Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains certain statements that may be deemed “forward-looking statements” within the meaning of United States securities laws.  All statements, other than statements of historical fact, that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements.  Such statements are based upon certain assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate.  The forward-looking statements included in this report are also subject to a number of material risks and uncertainties, including but not limited to the risks described in “Risk Factors” described in Item 3 of this Form 10-Q under the heading “Quantitative and Qualitative Disclosures About Market Risk.”  We encourage you to read those descriptions carefully.  We caution investors not to place undue reliance on the forward-looking statements contained in this report.  These statements, like all statements in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise the statements except as required by law.  Such forward-looking statements are not guarantees of future performance and actual results will likely differ, perhaps materially, from those suggested by such forward-looking statements.

Overview

We were initially formed as a California general partnership in July 1996, and incorporated in the State of Delaware in May 1997.  Our two platform technologies include biomaterials (bioresorbable implants) and biologics (regenerative medicine).  Within our biomaterials platform we design, develop, manufacture and market bioresorbable polymer implants for use in the reconstruction, repair and regeneration of hard tissue (bone) and soft tissue throughout the body.  Additionally, we design, develop, and manufacture related instruments and accessories used in connection with our implants.  Our bioresorbable implants are used in spine, orthopedic, neurosurgical, and other musculoskeletal reconstructive surgical applications, while our bioresorbable thin films are used for soft tissue applications.

In September 2002 we sold our craniomaxillofacial “CMF” (skull and face) bone fixation implant and accessory product line to a subsidiary of Medtronic, Inc. (“Medtronic”).  We will continue to be a backup supplier for the acquired products during a transition period, which we expect to be completed in 2003.

In November 2002, we acquired StemSource, Inc. (“StemSource”), a California company specializing in stem cell bioengineering, research and technology. This has allowed us to begin developing our biologics platform technology of regenerative (stem cell) therapies using adult stem cells derived from a patient’s own adipose (fat) tissue.  In addition, this acquisition provides us technology in the field of stem cell preservation and banking, offering the opportunity for people worldwide to bank their stem cells for later personal use.

Our bioresorbable implants are made from a polylactide copolymer composed of lactic acid similar to that which occurs naturally in the human body.  The polymer implant maintains its strength during the healing process, while slowly breaking down in the body through hydrolysis.  The polymer fragments into single lactic acid molecules, and the lactic acid molecules are then metabolized by the liver into carbon dioxide and water, and released from the body through the lungs.

We have received regulatory clearance or approval to market and sell some of our bioresorbable implant products in the United States, Canada, Europe and other countries.

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In January 2000, we entered into an exclusive worldwide Distribution Agreement with Medtronic for the global marketing and distribution of some of our products for use in CMF applications. We also entered into a Development and Supply Agreement with Medtronic, in January 2000, to co-develop bioresorbable implants for use in spinal fixation, stabilization and fusion applications and supply any such new implants to Medtronic as the distributor.  As mentioned above, in September 2002, we entered into an agreement to sell substantially all of the assets related to the CMF product line to a subsidiary of Medtronic.  The sale included a perpetual exclusive license to certain intangible assets to be used in the CMF surgical field, along with use of our bioresorbable implants for repair of the bone harvest site in the iliac crest.  We retained all other rights to use the intangible assets in other parts of the body.  In another agreement with Medtronic on the same day, we extended the term of our existing co-development and supply agreement for spinal implants to 2012, and obtained a waiver of the right of first offer to market our bioresorbable films in certain fields.

We are continuing development of new products and materials useful for the repair and regeneration of bone.  We are currently engaged in a clinical marketing study related to our FDA approved faster-resorbing polymer (FRP) which may be particularly useful in treating pediatric patients due to their rapid rate of bone growth, and we are developing additional products for use in spinal fusion procedures, long-bone repair, healing of nonunion fractures and cyst or tumor removal site repair, among other things.  These future products may require further development and regulatory clearance or approval, potentially including clinical trials, prior to marketing and commercial use.

Building on our initial biomaterials platform technology, we have developed the SurgiWrap™ and CardioWrap™ families of bioresorbable surgical thin film.  These products are constructed from the same polylactide copolymer as our other implants.  Our bioresorbable thin films have present and potential clinical applications across multiple surgical specialties in which the primary intended market includes the control of postsurgical adhesions in cardiothoracic, general, spinal and obstetric surgeries.  We have not yet obtained clearance to market in the United States (“U.S.”) for postsurgical adhesion indications, although we have received clearance for postsurgical adhesion indications in Europe and in other countries.  In addition to its soft tissue reinforcement properties, extensive preclinical research has demonstrated that our bioresorbable film also acts as a barrier, controlling the formation of fibrous bands which cause adhesions.

In 2001 we received our first regulatory clearances from the FDA to market our SurgiWrap™ bioresorbable film for reinforcement of soft tissues throughout the body and as a bridging material where indicated.  Some of the uses include, but are not limited to, repair of fascial defects including vaginal prolapse repair, colon and rectal prolapse repair, and reconstruction of the pelvic floor.  Additional U.S. clearance includes the prevention of postsurgical adhesions in specific ear, nose and throat (“ENT”) procedures.  In June 2002, we hired a direct sales force in the U.S. to sell SurgiWrap™ film as an adhesion control product for specified ENT procedures and for soft tissue support.  The sales team covered some of  the major metropolitan areas in the U.S. market.

In 2002 we received the CE Mark (marketing clearance in Europe) to market our bioresorbable film (SurgiWrap™ ) for the prevention of postsurgical adhesions in cardiothoracic, general, spinal and gynecological & obstetric (“OB/GYN”) surgeries.  In Canada, Thailand, Korea, Mexico, Peru, Singapore, Malaysia and Australia we have received clearance to market our surgical film for the prevention of adhesions in the heart, spine, peritoneal cavity (including bowels and organs) and OB/GYN surgeries.  To date we have established distribution agreements with a network of 29 independent international distributors to sell our bioresorbable surgical film throughout Europe, South America, the Middle East and the Far East.

Through the acquisition of StemSource in November 2002, we are moving to advance stem cell

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therapies that promote the healing or regeneration of the patient’s own tissues with the patient’s own stem cells.  We believe adult stem cells, harvested from the patient’s fat tissue through a liposuction procedure, have the ability to offer replacement cells to treat life-altering or life-threatening disorders.  StemSource’s approach has significant advantages over many other stem cell technologies.   StemSource developed devices and techniques to harvest adult stem cells from fat, and demonstrated the ability of adipose (fat)-derived stem cells to differentiate into a variety of tissues in vitro .

A stem cell is an unspecialized cell that can become many of the two-hundred-plus tissues that make up the body.  Of the two types of stem cells, adult (found in various tissues after birth), and embryonic (fetal tissue), our efforts are exclusively directed toward adult stem cell autologous transplantation (separation of the stem cells from a person’s fat and delivering them back to the same person where needed).

The acquisition of StemSource has also provided us a California state-licensed tissue bank facility for the preservation of extracted stem cells.  Typically arranged through a patient’s physician, stem cell banking is the process by which adult stem cells, taken from a liposuction or other procedure, are stored (cryopreserved) in a liquid nitrogen freezer at -320°F (-196°C) exclusively for the particular patient who banked them. The banked stem cells, frozen in suspended animation, can be preserved for the life of the individual.

We are required to obtain from the Food and Drug Administration regulatory clearance of our medical device products that we market in the United States.  In addition, we must obtain marketing authorization for our products that we market in Europe, Canada, Mexico and certain other non-U.S. jurisdictions.  During 2002 and 2003, we received additional regulatory clearance or marketing authorization for our products from various jurisdictions, for the following indications:

•                   the use of our SurgiWrap ^TM surgical barrier film to cover orbital implants used in enucleation  (eye removal) surgery and to protect the surrounding orbital tissue from the surface of the implant (U.S.)

•                   the use of our HYDROSORB™ TELAMON™ device to maintain the relative position of bone graft material and to promote fusion in the lumbar spine (in Europe – HYDROSORB™ is a trademark of Medtronic, Inc.)

•                   the use of our bioresorbable adhesion barrier film to prevent the formation or reformation of adhesions and promote the formation of a surgical dissection plane to include the following anatomical regions: pericardium, epicardium, and retrosternal (Canada, Thailand, Korea, Australia)

•                   the use of our bioresorbable adhesion barrier film (in Europe) as a temporary physical barrier to separate opposing tissues and prevent the in growth of scar tissues and the formation or reformation of adhesions immediately adjacent to the barrier film; aid in reoperation procedures by promoting the formation of a surgical dissection plane immediately adjacent to the barrier film; prevent the formation or reformation of adhesions and promote the formation of a surgical dissection plane to include the following anatomical regions:

a) Pericardium, epicardium, and retrosternal

b) Peritoneum, peritoneal cavity, bowels, cecum, organs

c) Dura, spinal dura, peridural, epidural

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d) OB/GYN (e.g. female pelvic, reproductive organs, ovaries, uterus, uterine tubes, etc.)

•                   the use of our orthopedic graft containment products (OS Trauma) to support weak bony tissue in orthopedic reconstruction procedures including iliac crest and rib reconstructions

We are also developing additional products for use in spinal fusion procedures, soft tissue repair, adhesion control products and long-bone repair, among other things.  These future products may require further development and regulatory clearance or approval, potentially including clinical trials, prior to marketing and commercial use.

We continue to seek patent protection for our new products as evidenced by our recent receipt of a U.S. patent (No. 6,531,146) for our family of bioresorbable thin films (SurgiWrap ^TM /CardioWrap ^TM ) for the control of postsurgical adhesions, as well as a new patent in Australia (No. 752357) for our macro-porous mesh.

         For the six months ended June 30, 2003 and 2002, revenues related to the craniomaxillofacial product line sold to Medtronic in September 2002 were $1,226,000 and $1,296,000, respectively.  Included in revenue for the six months ended June 30, 2003 was $788,000 related to the amortization of the deferred gain on sale of assets, related party.  For the three months ended June 30, 2003 and 2002, revenues related to the craniomaxillofacial product line were $613,000 and $627,000, respectively.  Included in revenue for the three months ended June 30, 2003 was $407,000 related to the amortization of the deferred gain on sale of assets, related party.  We continue to be a backup supplier to Medtronic for the acquired products during a transition period, which we expect to be completed in the fourth quarter of 2003 or the first quarter of 2004.  The amortization of deferred gain on the sale of assets, related party, relates to the sale of the CMF product line to Medtronic in September 2002.  A portion of the deferred gain is recognized as revenue under the backup supplier agreement with Medtronic which provides for sales of CMF products at cost.  Discounts from the previously agreed price have been recorded as a reduction to the deferred gain on sale of assets, related party.

Medtronic continues to be a significant stockholder of MacroPore and our largest customer, as the primary distributor of our bioresorbable implant products for use in musculoskeletal applications.  Under the Amended Development Agreement, we sell these products to Medtronic at fixed selling prices which are subject to adjustment upon biannual reviews.  Therefore, our revenues, operating results and cash flow will be affected by fluctuations in the cost of sales, sales volumes and operating expenses.  Although the Amended Development Agreement provides that direct selling costs are borne by the distributor, our cash flow may be adversely affected if our fixed costs increase and we are unable to negotiate or otherwise obtain an increase in product pricing with Medtronic.

We incurred net losses of $5,339,000 for the six months ended June 30, 2003, $13,003,000 and $11,207,000 for the years ended December 31, 2002 and 2001, respectively.  As of June 30, 2003, we had an accumulated deficit of $45,441,000.  These net losses resulted to a large extent from expenses associated with developing bioresorbable implant designs, performing preclinical studies, preparing  submissions to the FDA and foreign regulatory agencies, expanding marketing and distribution channels, further developing our manufacturing capabilities, securing intellectual property rights and trademarks and supporting our status as a public company.  We expect to expend substantial financial resources to expand marketing, training and customer support needed to generate and support higher sales, obtain additional regulatory clearances and to develop new products.  This investment is likely to result in continued operating losses for the foreseeable future until operational efficiencies are reached.

For the six months ended June 30, 2003, our $4,832,000 in revenue was composed of $4,671,000 or 96.7% from sales of our bioresorbable implant products for use in musculoskeletal, soft tissue

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applications, and craniomaxillofacial.  Craniomaxillofacial products were included in the September 2002 product line sale to Medtronic.  The $4,671,000 in revenue from bioresorbable implant products was comprised of $2,958,000 or 63.3% of musculoskeletal sales, $637,000 or 13.6% of thin film products for soft tissue applications and $1,076,000 or 23.1% of craniomaxillofacial revenue.  The $161,000 in revenue not related to bioresorbable implants was composed of $156,000 from sales of instruments and accessories used by surgeons to form, mold and manipulate our bioresorbable products during surgical procedures and $5,000 from our stem cell storage services.  Included in revenue for the three and six months ended June 30, 2003 was $407,000 and $787,000, respectively, related to the amortization of gain on sale of assets, related party.

Results of Operations

Three months ended June 30, 2003 compared to three months ended June 30, 2002

Revenues .  For the three months ended June 30, 2003, revenues were $2,903,000 compared to $2,707,000 for the three months ended June 30, 2002, an increase of $196,000, or 7.2%.  The revenue for the three months ended June 30, 2003 was comprised of $1,972,000 in musculoskeletal applications, $317,000 in thin film products, $613,000 in craniomaxillofacial products of which $408,000 related to the amortization of gain on sale of assets, related party and $1,000 in stem cell storage services.  The revenue for the three months ended June 30, 2002 was composed of $2,001,000 in musculoskeletal applications of which $150,000 related to an engineering project that involved musculoskeletal products, $4,000 in thin film products, $627,000 in craniomaxillofacial products and $75,000 that related to craniomaxillofacial product license fees.  Excluding the musculoskeletal engineering project of $150,000 in 2002, the $121,000 increase in musculoskeletal products revenue in the three months ended June 30, 2003 related to replenishment orders exceeding an initial stocking order in the three months ended June 30, 2002.  The $313,000 increase in bioresorbable thin film product revenue in the three months ended June 30, 2003 was attributable to increased market acceptance.  The $14,000 decrease in craniomaxillofacial products and the $75,000 decrease in license fee revenue in the three months ended June 30, 2003 related to Medtronic continuing to transition the manufacturing of craniomaxillofacial production to their own facilities.  We expect craniomaxillofacial product sales to continue to decrease throughout 2003 and cease shortly thereafter.  Revenues attributable to Medtronic, which owns approximately 6.9% of our outstanding common stock, represented 89.0% of our revenues for the three months ended June 30, 2003, compared to 99.7% for the three months ended June 30, 2002.  The decrease in the revenue percentage attributable to Medtronic relates to the distribution of our bioresorbable thin film products by our own direct sales force and other third party distributors in the three months ended June 30, 2003 and the sale of craniomaxillofacial product line to Medtronic in September 2002.

Cost of revenues .  For the three months ended June 30, 2003, cost of revenues was $787,000 or 27.1% compared to $981,000 or 36.2% of revenues for the three months ended June 30, 2002.  Cost of revenues includes material, manufacturing labor and overhead costs.  Included in the cost of revenue in the three months ended June 30, 2002 was $188,000 of costs associated with an engineering project that involved musculoskeletal products.  Excluding the costs associated with the engineering project and $150,000 of related revenue, the cost of revenue percentage would be 31.0% for the three months ending June 30, 2002.  Excluding the engineering project, the decrease of 3.9% in cost as a percentage of revenues in the three months ended June 30, 2003 was primarily attributable to increased sales revenue that allowed us to absorb more of our fixed manufacturing labor and overhead costs.  The continued reduction of revenues as a result of the sale of the craniomaxillofacial product line in September 2002 could negatively impact our margins until our other products’ sales grow enough to replace the lost revenue.

Gross profit .  For the three months ended June 30, 2003, gross profit was $2,116,000 or 72.9% of

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revenues, compared to $1,726,000 or 63.8% of revenues for the three months ended June 30, 2002.  The increase in gross profit as a percentage of revenues was primarily attributable to increased revenue and the ability to absorb more of our fixed manufacturing labor and overhead costs, as discussed above.

Research and development expenses .  For the three months ended June 30, 2003, research and development expenses excluding related stock based compensation expenses were $2,107,000, compared to $1,388,000 for the three months ended June 30, 2002, an increase of $719,000 or 51.8%.  Research and development expenses include costs associated with the design, development, testing and enhancement of our products, regulatory fees, the purchase of laboratory supplies and preclinical studies.  The $719,000 increase in research and development expenses in the three months ended June 30, 2003 as compared to the three months ended June 30, 2002 was primarily attributable to our expenditures in the biologic (stem cell) platform technology.  We expended $1,066,000 in the development of our biologic platform technology in the three months ended June 30, 2003 by employing 12 researchers, engineers and support staff, in addition to incurring other significant expenses related to regulatory, consulting, and facilities to develop this technology.  There were no comparable expenses in the three months ended June 30, 2002.  We spent $1,041,000 in our biomaterial platform technology relating to the development of musculoskeletal products and faster-resorbing polymer products in the three months ended June 30, 2003 as compared to $1,388,000 in the three months ended June 30, 2002.  The $347,000 decrease in spending during the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, was attributable to the successful development of our thin film product line and the discontinuance of development of the craniomaxillofacial product line which was sold to Medtronic.  In addition, stock based compensation related to research and development was $20,000 for the three months ended June 30, 2003 and $25,000 for the three months ended June 30, 2002.  For further information regarding stock based compensation, you should read the discussion under the section entitled “Stock based compensation expenses.”  We expect research and development spending for the year ended December 31, 2003 to increase by approximately $3,000,000 as compared to the year ended December 31, 2002 as we continue to support the research and development of therapies based on adult stem cells which we acquired with the purchase of StemSource.  We also plan to continue to fund the product development efforts and seek further regulatory approvals for our current bioresorbable product lines related to musculoskeletal and thin film.

Sales and marketing expenses .  For the three months ended June 30, 2003, sales and marketing expenses excluding related stock based compensation expenses were $1,004,000, compared to $1,026,000 for the three months ended June 30, 2002, a decrease of $22,000 or 2.1%.  Sales and marketing expenses include costs for marketing personnel, tradeshow expenses, and promotional activities and materials.  We use Medtronic for the distribution of our musculoskeletal product lines; therefore, we are focusing our sales and marketing efforts on our thin film product line domestically through a dedicated sales force and internationally through independent distributors.  The $22,000 decrease in sales and marketing expenses in the three months ended June 30, 2003 as compared to the three months ended June 30, 2002 was primarily attributable to the expense of a sales and marketing team dedicated to selling our thin film product line which was offset by the decision not to supplement Medtronic’s marketing of our products.  We spent $728,000 for sales and marketing to directly sell our thin film product line domestically in the three months ended June 30, 2003, as compared to $376,000 in expense in the three months ended June 30, 2002.  The $352,000 increase in such spending in the three months ended June 30, 2003 primarily related to the labor costs of our sales and marketing team being employed for the full three months as compared to the three months ended June 30, 2002 where they were hired in the last month of the period.  We spent $180,000 in international sales and marketing of thin film during the three months ended June 30, 2003 as compared to $128,000 in for the three months ended June 30, 2002.  The $52,000 increase in such spending during the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, was attributable to the labor and travel expenses relating to developing international distributors and a sales office in Japan for the thin product line.  We spent $96,000 in general product and corporate

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marketing expenditures in the three months ended June 30, 2003, or $427,000 less than in the three months ended June 30, 2002 which was a result of our decision not to continue to supplement Medtronic’s marketing of our musculoskeletal and craniomaxillofacial product lines.   In addition, stock based compensation related to sales and marketing was $18,000 for the three months ended June 30, 2003 and $34,000 for the three months ended June 30, 2002.  For further information regarding fluctuations in sales and marketing inclusive of stock based compensation, you should read the discussion under the section entitled “Stock based compensation expenses”.  We do not expect to make significant marketing expenditures related to our biologic platform technology until our research and development efforts result in commercially viable products.  We expect sales and marketing expenses to increase approximately $1,000,000 in 2003 as compared to 2002 as we continue our promotional efforts related to the thin film product line with a dedicated sales force.

General and administrative expenses .  For the three months ended June 30, 2003, general and administrative expenses excluding related stock based compensation expenses were $951,000, compared to $855,000 for the three months ended June 30, 2002, an increase of $96,000 or 11.2%.  General and administrative expenses include costs for administrative personnel, legal and other professional expenses and general corporate expenses.  The $96,000 increase in general and administrative expenses for the three months ended June 30, 2003 was primarily attributable to a $183,000 increase that related to domestic salaries, legal, amortization of intangibles and other general corporate expenditures that were offset by a $87,000 decrease in international salaries, meeting and conferences and other general expenditures.  In addition, stock based compensation related to general and administrative expenses was $174,000 for the three months ended June 30, 2003, compared to $216,000 for the three months ended June 30, 2002.  For further information regarding fluctuations in general and administrative expenses inclusive of stock based compensation, you should read the discussion under the section entitled “Stock based compensation expenses.”  We expect general and administrative expenses in absolute dollars to remain at current levels for the remainder of the year ending December 31, 2003.

Stock based compensation expenses .  For the three months ended June 30, 2003, total non-cash stock based compensation expenses classified in operating expenses were $212,000, compared to $275,000 for the three months ended June 30, 2002, a decrease of $63,000, or 22.9%.  Stock based compensation results from options issued to employees, directors and non-employees.  The stock based compensation relating to employees and directors represents the difference between the exercise price of the stock based awards and the deemed market value of the underlying common stock on the date of the grant.  The stock based compensation relating to non-employees represents the fair value of the underlying common stock on the initial date of grant, then marked to market over the vesting period until meeting the performance commitment.  Unearned stock based compensation is amortized over the remaining vesting periods of the options, which generally vest over a four year period from the date of grant.  The overall decrease in stock based compensation expense was related to the normal amortization of the stock based compensation expense over the remaining vesting periods.  There was no stock based compensation expense relating to non-employees for the three months ended June 30, 2003.

Interest income.   For the three months ended June 30, 2003, interest income was $105,000, compared to $263,000 for the three months ended June 30, 2002, a decrease of $158,000, or 60.1%.  The decrease in interest income resulted from lower interest rates and a decrease in funds we had available for investments.

Interest and other expenses .  For the three months ended June 30, 2003, interest and other expenses were $6,000 in expense compared to $9,000 in income for the three months ended June 30, 2002, an increase of $15,000 or 166.7% in expense.  The increase in interest and other expense related to the interest expense on our long-term debt obligations not continuing to be offset by foreign currency gains.

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Equity loss in investment .  For the three months ended June 30, 2002, our equity loss in investment was $57,000, with no comparable loss in the three months ended June 30, 2003.  The loss related entirely to our former 13.5% equity interest in StemSource, which we accounted for using the equity method.  Under the equity method of accounting, we recognized a pro rata share of StemSource’s operating losses.  In November 2002 we acquired 100% of the outstanding stock of StemSource and now include 100% of StemSource in the results of operations.

Six months ended June 30, 2003 compared to six months ended June 30, 2002

Revenues .  For the six months ended June 30, 2003, revenues were $4,832,000 compared to $3,817,000 for the six months ended June 30, 2002, an increase of $1,015,000, or 26.6%.  The revenue for the six months ended June 30, 2003 was comprised of $2,964,000 in musculoskeletal applications, $637,000 in thin film products, $1,226,000 in craniomaxillofacial products of which $788,000 relates to the amortization of gain on sale of assets, related party and $5,000 in stem cell storage services.  The revenue for the six months ended June 30, 2002 was composed of $2,367,000 in musculoskeletal applications of which $150,000 related to an engineering project that involved musculoskeletal products, $4,000 in thin film products, $1,296,000 in craniomaxillofacial products and $150,000 that related to craniomaxillofacial product license fees.  Excluding the musculoskeletal engineering project of $150,000 in 2002, the $747,000 increase in musculoskeletal products revenue in the six months ended June 30, 2003 related to the increase in availability of the product from limited clinical evaluations to a full product release.  The $633,000 increase in bioresorbable thin film revenue in the six months ended June 30, 2003 was attributable to increased market acceptance.  The $70,000 decrease in craniomaxillofacial products and the $150,000 decrease in license fee revenue in the six months ended June 30, 2003 relates to Medtronic continuing to transition the manufacturing of craniomaxillofacial production to their own facilities.  We expect craniomaxillofacial product sales to continue to decrease throughout 2003 and cease shortly thereafter.  Revenues attributable to Medtronic represented 86.7% of our revenues for the six months ended June 30, 2003, compared to 99.5% for the six months ended June 30, 2002.  The decrease in the revenue percentage attributable to Medtronic relates to the distribution of our bioresorbable thin film products by our own direct sales force and other third party distributors in the six months ended June 30, 2003 and the sale of the craniomaxillofacial product line to Medtronic in September 2002.

Cost of revenues .  For the six months ended June 30, 2003, cost of revenues was $1,426,000 or 29.5% of revenues, compared to $1,531,000 or 40.1% of revenues for the six months ended June 30, 2002.  Cost of revenues includes material, manufacturing labor and overhead costs.  Included in the cost of revenue in the six months ended June 30, 2002 was $188,000 of costs associated with an engineering project that involved musculoskeletal products.  Excluding the costs associated with the engineering project and $150,000 of related revenue, the cost of revenue percentage would have been 36.6% for the six months ending June 30, 2002.  Excluding the engineering project, the decrease of 7.4% in cost as a percentage of revenues in the six months ended June 30, 2003 was primarily attributable to increased sales revenue that allowed us to absorb more of our fixed manufacturing labor and overhead costs.  The continued reduction of revenues as a result of the sale of the craniomaxillofacial product line in September 2002 could negatively impact our margins until our other products’ sales grow large enough to replace the lost revenue.

Gross profit .  For the six months ended June 30, 2003, gross profit was $3,406,000 or 70.5% of revenues, compared to $2,286,000 or 59.9% of revenues for the six months ended June 30, 2002.  The increase in gross profit as a percentage of revenues was primarily attributable to increased revenue and the ability to absorb more of our fixed manufacturing labor and overhead costs, as discussed above.

Research and development expenses .  For the six months ended June 30, 2003, research and development expenses excluding related stock based compensation expenses were $4,258,000, compared

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to $2,873,000 for the six months ended June 30, 2002, an increase of $1,385,000 or 48.2%.  Research and development expenses include costs associated with the design, development, testing and enhancement of our products, regulatory fees, the purchase of laboratory supplies and preclinical studies.  The $1,385,000 increase in research and development expenses in the six months ended June 30, 2003 as compared to the six months ended June 30, 2002 was primarily attributable to our expenditures in the biologic (stem cell) platform technology.  We expended $1,902,000 in the development of our biologic platform technology in the six months ended June 30, 2003 by employing 12 researchers, engineers and support staff, in addition to, incurring other significant expenses related to regulatory, consulting, and facilities to develop this technology.  There were no comparable expenses in the six months ended June 30, 2002.  We spent $2,356,000 in our biomaterial platform technology development of musculoskeletal products and faster-resorbing polymer products in the six months ended June 30, 2003 as compared to $2,873,000 in the six months ended June 30, 2002.  The $517,000 decrease in spending during the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, was attributable to the successful development of our thin film product line and the discontinuance of development of the craniomaxillofacial product line which was sold to Medtronic.  In addition, stock based compensation related to research and development was $39,000 for the six months ended June 30, 2003 and $160,000 for the six months ended June 30, 2002.  For further information regarding stock based compensation, you should read the discussion under the section entitled “Stock based compensation expenses.”

Sales and marketing expenses .  For the six months ended June 30, 2003, sales and marketing expenses excluding related stock based compensation expenses were $2,299,000, compared to $1,697,000 for the six months ended June 30, 2002, an increase of $602,000 or 35.5%.  Sales and marketing expenses include costs for marketing personnel, tradeshow expenses, and promotional activities and materials.  We use Medtronic for the distribution of our musculoskeletal product lines; therefore, we are focusing our sales and marketing efforts on our thin film product line domestically through a dedicated sales force and internationally through independent distributors.  The $602,000 increase in sales and marketing expenses in the six months ended June 30, 2003 as compared to the six months ended June 30, 2002 was primarily attributable to the expense of a sales and marketing team dedicated to selling our thin film product line which was offset by the decision not to supplement Medtronic’s marketing of our products.  We spent $1,630,000 for sales and marketing to sell directly our thin film product line domestically in the six months ended June 30, 2003, as compared to $376,000 in expense in six months ended June 30, 2002. The $1,254,000 increase spending in the six months ended June 30, 2003 primarily related to the labor costs of our sales and marketing team being employed for the full six months as compared to the six months ended June 30, 2002 where they were hired in the last month of the period.  We spent $473,000 in international sales and marketing of thin film during the six months ended June 30, 2003 as compared to $213,000 in the six months ended June 30, 2002.  The $260,000 increase in such spending during the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, was attributable to the labor and travel expenses relating to developing international distributors and a sales office in Japan for the thin film product line.  We spent $196,000 in general product and corporate marketing expenditures in the six months ended June 30, 2003 or $912,000 less than the six months ended June 30, 2002 which was a result of our decision not to continue to supplement Medtronic’s marketing of our musculoskeletal and craniomaxillofacial product lines.  In addition, stock based compensation related to sales and marketing was $36,000 for the six months ended June 30, 2003 and $67,000 for the six months ended June 30, 2002.  For further information regarding fluctuations in sales and marketing inclusive of stock based compensation, you should read the discussion under the section entitled “Stock based compensation expenses”.

General and administrative expenses .  For the six months ended June 30, 2003, general and administrative expenses excluding related stock based compensation expenses were $1,999,000, compared to $1,968,000 for the six months ended June 30, 2002, an increase of $31,000 or 1.6%.  General and administrative expenses include costs for administrative personnel, legal and other

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professional expenses and general corporate expenses.  The $31,000 increase in general and administrative expenses for the six months ended June 30, 2003 was primarily attributable to a $71,000 increase that related to the amortization of intangibles which was moderated by lower domestic salaries, legal and other general corporate expenditures and was further offset by a $40,000 decrease in international salaries, legal and other general corporate expenditures.  In addition, stock based compensation related to general and administrative expenses was $350,000 for the six months ended June 30, 2003, compared to $517,000 for the six months ended June 30, 2002.  For further information regarding fluctuations in general and administrative expenses inclusive of stock based compensation, you should read the discussion under the section entitled “Stock based compensation expenses.”

Stock based compensation expenses .  For the six months ended June 30, 2003, total non-cash stock based compensation expenses classified in operating expenses were $425,000, compared to $744,000 for the six months ended June 30, 2002, a decrease of $319,000, or 42.9%.  Stock based compensation results from options issued to employees, directors and non-employees.  The stock based compensation relating to employees and directors represents the difference between the exercise price of the stock based awards and the deemed market value of the underlying common stock on the date of the grant.  The stock based compensation relating to non-employees represents the fair value of the underlying common stock on the initial date of grant, then marked to market over the vesting period until meeting the performance commitment.  Unearned stock based compensation is amortized over the remaining vesting periods of the options, which generally vest over a four year period from the date of grant.  The overall decrease in stock based compensation expense was related to the acceleration of vesting and other modifications to compensatory stock options granted to our former president and stock options granted to consultants for services rendered in the six months ended June 30, 2002.  The decrease of $121,000 in research and development stock based compensation expense was primarily due to issuing 50,000 fully vested stock options to non-employees for consulting services rendered in the six months ended June 30, 2002.  The decrease of $31,000 in sales and marketing stock based compensation expense was due primarily to less than a full period of cost being expensed in the last year of vesting.  The decrease of $167,000 in general and administrative stock based compensation expense was primarily due to additional expenses recorded in the six months ended June 30, 2002 as a result of accelerating vesting and modifying the exercise period of certain stock options held by our former president.  There was no stock based compensation expense relating to non-employees for the six months ended June 30, 2003.

Interest income.   For the six months ended June 30, 2003, interest income was $247,000, compared to $637,000 for the six months ended June 30, 2002, a decrease of $390,000, or 61.2%.  The decrease in interest income resulted from lower interest rates and a decrease in funds we had available for investments.

Interest and other expenses .  For the six months ended June 30, 2003, interest and other expenses were $11,000, compared to $65,000 for the six months ended June 30, 2002, a decrease of $54,000 or 83.1%.  The decrease in interest and other expense related to a decrease in interest expense on our long-term debt obligations which principal balances have decreased.

Equity loss in investment .  For the six months ended June 30, 2002, our equity loss in investment was $113,000, with no comparable loss in the six months ended June 30, 2003.  The loss related entirely to our former 13.5% equity interest in StemSource, which we accounted for using the equity method.  Under the equity method of accounting, we recognized a pro rata share of StemSource’s operating losses.  In November 2002 we acquired 100% of the outstanding stock of StemSource and now include 100% of StemSource in the results of operations.

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Gain on Asset Sale to Medtronic

We have not yet recognized the full gain on the September 2002 asset sale to Medtronic, and will not do so until we successfully transfer the technology and know how, including training, related to the manufacture of the craniomaxillofacial product line, which we expect to occur in the fourth quarter of 2003 or the first quarter of 2004.  However, we have recognized approximately $1,053,000 of the gain as revenue related to the sale of CMF product to Medtronic under our backup supply arrangement, which provides for sales of CMF products to Medtronic at cost.  Discounts from the previously agreed price have been recorded as a reduction to the deferred gain.  We have recorded $8,798,000 of unamortized “Deferred gain on sale of assets, related party” on our balance sheet at June 30, 2003.

Liquidity and Capital Resources

As of June 30, 2003, we had cash and cash equivalents, and short-term investments, available-for-sale, of $18,696,000 and working capital of $19,091,000.  Since inception, we have financed our operations primarily through sales of stock and from the September 2002 product line sale to Medtronic.  Our sales of preferred stock in 1999, 1998 and 1997 yielded net proceeds of $14,679,000.  On August 8, 2000, we completed our initial public offering in Germany and listed our common stock for trading on the Frankfurt Stock Exchange in Frankfurt, Germany, at which time the outstanding shares of our preferred stock were converted into 6,831,398 shares of common stock.  We received net proceeds of $43,244,000 from the sale of 3,500,000 shares of our common stock in our initial public offering.  A portion of those net proceeds have been used for research and development, to expand our manufacturing operations, to promote our brand and to pursue regulatory approvals for our products.  In addition, some of the proceeds have been used for working capital and general corporate purposes.  We have invested some of the proceeds from the offering in short-term investments, pending other uses of the proceeds in our business.

Our capital requirements depend on numerous factors, including market acceptance of our products and regulatory approvals, the resources we devote to developing and supporting our products and other factors.  We expect to devote substantial capital resources to continue our research and development efforts, to expand our support and product development activities and for other general corporate activities.  We believe that our current cash and cash equivalents, short-term investments, available for sale, and revenue to be derived from the sale of our products will be sufficient to fund our operations at least through June 30, 2004.  Due to the acquisition of StemSource, we will also have to commit substantial cash resources to fund StemSource’s development activities in 2003, which is estimated at approximately $4,000,000 in 2003.  Our strategic concept is to use the cash from the Medtronic asset sale to enable us to undertake the StemSource opportunity without depriving our remaining bioresorbable product lines of capital resources which would otherwise have been available to them.  Nonetheless, until we begin to generate sufficient revenues from our bioresorbable products operations to cover our operating costs, we may need to seek additional sources of financing in the future.  We cannot give assurance that we will generate sufficient revenues to cover our bioresorbable products operating costs or that we will be able to obtain additional financing on terms satisfactory to us, if at all.

Net cash used in operating activities was $4,959,000 and $4,508,000 for the six months ended June 30, 2003 and 2002, respectively.  For each period, net cash used in operating activities resulted primarily from net losses and working capital requirements.  Net losses for each period resulted to a large extent from expenses associated with the development of our bioresorbable designs, preclinical studies, preparation of submissions to the FDA and foreign regulatory agencies, the establishment of marketing and distribution channels, and the improvement of our manufacturing capabilities.  In the six months ended June 30, 2003, net cash used in operating activities primarily related to our net loss of $5,339,000 and the following events: a decrease in accounts payable and accrued expenses of $577,000 related to payment of bonuses and outstanding raw materials invoices and $788,000 of non-cash amortization of gain on the sale of assets to a related party that related to products acquired by Medtronic under a back-up supplier agreement at discounts from previously agreed prices.  The cash used in these operating activities

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was offset by non-cash charges for depreciation and amortization of $822,000 and stock based compensation of $431,000, and other current assets of $268,000 primarily related to the collection of non-trade receivables.   In the six months ended June 30, 2002, net cash used in operating activities primarily related to our net loss of $4,537,000, increases in accounts receivable of $1,312,000 and  inventory of $477,000, offset by non-cash charges of $723,000 of depreciation and amortization and $751,000 for stock based compensation.  Our working capital requirements fluctuate with changes in our operating activities that include such items as sales and manufacturing costs, which affect the levels of accounts receivable, inventories and current liabilities.  We expect to use less cash in operating activities as our product lines become more profitable, further offsetting the associated costs.

Net cash provided by investing activities was $2,348,000 and $8,312,000 for the six months ended June 30, 2003 and 2002, respectively.  Net cash provided by investing activities for the six months ended June 30, 2003 consisted of net proceeds from the sale of short-term investments, which was offset by the purchase of fewer short-term investments (i.e. we cashed in short-term investments to fund our operating activities and our financing activities).  In the six months ended June 30, 2003 we purchased $531,000 in property and equipment primarily to support biomaterial manufacturing and research and development of the biologics platform technology and incurred $344,000 of costs associated with the acquisition of StemSource related to additional professional services and excess facility capacity relating to a StemSource lease.  Net cash provided by investing activities for the six months ended June 30, 2002 consisted of net proceeds from the purchase and sale of short-term investments, which was offset by capital expenditures and loans (which have been repaid) to our corporate officers.  We expect to continue to have cash provided by investing activities as we sell our short-term investments to provide cash for our operating activities and property and equipment purchases.

Net cash used in financing activities was $409,000 and $3,055,000 for the six months ended June 30, 2003 and 2002, respectively.  Net cash used in financing activities for the six months ended June 30, 2003 was primarily related to $249,000 for our repurchase of 63,499 shares of our common stock on the open market at an average price of $3.92 per share and $173,000 for payments of long term obligations.  Net cash used by financing activities for the six months ended June 30, 2002 was primarily related to $2,783,000 for the repurchase of 836,945 shares of our common stock at an average price of $3.33 and $225,000 for payments toward long term obligations.  On April 9, 2002 and September 17, 2002, the Board of Directors amended the April 3, 2001 authorization to purchase treasury stock and authorized the repurchase of up to 3,000,000 shares of the Company’s common stock in the open market, from time to time until September 16, 2003, subject to the Company’s assessment of market conditions and buying opportunities, and at a purchase price per share not to exceed €15.00, based on the exchange rate in effect on September 17, 2002.

In October 2000, we issued $2,433,000 of equipment financing promissory notes that mature in October 2005 at an interest rate of 9.3%.  In 2002 we prepaid $621,000 relating to a 48 month promissory note and the lender changed the terms of this promissory note to bear interest at 8.8% per annum with principal and interest due in monthly payments of approximately $34,000, maturing over 35 months and secured by equipment with a cost of $1,442,000 .

As of June 30, 2003, we had property and equipment of $6,678,000, less accumulated depreciation of $3,207,000, to support our clinical, research, development, manufacturing and administrative activities.  Our capital expenditures were $531,000 and $761,000 for the six months ended June 30, 2003 and 2002, respectively.  We expect capital expenditures for the next twelve months to be approximately $500,000 as we acquire additional equipment and expand our facilities that include capital expenditures for our biologics platform technology.  We intend to pay for future capital expenditures with available working capital.

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The following summarizes our contractual obligations and other commitments at June 30, 2003, and the effect such obligations could have on our liquidity and cash flow in future periods:

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of our assets, liabilities, revenues and expenses, and that affect our disclosure of contingent assets and liabilities.  While our estimates are based on assumptions we consider reasonable at the time they were made, our actual results may differ from our estimates, perhaps significantly.  If results differ from our estimates, we will make adjustments to our financial statements as we become aware of the necessity for an adjustment.  Specifically, we make estimates in the following areas:

Revenue Recognition.  We sell our products to hospitals and distributors.  Revenue from sales to hospitals is recognized upon delivery of the product.  We have agreements with our distributors that title and risk of loss pass upon shipment of the products to the distributor.  We warrant that our products are free from manufacturing defects at the time of shipment to the distributor.  Revenue is recognized upon shipment of products to distributors following receipt and acceptance of a distributor’s purchase order.

Revenue from license agreements is recognized ratably over the term of the agreement, provided no significant obligations remain.

We recognize revenue from the collection and storage of Stem Cell rich adipose tissue.  In our StemBank operations, we recognize revenue when the collection procedure is performed and the adipose tissue is received by MacroPore; fees from the procedure are fixed and determinable, and payment is probable.  We use the residual method to recognize revenue when a procedure includes elements to be delivered at a future date if evidence of the fair value of all undelivered elements exists.  If evidence of the fair value of the undelivered elements does not exist, revenue is deferred on all elements and recognized when all elements are delivered.

We recognize revenue from Stem Cell storage services as the services are performed.

We earn revenue for performing services under development agreements.  Milestone payments are considered to be payments received for the accomplishment of a discrete, substantive earnings event.  The non-refundable payment arising from the achievement of a defined milestone is recognized as revenue when the performance criteria for that milestone have been met if substantive effort is required to achieve the milestone, the amount of the milestone payments appears reasonably commensurate with the effort expended and collection of the payment is reasonably assured.  Income earned under development agreements are classified under revenues in our statement of operations.  The costs associated with development agreements are recorded as research and development expense.

Additionally, we earn revenue from contracted development arrangements.  These arrangements are generally time and material arrangements and accordingly any revenue is recognized as services are

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performed.  Any costs related to these arrangements are recognized as cost of revenue as these costs are incurred.

A majority of our revenues are from Medtronic, under its Distribution Agreement dated January 5, 2000 and amended December 22, 2000 and October 8, 2002, as well as its Development and Supply Agreement dated January 5, 2000 and amended December 22, 2000 and September 30, 2002.

Allowance for doubtful accounts.   We provide a reserve against our receivables for estimated losses that may result from our customers’ inability to pay.  These reserves are based on known uncollectible accounts, aged receivables, historical losses and our estimate of our customers’ credit-worthiness.  Should a customer’s account become past due, we generally place a hold on the account and discontinue further shipments to that customer, minimizing further risk of loss.  The likelihood of our recognition of a material loss on an uncollectible account mainly depends on deterioration in the economic financial strength of the customer and the general business environment.  Medtronic is our single largest customer, directly accounting for 86.7% and 99.5% of our revenues in the six months ended June 30, 2003 and 2002, respectively.  We believe that our allowance for doubtful accounts as of June 30, 2003 with respect to Medtronic’s account is sufficient, given Medtronic’s collection history and overall financial strength.

Inventory .   We state inventories at the lower of average cost, determined on the first-in first-out method, or fair market value.  We review the components of our inventory on a regular basis for potential excess, obsolete and impaired inventory, based on estimated future usage.  The likelihood of any material adjustment of our stated inventory depends on whether there are significant changes in the competitive conditions in which we operate, new product introductions by us or our competitors, or fluctuations in customer demand.

We estimate our labor and overhead costs based on the estimated utilization of our labor force and manufacturing facilities.  We periodically evaluate these costs in order to determine that any excess capacity is treated as a period expense rather than capitalized.  The likelihood of a material change in our estimates of labor and overhead costs is directly related to manufacturing volume, which can vary significantly between reporting periods.

Accounting for income taxes:   As part of preparing our condensed consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate.  This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes.  These differences result in deferred tax assets and liabilities.  We establish valuation allowances, when necessary, to reduce deferred tax assets to the amount we expect to realize, using a “more likely than not” standard.

We have established a full valuation allowance against our deferred tax assets due to the uncertainty surrounding the realization of such assets, which consist mostly of net operating loss carryforwards.  We periodically evaluate the recoverability of the deferred tax asset.  The likelihood of a material change in our expected realization of these assets depends on our generation of future taxable income, our ability to deduct tax loss carryforwards against future taxable income and the effectiveness of our tax planning strategies in the various tax jurisdictions that we operate in.  At such time as it is determined that it is more likely than not that the deferred assets are realizable, the valuation allowance will be reduced.

Unearned Compensation

We record unearned compensation for options granted to employees as the difference between the exercise price of options granted and the fair market value of our common stock on the date of grant.

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Unearned compensation is amortized to stock based compensation expense and reflected as such in the Statement of Operations and Comprehensive Income (Loss).  Unearned compensation recorded through June 30, 2003 was $6,665,000 with an accumulated amortization, net of charges reversed during the period for the forfeiture of unvested awards, of $6,030,000.  The remaining $635,000 as of June 30, 2003 will be amortized using the straight-line method over the remaining vesting periods of the options, which generally vest over a four year period from the date of grant.  We expect to record amortization expense for unearned compensation of $422,000 for the period July 1, 2003 to December 31, 2003 and $213,000 in 2004.  The amount of unearned compensation expense recorded in future periods may decrease if unvested options for which unearned compensation has been recorded are subsequently forfeited.

Recent Accounting Pronouncements

In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”  SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  It applies to all entities and to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal operation of long-lived assets, except for some lessee obligations.  SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002.  The adoption of SFAS No. 143 did not have a material impact on our consolidated financial position or consolidated results of operations.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.  SFAS No. 145 updates, clarifies and simplifies existing accounting pronouncements including (i) rescinding Statement No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect, and (ii) amending Statement No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions.  SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with early adoption of the provisions related to the rescission of Statement No. 4 encouraged.  The adoption of SFAS No. 145 did not have a material impact on our consolidated financial position or consolidated results of operations.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities.  SFAS No. 146 also addresses recognition of certain costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees, and termination benefits provided to employees that are involuntarily terminated under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract.  SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have a material impact on our consolidated financial position or consolidated results of operations.

In December 2002, the FASB issued FASB Interpretation No. 45 (FIN 45).  FIN 45 provides guidance on how companies should record and disclose “guarantees.”  The primary principle of FIN 45 is that guarantees must be recorded as a liability, regardless of the probability of occurrence.  The amount of the liability to be accrued depends on the likelihood of the liability to occur.  The liability recognition provisions of FIN 45 shall be applied on a prospective basis to guarantees issued or modified after December 31, 2002.  Additionally, FIN 45 requires certain disclosures about guarantees in our December 31, 2002 consolidated financial statements.  The adoption of FIN 45 did not have a material impact on our consolidated financial position or consolidated results of operations as we currently do not have any

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guarantees falling within the scope of this standard.

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 148).”  This Statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  We have elected not to adopt the recognition and measurement provisions of SFAS No. 123 and continue to account for our stock-based employee compensation plan under APB Opinion No. 25 and related interpretations.  We have adopted the interim disclosure provisions required by SFAS 148 for our March 31, 2003 Form 10-Q.

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities”.  FIN 46 clarifies the application of Accounting Research Bulletin No. 51 - Consolidated Financial Statements to those entities defined as “Variable Interest Entities” (more commonly referred to as special purpose entities) in which equity investors do not have the characteristics of a “controlling financial interest” or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  FIN 46 applies immediately to all Variable Interest Entities created after January 31, 2003, and by the beginning of the first interim or annual reporting period commencing after June 15, 2003 for Variable Interest Entities created prior to February 1, 2003.  We do not expect this interpretation to have a material effect on our consolidated financial position or consolidated results of operations as we currently do not have any variable interest entities falling within the scope of FIN 46.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133.  In particular, SFAS No. 149 clarifies under what circumstances a contract within an initial net investment meets the characteristic of a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows.  SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003.  We do not expect this interpretation to have a material effect on our consolidated financial position or consolidated results of operations as we currently do not have any derivative instruments and hedging activities falling within the scope of SFAS No. 149.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.”  SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  Many of those instruments were previously classified as equity.  SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  We do not expect this interpretation to have a material effect on our consolidated financial position or consolidated results of operations.