Stem cells are a special class of cells that can self-replicate and differentiate into multiple tissue types. Different populations of stem cells, also called progenitor or precursor cells, reside within the body. These cells are generally classified according to their differentiation potential, or ability to become distinct cell types. Embryonic stem cells are recognized as being totipotent, or unlimited, in terms of the number of different cell types they can become. Other stem cells are either multipotent, meaning capable of becoming two or more cell types, or unipotent, meaning preprogrammed for a single final cell type. Multipotent stem cells include the hematopoietic stem cells responsible for generating cells associated with the circulatory and immune systems, mesenchymal stem cells responsible for the formation of connective tissue cells, and neuronal stem cells dedicated to producing the different nervous system cell types. Stem cells participate in embryological and fetal development and orchestrate tissue repair following disease or injury in the adult. Though the precise mechanism of their activity has not yet been determined, experimental work has provided empirical evidence of the therapeutic benefit of various types of stem cells administered to animal and human subjects.

The embryonic stem cell, or ESC, has the greatest differentiation potential and is capable of developing into all cell types found within the human body. ESCs must be harvested from human embryos, giving rise to ethical controversies surrounding the procurement of ESCs, which has hindered progress in ESC research. The United States government has significantly restricted the funding of ESC research. Also, technical difficulties in purifying and growing ESCs have prevented widespread experimental work capable of withstanding academic or regulatory scrutiny.

Osteocel consists of a matrix of cancellous bone containing mesenchymal stem cells and is used in spinal fusion and other orthopedic surgical procedures. It is the first commercially available product in the United States containing stem cells. The Company produces Osteocel from the marrow-rich bone of organ and tissue donors. The Company is in the process of developing a second generation MSC product for bone repair, Osteocel-XC, as a long-term strategy to relieve supply constraints.

Prochymal is the Company’s biologic drug candidate for the treatment of inflammatory disease. The Company is currently entering a pivotal Phase III trial for the treatment of steroid refractory GvHD. GvHD is a life threatening immune system reaction that commonly affects the skin, gastrointestinal tract, and liver in patients who have received a bone marrow transplant.

Chondrogen is the Company’s biologic drug candidate for regeneration of meniscus, a type of cartilage that cushions the knee joint. There are currently no products available to regenerate meniscal tissue. In several preclinical studies, Chondrogen regenerated meniscus and prevented osteoarthritis in animal models. The Company recently completed enrollment in a Phase I/II clinical trial for Chondrogen. This trial is designed to evaluate the safety and efficacy of Chondrogen in patients following surgery to remove torn meniscus.

Cost of goods sold were $0.4 million for the year ended December 31, 2005 compared to $0.0 in the prior year.

Research and development costs were approximately $16.9 million for the year ended December 31, 2005 compared to $11.9 million in the prior year.

General and administrative expenses were $2.3 million for the year ended December 31, 2005 compared to $1.7 million in the prior year.