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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

                         Commission File Number 0-27035

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

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

6370 Nancy Ridge Drive, Suite 112, San Diego, California           92121
--------------------------------------------------------           -----
        (Address of principal executive offices)                 (Zip Code)

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

        SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
           SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                          Common Stock, $.001 par value
                          -----------------------------
                                (Title of Class)

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

The Registrant's revenues for its most recent fiscal year were $255,857.

As of March 16, 2004, the aggregate market value of the voting stock of the
Registrant held by non-affiliates of the Registrant was $56,125,737.*

The number of shares of Common Stock, $.001 par value, outstanding on March 16,
2004, was 38,413,030.

* Excludes the Common Stock held by executive officers, directors and
shareholders whose ownership exceeds 5% of the Common Stock outstanding on March
16, 2004. The calculation does not reflect a determination that such persons are
affiliates for any other purposes.

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                                TABLE OF CONTENTS


                                                                            Page
                                     PART I


ITEM 1.    Business                                                            3
ITEM 2.    Properties                                                         12
ITEM 3.    Legal Proceedings                                                  12
ITEM 4.    Submission of Matters to a Vote of Security Holders                12

                                     PART II


ITEM 5.    Market for Common Equity and Related Stockholder Matters           12
ITEM 6.    Management's Discussion and Analysis                               14
ITEM 7.    Financial Statements                                          30, F-1
ITEM 8.    Changes in and Disagreements with Accountants on
           Accounting and Financial Disclosure                                30
ITEM 8A.   Controls and Procedures                                            30

                                    PART III


ITEM 9.    Directors, Executive Officers, Promoters and Control Persons;
           Compliance with Section 16(a) of the Exchange Act                  31
ITEM 10.   Executive Compensation                                             34
ITEM 11.   Security Ownership of Certain Beneficial Owners and
           Management and Related Stockholder Matters                         36
ITEM 12.   Certain Relationships and Related Transactions                     39
ITEM 13.   Exhibits List and Reports on Form 8-K                              41
ITEM 14.   Principal Accountant Fees and Services                             44

                           FORWARD-LOOKING STATEMENTS


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

                                       2
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                                     PART I


ITEM 1. BUSINESS

OVERVIEW

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

PRODUCT

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

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

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

LICENSE AND SPONSORED RESEARCH

We entered into a license agreement with Duke University in September 1998,
which agreement was amended in February 1999. Pursuant to the license agreement,
we sponsored research conducted by Duke from 1998 through 2001 in connection
with the isolation, culture, storage and encapsulation of insulin-producing
islet cells from porcine sources to be used for transplantation in patients with
insulin-dependent diabetes. The research was conducted under the supervision of
Dr. Emmanuel C. Opara. Under the license agreement, we agreed to pay Duke
University for all direct and indirect costs incurred in the performance of the
research. As of December 31, 2003, we have paid Duke approximately $250,000 for
research efforts and accrued an additional $230,000. In March 2004 we paid Duke
$200,000 in settlement of all amounts owed.

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

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

The agreement imposes on us an obligation to indemnify Duke, its officers,
employees and agents against claims arising from our or any sublicensee's
development, manufacture or sale of any products that are developed through the
use of the patented technology licensed from Duke. The agreement also imposes on
us an obligation to use best efforts to market for exploitation the licensed


                                       3
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technology, to develop manufacturing capabilities internally or through third
parties, and to continue active, diligent marketing efforts for products based
on the licensed technology, including a vigorous sublicensing program to effect
commercialization of such products in any field we do not exploit on our own. If
we fail to meet these obligations, Duke may reduce the license to a
non-exclusive one. Moreover, if we fail to meet our obligations under the
agreement, including our payment obligations, and fail to remedy our breach
within 30 days of notice of the breach from Duke, Duke may terminate the
agreement. The license agreement expires when the last patent within the patent
rights licensed to us by Duke has expired.

We also have an active collaboration with the University of Alberta, Edmonton
(Canada). This facility is assisting us with transplantation surgery and
subsequent monitoring in animal models. Under the terms of the arrangement, we
paid the University approximately $42,000 during fiscal 2003 and have agreed to
pay the University a maximum of $100,000 per year until September 30, 2004 based
on services provided as agreed upon from time to time.

We have also entered into a broad collaboration in the area of islet cell
transplantation therapies for treatment of insulin-dependent diabetes with The
Scripps Research Institute. Under the terms of the agreement, MicroIslet and The
Scripps Research Institute are conducting preclinical studies utilizing
MicroIslet's proprietary technologies. MicroIslet believes the completion of
this work will set the stage for studies enabling an Investigational New Drug
application (IND) and can be included as part of the IND process for human
clinical trials. The agreement calls for MicroIslet to fund The Scripps Research
Institute in the amount of approximately $500,000 over a two year period ending
in March 2005. As of December 31, 2003, we have funded approximately $215,000 to
The Scripps Research Institute.

INTELLECTUAL PROPERTY

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

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

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

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

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

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RESEARCH AND DEVELOPMENT STRATEGY

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

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

Together with the University of Alberta, The Scripps Research Institute and
possibly other collaborators, we will obtain data relating to the level of
insulin delivery, blood glucose control, the immune reaction of the animals to
both the microencapsulated islets and the capsule itself, and any side effects
associated with the transplantation. We will also develop information on dose
and duration of implanted cells in relevant diabetes models, as well as the
longevity and ultimate fate of the capsule in vivo. Through these activities, we
are planning to establish the feasibility of the concepts behind our product
candidate in animals.

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

In September 2003, we received preliminary data from The Scripps Research
Institute (TSRI) showing interim results of transplants using our proprietary
technology in approximately 150 small animals. In the study, groups of
streptozotocin-diabetic NOD/SCID as well as groups of immunocompetent mice were
transplanted with MicroIslet's microencapsulated porcine islet cells. The
transplanted capsules at various dosing levels were able to normalize blood
glucose (normoglycemia) levels in all animals within one week of
transplantation. The grafts have remained functional for up to 180 days after
implantation. This ongoing study is being conducted under the supervision of Dr.
Daniel R. Salomon of the Department of Molecular and Experimental Medicine at
TSRI.

         The preliminary data allow the following conclusions:

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

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

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

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 will be focused on preparing our current microencapsulated
porcine islet technology for clinical studies. These objectives are outlined as
follows:

         o        Optimization of our proprietary microencapsulated porcine
                  islet technology.

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

Once we are satisfied that we have adequately optimized our processes, we expect
to begin work on further objectives as follows:

                                       5
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         o        Conduct allotransplantation human clinical studies in
                  cooperation with the University of Alberta, Edmonton using
                  their human islets and MicroIslet's encapsulation process.
                  This will validate the microencapsulation technology's ability
                  to provide effective immunoisolation in humans prior to
                  clinical trials of MicroIslet-P(TM).

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

Our total research and development expenses were approximately $1.5 and $1.1
million for 2003 and 2002.

MARKET OPPORTUNITY

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

COMPETITION

The pharmaceutical and biotechnology industries are intensely competitive, and
technological progress can be rapid. Although there are no other products
currently available or in late stage clinical trials that can effectively cure
insulin dependent diabetes, we anticipate that this area will remain the focus
of intense competition.

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

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

         o        Diatranz -- a New Zealand-based company developing an
                  alginate-encapsulated porcine islet cell product;

         o        Islet Sheet Biomedical -- company engaged in the research and
                  development of a bioartificial pancreas;

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

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

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

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

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SALES AND MARKETING

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

MANUFACTURING

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

GOVERNMENT REGULATION

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

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

CLINICAL TRIAL PROCESS. Development of a therapeutic product for human use under
applicable laws and regulations is a multi-step process. First, in vitro and/or
animal testing must be conducted in a manner consistent with good laboratory
practices to establish the potential safety and effectiveness of the
experimental product in a given disease. Before human clinical trials may begin
for new drugs and biologics, an investigational new drug application containing,
among other things, the preclinical data, chemistry, manufacturing and control
information, and an investigative plan, must be submitted to the FDA. Clinical
trials of medical devices generally require the same sort of submission in the
form of an application for an investigational device exemption. In addition,
approval and oversight by an Institutional Review Board and adherence to
requirements for proper informed consent from study subjects are required,
unless a device sponsor is exempted from these requirements. Once a trial
begins, changes to the investigational product or study protocol may require
prior approval before they can be implemented. There can be no assurance that
submission of an investigational new drug application or an investigational
device exemption will result in the ability to commence clinical trials. In
addition, the FDA may place a clinical trial on hold or terminate it at any
phase if, among other reasons, it concludes that clinical subjects are being
exposed to an unacceptable health risk.

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

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

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

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

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

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

If the FDA approves a BLA, we will need to continue to be compliant with strict
FDA requirements concerning good manufacturing practices, enforced by periodic
inspections, and adverse event reporting, as well as with any special
requirements imposed as a part of the biologics license application approval.
With certain exceptions, changes to the labeling of approved biological products
require approved supplemental applications. In addition, changes in the product
or manufacturing that have a substantial potential to adversely affect product
safety or effectiveness likewise require supplemental applications. These
supplemental applications may require the submission of clinical or
comparability data and must be approved before the product may be marketed as
modified. The approval process is lengthy, expensive and uncertain.

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

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

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

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

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

Whether or not a product is required to be approved before marketing, we must
comply with strict FDA requirements applicable to devices, including quality
system requirements pertaining to all aspects of our product design and
manufacturing process, such as requirements for packaging, labeling, record
keeping, including complaint files, and corrective and preventive action related
to product or process deficiencies. The FDA enforces its quality system
requirements through periodic inspections of medical device manufacturing
facilities. In addition, Medical Device Reports must be submitted to the FDA to
report device-related deaths or serious injuries, and malfunctions the
recurrence of which would likely cause serious injury or death. Medical device
reports can result in agency action such as inspection, recalls, and
patient/physician notifications, and are often the basis for agency enforcement
actions. Because the reports are publicly available, they can also become the
basis for private tort suits, including class actions.

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

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

EMPLOYEES

As of March 16, 2004, we had eight full time employees and one part time
employee. Five of our employees are engaged in research and development. We also
maintain a Scientific Advisory Board of outside consultants consisting of seven
persons, all with doctoral degrees. These consultants are:

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<TABLE>
<CAPTION>

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

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

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

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

Morton D. Bogdonoff, M.D.                         Emeritus Professor of Medicine at Weill Medical College of Cornell
                                                  University and Senior Attending Physician at The New
                                                  York-Presbyterian Hospital in New York City.

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

HISTORY

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

MSLT Delaware was founded by John F. Steel IV, who at the time of the merger
owned 49% of the outstanding shares of MSLT Delaware and was its Chairman and
CEO. DiaSense, Inc. and Richard Schoninger were also principal stockholders of
MSLT Delaware, owning 18% and 11.4%, respectively, of the outstanding shares at
that time. The other executive officer of MSLT Delaware prior to the merger was
Hartoun Hartounian, who served as its Chief Operating Officer. Mr. Steel, Dr.
Hartounian, Robert Anderson and James Gavin made up the board of directors. Each
of these individuals remains with our company in the same or similar capacity.
MSLT Delaware was incorporated in Delaware in August 1998. From the time of its
formation, the company has been engaged in the research, development and
commercialization of technologies in the field of cell transplantation therapy
for insulin-dependent diabetes. MSLT Delaware has licensed patented technologies
from Duke University Medical Center for the isolation, culture, storage and
microencapsulation of insulin-producing islet cells. Transplantation of cells
using these proprietary methods may enable diabetic patients to become free from
insulin injections. Our ultimate goal is to offer a treatment towards a cure for
diabetes worldwide.

                                       10
<PAGE>

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

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

In December 2001, Frank Danesi, Jr., the sole officer and director of our
company at the time and owner of approximately 90% of our then outstanding
shares of capital stock, sold all of his 3,075,000 shares of common stock to the
Don and Bonnie Saunders Family Trust, a family trust affiliated with Mr.
Saunders, for a cash purchase price of $300,000. The Don and Bonnie Saunders
Family Trust purchased a total of 615,000 of such shares as nominee for others,
including 275,132 shares for Thomas K. Russell and 137,566 shares for Mark C.
Russell. The sale constituted a change of control of our company. Thomas K.
Russell also became our President, Chairman and sole director at that time. The
successor management elected to change our business plan by characterizing us as
a public "blind pool" or "blank check" company. Our plan of operations became to
seek, investigate, and if warranted, acquire one or more properties or
businesses through a reverse merger or other similar type of business
acquisition transaction.

Consistent with the business combination requirement under the Investment
Banking Agreement, Mr. Saunders, Thomas K. Russell and Mark C. Russell
introduced our company to MSLT Delaware and performed all management services
for us from December 2001 to April 2002 on a part time, as needed basis. Those
services included coordinating with ASA and MSLT Delaware to facilitate the
business combination and the related private placement, performing management
and financial reporting for us, completing required SEC filings and negotiating
for us the terms of the business combination agreement. In April 2002, we
granted warrants to Mr. Saunders, Thomas K. Russell and Mark C. Russell for the
foregoing services. The warrants consisted of Class A Warrants for the purchase
of 1,000,000 shares at $6.00 per share, and Class B Warrants for the purchase of
500,000 shares at $12.00 per share. Both the Class A and the Class B Warrants
provided that they are generally exercisable at any time until July 31, 2007. We
are required to register the shares underlying the warrants and to maintain an
effective registration statement during such time as the warrants and underlying
shares remain outstanding. Mr. Saunders received 850,000 Class A Warrants and
425,000 Class B Warrants, Thomas K. Russell received 100,000 Class A Warrants
and 50,000 Class B Warrants, and Mark C. Russell obtained 50,000 Class A
Warrants and 25,000 Class B Warrants. We valued those warrants at approximately
$5.9 million. See Note 7 to our consolidated financial statements on page F-12
below.

On April 24, 2002, MSLT Delaware sold 504,620 shares of its common stock in the
second stage of its private placement, raising approximately $3 million in gross
proceeds. We simultaneously completed our business combination with MSLT
Delaware. MSLT Delaware's stockholders were issued a total of 19,215,538 shares
of our authorized but unissued common stock, representing approximately 85% of
our post-merger outstanding shares. In the merger, MSLT Delaware common shares
were exchanged on a one-for-one basis for our common shares, and MSLT Delaware's
Series A Preferred shares were exchanged on a 15.6275-for-one basis for our


                                       11
<PAGE>

common shares. Soon after the merger, we changed our name from ALD Services,
Inc. to MicroIslet, Inc. ASA received a commission of $302,770 in connection
with the second private placement closing, and earned an investment banking fee
of $200,000 plus 33,334 of our common shares in connection with our acquisition
of MSLT Delaware.

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

We regard the Class A and Class B Warrants to have been issued for services
rendered in connection with the private placement and business combination. See
Note 7 to our consolidated financial statements on page F-12 of this Form
10-KSB. Except for such warrants, none of Mr. Saunders, Thomas K. Russell or
Mark C. Russell earned any compensation in connection with the private
placements or the business combination with MSLT Delaware. Immediately after the
business combination, Mr. Saunders beneficially owned 16.8% of our common
shares, Thomas K. Russell beneficially owned 1.9% of our common shares, and Mark
C. Russell beneficially owned less than 1% of our common shares, in each case
giving effect to the exercise of their Class A and Class B Warrants.

In August 2003, we agreed to pay ASA an 11% finder's fee for any completed
financing from persons introduced to us by ASA. Pursuant to this agreement, we
paid ASA a finder's fee of $55,003 in connection with our August 2003 financing.
See "Management's Discussion and Analysis - Liquidity and Capital Resources." We
are not obligated to use the services of ASA in connection with any financings.

ITEM 2. PROPERTIES

We own no real property. We lease approximately 7,100 square feet of office and
laboratory space in San Diego, California at a current rental rate of $18,000
per month. The lease expires September 30, 2005. This facility is adequate for
our current requirements.

ITEM 3. LEGAL PROCEEDINGS

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

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

None.

                                     PART II


ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

                               MARKET INFORMATION

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

                                       12
<PAGE>

                                                       Bid Quotations
                                                       --------------
                                                     High           Low
                                                     ----           ---
2002
           First Quarter                              6.20           0.70
           Second Quarter                             6.75           3.65
           Third Quarter                              4.15           1.80
           Fourth Quarter                             3.50           2.05

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


On March 16, 2004, there were approximately 130 stockholders of record of our
common stock. This number does not include beneficial owners of the common stock
whose shares are held in the names of various dealers, clearing agencies, banks,
brokers and other fiduciaries.

MicroIslet does not pay dividends.

                     RECENT SALES OF UNREGISTERED SECURITIES

Set forth below, is information regarding the issuance and sales of our
securities during the period covered by this report without registration under
the Securities Act of 1933, which have not previously been reported on Form
10-QSB.

During the quarter ended December 31, 2003, we sold an aggregate of 294,747
shares of common stock to Fusion Capital Fund II, LLC for gross proceeds of
approximately $180,000 during such quarter, pursuant to the terms of the common
stock purchase agreement dated April 1, 2003. The common stock purchase
agreement is described in more detail at "Management's Discussion and Analysis
-- Liquidity and Capital Resources" below.

We did not register under the Securities Act of 1933 the shares of common stock
sold to Fusion Capital under the common stock purchase agreement. We determined
that Fusion Capital is an accredited investor, and we relied on Rule 506 of
Regulation D under the Securities Act to sell shares to Fusion Capital pursuant
to its commitment to purchase shares under the common stock purchase agreement.
Fusion Capital has acknowledged to us the restricted nature of the securities
issued to it, and its obligations under the Securities Act with respect to the
resale of such securities. The shares are registered for resale on a
registration statement declared effective by the SEC on April 23, 2003.

In October and November 2003, we sold to certain accredited investors 2,402,200
shares of common stock at a purchase price of $0.50 per share. The purchasers
were also granted warrants to purchase an aggregate of 960,880 shares of common
stock at $1.00 per share until October 31, 2006. World Link Asset Management, a
placement agent, received a placement fee of $37,800 plus a warrant to purchase
64,800 shares of common stock at $1.00 per share in connection with the sale of
such securities. This warrant also expires on October 31, 2006. We determined
that all of the purchasers were accredited investors and relied on Regulation D,
Rule 506, in issuing such shares. The shares were issued with appropriate
restrictive legends, and were subsequently registered for resale on a
registration statement declared effective by the SEC on November 12, 2003.

In April 2003, we granted to a consultant an option to purchase 155,000 shares
of common stock at an exercise price of $0.30 per share. The option vests
monthly over two years from the grant date. This option was issued to in
reliance on Section 4(2) of the Securities Act of 1933, as amended. The option
recipient had access to the kind of information normally provided in a
prospectus.

In November 2003, we granted to each of our outside directors non-qualified,
fully-vested options to purchase 50,000 shares of common stock at an exercise
price of $0.80 per share. The options expire ten years after the date of grant.
As the options were granted to directors, we relied on Regulation D, Rule 506,
in issuing such options.

                                       13
<PAGE>

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

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

OVERVIEW

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

We have no products for sale and are focused on research and development
activities. We have had only limited revenues from grants, and we have had
significant losses since inception. We anticipate that we will incur substantial
additional operating losses in future years as we progress in our research and
development programs. At December 31, 2003, we had an accumulated deficit of
approximately $15.1 million. We do not expect to produce revenues from
operations for the foreseeable future, so our revenues will be limited to
research grants we are able to obtain.

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

Our business plan for the next twelve months is to demonstrate the efficacy of
our product candidate in animal models. It is necessary for us to establish
evidence of efficacy of our approach in order to advance to subsequent
milestones.

In March 2004, we sold to certain accredited investors 9,834,218 shares of
common stock at a purchase price of $1.30 per share. In connection with the
financing we also issued to the investors five-year warrants to purchase
4,917,116 shares at $1.00 per share. We have agreed to pay placement fees to
various placement agents in the aggregate amount of $704,760, and to issue
warrants to various placement agents to purchase an aggregate of 750,653 shares.
The placement agent warrants will have exercise prices of $1.30 per share and
terms ranging from two to five years.


                          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 judgement in making estimates and assumptions that affect the amounts
reported in the consolidated financial statements and disclosures made in the
accompanying notes. Those estimates and assumptions are based on historical
experience and various other factors deemed to be applicable and reasonable


                                       14
<PAGE>

under the circumstances. The use of judgement in determining such estimates and
assumptions is by nature, subject to a degree of uncertainty. Accordingly,
actual results could differ from the estimates made. Our significant accounting
policies include:

GRANT REVENUE

We recognize grant revenue as qualifying research expenses are incurred.

STOCK-BASED COMPENSATION

We have adopted the disclosure provisions of FASB Statement No. 123, "Accounting
for Stock-Based Compensation" ("FAS 123"). Under FAS 123, companies have the
option to measure compensation costs for stock options using the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). Under APB 25, compensation expense is
generally not recognized when both the exercise price is the same as the market
price and the number of shares to be issued is set on the date the employee
stock option is granted. Since our employee stock options are granted on this
basis and we have chosen to use the intrinsic value method, we do not recognize
compensation expense for stock option grants. We do, however, include in Note 2
pro forma disclosures of net income and earnings per share as if the fair value
method of accounting had been applied.

Deferred charges for options granted to non-employees are determined in
accordance with Statement of Financial Accounting Standards No. 123 and EITF
96-18 as the fair value of the consideration or the fair value of the equity
instruments issued, whichever is more reliably measured. Deferred charges for
options granted to non-employees are periodically remeasured as the underlying
options vest and are included as unearned stock compensation in the
stockholders' equity section of the balance sheet.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of FASB Statement No.
123." SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value-based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based compensation
and the effect of the method used on reported results. The voluntary transition
and amended disclosure requirements are effective for the Company for fiscal
years ending after December 15, 2002. The interim reporting requirements are
effective for our interim periods beginning January 1, 2003. We currently
account for stock-based employee compensation under the intrinsic value method
in accordance with APB No. 25. We do not plan to voluntarily change our method
of accounting, but had implemented the amended disclosure requirements as of
December 31, 2002. Refer to Note 2 to our pro forma financial results using the
fair value method of accounting for stock based compensation.

ALLOCATION OF COSTS

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

OFF-BALANCE SHEET ARRANGEMENTS

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

                              RESULTS OF OPERATIONS

Grant revenue for fiscal year 2003 and 2002 was $255,857 and $137,087,
respectively, consisting entirely of research grants. The increase reflected the
award of a new Phase I Small Business Innovation Research (SBIR) grant from the
National Institutes of Health (NIH), which began on June 1, 2003 and related
reimbursed research activities.

                                       15
<PAGE>

Total operating expenses were $3,138,071 in 2003 and $6,243,877 in 2002. The
decrease in expenses in 2003 was principally the result of warrant compensation
expense of $3,477,723 recognized in 2002, as discussed in Note 7 to our
consolidated financial statements for the fiscal year ended December 31, 2002.
General and administrative expenses decreased to $1,640,389 in 2003 from
$5,106,412 in 2002. The decrease was due primarily to the warrant compensation
expense and other expenses incurred in connection with our business combination
and related compliance costs during 2002. Research and development expenses
increased to $1,497,682 in 2003 from $1,137,465 in 2002, reflecting spending for
our research collaboration with TSRI and supplies and materials for work in our
own laboratories.

Interest income was $3,600 in 2003 and $19,432 in 2002. The fluctuations in
interest income are due primarily to corresponding changes in the levels of cash
and cash equivalents during the periods and decreasing yields from our
investments.

Our net loss was $3,039,817 or $0.12 per common share in 2003, and $6,106,135,
or $0.29 per common share in 2002. 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 since inception. At December 31, 2003, our federal tax net
operating loss and federal tax credit carryforwards were $9,140,000 and
$800,000, respectively, which will begin to expire in 2019, if not utilized. Our
ability to utilize our net operating loss and tax credit carryforwards may
become subject to limitation in the event of a change in ownership.

LIQUIDITY AND CAPITAL RESOURCES

We and MSLT Delaware financed our operations since inception primarily through
private sales of equity securities, which, from inception through December 31,
2003, have netted approximately $7.6 million, and to a lesser degree, through
grant funding and interest earned on cash and cash equivalents. In March 2004,
we completed a financing for approximately $12.0 million in net proceeds. We
have from time to time experienced significant strains on our cash reserves, and
during such times, we have curtailed non-essential operations and extended
payment terms with our trade creditors wherever possible.

Our combined cash and cash equivalents totaled $529,877 at December 31, 2003, a
decrease of $283,819 from December 31, 2002. The primary uses of cash and cash
equivalents for the year ended December 31, 2003 included $2.8 million to
finance our operations and working capital requirements, and approximately
$17,000 in capital equipment purchases.

Our future cash requirements will depend on many factors, including continued
scientific progress in our research and development programs, the scope and
results of pre-clinical and clinical trials, the time and costs involved in
obtaining regulatory approvals, the costs involved in filing, prosecuting and
enforcing patents, competing technological and market developments and the cost
of product commercialization. We do not expect to generate a positive cash flow
from operations at least until the commercial launch of our first product and
possibly later given the expected spending for research and development programs
and the cost of commercializing our product candidates. We intend to seek
additional funding through grants and through public or private financing
transactions. Successful future operations are subject to a number of technical
and business risks, including our continued ability to obtain future funding,
satisfactory product development, regulatory approvals and market acceptance for
our products. See "Business Risks" below.

FUSION CAPITAL

In April 2003, we entered into a common stock purchase agreement with Fusion
Capital Fund II, LLC, under which Fusion Capital agreed, subject to certain
conditions, to purchase, on each trading day during the term of the agreement,
$20,000 of our common stock up to an aggregate of $12.0 million. Fusion Capital


                                       16
<PAGE>

is committed to purchase the shares through October 2005, if not extended by us
for six additional months. We may decrease this amount or terminate the
agreement at any time. If our stock price equals or exceeds $3.00 per share for
five consecutive trading days, we have the right to increase the daily purchase
amount above $20,000, providing that the sale price of our common stock remains
at least $3.00. The sale price per share to Fusion Capital is equal to the
lesser of: the lowest sale price of our common stock on the day of purchase by
Fusion Capital, or the average of the lowest three closing sale prices of our
common stock during the ten trading days prior to the date of purchase by Fusion
Capital. Fusion Capital has agreed that neither it nor any of its affiliates
will engage in any direct or indirect short-selling or hedging of our common
stock during any time prior to the termination of the common stock purchase
agreement. We have agreed not to enter into any variable priced equity
financings during the term of the common stock purchase agreement without Fusion
Capital's consent. As compensation for its commitment and for expenses incurred,
we paid Fusion Capital $10,000 during the quarter ended March 31, 2003, and
issued to Fusion Capital in April 2003, 501,468 shares of common stock. Fusion
Capital has agreed not to sell 491,468 of such shares until the earlier of
October 2005, or the termination or a default under the common stock purchase
agreement. A registration statement registering the resale of 6,501,468 shares
by Fusion Capital was declared effective by the SEC on April 23, 2003.

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

As of March 16, 2004, we have issued an aggregate of 1,432,602 shares to Fusion
Capital and have received $1,059,995 in total proceeds under the common stock
purchase agreement. The Fusion Capital purchase commitment is currently on hold,
and we expect it to remain on hold while we have sufficient working capital on
hand to meet our operating needs.

OTHER FINANCINGS

In April 2003, we borrowed $300,000 from a trust affiliated with Mr. John J.
Hagenbuch for working capital needs. Mr. Hagenbuch is the brother-in-law of our
Chairman and Chief Executive Office, John F. Steel IV. The loan had an annual
interest rate of 4.25%, with principal and accrued interest originally due
August 9, 2003. As additional consideration for the loan, we issued to the
lender a ten-year warrant to purchase 50,000 shares of common stock at an
exercise price of $1.49 per share. The lender agreed to extend the maturity date
of the loan to December 7, 2003. As consideration for the loan extension, we
issued the lender a ten-year warrant exercisable for 50,000 shares of our common
stock at an exercise price of $0.50 per share.

In May 2003, we borrowed an additional $200,000 from the same trust. The loan
had an annual interest rate of 4.25%, with principal and accrued interest
originally due September 9, 2003. As additional consideration for the loan, we
issued to the lender a ten-year warrant to purchase 50,000 shares of common
stock at an exercise price of $0.85 per share. The lender agreed to extend the
maturity date of the loan to January 8, 2004. As consideration for the loan
extension, we issued the lender a ten-year warrant exercisable for 50,000 shares
of our common stock at an exercise price of $0.50 per share. The April 2003 and
May 2003 loan amounts have been applied to the purchase of common stock and
warrants as described below.

In June 2003, we received $250,000 from the Juvenile Diabetes Research
Foundation to fund our research and development program. In exchange for this
funding we issued 500,000 shares of common stock.

In September 2003, we sold to certain investors 1,000,600 shares of common stock
at a purchase price of $0.50 per share. The gross proceeds received from these
financings were $500,300. We paid a placement fee of 11% of the gross proceeds
to ASA Investments, Inc.

                                       17
<PAGE>

In October and November 2003, we sold to certain investors 2,402,200 shares of
common stock at a purchase price of $0.50 per share. These investors were also
granted warrants to purchase an aggregate of 960,880 shares of our common stock
at $1.00 per share until October 31, 2006. Included in these amounts are
1,022,200 shares and a warrant to purchase 408,880 shares issued to a trust
affiliated with Mr. Hagenbuch in exchange for the cancellation of the loans
described above. At that time, the two loans had a combined principal and
interest balance of $511,100. We paid a placement fee of $37,800 plus a
three-year warrant to purchase 64,800 shares of common stock at $1.00 per share
in connection with the sale of shares to certain of the investors. This warrant
also expires on October 31, 2006.

In March 2004, we sold to certain accredited investors 9,834,218 shares of
common stock at a purchase price of $1.30 per share. In connection with the
financing we also issued to the investors five-year warrants to purchase
4,917,116 shares at $1.00 per share. We have agreed to pay placement fees to
various placement agents in the aggregate amount of $705,000, and to issue
warrants to various placement agents to purchase an aggregate of 719,891 shares.
The placement agent warrants will have exercise prices of $1.30 per share and
terms ranging from two to five years.

We have agreed to prepare and file on or before May 28, 2004, a registration
statement covering the resale of the shares and the shares issuable upon
exercise of the warrants, and to use our commercially reasonable efforts to have
such registration statement declared effective by the SEC no later than August
30, 2004. In the event we do not file the registration statement before May 28,
2004, or in the event the registration statement is not declared effective
before August 30, 2004, we are required to issue additional shares to each
investor equal to 2% of the number of shares purchased for each month that our
obligation is unsatisfied.

In the event we sell securities at a price lower than $1.30 per share before the
effectiveness of the registration statement registering for resale the shares
issued in the financing and upon exercise of the warrants, the number of shares
issued to each investor will be increased to effectively reprice the shares to
such lower price. We have no plans to issue securities prior to the
effectiveness of the registration statement in a manner that would trigger these
share issuance provisions.

Following completion of this financing, we received a demand from a purported
investor claiming that we had breached an agreement to sell $750,000 of
securities to the purported investor. The purported investor seeks unspecified
damages and specific performance of the terms of the purported investment
agreement. We do not believe we have any obligation to the purported investor.

We expect that our available cash and expected grant and interest income will be
sufficient to finance currently planned activities into the fourth quarter of
2005.

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

                                       18
<PAGE>

PLAN OF OPERATION

We have budgeted our total costs for our operations for the next twelve months
at $5.1 million. We believe however that the costs of remaining pre-clinical
studies and the preparation for human clinical trials could range from $10 to
$15 million as further explained in the Milestone table below. The actual amount
of funds required within the next twelve months, and the amount required to
complete initial pre-clinical studies, will depend on a variety of factors, many
of which are outside of our control. These factors include, among others, the
results of initial and follow-up studies and unforeseen changes in
biopharmaceutical regulations.

The $5.1 million we have budgeted for the next twelve months is divided into the
following categories:

Category                                                          Estimated Cost
--------                                                          --------------
Personnel............................................................$1,737,000
Sponsored research.....................................................$680,000
Outside consultants and services.......................................$438,000
Supplies and materials...............................................$1,012,000
Travel & entertainment.................................................$123,000
Facilities.............................................................$421,000
General & administrative...............................................$732,000
Total................................................................$5,143,000

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

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

The transplantation surgery and subsequent monitoring is expected to take place
at one or more academic institutions with which we have relationships through
our Scientific Advisory Board. Together with these collaborators, we will obtain
data relating to the level of insulin delivery, blood glucose control, the
immune reaction of the animals to both the microencapsulated islets and the
capsule itself, and any side effects associated with the transplantation. We
will also develop information on dose and duration of implanted cells in
relevant diabetes models, as well as the longevity and ultimate fate of the
capsule in vivo. Through these activities, we are planning to establish the
feasibility of the concepts behind our product candidate in animals. The
following are the milestones associated with our initial feasibility studies,
and the estimated time of completion and estimated cost of each:

<TABLE>
<CAPTION>

                                                                 ESTIMATED TIME OF               ESTIMATED COST OF
MILESTONE                                                       MILESTONE COMPLETION          ACHIEVING EACH MILESTONE
                                                                --------------------          ------------------------
<S>                                                               <C>                            <C>
Ongoing optimization of viability and functionality of            4th Quarter 2004               $1 to $1.4 million
encapsulated islets in vitro and in small animals
Testing viability and functionality of encapsulated islets        1st Quarter 2005                $3 to $4 million
in vitro and in non-human primates
</TABLE>

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

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

                                       19
<PAGE>

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

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

<S>                                                         <C>                       <C>
COMPLETE FORMAL ANIMAL STUDIES IN ANTICIPATION OF           2nd Half of 2005          $6-10 Million
FILING INVESTIGATIONAL NEW DRUG APPLICATION WITH THE
FOOD AND DRUG ADMINISTRATION. Once we have
established the "proof of concept" behind our product
candidates, we plan to initiate formal studies to
demonstrate safety and efficacy in support of human
clinical trials. These studies will involve both
small and large mammals under controlled conditions
and will likely be performed in our academic
collaborators' and outside contract facilities. These
studies will depend on our ability to identify one or
more sources that will supply to us or our
collaborators a requisite amount of ultra-pure
alginate for the capsules and porcine islets. We
intend to engage in ongoing discussions with the FDA
during these evaluations. Once we are comfortable
with the safety and efficacy results of these studies
we plan to file the investigational new drug
application with the FDA.


INITIATE ALLOTRANSPLANTATION HUMAN CLINICAL STUDIES.        2nd Half of 2005          $2-3 Million
These studies involve the transplantation of human
islet cells using our encapsulation processes from
one human to another. We hope these studies will
validate our microencapsulation technology's ability
to provide effective immunoisolation in humans prior
to clinical trials.


INITIATE PHASE I HUMAN CLINICAL TRIALS. Once the                  2006                   Unknown
formal controlled animal studies have been completed,
we plan to file the investigational new drug
application. If the application is approved, we hope
to begin clinical trials in humans with Type 1
diabetes shortly thereafter. Clinical trials of
pharmaceuticals or biologics typically involve three
phases. The first of these phases involves an
evaluation of the safety of the experimental product
in humans, and if possible, an evaluation of the
early indications of its effectiveness.


INITIATE PHASE II HUMAN CLINICAL TRIALS. The second               2007                   Unknown
phase involves further safety testing, and an
evaluation of efficacy, dose schedules and routes of
administration in a larger human population. This
phase sometimes overlaps with the Phase I study.


INITIATE PHASE III HUMAN CLINICAL TRIALS. These                   2009                   Unknown
studies are usually randomized, double-blind studies
testing product safety and effectiveness in an
expanded patient population in order to evaluate the
overall risk/benefit relationship of the product and
to provide an adequate basis for product labeling.
Because of the scope and the number of patients
involved, significant capital is required for these
trials.

                                       20
<PAGE>

COMPLETE HUMAN CLINICAL TRIALS AND SUBMIT OUR PRODUCT         2010 or later               Unknown
TO THE FDA FOR APPROVAL. Once the clinical
investigations are complete, we intend to submit an
application to the FDA including all of our clinical
and preclinical data.

BEGIN TO MANUFACTURE, MARKET AND SELL OUR PRODUCT             2010 or later               Unknown
</TABLE>

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

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

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

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

NEW ACCOUNTING PRONOUNCEMENTS

A number of new pronouncements have been issued for future implementation as
discussed in the footnotes to our audited financial statements (see Note 2). As
discussed in the notes to the audited financial statements, the implementation
of these new pronouncements is not expected to have a material effect on our
financial statements.

                                 BUSINESS RISKS

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

WE HAVE A HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT, AND WE MAY NOT
ACHIEVE OR MAINTAIN PROFITABILITY IN THE FUTURE.

We have experienced significant operating losses in each period since our
inception. As of December 31, 2003, we have incurred total losses of $15.1
million. We expect these losses to continue and it is uncertain when, if ever,
we will become profitable. These losses have resulted principally from costs
incurred in research and development and from general and administrative costs
associated with operations. We expect to incur increasing operating losses in
the future as a result of expenses associated with research and product
development as well as general and administrative costs. Even if we do achieve
profitability, we may not be able to sustain or increase profitability on a
quarterly or annual basis.

                                       21
<PAGE>

WE WILL NEED ADDITIONAL CAPITAL IN THE FUTURE TO SUPPORT OUR GROWTH, AND RAISING
SUCH CAPITAL WILL LIKELY CAUSE SUBSTANTIAL DILUTION TO EXISTING STOCKHOLDERS. IF
ADDITIONAL CAPITAL IS NOT AVAILABLE, WE MAY HAVE TO CURTAIL OR CEASE OPERATIONS.

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

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

         o        our progress with research and development;

         o        the costs and timing of obtaining new patent rights;

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

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

Fusion Capital Fund II, LLC has agreed to provide us up to $12 million under a
common stock purchase agreement, of which $10.4 million remains available. See
"Management's Discussion and Analysis--Liquidation and Capital Resources--Fusion
Capital". However, the extent we rely on Fusion Capital as a source of funding
will depend on a number of factors including, the prevailing market price of our
common stock and the factors listed above. For example, our continued access to
financing under our common stock purchase agreement with Fusion Capital requires
the market price of our common stock to remain above $0.50 per share and a
registration statement for the shares to be purchased by Fusion Capital to
remain effective. If investment from Fusion Capital is unavailable or
prohibitively expensive, we will need to secure another source of funding, in
order to satisfy our working capital needs.

When we require additional funds, which may be above and beyond the remaining
$10.4 million that we may raise from Fusion Capital, general market conditions
or the then-current market price of our common stock may not support capital
raising transactions such as an additional public or private offerings of our
common stock. If we require additional funds and we are unable to obtain them on
a timely basis or on terms favorable to us, we may be required to scale back our
development of new products, sell or license some or all of our technology or
assets or curtail or cease operations.

If we raise additional funds by selling additional shares of our capital stock,
the ownership interest of our stockholders will be diluted. In order to provide
flexibility for our capital raising efforts, our board of directors has approved
an amendment to our articles of incorporation to increase our authorized common
shares from 50 million to 100 million, subject to the approval of our
stockholders at the annual meeting scheduled for May 25, 2004.

WE MAY NOT BE ABLE TO OBTAIN THE FULL $12.0 MILLION GROSS PROCEEDS UNDER OUR
COMMON STOCK PURCHASE AGREEMENT WITH FUSION CAPITAL.

We only have the right to receive $20,000 per trading day under the agreement
with Fusion Capital unless our stock price equals or exceeds $3.00, in which
case the daily amount may be increased under certain conditions as the price of
our common stock increases. Fusion Capital will not have the right or the
obligation to purchase any shares of our common stock on any trading days that
the purchase price of our common stock under the purchase agreement would be
less than $0.50. We registered 6,000,000 purchase shares for sale by Fusion
Capital, 4,467,400 of which have not yet been issued. The selling price of our


                                       22
<PAGE>

common stock to Fusion Capital will have to average at least $2.33 per share,
and our stockholders will have to approve an increase in our authorized shares,
for us to receive the maximum proceeds of $12.0 million from sale of such
remaining registered shares.

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

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

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

We are a relatively new company and our technologies are still in the early
stages of development. We are currently working to develop our first product,
MicroIslet-P(TM). This product may not be successfully developed or
commercialized on a timely basis, or at all. If we are unable, for technological
or other reasons, to complete the development, introduction or scale-up of
manufacturing of this product or other potential products, or if our products do
not achieve a significant level of market acceptance, we would be forced to
curtail or cease operations. Even if we develop our products for commercial use
and obtain all necessary regulatory approval, we may not be able to develop
products that:

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

         o        are safe and effective;

         o        are protected from competition by others;

         o        do not infringe the intellectual property rights of others;

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

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

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

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

                                       23
<PAGE>

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

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

Collaborative agreements generally pose the following risks:

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

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

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

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

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

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

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

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

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

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

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

The FDA must approve any biological product before it can be marketed in the
United States. Biological products must also be approved by the regulatory
agencies of foreign governments before the product can be sold outside the U.S.
Before an investigational new drug application (IND) can be filed with the FDA,


                                       24
<PAGE>

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

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

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

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

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

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

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

                                       25
<PAGE>

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

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

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

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

         o        biotechnology, pharmaceutical, chemical and other companies;

         o        academic and scientific institutions;

         o        governmental agencies; and

         o        public and private research organizations.

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

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

Our success will depend on our ability to obtain and protect patents on our
technology and to protect our trade secrets. The patents we currently license,
and any future patents we may obtain or license, may not afford meaningful
protection for our technology and products. Others may challenge our patents
and, as a result, our patents could be narrowed, invalidated or unenforceable.
In addition, our current and future patent applications may not result in the
issuance of patents in the United States or foreign countries. Competitors may
develop products similar to ours that do conflict with 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


                                       26
<PAGE>

factual questions, and has recently been the subject of much litigation. No
consistent policy has emerged from the U.S. Patent and Trademark Office or the
courts regarding the breadth of claims allowed or the degree of protection
afforded under biotechnology patents. In addition, there is a substantial
backlog of biotechnology patent applications at the U.S. Patent and Trademark
Office, and the approval or rejection of patent applications may take several
years.

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

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

We may be sued for infringing on the patent rights or misappropriating the
proprietary rights of others. Intellectual property litigation is costly, and,
even if we prevail, the cost of such litigation could adversely affect our
business, financial condition and results of operations. In addition, litigation
is time consuming and could divert management attention and resources away from
our business. If we do not prevail in any litigation, we could be required to
stop the infringing activity and/or pay substantial damages. Under some
circumstances in the United States, these damages could be triple the actual
damages the patent holder incurs. If we have supplied infringing products to
third parties for marketing or licensed third parties to manufacture, use or
market infringing products, we may be obligated to indemnify these third parties
for any damages they may be required to pay to the patent holder and for any
losses the third parties may sustain themselves as the result of lost sales or
damages paid to the patent holder.

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

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

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

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

To date, we have not produced any product. Customers for any potential products
and regulatory agencies will require that we comply with current good
manufacturing practices that we may not be able to meet. We may not be able to
maintain acceptable quality standards if we ramp up production. To achieve
anticipated customer demand levels, we will need to scale-up our production
capability and maintain adequate levels of inventory. We may not be able to
produce sufficient quantities to meet market demand. If we cannot achieve the
required level and quality of production, we may need to outsource production or
rely on licensing and other arrangements with third parties. This reliance could
reduce our gross margins and expose us to the risks inherent in relying on
others. We may not be able to successfully outsource our production or enter
into licensing or other arrangements under acceptable terms with these third
parties, which could adversely affect our business.

                                       27
<PAGE>

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

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

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

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

If we are able to launch commercially our products, we will face exposure to
product liability claims. We intend to secure limited product liability
insurance coverage, but may not be able to obtain such insurance on acceptable
terms with adequate coverage, or at reasonable costs. There is also a risk that
third parties for which we have agreed to indemnify could incur liability.

Since we will conduct clinical trials on humans, we face the risk that the use
of our products will result in adverse effects. These risks will exist even for
products developed that may be cleared for commercial sale. We cannot predict
all of the possible harms or side effects that may result and, therefore, the
amount of insurance coverage we obtain may not be adequate to protect us from
all liabilities. We may not have sufficient resources to pay for any liabilities
resulting from a claim beyond the limit of, or excluded from, our insurance
coverage.

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

Our research and development processes involve the controlled storage, use and
disposal of hazardous materials including biological hazardous materials. We are
subject to federal, state and local regulations governing the use, manufacture,
storage, handling and disposal of materials and waste products. Although we
believe that our safety procedures for handling and disposing of these hazardous
materials comply with the standards prescribed by law and regulation, the risk
of accidental contamination or injury from hazardous materials cannot be
completely eliminated. In the event of an accident, we could be held liable for
any damages that result, and any liability could exceed the limits or fall
outside the coverage of our insurance. We may not be able to maintain insurance
on acceptable terms, or at all. We could be required to incur significant costs
to comply with current or future environmental laws and regulations.

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

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

As of December 31, 2003, we have on file with the SEC effective registration
statements for a total of 6,501,468 shares for resale by Fusion Capital, and a
total of 4,461,814 shares for resale by other investors and investment-related
service providers. The selling stockholders under our registration statements
will be permitted to sell their registered shares in the open market from time
to time without advanced notice to us or to the market and without limitations
on volume. We have also agreed to register 9,834,218 shares and 4,917,116 shares


                                       28
<PAGE>

underlying warrants on or before May 28, 2004 in connection with recently
completed financing transactions, and we have other registration obligations
that have not yet vested.

In addition, approximately 17.9 million shares of common stock issued to
stockholders of MicroIslet of Delaware in our business combination are available
for resale under Rule 144, subject to notice, volume and manner of sale
restrictions under that rule. Beginning April 24, 2004, to the extent these
shares are held by persons who were not affiliates during the three months prior
to sale, these shares will be available for resale without notice, volume or
manner of sale restrictions.

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

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

The trading volume of our stock on the OTC Bulletin Board has been low, which
can cause the trading price of our stock to change substantially in response to
relatively small orders. During the quarter ended December 31, 2003, the average
daily trading volume of our stock was approximately 38,400 shares and the shares
traded as low as $0.45 and as high as $0.89 per share. Both volume and price
could also be subject to wide fluctuations in response to various factors, many
of which are beyond our control, including:

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

         o        announcements of technological innovations by us or our
                  competitors;

         o        developments or disputes concerning patent or proprietary
                  rights; and

         o        general market perception of biotechnology and pharmaceutical
                  companies.

BECAUSE OUR STOCK CURRENTLY TRADES BELOW $5.00 PER SHARE, AND IS QUOTED ON THE
OTC BULLETIN BOARD, OUR STOCK IS CONSIDERED BY THE SEC A "PENNY STOCK," WHICH
CAN ADVERSELY AFFECT ITS LIQUIDITY.

Our common stock does not currently qualify for listing on the Nasdaq Stock
Market. If our common stock continues to be quoted on the OTC Bulletin Board,
and if the trading price of our common stock remains less than $5.00 per share,
our common stock is considered a "penny stock," and trading in our common stock
is subject to the requirements of Rule 15g-9 under the Securities Exchange Act
of 1934. Under this rule, brokers or dealers who recommend low-priced securities
to persons other than established customers and accredited investors must
satisfy special sales practice requirements. The broker or dealer must make an
individualized written suitability determination for the purchaser and receive
the purchaser's written consent prior to the transaction.

SEC regulations also require additional disclosure in connection with any trades
involving a penny stock, including the delivery, prior to any penny stock
transaction, of a disclosure schedule explaining the penny stock market and its
associated risks. These requirements could severely limit the liquidity of such
securities in the secondary market because few brokers or dealers are likely to
undertake these compliance activities. In addition to the applicability of the
penny stock rules, another risk associated with trading in penny stocks may be
high price fluctuations.

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


                                       29
<PAGE>

10,059,218 shares outstanding that have exercise prices at or below the recent
market price of our stock of $2.83 per share. We have options and warrants for
2,012,894 shares outstanding at prices above the current $2.83 market price, and
if the current market price increases, these options and warrants could have a
dilutive effect on stockholders if exercised. Future options issued under our
stock option plan may have further dilutive effects.

IF PROPOSED ACCOUNTING REGULATIONS THAT REQUIRE COMPANIES TO EXPENSE STOCK
OPTIONS ARE ADOPTED, OUR LOSSES MAY INCREASE AND OUR STOCK PRICE MAY DECLINE.

A number of publicly-traded companies have recently announced that they will
begin expensing stock option grants to employees. In addition, the Financial
Accounting Standards Board (FASB) has indicated that possible rule changes
requiring expensing of stock options may be adopted in the near future.
Currently, we include such expenses on a pro forma basis in the notes to our
annual financial statements in accordance with accounting principles generally
accepted in the United States, but do not include stock option expense for
employee options in our reported financial statements. If accounting standards
are changed to require us to expense stock options, our reported losses may
increase significantly and our stock price could decline.

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

As of March 16, 2004, our executive officers, directors and their affiliates
beneficially own or control approximately 28.5% of the outstanding shares of our
common stock (after giving effect to the exercise of all options held by them
which are exercisable on or before May 16, 2004). Accordingly, our current
executive officers, directors and their affiliates will have substantial control
over the outcome of corporate actions requiring stockholder approval, including
the election of directors, any merger, consolidation or sale of all or
substantially all of our assets or any other significant corporate transactions.
These stockholders may also delay or prevent a change of control of us, even if
such a change of control would benefit our other stockholders. The significant
concentration of stock ownership may adversely affect the trading price of our
common stock due to investors' perception that conflicts of interest may exist
or arise.

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

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

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

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

ITEM 7. FINANCIAL STATEMENTS

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

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

Not applicable.

ITEM 8A. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures designed to ensure that material
information related to our company is recorded, processed, summarized and
reported within the time periods specified in the SEC rules and forms.

                                       30
<PAGE>

(a) As of the end of the period covered by this report, we carried out an
evaluation under the supervision and with the participation of management,
including our Principal Executive Officer and Principal Financial Officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934). Based upon that evaluation, our Principal Executive
Officer and Principal Financial Officer concluded, as of the date of such
evaluation, that the design and operation of such disclosure controls and
procedures were effective.

(b) No significant changes were made in our internal controls over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act)
during our most recent fiscal quarter.

Limitations. Our management, including our Principal Executive Officer and
Principal Financial Officer, does not expect that our disclosure controls or
internal controls over financial reporting will prevent all errors or all
instances of fraud. A control system, no matter how well designed and operated,
can provide only reasonable, not absolute, assurance that the control system's
objectives will be met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within our company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and any design may not
succeed in achieving its stated goals under all potential future conditions.
Over time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or procedures. Because
of the inherent limitation of a cost-effective control system, misstatements due
to error or fraud may occur and not be detected.

                                    PART III

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

DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

The following table sets forth the names and ages as of December 31, 2003, and
business experience of the directors, executive officers and certain other
significant employees of our company. Our directors hold their offices for a
term of one year or until their successors are elected and qualified. Our
officers serve at the discretion of the Board of Directors. Each officer devotes
all of his or her working time to our business.

<TABLE>
<CAPTION>

NAME                                        AGE               POSITION HELD AND TENURE
----                                        ---               ------------------------
<S>                                         <C>               <C>
John F. Steel IV                            45                Chairman, Chief Executive Officer and Director

Hartoun Hartounian, Ph.D.                   44                President, Chief Operating Officer and Director

William G. Kachioff                         38                Vice President, Finance and Chief Financial Officer

                                       31
<PAGE>

Robert W. Anderson, M.D.*                   66                Director

Steven T. Frankel *                         60                Director

James R. Gavin III, M.D., Ph.D.*            58                Director

* Member of the Audit and Compensation Committees

SIGNIFICANT EMPLOYEES

Ingrid Stuiver, Ph.D                        42                Director of Research

Dagmar Meissner                             38                Director of Process Research and Development

Mayank Patel                                34                Director of Engineering and Manufacturing
</TABLE>


JOHN F. STEEL IV, CHAIRMAN AND CHIEF EXECUTIVE OFFICER. Mr. Steel joined us in
April 2002 as Chairman of the Board of Directors and Chief Executive Officer. In
January 1998, Mr. Steel founded MSLT Delaware and has served as its Chairman and
Chief Executive Officer from September 1998 to April 2002. Mr. Steel also served
as a director of DiaSense, Inc. from January 4, 2001 to April 2, 2002. From
January 1996 to December 1997, Mr. Steel was a founder, Chief Executive Officer
and a director of AKESIS Pharmaceuticals, Inc., a company that developed a
patented treatment for insulin resistance for Type II diabetes. From January
1987 to June 1990, Mr. Steel served as the Vice President of Defined Benefit
Inc., a company he founded in 1986 that provided financial services to health
care professionals. From 1989 to 1994, Mr. Steel consulted to several public and
private companies on business issues related to distribution of goods, services,
and finances through Steel Management. Mr. Steel received his MBA degree with an
emphasis in finance from the University of Southern California and a Bachelor of
Arts degree from Dartmouth College.

HARTOUN HARTOUNIAN, PH.D., PRESIDENT AND CHIEF OPERATING OFFICER. Dr. Hartounian
joined us in April 2002 and had served as President and Chief Operating Officer
of MSLT Delaware from August 2000 to April 2002. Before joining MSLT Delaware,
Dr. Hartounian served from July 1998 to August 2000 as the Head of the Process
Development at Kelco BioPolymers, one of the world's largest producers of
biopolymers and a unit of Pharmacia. From April 1994 to June 1998, Dr.
Hartounian served as the Associate Director of Process Development at SkyePharma
PLC (formerly known as Depotech), where he was responsible for all aspects of
process development, scale up and technology transfer and was the key
contributor in the commercialization of SkyePharma's first product. Dr.
Hartounian received his Ph.D. in Chemical Engineering from the University of
Delaware in 1992.

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

                                       32
<PAGE>

ROBERT W. ANDERSON, M.D. Dr. Anderson has been a director of our company since
April 2002 and was a director of MSLT Delaware from March 2001 to April 2002.
From June 1994 to the present, Dr. Anderson has served as the David C. Sabiston,
Jr., Distinguished Professor and Chairman Emeritus of the Department of Surgery
at Duke University Medical Center in Durham, North Carolina. He received an MBA
degree from the Kellogg School of Management at Northwestern in 1994 and was
appointed as the Chairman of the Department of Surgery at Duke in the same year.
Dr. Anderson received his B.S. degree in Engineering from Duke University and
was awarded the M.D. degree from Northwestern University in 1964.

STEVEN T. FRANKEL. Mr. Frankel was elected as director of MicroIslet in May
2002. Mr. Frankel is a Principal with the Frankel Merchant Group and President
of ACON Laboratories, Inc., a developer and manufacturer of rapid diagnostic
tests and advisor to Genetic Diagnostics Inc., a start-up with proprietary DNA
hybridization and analysis technology. He is also Chief Executive Officer of
Zybernetix, Inc., a start-up neuro-technology company focusing on commercial
applications of brain computer interfaces. From April 1998 to February 2004, he
was the Chief Executive Officer and President of A-Fem Medical Corporation
(NASDAQ:AFEM.OB), a developer of women's healthcare products. From May 1992 to
March 1998, he was the Chief Executive Officer and President of Quidel
Corporation (NASDAQ:QDEL), a manufacturer of physicians' office diagnostic test
kits. From October 1979 to May 1992, Mr. Frankel was President of various
domestic and international divisions of Becton, Dickinson and Company
(NYSE:BDX). Mr. Frankel attended the Executive Program at Stanford University in
1989 and received his BA in Philosophy from Clark University in 1964. He is also
a board member of ProSpine, Inc., a start-up medical device company with a focus
on spinal surgery.

JAMES R. GAVIN III, M.D., PH.D. Dr. Gavin has been a director of our company
since April 2002 and was a director of MSLT Delaware from March 2001 to April
2002. Since July 2002, he has been the President of Atlanta Morehouse School of
Medicine. Dr. Gavin has been a member of the Board of Directors of Baxter
International Inc., and Anastasia Marie Laboratories, Inc. since February 2003
and 1998, respectively. Dr. Gavin was Chairman of the Board of Directors of
Equidyne Corporation from August 2001 to 2003. He was also a member of the Board
of Directors of Taste for Living, Inc. from 1999 to 2002. From July 1991 to June
2002, Dr. Gavin was the Senior Scientific Officer of the Howard Hughes Medical
Institute in Chevy Chase, Maryland. He completed his B.S. in Chemistry at
Livingstone College, a Ph.D. in Biochemistry at Emory University and his M.D. at
Duke University Medical School. Dr. Gavin has received numerous civic and
academic awards and honors.

INGRID STUIVER, PH.D., DIRECTOR OF RESEARCH. Dr. Stuiver joined us in April 2002
and was the Director of Research at MSLT Delaware from March 2001 to April 2002.
Before joining MSLT Delaware, Dr. Stuiver was the Assistant Director of Clinical
Research and Research Scientist at Maxia Pharmaceuticals from June 1998 to March
2001. From December 1993 to January 1998, Dr. Stuiver was a Sr. Research
Associate/Postdoctoral Fellow at The Scripps Research Institute and studied
adhesion receptors in cancer, hemostasis, thrombosis and the CNS. Dr. Stuiver
received her Ph.D. in Molecular and Cellular Biology from the University of
Arizona in 1992 and her B.A. in Biochemistry and Cell Biology from the
University of California, San Diego in 1985.

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

MAYANK PATEL, DIRECTOR OF ENGINEERING AND MANUFACTURING. Mr. Patel joined us in
April 2002 and was the Director of Engineering and Manufacturing at MSLT
Delaware from December 2000 to April 2002. From December 1998 to December 2000,
he was a senior process engineer at Sequenom Inc., where he was responsible for
consumable product design, product validation, and development of manufacturing
equipment for silicon-based DNA chips. Prior to that, he worked at SkyePharma


                                       33
<PAGE>

PLC (formerly DepoTech) from May 1995 to January 1999 where he was a senior
engineer, responsible for the design and commissioning of an FDA approved
pharmaceutical production system. From April 1993 to May 1995, he was the
Manufacturing Associate at Regeneron Pharmaceuticals, where he performed
large-scale development and GMP production of clinical protein products. Mr.
Patel received his MBA in Operations Management and his B.S. in Chemical
Engineering from Rutgers University.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

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

         Based solely on a review of copies of such reports furnished to us and
written representations that no other reports were required during the fiscal
year ended December 31, 2003, we believe that all persons subject to the
reporting requirements of Section 16(a) filed the required reports on a timely
basis with the SEC, except as follows:

         John J. Hagenbuch, an individual having beneficial ownership of greater
than 10% of our stock as of December 31, 2003, failed to timely file a Form 3
disclosing his holdings as of the date he became a 10% beneficial owner. The
information required on Form 3 is intended to be filed promptly on Form 5. James
R. Gavin III, Robert W. Anderson and Steven T. Frankel, each a director, each
failed to timely file a Form 4 during the year ended December 31, 2003,
disclosing one transaction, an option grant. Each of these transactions were
subsequently reported on Form 5.

CODE OF ETHICS

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

AUDIT COMMITTEE FINANCIAL EXPERT

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

ITEM 10. EXECUTIVE COMPENSATION

COMPENSATION OF DIRECTORS

         During the fiscal year ended December 31, 2003, as compensation for
services provided as our directors, we paid $10,500 to James R. Gavin III, M.D.,
Ph.D., $10,500 to Robert W. Anderson, M.D. and $10,500 to Steven T. Frankel.

                                       34
<PAGE>

         In November 2003, each of our outside directors received non-qualified,
fully-vested options to purchase 50,000 shares of common stock at an exercise
price of $0.80 per share. The options expire ten years after the date of grant.

COMPENSATION OF EXECUTIVE OFFICERS

The following table sets forth the annual and long-term compensation paid by our
company or MSLT Delaware for services performed on our company's or MSLT
Delaware's behalf for the three fiscal years ended December 31, 2003, with
respect to those persons who served as the Chief Executive Officer during the
year ended December 31, 2003, and those executive officers who received more
than $100,000 in compensation for fiscal 2003.

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

                                                                                               Long-Term
                                                              Annual Compensation             Compensation
                                                              -------------------             ------------
                                                                                               Securities
Name and Principal Position                   Year         Salary              Bonus        Underlying Options
---------------------------                   ----         ------              -----        ------------------
<S>                                           <C>          <C>                 <C>                 <C>
John F. Steel IV, Chairman and Chief          2003         $168,000            $2,000                  -0-
    Executive Officer (2)                     2002         $179,500               -0-                  -0-
                                              2001         $130,000               -0-                  -0-

Hartoun Hartounian, Ph.D., President          2003         $234,230            $2,000              150,000
    and Chief Operating Officer (3)           2002         $185,620               -0-               62,510
                                              2001         $167,000               -0-                  -0-

William G. Kachioff, Vice President,          2003         $150,000            $2,000              150,000
    Finance and Chief Financial Officer (4)   2002         $122,322            $5,000              262,500
</TABLE>

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

(2) Mr. Steel and Dr. Hartounian joined us in April 2002 with the completion of
the acquisition of MSLT Delaware. Compensation in 2002 includes compensation
paid by us after the acquisition and compensation paid by MSLT Delaware prior to
the acquisition. Compensation in 2001 reflects compensation paid by MSLT
Delaware.

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

<TABLE>
<CAPTION>

OPTION GRANTS IN LAST FISCAL YEAR

                                    Number of           Percent of Total
                                   Securities          Options Granted to
                                   Underlying             Employees in         Exercise or Base
       Name                          Options               Fiscal Year           Price ($/Sh)        Expiration Date
       ----                          -------               -----------           ------------        ---------------
<S>                                  <C>                      <C>                    <C>               <C>
Hartoun Hartounian                   150,000(1)               16.0%                  $0.45             July 16, 2013
William G. Kachioff                  150,000(2)               16.0%                  $0.55             June 10, 2013

</TABLE>

(1) These options were granted under the 2000 Stock Option Plan. These options
were 100% vested at the time of grant. All of the shares underlying these
options are subject to a nonqualified stock option.

(2) These options were granted under the 2000 Stock Option Plan. These options
were 100% vested at the time of grant. All of the shares underlying these
options are subject to a nonqualified stock option.

                                       35
<PAGE>

FISCAL YEAR END OPTION VALUES

The following table sets forth, as to the named officers, certain information
concerning the number and value of unexercised options held by each of the named
officers at December 31, 2003. There were no option exercises by the named
executive officers during 2003.

<TABLE>
<CAPTION>
                                            Number of Options                 Value of Unexercised In-the-Money
                                         Unexercised at Year End                   Options at Year End (1)
                                         -----------------------                   -----------------------
        Name                          Exercisable      Unexercisable          Exercisable       Unexercisable
        ----                          -----------      -------------          -----------       -------------
<S>                                    <C>                 <C>                  <C>                   <C>
Hartoun Hartounian, Ph.D.              1,462,710              -0-               $550,082              $-0-
William G. Kachioff                      350,000           47,500                 22,500               -0-
</TABLE>

(1) Based on fair market value of the common stock at fiscal year end, which was
$0.70 per share less the exercise price of the options.

EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS

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

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


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

EQUITY COMPENSATION PLAN INFORMATION

The following table gives information as of December 31, 2003:

                                       36
<PAGE>

<TABLE>
<CAPTION>
                                                                                               NUMBER OF SECURITIES
                                                                                             REMAINING AVAILABLE FOR
                                                                                              FUTURE ISSUANCE UNDER
                                          NUMBER OF SECURITIES TO       WEIGHTED-AVERAGE       EQUITY COMPENSATION
                                          BE ISSUED UPON EXERCISE      EXERCISE PRICE OF         PLANS (EXCLUDING
                                          OF OUTSTANDING OPTIONS,     OUTSTANDING OPTIONS,   SECURITIES REFLECTED IN
             PLAN CATEGORY                  WARRANTS AND RIGHTS       WARRANTS AND RIGHTS          COLUMN (a))
             -------------                  -------------------       -------------------          -----------
                                                     (a)                        (b)                    (c)
<S>                                            <C>                           <C>                        <C>
Equity compensation plans approved by
security holders (1)                           3,858,667  (2)                $0.91                      111,333

Equity compensation plans not approved
by security holders                            2,135,449  (3)                $5.80                          --

Total                                          5,994,116                     $2.65                      111,333
</TABLE>


(1) Our board of directors adopted the MSLT Delaware 2000 Stock Option Plan on
May 9, 2002 and our shareholders approved it on May 28, 2002. All options
granted by MSLT Delaware prior to our acquisition of MSLT Delaware were assumed
by us, and those options became exercisable for shares of our common stock. In
January 2004, our board amended the 2000 Stock Option Plan to increase the
number of shares reserved under the plan from 4,000,000 to 6,000,000, and to
implement per person annual grant maximums, subject to stockholder approval of
the plan amendments and an amendment to our articles of incorporation to
increase authorized shares of common stock.

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

(3) Consists of individual stock options and warrant grants to employees,
directors, consultants and advisors. Options representing 50,000 shares of
common stock were granted outside of the 2000 Stock Option Plan each to Robert
W. Anderson, James R. Gavin III and Steven T. Frankel in November 2003. Of
those, options representing 150,000 shares remain outstanding. Dr. Anderson, Dr.
Gavin and Mr. Frankel are directors of our company. The option agreements
entered into with each of Dr. Anderson, Dr. Gavin and Mr. Frankel are attached
hereto as Exhibits 10.34, 10.35 and 10.36, respectively. In addition, options
representing a total of 280,000 shares of common stock were granted outside of
the 2000 Stock Option Plan to three individuals in 2003, none of whom is an
officer or director of the company pursuant to the form of option agreement
attached hereto as Exhibit 10.33. Of those, options representing 280,000 shares
remain outstanding. Warrants representing 1,500,000 shares of common stock in
the aggregate were granted to Donald Saunders, Thomas K. Russell and Mark C.
Russell for services in connection with the merger of MSLT Delaware and us in
April 2002, as described in greater detail in "Company Overview - History" in
Item 1. Of those, warrants representing 1,500,000 shares remain outstanding.
Warrants representing 64,800 shares of common stock were granted to World Link
Asset Management for services in connection with our November 2003 financing, as
discussed more fully in Item 5, "Recent Sales of Unregistered Securities". Of
those, warrants representing 64,800 shares remain outstanding. Options
representing 140,649 shares of common stock granted outside of the 2000 Stock
Option Plan were assumed by us pursuant to our acquisition of MSLT Delaware. Of
those, options representing 140,649 shares remain outstanding.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the ownership of
our common stock as of March 16, 2004, by: (i) each director; (ii) each person
who is known to us to be the beneficial owner of more than five percent of our
outstanding common stock; (iii) each of our executive officers named in the
Summary Compensation Table; and (iv) all our executive officers and directors of
as a group. Except as otherwise indicated in the footnotes, all information with
respect to share ownership and voting and investment power has been furnished to
us by the persons listed. Except as otherwise indicated in the footnotes, each
person listed has sole voting power with respect to the shares shown as
beneficially owned.

                                       37
<PAGE>

<TABLE>
<CAPTION>

                                                             Number of Shares
Name and Address of Beneficial Owner (1)                  Beneficially Owned (2)            Percent of Class (2)
----------------------------------------                  ----------------------            --------------------
<S>                                                             <C>                                 <C>
John F. Steel IV                                                9,314,500(3)                        24.3%

Richard Schoninger                                              3,190,850(4)                         8.3%
667 Madison Avenue
New York, NY 10021

Don and Bonnie Saunders Family Trust                            2,744,339(5)                         7.1%
900 E. Desert Inn Road, Apt. 521
Las Vegas, NV 89109

John J. Hagenbuch                                               3,819,852(6)                         9.8%
3673 Jackson Street
San Francisco, CA 94118

Hartoun Hartounian, Ph.D.                                       1,462,710(7)                         3.7%

William G. Kachioff                                               350,000(7)                         0.9%

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

Steven T. Frankel                                                 112,667(7)                         *

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

All officers and directors as a group (6 in number)            11,621,173(8)                        28.5%

* Less than one percent.
</TABLE>

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

(2) Unless otherwise indicated in the footnotes to this table and subject to
community property laws where applicable, we believe that each of the
stockholders named in this table has sole voting and investment power with
respect to the shares indicated as beneficially owned. Applicable percentages
are based on 38,413,030 shares outstanding on March 16, 2004, adjusted as
required by rules promulgated by the Commission.

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

(4) Includes 3,000 shares held by Mr. Schoninger's minor son, for which Mr.
Schoninger may be deemed to share voting and investment control with the child's
mother.

(5) Don and Bonnie Saunders are the trustees of the Don and Bonnie Saunders
Family Trust, and share voting and investment power over the 2,096,971 shares
held by such trust. Also includes 647,368 shares held by Mr. Saunders and his
wife as trustees of an irrevocable trust for which Mr. and Mrs. Saunders share
voting and investment power. Excludes 850,000 shares subject to a warrant with
an exercise price of $6.00 per share and 425,000 shares subject to a warrant
with an exercise price of $12.00 per share, as these warrants are substantially
out of the money and are not currently exercisable for common stock. If and when
Mr. and Mrs. Saunders determine to sell any of the 2,499,339 shares beneficially
owned by them, or Mr. Saunders determines to sell any of the 1,275,000 shares
subject to the warrants, they may do so only pursuant to a registration
statement covering such resales. The ownership information for the Don and
Bonnie Saunders Family Trust in this table is based solely on information
disclosed on Schedule 13G under the Securities Exchange Act of 1934.

                                       38
<PAGE>

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

(7) For each person, the shares shown represent shares that are issuable upon
exercise of options exercisable within 60 days of March 16, 2004.

(8) Includes 2,400,506 shares subject to options exercisable within 60 days of
March 16, 2004.


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In December 2001, Frank Danesi, Jr., our sole officer and director and owner of
approximately 90.22% of our then outstanding shares of capital stock, sold all
of his 3,075,000 shares of common stock to the Don and Bonnie Saunders Family
Trust for a cash purchase price of $300,000. The Don and Bonnie Saunders Family
Trust purchased a total of 615,000 of such shares as nominee for others,
including 275,132 shares for Thomas K. Russell and 137,566 for Mark C. Russell.
Thomas K. Russell and Mark C. Russell are brothers. The sale constituted a
change of control of our company. Thomas K. Russell also became our President,
Chairman and sole director at that time. In April 2002, we acquired MSLT
Delaware through a merger of our newly-formed, wholly-owned subsidiary with MSLT
Delaware. MSLT Delaware's stockholders were issued a total of 19,215,538 shares
of our authorized but unissued common stock, representing 85% of the post-merger
outstanding shares of the company. In the merger, MSLT Delaware common shares
were exchanged on a one-for-one basis for our common shares, and MSLT Delaware's
Series A Preferred shares were exchanged on a 15.6275 for-one basis for our
common shares.

ASA Investment Company served as the private placement adviser for a private
offering of securities by MSLT Delaware which closed simultaneously with the
merger, and for our subsequent private placement of 34,667 shares of our common
stock. MSLT Delaware was introduced to ASA through Donald G. Saunders. At the
time of the introduction, Mr. Saunders was negotiating with ASA to form a
successor broker-dealer in which Mr. Saunders, Thomas K. Russell and Mark C.
Russell would have equity interests. Those negotiations did not ultimately
result in a restructuring of ASA, and none of Mr. Saunders, Thomas K. Russell or
Mark C. Russell obtained an ownership interest or other interest in ASA. Mr.
Saunders, his wife Bonnie Saunders, and the Don and Bonnie Saunders Family Trust
collectively purchased 122,500 MSLT Delaware shares in the private offering with
gross proceeds to us of $735,000. Temple Securities, Ltd., a company associated
with Thomas K. Russell and Mark C. Russell, purchased 52,500 MSLT Delaware
shares with gross proceeds to us of $315,000. These investments were on the same
terms as all other investments in the private offering. ASA Investment Company
received commissions equal to ten percent of the approximately $4 million in
gross offering proceeds, and in connection with the merger, received an
investment banking fee of $200,000 plus 33,334 shares of our common stock. ASA
earned additional commissions totaling $75,833 in connection with
post-acquisition private placements including $55,033 from the sale of 1,000,600
shares in September 2003 to certain investors.

In April 2002, we issued warrants to purchase 1,000,000 shares of our common
stock at $6.00 per share and 500,000 shares of our common stock at $12.00 per
share to the following persons in the amounts set forth opposite their names:


Name                           $6.00 Warrants                 $12.00 Warrants
----                           --------------                 ---------------

Donald G. Saunders                     850,000                      425,000
Thomas K. Russell                      100,000                       50,000
Mark C. Russell                         50,000                       25,000
                                        ------                       ------

Total:                               1,000,000                      500,000
                                     =========                      =======

The warrants are exercisable at any time until July 31, 2007.

                                       39
<PAGE>

In April 2003 and May 2003, we borrowed $300,000 and $200,000, respectively,
from a trust affiliated with Mr. John J. Hagenbuch, a significant beneficial
owner of our shares. The loans had an annual interest rate of 4.25%, with
principal and accrued interest originally due August 9, 2003 and September 9,
2003. As additional consideration for the loans, we issued to the lender two
ten-year warrants exercisable for an aggregate of 100,000 shares of common stock
at an exercise price of $1.49 per share.

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

On October 31, 2003, we reached agreement with Mr. Hagenbuch to cancel the notes
evidencing the loans in exchange for 1,022,200 shares and a warrant to purchase
408,880 shares at $1.00 per share. The two loans had a combined principal and
interest balance of $511,100. At the same time, Mr. Hagenbuch agreed to have his
trust purchase for cash 300,000 shares at $0.50 per share. Mr. Hagenbuch's trust
also received a warrant to purchase 120,000 shares at $1.00 per share in
connection with this purchase. As a result of these transactions, Mr. Hagenbuch
is now beneficial owner of approximately 12.6% of our outstanding stock.

                                       40
<PAGE>

ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K

(a) EXHIBITS

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

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

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

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

         3.3      Amended and Restated Bylaws of the Registrant (incorporated by
                  reference to the Registrant's Amendment No. 1 to Registration
                  Statement on Form SB-2 filed with the Commission on November
                  20, 2002).

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

         10.1     Amended and Restated 2000 Stock Option Plan of the Registrant,
                  as amended and restated January 30, 2004.*

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

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

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

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

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

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

                                       41
<PAGE>

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

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

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

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

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

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

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

         10.15    Employment Agreement between MSLT Delaware and Hartoun
                  Hartounian dated June 23, 2000.*

         10.16    Amendment Agreement dated January 30, 2004 to Employment
                  Agreement between MSLT Delaware and Hartoun Hartounian dated
                  June 23, 2000.*

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

         10.18    Amendment Agreement dated January 30, 2004 to Employment
                  Agreement between the Registrant and William Kachioff dated
                  May 1, 2002.*

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

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

         10.21    120 Day Note, dated April 11, 2003 between the Registrant and
                  John J. Hagenbuch, Trustee U/D/T dated September 13, 1995
                  (incorporated by reference to Exhibit 10.18 to the
                  Registrant's Form SB-2 filed April 15, 2003).

                                       42
<PAGE>

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

         10.23    120 Day Note, dated May 12, 2003 between the Registrant and
                  John J. Hagenbuch, Trustee U/D/T dated September 13, 1995
                  (incorporated by reference to Exhibit 10.1 to the Registrant's
                  Form 8-K filed May 13, 2003).

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

         10.25    Amendment to 120 Day note, dated August 26, 2003 between the
                  Registrant and John J. Hagenbuch, Trustee U/D/T dated
                  September 13,1995 (incorporated by reference to Exhibit 10.1
                  to the Registrants 8-K filed August 28, 2003).

         10.26    Warrant Amendment, dated August 26, 2003 between the
                  Registrant and John J. Hagenbuch, Trustee U/D/T dated
                  September 13,1995 (incorporated by reference to Exhibit 10.2
                  to the Registrants 8-K filed August 28, 2003).

         10.27    Amendment to 120 Day note, dated August 26, 2003 between the
                  Registrant and John J. Hagenbuch, Trustee U/D/T dated
                  September 13,1995 (incorporated by reference to Exhibit 10.3
                  to the Registrants 8-K filed August 28, 2003).

         10.28    Warrant Amendment, dated August 26, 2003 between the
                  Registrant and John J. Hagenbuch, Trustee U/D/T dated
                  September 13,1995 (incorporated by reference to Exhibit 10.4
                  to the Registrants 8-K filed August 28, 2003).

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

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

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

         10.32    Warrant dated October 31, 2003 to World Link Asset
                  Management.*

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

         10.34    Special Stock Option granted to Robert W. Anderson on November
                  10, 2003.*

         10.35    Special Stock Option granted to James R. Gavin III on November
                  10, 2003.*

         10.36    Special Stock Option granted to Steven T. Frankel on November
                  10, 2003.*

         10.37    Form of Securities Purchase Agreement dated as of March 16,
                  2004.*

         10.38    Form of Warrant Agreement dated as of March 16, 2004.*

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

                                       43
<PAGE>

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

         23.1     Consent of Deloitte & Touche LLP *

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

         31.1     Certification of John F. Steel IV, Principal Executive
                  Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the
                  Securities Exchange Act of 1934, as adopted pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002

         31.2     Certification of William G. Kachioff, Principal Financial
                  Officer, pursuant to Rule 13a-14(a) or 15d-14(a) of the
                  Securities Exchange Act of 1934, as adopted pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002

         32.1     Certificate pursuant to 18 U.S.C. Section 1350, as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
                  executed by John F. Steel IV, Principal Executive Officer, and
                  William G. Kachioff, Principal Financial Officer

* Filed herewith.

+ 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.

(b)  REPORTS ON FORM 8-K

We filed a Form 8-K on November 3, 2003, containing disclosure in Items 5 and 7.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The following table describes fees for professional audit services rendered by
Deloitte & Touche LLP, our principal accountant, for the audit of our annual
financial statements for the years ended December 31, 2003 and December 31, 2002
and fees billed for other services rendered by Deloitte & Touche LLP during
those periods.

--------------------------------------------------------------------------------
Type of Fee                                   2003                  2002
--------------------------------------------------------------------------------
Audit Fees (1)                              $  71,577             $24,200
--------------------------------------------------------------------------------
Audit Related Fees (2)                         29,140              48,990
--------------------------------------------------------------------------------
Tax Fees (3)                                   10,560               3,367
--------------------------------------------------------------------------------
Total                                       $ 111,277             $76,557
--------------------------------------------------------------------------------

(1) Audit Fees include the aggregate fees paid by us during the fiscal year
indicated for professional services rendered by Deloitte & Touche LLP for the
audit of our annual financial statements and review of financial statements
included in our Forms 10-Q.

(2) Audit Related Fees include the aggregate fees paid by us during the fiscal
year indicated for assurance and related services by Deloitte & Touche LLP that
are reasonably related to the performance of the audit or review of our
financial statements and not included in Audit Fees. Also included in Audit
Related Fees are fees for accounting advice.

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

                                       44
<PAGE>

AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES

The Audit Committee on an annual basis reviews audit and non-audit services
performed by the independent auditor. All audit and non-audit services are
pre-approved by the Audit Committee, which considers, among other things, the
possible effect of the performance of such services on the auditors'
independence. The Audit Committee has considered the role of Deloitte & Touche
LLP in providing services to us for the fiscal year ended December 31, 2003 and
has concluded that such services are compatible with their independence as our
company's auditors. The Audit Committee has established its pre-approval
policies and procedures, pursuant to which the Audit Committee approved the
foregoing audit services provided by Deloitte & Touche LLP in fiscal 2003.



                                   SIGNATURES


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

                                     MICROISLET, INC.

                                     By:  /S/ John F. Steel IV
                                          --------------------------------------
                                          John F. Steel IV
                                          Chairman and Chief Executive Officer
                                          (Principal Executive Officer)

                                     Date:  March 30, 2004

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

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

<TABLE>
<CAPTION>
               Signature                            Title                           Date
               ---------                            -----                           ----

<S>                                    <C>                                    <C>
/S/ John F. Steel IV                   Chairman and Chief Executive Officer   March 30, 2004
------------------------------         (Principal Executive Officer)
John F. Steel IV
                                       Vice President, Finance and Chief      March 30, 2004
                                       Financial Officer
/S/ William G. Kachioff                (Principal Financial and Accounting
------------------------------         Officer)
William G. Kachioff


/S/ Hartoun Hartounian                 President, Chief Operating Officer     March 30, 2004
------------------------------         and Director
Hartoun Hartounian, Ph.D.

                                                                              March 30, 2004
/S/ Robert W. Anderson                 Director
------------------------------
Robert W. Anderson, M.D.

                                                                              March 30, 2004
/S/ James R. Gavin III                 Director
------------------------------
James R. Gavin III, M.D., Ph.D.

                                                                              March 30, 2004
/S/ Steven T. Frankel                  Director
------------------------------
Steven T. Frankel

</TABLE>

                                       45
<PAGE>

INDEPENDENT AUDITOR'S REPORT

The Board of directors and Shareholders of
MicroIslet, Inc.
San Diego, California

We have audited the accompanying consolidated balance sheets of MicroIslet, Inc.
(the "Company"), a development stage enterprise, as of Deceinber 31, 2003 and
2002, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the years then ended, and for the period of from
August 21, 1998 (date of inception) to December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these fmancial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also included 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 the Company at December 31, 2003
and 2002, and the results of its operations and its cash flows for the years
then ended, and for the period ftom August 21, 1998 (date of inception) to
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America.

As described in Note 12 to the consolidated financial statements, subsequent to
December 31, 2003, the Company completed a sale of common stock for gross
proceeds of $12.8 million.



/S/ Deloitte & Touche LLP

March 29, 2004
San Diego, California

                                      F-1
<PAGE>
<TABLE>
                                             MICROISLET, INC.
                                       (A Development Stage Company)
                                        Consolidated Balance Sheets
<CAPTION>

                                                                            December 31,     December 31,
                                                                                2003              2002
                                                                           -------------     -------------
<S>                                                                        <C>               <C>
ASSETS

Current Assets:
         Cash                                                              $    529,877      $    813,696
         Grants receivable                                                       16,242            35,047
         Prepaid expenses                                                        65,849           110,469
                                                                           -------------     -------------

                  Total current assets                                          611,968           959,212
                                                                           -------------     -------------

Equipment, net                                                                  104,952           167,074
Patents, net                                                                     11,522            11,996
Deposits and other assets                                                        50,210            50,210
                                                                           -------------     -------------

                  Total assets                                             $    778,652      $  1,188,492
                                                                           =============     =============

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
         Research expenses due to stockholder                              $    230,000      $    230,000
         Deferred grant revenue                                                      --            40,352
         Accounts payable and accrued expenses                                  181,458           435,303
                                                                           -------------     -------------

                  Total current liabilities                                     411,458           705,655
                                                                           -------------     -------------

Stockholders' Equity:
         Convertible preferred stock - $.001 par value: 10,000,000
              shares authorized; zero shares issued and outstanding
              at December 31, 2003 and December 31, 2002                             --                --
         Common stock - $.001 par value: 50,000,000 shares authorized;
              28,143,699 and 22,658,592 shares issued and outstanding
              at December 31, 2003 and December 31, 2002, respectively           28,144            22,659
         Additional paid-in capital                                          15,417,108        12,498,419
         Deficit accumulated during the development stage                   (15,078,058)      (12,038,241)
                                                                           -------------     -------------

                  Total stockholders' equity                                    367,194           482,837
                                                                           -------------     -------------

                  Total liabilities and stockholders' equity               $    778,652      $  1,188,492
                                                                           =============     =============

                              See notes to consolidated financial statements.

                                                   F-2
</TABLE>
<PAGE>
<TABLE>
                                               MICROISLET, INC.
                                        (A Development Stage Company)
                                    Consolidated Statements of Operations
<CAPTION>

                                                             Year Ended              August 21, 1998
                                                            December 31,                    to
                                                  -------------------------------      December 31,
                                                       2003              2002              2003
                                                  -------------     -------------     -------------
<S>                                               <C>               <C>               <C>
Grant revenue                                     $    255,857      $    137,087      $    409,790

Expenses:
     Research and development expenses               1,497,682         1,137,465         7,363,014
     General and administrative expenses             1,640,389         5,106,412         8,000,895
                                                  -------------     -------------     -------------
          Operating expenses                        (3,138,071)       (6,243,877)      (15,363,909)
                                                  -------------     -------------     -------------
          Loss from operations                      (2,882,214)       (6,106,790)      (14,954,119)
                                                  -------------     -------------     -------------

Other income (expense):
     Interest income                                     3,600            19,432            53,883
     Interest and other expenses                      (153,763)          (18,777)         (172,701)
     Other                                              (7,440)               --            (5,121)
                                                  -------------     -------------     -------------
              Total other income (expense)            (157,603)              655          (123,939)
                                                  -------------     -------------     -------------

              Net loss                            $ (3,039,817)     $ (6,106,135)     $(15,078,058)
                                                  =============     =============     =============


Basic and diluted net loss per share              $       (.12)     $       (.29)     $       (.81)
                                                  =============     =============     =============

Weighted average number of shares outstanding
     used in calculation                            24,359,263        20,904,114        18,537,683

                               See notes to consolidated financial statements.

                                                     F-3
</TABLE>
<PAGE>
<TABLE>
                                                   MICROISLET, INC.
                                             (A Development Stage Company)
                                               Statements of Cash Flows
<CAPTION>

                                                                       Year Ended        Year Ended   August 21, 1998 to
                                                                      December 31,      December 31,      December 31,
                                                                          2003              2002             2003
                                                                     -------------     -------------     -------------
<S>                                                                  <C>               <C>               <C>
Cash flows from operating activities:
     Net loss                                                        $ (3,039,817)     $ (6,106,135)     $(15,078,058)
     Adjustments to reconcile net loss to net cash used in
       operating activities:
          Compensation paid with warrant                                       --         3,477,723         3,477,723
           Interest paid with warrant                                     142,300                --           142,300
          In process research and development
               acquired for common stock                                       --                --         2,067,518
          Compensation paid with stock options                            253,717           331,473         2,136,958
          Depreciation and amortization                                    45,314            34,484           106,910
          Loss on disposal of equipment                                     3,149            15,084            18,233
Changes in operating assets and liabilities:
     Deposits and other assets                                                 --           (33,508)          (62,680)
     Grants receivable                                                     18,805           (30,075)          (16,242)
     Prepaid expenses                                                      44,620           (86,561)          (65,849)
     Deferred grant revenue                                               (40,352)           40,352                --
     Accounts payable and accrued expenses                                (23,885)          368,924           411,418
     Research expenses due to stockholder                                      --           (10,000)          230,000
                                                                     -------------     -------------     -------------

               Net cash used in operating activities                   (2,596,149)       (1,998,239)       (6,631,769)
                                                                     -------------     -------------     -------------

Cash flows from investing activities:
     Proceeds from sale of equipment                                        1,000                --             1,000
     Purchases of equipment                                               (16,867)         (154,904)         (260,147)
                                                                     -------------     -------------     -------------

               Net cash used in investing activities                      (15,867)         (154,904)         (259,147)
                                                                     -------------     -------------     -------------

Cash flows from financing activities:
     Loan from related parties                                            525,000                --           525,000
     Repaymnet of loan from related parties                               (25,000)               --           (25,000)
     Proceeds from sale of common stock                                 1,828,197         2,418,158         6,734,293
     Proceeds from sale of preferred stock                                     --                --           186,500
                                                                     -------------     -------------     -------------

               Net cash provided by financing activities                2,328,197         2,418,058         7,420,793
                                                                     -------------     -------------     -------------

               Net increase (decrease) in cash                           (283,819)          264,915           529,877

Cash at beginning of period                                               813,696           548,781                --
                                                                     -------------     -------------     -------------

Cash at end of period                                                $    529,877      $    813,696      $    529,877
                                                                     =============     =============     =============

Interest paid                                                        $        364      $        411      $        936
Income taxes paid                                                    $      3,445      $      3,282      $      6,727

Non-cash investing and financing activities:
     Conversion of loan from related parties to
          common stock                                               $    500,000      $         --      $    500,000
     In-process research and development
          acquired for common stock                                  $         --      $         --      $  2,067,518

                                    See notes to consolidated financial statements.

                                                         F-4
</TABLE>
<PAGE>
<TABLE>
                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
<CAPTION>

                                              PREFERRED STOCK            COMMON STOCK        ADDITIONAL
                                        -------------------------  -------------------------   PAID-IN     ACCUMULATED
                                           Shares       Amount        Shares      Amount       CAPITAL       DEFICIT       TOTAL
                                        ------------ ------------  ------------ ------------ ------------  ------------ ------------
<S>                                          <C>     <C>          <C>           <C>          <C>           <C>          <C>
Sale of common stock to
  founders, August 21, 1998                      --  $        --    12,594,203  $    12,594  $   (12,110)  $        --  $       484

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

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

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

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

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

Sale of common stock, net:
                       January 20, 2000          --           --     1,706,679        1,707      498,293            --      500,000
                       January 24, 2000          --           --       500,080          500         (468)           --           32
Payments received for
  January 1, 2001 stock sale                     --           --            --           --      500,000            --      500,000

Compensation expense related to
  valuation of options issued                    --           --            --           --      211,022            --      211,022

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

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

                                           See notes to consolidated financial statements.

                                                                F-5
</TABLE>
<PAGE>
<TABLE>
                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
<CAPTION>

                                         PREFERRED STOCK              COMMON STOCK          ADDITIONAL
                                   ---------------------------  --------------------------    PAID-IN     ACCUMULATED
                                       Shares        Amount        Shares        Amount       CAPITAL       DEFICIT        TOTAL
                                   ------------- ------------- ------------- ------------- ------------- ------------- -------------
<S>                                     <C>      <C>             <C>         <C>           <C>           <C>           <C>
Balance, December 31, 2000               82,888            83    15,145,548        15,146     1,382,831    (1,038,010)      360,050

Sale of common stock, net:
                  January 1, 2001            --            --     1,706,679         1,707       498,293            --       500,000
                     July 2, 2001            --            --        52,094            52        99,948            --       100,000
                 November 2, 2001            --            --       166,668           166       887,334            --       887,500
Stock issued pursuant to
license agreement,
                 October 16, 2001            --            --       344,586           345     2,067,173            --     2,067,518
Compensation expense related to
valuation of options issued                  --            --            --            --     1,340,746            --     1,340,746
Net loss                                     --            --            --            --            --    (4,894,096)   (4,894,096)
                                   ------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 2001               82,888  $         83    17,415,575  $     17,416  $  6,276,325  $ (5,932,106) $    361,718
                                   ============= ============= ============= ============= ============= ============= =============

Sale of common stock, net:

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

33,334 shares due pursuant to
  Investment Banking Agreement               --            --            --            --      (200,000)           --      (200,000)

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

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

Reverse Merger Warrant Expense               --            --            --            --     3,477,723            --     3,477,723

Compensation expense related to
  valuation of options issued                --            --            --            --       331,473            --       331,473

Net loss                                     --            --            --            --            --    (6,106,135)   (6,106,135)
                                   ------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 2002                   --  $         --    22,658,592  $     22,659  $ 12,498,419  $(12,038,241) $    482,837
                                   ============= ============= ============= ============= ============= ============= =============

                                           See notes to consolidated financial statements.

                                                                F-6
</TABLE>
<PAGE>
<TABLE>
                                                          MICROISLET, INC.
                                                    (A Development Stage Company)
                                                 Statements of Stockholders' Equity
<CAPTION>

                                       PREFERRED STOCK              COMMON STOCK          ADDITIONAL
                                 ---------------------------  --------------------------    PAID-IN     ACCUMULATED
                                     Shares        Amount        Shares        Amount       CAPITAL       DEFICIT        TOTAL
                                 ------------- ------------- ------------- ------------- ------------- ------------- -------------
<S>                                   <C>      <C>             <C>         <C>           <C>           <C>           <C>

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

Sale of common stock, net of
  $79,806 issuance cost :
                    June 26, 2003          --            --       500,000           500       249,500             --        250,000
                September 4, 2003          --            --     1,000,600         1,001       399,429             --        400,430
                 October 31, 2003          --            --     1,080,000         1,080       468,984             --        470,064
Common stock sold to related
  party, October 31, 2003                  --            --       300,000           300       149,700             --        150,000

Common stock sold under
  agreement with Fusion
  Capital, net of $25,335
  issuance cost                            --            --     1,017,505         1,018       533,645             --        534,663

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

Compensation expense
  related to valuation of
  options issued                           --            --            --            --       253,717             --        253,717

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

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

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

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

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

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

                                           See notes to consolidated financial statements.

                                                                F-7
</TABLE>
<PAGE>

NOTES TO THE FINANCIAL STATEMENTS

NOTE 1.   DESCRIPTION OF BUSINESS

MicroIslet, Inc. ("MicroIslet", "We," 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 shareholders 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 2002 condensed consolidated
financial information presented herein includes the financial results of
MicroIslet of Delaware for the entire year ended December 31, 2002, 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,
2002. The financial information from inception includes the financial results of
MicroIslet of Delaware from its inception on August 21, 1998 to December 31,
2003, and the financial results of the Company for the post-Merger period from
April 24, 2002 through December 31, 2003.

As shown in the financial statements, the Company incurred net losses of $3.0
million and $6.1 million for 2003 and 2002, respectively, and had an accumulated
deficit of $15.1 million as of December 31, 2003. As described in Note 12, on
March 16, 2004, the Company completed the sale of common stock for gross
proceeds of $12.8 million. The Company sold an aggregate of approximately 9.8
million shares for $1.30 per share. In connection with the financing, the
Company also issued to the investors five-year warrants to purchase an aggregate
of approximately 4.9 million shares at $1.00 per share. The Company expects to
incur substantial additional costs, including costs related to ongoing research
and development activities, preclinical studies and trials. The Company believes
that its existing funds will be sufficient to fund its operating expenses and
capital requirements into the fourth quarter of 2005. The Company intends to
raise additional debt and/or equity financing to sustain its operations. The
Company's future cash requirements will depend on many factors, including
continued scientific progress in its research and development programs, the
scope and results of pre-clinical and clinical trials, the time and costs
involved in obtaining regulatory approvals, the costs involved in filing,
prosecuting and enforcing patents, competing technological and market
developments and the cost of product commercialization. The Company does not
expect to generate a positive cash flow from operations at least until the
commercial launch of its first product and possibly later given the expected
spending for research and development programs and the cost of commercializing
product candidates. Accordingly, the Company will require external financing to
sustain its operations, perhaps for a significant period of time. The Company
intends to seek additional funding through grants and through public or private
financing transactions. Successful future operations are subject to a number of
technical and business risks, including the Company's continued ability to
obtain future funding, satisfactory product development, regulatory approvals
and market acceptance for the Company's products.

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

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

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

                                       F-8
<PAGE>

Reclassifications
-----------------

Certain prior year reclassifications have been made to conform to the current
year presentation.

Equipment
---------

Equipment is stated at cost. Depreciation is computed on the straight-line
method over the estimated useful asset lives, which range from three to five
years. Repairs and maintenance are charged to expense as incurred.

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

The Company's policy regarding long-lived assets is to review such long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. If the review indicates
that long-lived assets are not recoverable (i.e. the carrying amount is less
than the future projected undiscounted cash flows), their carrying amount is
reduced to fair value. The Company carries no goodwill on its books at either
December 31, 2003 or 2002. Further, during fiscal 2003 and 2002, the Company had
no material impairments of intangible assets, which consist primarily of
patents.

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

Research and development costs are charged to operations when incurred.

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

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

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

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

                                      F-9
<PAGE>

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

The Company accounts for employee stock-based compensation in accordance with
the intrinsic value method prescribed in Accounting Principles Board Opinion
(APB) No. 25 entitled "Accounting for Stock Issued to Employees," and related
interpretations. Accordingly, compensation cost for stock options is measured as
the excess, if any, of the fair value of the Company's stock at the date of
grant over the amount an employee must pay to acquire the stock amortized over
the vesting period. The Company applies the disclosure requirements of SFAS No.
123 entitled, "Accounting for Stock-Based Compensation". Had the compensation
cost for the Company's stock option plans been determined based on the fair
value at the grant dates for awards under the plans consistent with the method
of SFAS No. 123, the Company's net loss and fully diluted earnings per share on
a pro forma basis would have been as follows:

<TABLE>
<CAPTION>
                                                                                    August 21, 1998
                                                                                    (Inception) to
                                                                                     December 31
                                                     2003              2002              2003
                                                -------------     -------------     -------------
<S>                                             <C>               <C>               <C>
Net loss, as reported                           $ (3,039,817)     $ (6,106,135)     $(15,078,058)

Add: Total stock-based compensation expense
   under APB No. 25                                  174,799           228,701           725,889

Deduct: Stock-based compensation
   expense determined under the
   fair value method for all awards               (1,202,185)       (1,155,119)       (2,865,774)
                                                -------------     -------------     -------------


Net loss, pro forma                             $ (4,067,203)     $ (7,032,553)     $(17,217,943)
                                                =============     =============     =============


Net loss per share, as reported:
     Basic and diluted                          $       (.12)     $       (.29)     $       (.81)
                                                =============     =============     =============

Net loss per share, pro forma:
     Basic and diluted                          $       (.17)     $       (.37)     $       (.93)
                                                =============     =============     =============
</TABLE>

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

                                                     Year ended
                                        -----------------------------------
                                        Dec. 31, 2003         Dec. 31, 2002
                                        -------------         -------------

Risk free interest rate                           3%                    5%
Dividend yield                                    --                    --
Volatility                                      123%                   80%
Weighted average expected life               8 years              10 years

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

                                      F-10
<PAGE>

     Deferred charges for options granted to non-employees are determined in
accordance with Statement of Financial Accounting Standards No. 123 and EITF
96-18 as the fair value of the consideration or the fair value of the equity
instruments issued, whichever is more reliably measured. Deferred charges for
options granted to non-employees are periodically remeasured as the underlying
options vest and are included as unearned stock compensation in the
stockholders' equity section of the balance sheet.

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

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

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

In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB NO. 51,
which was subsequently revised prior to implementation in December 2003. The
revised Interpretation, known as "FIN 46(R)", requires the consolidation of
certain variable interest entities by the primary beneficiary of the entity if
the equity investment at risk is not sufficient to permit the entity to finance
its activities without additional subordinated financial support from other
parties, or if the equity investors lack the characteristics of a controlling
financial interest. The Company does not have any variable interest entites
covered by the Statement.

  In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS 150
establishes standards for how an issuer classifies and measures certain
financial instruments with the characteristics of both liability and equity, and
requires that such financial instruments be reported as liabilities. The
provisions of SFAS 150 are effective for instruments entered into or modified
after May 31, 2003, and pre-existing instruments after June 15, 2003. The
Company does not have any financial instruments covered by the Statement.

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

The Company maintains its cash balances in a financial institution and a money
market fund at the same institution. Cash balances at the institution are
insured by the Federal Deposit Insurance Corporation up to $100,000. The money
market fund is uninsured.

NOTE 3.  COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

                                                      2003                2002
                                                   ----------         ----------
Equipment:
----------
Laboratory equipment                               $ 117,361          $ 101,823
Computer equipment                                    41,078             41,078
Furniture and fixtures                                24,096             30,655
Leasehold improvements                                14,488             14,488
Assets in progress                                        --             30,000
                                                   ----------         ----------
                                                   $ 197,023          $ 218,044

Less accumulated depreciation                        (92,071)           (50,970)
                                                   ----------         ----------

                                                   $ 104,952          $ 167,074
                                                   ==========         ==========

Intangible assets:
------------------
Patents                                            $  13,892          $  13,892
Less accumulated amortization                         (2,370)            (1,896)
                                                   ----------         ----------

                                                   $  11,522          $  11,996
                                                   ==========         ==========

NOTE 4.  LICENSE AGREEMENT

In September 1998, the Company entered into a license agreement with Duke
University (Duke). Under the terms of the agreement, the Company has the right
to develop and commercialize technology related to therapies for diabetes
developed and patented by Duke. The Company issued 344,586 shares of its common
stock to Duke upon the execution of the license agreement. The Company issued an
additional 344,586 shares to Duke upon issuance of the first patent involving

                                      F-11
<PAGE>

the technology, which occurred in October 2001. The Company is obligated to
issue an additional 344,586 shares to Duke upon approval of a licensed product.
The cost of the license rights is based on the fair value of the Company's stock
when earned by Duke and has been expensed as acquired in-process research and
development ("R&D") because the technology is in the early development stage and
has no foreseeable alternative future uses. The Company is obligated to pay Duke
a royalty of 5% of all proceeds generated by any future commercial products
derived from the licensed technology. The Company has also reimbursed Duke for
research costs related to developing the technology for commercial use. The
Company sponsored Duke's research in the amount of $0 in 2003 and 2002 and
$500,000 from August 21, 1998 (inception) to December 31, 2001. The amount
recorded as research expenses due stockholder of $230,000 as of December 31,
2003 represents charges Duke has billed the Company. In March 2004, the Company
paid $200,000 to Duke in full settlement of this obligation.

NOTE 5.  COMMITMENTS

The Company has office and laboratory facilities under noncancelable operating
leases. Rent expense was $222,087 for the year ended December 31, 2003 and
$437,897 from August 21, 1998 (inception) to December 31, 2003. The following is
a schedule of total future minimum lease payments under all noncancelable
operating leases:

         Year Ending December 31:


                  2004                                        $        215,972
                  2005                                                 167,732
                  2006                                                   2,705
                                                              -----------------

                  TOTAL                                       $        386,409
                                                              =================


NOTE 6.  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." Pursuant to this private offering, the investors
were granted the right to receive additional shares of common stock if
MicroIslet of Delaware sells any securities for less than $6.00 per share. In
the event of such a sale, these investors would be entitled to an additional
number of shares equal to the number of additional shares they would have
received had their initial investment been made at the lower price. MicroIslet
of Delaware has not sold any securities to trigger these rights.

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
shareholder"). Certain trusts affiliated with ALD's majority shareholder
subscribed for 175,000 MicroIslet of Delaware shares ($1,050,000 gross proceeds)
in the Private Offering. 52,500 of such shares ($315,000 gross proceeds) were
purchased by one of these trusts as a nominee for a company associated with
ALD's President and his brother, who was also then affiliated with ASA. ASA
received cash commissions equal to ten percent of the gross Private Offering
proceeds, and in connection with the Merger, received an investment banking fee
of $200,000 and 33,334 shares of common stock. Cash payments to ASA were
withheld from the gross offering proceeds distributed to the Company and have
been recorded as a direct reduction to the proceeds received by the Company in
the Private Offering. The Company was advised in May 2002 that ALD's majority
shareholder, ALD's President and his brother were no longer affiliated with ASA.

                                      F-12
<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
four-member board of directors appointed by MicroIslet of Delaware. The board of
directors expanded to five directors in May 2002.

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

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, was
subsequently amended, and was declared effective on February 14, 2003. The
unsold shares were dereistered in November 2003.

NOTE 7.  RELATED PARTIES /ISSUANCE OF WARRANTS

On April 2, 2002, ALD issued an aggregate of 1,000,000 Class A Warrants and
500,000 Class B Warrants to three persons, including ALD's majority shareholder,
ALD's President and his brother. The Class A Warrants and the Class B Warrants
are referred to collectively as the "Warrants."

Each outstanding Class A Warrant entitles the holder thereof to purchase one
share of common stock at a price of $6.00 per share and each outstanding Class B
Warrant entitles the holder thereof to purchase one share of common stock at a
price of $12.00 per share. Subject to restrictions and limitations contained in
an associated Warrant Agreement, both the Class A and the Class B Warrants are
generally exercisable until July 31, 2007. The Warrant Agreement requires the
Company to register the shares underlying the Warrants and to maintain an
effective registration statement during such time as the Warrants and underlying
shares remain outstanding.

The Company has valued the Warrants at approximately $5,900,000. This valuation
was determined using the Black-Scholes option pricing model using the five year
life of the Warrants, an annual risk free rate of return of 5.2%, volatility of
120% and no dividends.

Because the Warrants related to services provided in connection with the
transaction discussed in Note 2 above, these Warrants been recorded as a direct
reduction to the proceeds received by the Company in the Private Offering. The
excess of the value of the Warrants over the proceeds ($3,477,723) has been
recorded as warrant compensation expense. The shares of common stock issued upon
exercise of the Warrants are required to be registered upon exercise.

During 2003, the Company borrowed a total of $525,000 from two shareholders.
$500,000 of these loans plus $11,100 of accrued interest was converted to common
stock at $0.50 per share and $25,000 was repaid prior to December 31, 2003. In
relation to the borrowing of the $500,000, the Company issued the lender
ten-year warrants for a total of 200,000 shares of common stock, with exercise
prices ranging from $0.50 to $1.49. The Company recorded interest expense in
relation to the warrants in the amount of $142,300. These warrants have no
registration rights.

In addition, during 2003, in relation to various equity financings, the Company
issued two-year warrants for 1,025,680 shares of registered common stock, with
exercise prices of $1.00, of which warrants for 64,800 shares were issued to the
placement agent. During 2003, five-year warrants for 4,917,116 shares of common
stock, with an exercise price of $1.00 were also issued in relation to various
equity financing. The shares of common stock issued upon exercise of these
warrants will be registered during 2004.

As of December 31, 2003, the Company had total outstanding warrants to purchase
7,642,796 shares of common stock at exercise prices ranging from $0.50 to $12.00
per share as described above. No warrants were exercised to purchase common
stock during 2003 or 2002.

                                      F-13
<PAGE>

NOTE 8.  STOCKHOLDERS' EQUITY

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

In April 2003, we entered into a common stock purchase agreement with Fusion
Capital Fund II, LLC, under which Fusion Capital agreed, subject to certain
conditions, to purchase, on each trading day during the term of the agreement,
$20,000 of our common stock up to an aggregate of $12.0 million. Fusion Capital
is committed to purchase the shares through October 2005, if not extended by us
for six additional months. We may decrease this amount or terminate the
agreement at any time. If our stock price equals or exceeds $3.00 per share for
five consecutive trading days, we have the right to increase the daily purchase
amount above $20,000, providing that the sale price of our common stock remains
at least $3.00. The sale price per share to Fusion Capital is equal to the
lesser of: the lowest sale price of our common stock on the day of purchase by
Fusion Capital, or the average of the lowest three closing sale prices of our
common stock during the ten trading days prior to the date of purchase by Fusion
Capital. Fusion Capital has agreed that neither it nor any of its affiliates
will engage in any direct or indirect short-selling or hedging of our common
stock during any time prior to the termination of the common stock purchase
agreement. We have agreed not to enter into any variable priced equity
financings during the term of the common stock purchase agreement without Fusion
Capital's consent. As compensation for its commitment and for expenses incurred,
we paid Fusion Capital $10,000 during the quarter ended March 31, 2003, and
issued to Fusion Capital in April 2003, 501,468 shares of common stock. Fusion
Capital has agreed not to sell 491,468 of such shares until the earlier of
October 2005, or the termination or a default under the common stock purchase
agreement. A registration statement registering the resale of 6,501,468 shares
by Fusion Capital was declared effective by the SEC on April 23, 2002.

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

As of March 16, 2004, we have issued an aggregate of 1,432,602 shares to Fusion
Capital and have received $1,059,995 in total proceeds under the common stock
purchase agreement. The Fusion Capital purchase commitment is currently on hold,
and we expect it to remain on hold while we have sufficient working capital on
hand to meet our operating needs.

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

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

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

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

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

During 2000, the Company adopted a stock option plan for employees, outside
consultants and directors. There are 4,000,000 common shares available for grant
under the plan. The plan allows for incentive options with exercise prices of at
least 100% of the fair market value of the Company's common stock and
nonqualified options with exercise prices of at least 85% of the fair market
value of the Company's common stock. All options have a ten-year life and
generally vest over a three-year period.

The Company applies SFAS 123 and EITF 96-18 in accounting for stock options
granted to outside consultants and directors performing advisory services.
Compensation cost is recognized over the vesting period based on the fair value
of the options at each balance sheet date until the grantee's performance is
complete. The fair value of these options was estimated using the Black-Scholes

                                      F-14
<PAGE>

pricing model with the following weighted-average assumptions for the years
ended December 31, 2003 and 2002: risk free interest rate of 3%; dividend yield
of 0%; volatility of 123% in 2003 and 80% in 2002; expected life of 5 to 10
years; and market value of the Company's common stock ranging from $0.45 to
$1.45 in 2003 and from $2.05 to $3.50 in 2002. Compensation cost charged to
operations for options granted to consultants performing advisory services was
$78,919 in 2003, $102,770 in 2002 and $1,271,912 from August 21, 1998
(inception) to December 31, 2003.

The following summary presents the options granted, exercised, expired,
forfeited and outstanding at December 31, 2003 and 2002:

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

Outstanding at December 31, 2001                 3,158,319        $      .32

Granted                                            587,898        $     4.18
Exercised                                               --                --
Expired                                                 --                --
Forfeited                                         (312,550)              .29
                                               ------------

Outstanding at December 31, 2002                 3,433,667        $      .94

Granted                                          1,075,499        $      .53
Exercised                                          (30,000)              .40
Expired                                                 --                --
Forfeited                                          (50,000)             1.29
                                               ------------

Outstanding at December 31, 2003                 4,429,166        $      .87
                                               ============

The weighted average fair value of options granted during 2003 and 2002 was
$0.53 and $3.49, respectively. The following summary presents the exercise
prices, number of options outstanding and exercisable, and the remaining
contractual lives of the Company's stock options at December 31, 2003:

                                                                      WEIGHTED
                                                                      AVERAGE
                                  NUMBER OF SHARES                   REMAINING
                       --------------------------------------       CONTRACTUAL
EXERCISE PRICE         OUTSTANDING                EXERCISABLE           LIFE
--------------         -----------                -----------       ------------
 $0.29 - $0.29         2,507,593                   2,463,749            6.78
 $0.30 - $0.80         1,368,679                   1,160,404            8.87
 $1.45 - $2.95           391,000                     225,889            8.20
 $4.40 - $5.00           161,894                     133,561            8.91

    Total              4,429,166                   3,983,603            7.63
                      ===========                 ===========

NOTE 9.  EARNINGS PER SHARE

Basic earnings per share includes no dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflect the potential
dilution of securities that could share in the earnings of an entity, such as
stock options, warrants or convertible securities. Potential common shares
related to convertible preferred stock and stock options were not included in
the calculation of diluted earnings per share because of their anti-dilutive
effect.

                                      F-15
<PAGE>

NOTE 10. INCOME TAXES

                                                    2003              2002
                                               --------------    --------------
Deferred tax assets:
      Net operating loss carryforwards         $   3,918,000     $   2,876,000
      Acquired in-process R&D                             --                --
      Stock-based compensation                       549,000           511,000
      Warrants                                     1,490,000         1,490,000
      Research and development credit                800,000           683,000
      Accrual to cash                                141,000                --
      Other                                            4,000                --
                                               --------------    --------------
                                                   6,902,000         5,560,000
Deferred tax liabilities:
      State taxes                                   (581,000)         (462,000)
      Accrual to cash                                     --          (250,000)
      Other                                               --            (5,000)
                                               --------------    --------------

Net deferred tax asset                             6,321,000         4,843,000
Less valuation allowance                          (6,321,000)       (4,843,000)
                                               --------------    --------------

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

The net deferred tax asset has been fully reserved due to uncertainties as to
its realizability. The valuation allowance increased by $1,478,000 in 2003 and
$2,488,000 in 2002.

The Company has not recorded income tax expense or benefit for the years ended
December 31, 2003 and 2002, and the period from August 21, 1998 (inception)
through December 31, 2003. The net deferred tax asset has been full reserved due
to uncertainties as to its realizability.

At December 31, 2003, the Company has net operating loss carryforwards of
approximately $9,140,000 for federal and state purposes. The federal and state
net operating loss carryforwards begin to expire in 2019 and 2007, respectively.

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

                                                     2003              2002
                                                --------------    --------------
      Federal tax benefit at statutory rate     $   1,034,000     $   2,072,000
      State tax benefit, net                          163,000           588,000
      Increase in valuation allowance              (1,478,000)       (2,488,000)
      Research and development credit                 317,000                --
      Other permanent items                            20,000            15,000
      Stock based compensation                        (56,000)         (187,000)
                                                --------------    --------------

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

NOTE 11. EMPLOYEE SAVINGS PLAN

The Company has established an employee savings plan pursuant to Section 401(k)
of the Internal Revenue Code. The plan allows participating employees to deposit
into tax deferred investment accounts up to 60% of their salary, subject to
annual limits. The Company is not required to make matching contributions under
the plan, and we did not make any such contributions in fiscal years 2003 and
2002, nor in any prior period since inception of the plan.

NOTE 12. SUBSEQUENT EVENTS

On March 16, 2004, the Company completed the sale of common stock for gross
proceeds of $12.8 million. The Company sold an aggregate of approximately 9.8
million shares for $1.30 per share. In connection with the financing the Company
also issued to the investors five-year warrants to purchase an aggregate of
approximately 4.9 million shares at $1.00 per share. This transaction provided

                                      F-16
<PAGE>

net proceeds of approximately $12.0 million. In the event we sell securities at
a price lower than $1.30 per share before the effectiveness of the registration
statement registering for resale the shares and warrants issued in the
financing, the number of shares issued to each investor will be increased to
effectively reprice the shares to such lower price. We have no plans to issue
securities prior to the effectiveness of the registration statement in a manner
that would trigger these share issuance provisions.

The Company agreed to file, on or before May 28, 2004, a registration statement
registering for resale the shares issued in the financing and upon exercise of
the warrants, and to have such registration statement declared effective on or
before August 30, 2004. If the Company does not file the registration statement
by May 28, 2004, or does not have the registration statement declared effective
by August 30, 2004, it will be required to issue to the investors additional
common shares to purchase 2% of the number of shares purchased in the financing
on each monthly anniversary of the applicable date. In the event the Company
sells securities at a price lower than $1.30 per share before the effectiveness
of the registration statement, the number of shares issued to each investor will
be increased to effectively reprice the shares to such lower price. The Company
has no plans to issue securities prior to the effectiveness of the registration
statement in a manner that would trigger these share issuance provisions.

Following completion of this financing, the Company received a demand from a
purported investor claiming that the Company had breached an agreement to sell
$750,000 of securities to the purported investor. The purported investor seeks
unspecified damages and specific performance of the terms of the purported
investment agreement. The Company does not believe it has any obligation to the
purported investor. In the opinion of management, this demand will be resolved
without significant adverse consequences or material financial impact to the
Company.

In January 2004, the Board of Directors approved an amendment to the articles of
incorporation to increase the Company's authorized shares of common stock from
50 million to 100 million, subject to the approval of stockholders. Such
approval will be sought at the Company's annual meeting of stockholders
scheduled for May 25, 2004.

In January 2004, the Board of Directors amended the 2000 Stock Option Plan to
increase the number of shares reserved under the plan from 4,000,000 to
6,000,000, and to implement per person annual grant maximums, subject to
stockholder approval of the plan amendments and the amendment to the certificate
of incorporation to increase authorized shares of common stock. Such approval
will be sought at the Company's annual meeting of stockholders scheduled for May
25, 2004.

                                      F-17