. Effective January 1, 2007, the
Company adopted and implemented the provisions of FASB Interpretation No.
("FIN") 48, "Accounting for Uncertainty in Income Taxes- An interpretation of
FASB Statement No. 109", which requires the Company to accrue for the estimated
additional amount of taxes for the uncertain tax positions if it is more likely
than not that the Company would be required to pay such additional taxes. As a
result of the implementation of FIN 48 the Company recognized no charge for
uncertain tax positions.

FIN 48 not only impacts the amount of the Company's accrual for uncertain tax
positions, but it also impacts the manner in which such accruals should be
classified in the Company's consolidated financial statements. In connection
with the implementation of FIN 48, and if an accrual is recorded, the Company
will record the aggregate accrual for uncertain tax positions as a component of
current and non-current income tax payable and the offsetting amounts as a
component of the Company's net deferred tax assets and liabilities.

The Company's continuing practice is to recognize interest and/or penalties
related to income tax matters in income tax expense. As of December 31, 2007 and
2006, the Company had no accrual for the payment of interest and penalties.

The Company has not recorded income tax expense or benefit for the years ended
December 31, 2007 and 2006, and the period from August 21, 1998 (inception)
through December 31, 2007.

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

                                                      2007              2006
                                                   -----------      -----------
Federal tax benefit of statutory rate              $ 3,207,000      $ 3,626,000
State tax benefit, net                                 676,000          771,000
Increase in valuation allowance                     (4,082,000)      (4,777,000)
Research and development credit                        199,000          171,000
Other permanent items                                       --         (416,000)
Stock-based compensation                                    --          625,000
                                                   -----------      -----------
Provision for income taxes                         $        --      $        --
                                                   ===========      ===========

                                      F-33
<PAGE>

NOTE 15. 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 2007 and 2006,
nor in any prior period since inception of the plan.

NOTE 16. 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. In November 2005, the
Company entered into an agreement with Mr. Gallego to settle this matter. The
terms of the settlement were placed on the court record before United States
Magistrate Judge William McCurine, Jr. of the United States District Court,
Southern District of California. Any disputes that may arise in connection with
the final settlement documents or enforcement of the settlement will be resolved
by Judge McCurine. Any orders issued by Judge McCurine in this regard will be
final and binding on the parties.

In the settlement, the Company paid $50,000 cash and issued 170,000 shares of
common stock to Mr. Gallego. In addition, the Company filed with the Securities
and Exchange Commission a registration statement for the resale of these shares
and an additional 150,000 shares owned by Mr. Gallego. The Company recognized
expense of $229,000 (net of insurance proceeds) and reported this as part of
general and administrative expenses in the fourth quarter of 2005. The
registration statement was not filed until April, 2006. Therefore, Mr. Gallego
was entitled to liquidated damages totaling 20,000 shares. These liquidated
damages began accruing in February 2006. The Company recorded expense of $40,000
in April 2006, when these shares were issued to Mr. Gallego. A written
settlement agreement setting forth the foregoing terms was executed in January
2006.

In January 2007, the Company received a demand letter from an attorney stating
that he represented shareholders who purchased approximately $3 million of
common shares at a price of $6 per share. The letter alleges that these shares
were purchased in 2002 and that the Company and certain former officers engaged
in self-dealing, potential fraud with respect to manipulation of the stock
price, and diminution of share value. MicroIslet's insurance carriers have been
notified of the demand letter and as of March 31, 2008, no lawsuit has been
filed by these shareholders.

On March 16, 2007, the Company, along with MicroIslet of Delaware; John F.
Steel, IV, former Chairman of the Board and Chief Executive Officer; Haro
Hartounian, Ph.D., former President and Chief Operating Officer; and James R.
Gavin, III, M.D., Ph.D., former President and Chief Executive Officer, filed a
Declaratory Relief Lawsuit ("DLR") in the United States District Court for the
Southern District of California in San Diego against the shareholders on whose
behalf the demand letter was sent. The DLR seeks a declaration from the court
that the Company, MicroIslet of Delaware, Mr. Steel, Dr. Hartounian and Dr.
Gavin did not engage in conduct entitling the shareholders to any relief under
federal or state securities laws, or otherwise. The DLR also seeks attorneys'
fees and costs. The Company has not received a response to the DLR and intends
to dismiss the DLR without prejudice to its ability to refile the action. No
amounts have been accrued related to this litigation.

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

Indemnification Obligations
---------------------------

The Company has undertaken certain indemnification obligations pursuant to which
it may be required to make payments to an indemnified party in relation to
certain transactions. The Company has agreed to indemnify its directors,
officers, employees and agents to the maximum extent permitted under the laws of
the State of Nevada. In connection with its facility leases, the Company has
agreed to indemnify its lessors for certain claims arising from the use of the
facilities. In connection with certain of its debt, stock purchase and other


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agreements, the Company has agreed to indemnify lenders, sellers and various
other parties for certain claims arising from the Company's breach of
representations, warranties and other provisions contained in the agreements.
Certain of these indemnification obligations do not provide for any limitation
of the maximum potential future payments the Company could be obligated to make.
No liabilities have been recorded for these indemnities in the accompanying
consolidated balance sheets.

NOTE 17. SUBSEQUENT EVENTS

JANUARY 2008 AND MARCH 2008 FINANCINGS

On January 25, 2008, the Company entered into a securities purchase agreement
("Purchase Agreement") with a private trust. The Company's Chairman serves as
co-trustee of the trust. The trust's beneficiaries are not affiliated with the
Chairman. The Purchase Agreement permitted the Company to issue up to $2,000,000
in aggregate principal amount of Subordinated Convertible Unsecured Revolving
Promissory Notes due March 31, 2008 ("Notes") and warrants to purchase a number
of shares of common stock equal to the quotient of the aggregate funds advanced
to the Company under the Notes, divided by $2.50 ("Warrants"). Each Note accrues
interest at the rate of 10% per annum until maturity and 24% per annum
thereafter. Interest is payable monthly in arrears, and may, at the Company's
option, either be capitalized and added to the outstanding principal balance of
the Note, or paid to the holder in cash. The holder of a Note may, at its
option, convert all or a portion of the principal and accrued interest into the
securities sold in the Company's next equity financing transaction in which the
Company raises at least $3 million, on the same terms as the securities
purchased by the other investors in the financing. Each Warrant has an exercise
price of $0.40 per share and is exercisable for a period of five years,
commencing on the earlier of the one year anniversary of the grant and the
occurrence of any specified fundamental transaction involving the Company. The
holder may elect a cashless exercise of the Warrant under certain circumstances.

In connection with the Purchase Agreement, on January 25, 2008, the Company
issued to the trust (1) a Note in the principal amount of $1,000,000 ("January
Note"), and (2) a Warrant ("January Warrant") to purchase a number of shares of
common stock equal to the quotient of the aggregate funds advanced to the
Company under the January Note, divided by $2.50, up to a maximum of 400,000
shares. The full $1,000,000 under this Note has been drawn down by the Company,
and accordingly, the January Warrant is exercisable for 400,000 shares.

Pursuant to the Purchase Agreement, on January 25, 2008, the Company also
entered into a registration rights agreement with the trust, pursuant to which
the Company has agreed to register for resale the shares of common stock
issuable upon exercise of the Warrants on the next registration statement the
Company files with the SEC relating to an offering for any of the Company's
equity securities, other than a registration statement relating to equity
securities to be issued solely in connection with an acquisition of another
entity, in an exchange offer for the Company's securities, or in connection with
stock option or other employee benefit plans.

On March 17, 2008, the Company entered into a First Amendment to Securities
Purchase Agreement and Promissory Note ("First Amendment"), with the trust.
Pursuant to the First Amendment, the maximum aggregate original principal amount
of the Notes issuable under the purchase agreement was increased from $2,000,000
to $2,500,000, and the maturity date of the Notes was extended to May 31, 2008.
The maturity date may be accelerated by the trust upon the occurrence and during
the continuance of an event of default.

In connection with the First Amendment, on March 17, 2008, the Company issued to
the trust (1) a Note in the principal amount of $1,500,000 ("March Note"), and
(2) a Warrant ("March Warrant"), to purchase a number of shares of common stock
equal to the quotient of the aggregate funds advanced to the Company under the
March Note, divided by $2.50, up to a maximum of 600,000 shares. On that same
date, the trust advanced to the Company $500,000 under the terms of the March
Note. Prior to the maturity of the March Note, the Company may request
additional advances from the trust, up to a total aggregate principal amount of
$1,500,000, which the trust may agree to make in its sole discretion.

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The Company entered into a Second Amendment to Securities Purchase Agreement
("Second Amendment") with the trust effective April 2, 2008. Pursuant to the
amendment, the maximum aggregate original principal amount of the Notes issuable
under the Purchase Agreement was increased from $2,500,000 to $4,500,000. On
April 2, 2008, the Company borrowed $500,000 from one accredited investor
unaffiliated with the trust or the Company's Chairman, and the Company issued a
Note under the Purchase Agreement in the original principal amount of $500,000.
On April 4, 2008, the Company borrowed an additional $100,000 from another
accredited investor unaffiliated with the trust or the Company's Chairman on the
same terms. The Warrants issued in connection with these Notes are exercisable
for 240,000 shares. The terms and conditions of these Notes and Warrants are
otherwise substantially similar to the March Note and the March Warrant.

These loans are convertible, at the option of the holders, upon the first equity
or equity based financing transaction after the date of this note(s). It is
convertible all or in part into shares of the Company's common stock at the
purchase price in the first equity financing transaction of the Company's common
stock in which at least $3 million is raised from investors (a `Qualified
Financing") provided the Conversion Amount conforms with the minimum investment
amount established by the Board of Directors. In accordance with EITF No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratio" and EITF No. 00-27, "Application of
EITF Issue No. 98-5 to Certain Convertible Instruments," since the terms of the
contingent conversion option do not permit the Company to compute the additional
number of shares that it would need to issue upon conversion of the notes if the
contingent event occurs and the conversion price is determined, the Company
determined the value of the beneficial conversion feature as of the commitment
date and will record the beneficial conversion amount as additional interest
expense only if the contingent event occurs.

In accordance with APB No. 14, the Company has allocated the proceeds from the
note into debt and equity components, based on the relative fair values of each
instrument. The fair value of the January Warrant was estimated to be $119,000,
which was determined by the Company using the Black-Scholes pricing model using
an expected life of 10 years, a volatility rate of 80%, and a risk-free interest
rate of 3.61%, respectively. The estimated fair value of the warrant will be
accounted for as additional paid-in capital with a corresponding debt discount.
The fair value of the March Warrant was estimated to be $178,000, which was
determined by the Company using the Black-Scholes pricing model using an
expected life of 10 years, a volatility rate of 80%, and a risk-free interest
rate of 3.34%, respectively. The estimated fair value of the warrant will be
accounted for as additional paid-in capital with a corresponding debt discount.
The fair value of the April 2nd Warrant was estimated to be $60,000, which was
determined by the Company using the Black-Scholes pricing model using an
expected life of 10 years, a volatility rate of 80%, and a risk-free interest
rate of 3.60%, respectively. The estimated fair value of the warrant will be
accounted for as additional paid-in capital with a corresponding debt discount.
The fair value of the April 4th Warrant was estimated to be $12,000, which was
determined by the Company using the Black-Scholes pricing model using an
expected life of 10 years, a volatility rate of 80%, and a risk-free interest
rate of 3.50%, respectively. The estimated fair value of the warrant will be
accounted for as additional paid-in capital with a corresponding debt discount.

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