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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 0-22025

Aastrom Biosciences, Inc.

24 Frank Lloyd Wright Drive

Registrant’s telephone number, including area code: (734) 930-5555

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 75 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes þ          No o

      The approximate aggregate market value of the registrant’s Common Stock, no par value (“Common Stock”), held by non-affiliates of the registrant (based on the closing sales price of the Common Stock as reported on the Nasdaq SmallCap Market) on December 31, 2003 was approximately $94 million. This computation excludes shares of Common Stock held by directors, officers and each person who holds 5% or more of the outstanding shares of Common Stock, since such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

      As of August 31, 2004, 83,076,168 shares of Common Stock, no par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

AASTROM BIOSCIENCES, INC.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

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      Except for the historical information presented, the matters discussed in this Report, including our product development and commercialization goals and expectations, revenue expectations, potential market opportunities, our plans and anticipated results of clinical development activities and the potential advantage of our products and product candidates under development, include forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under the caption “Business Risks” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unless the context requires otherwise, references to “we,” “us,” “our” and “Aastrom” refer to Aastrom Biosciences, Inc.

PART I

      We are a late-stage development company focused on the development of processes and products for the ex vivo production and sale of human cell products for use in cell therapy and regenerative medicine. Our pre-clinical and clinical product development programs utilize adult bone marrow stem and progenitor cells for forming solid tissues such as bone, vascular tissue, cartilage, and blood and immune system cells.

      Cell therapy is the use of living cells in the treatment of medical disorders. These cells can either be used in conjunction with, or as a replacement for, traditional therapies. Cell therapy began with simple, but very effective, blood and platelet transfusions, expanding later to include specialized procedures including hematopoietic stem cell transplants obtained from the marrow or from the blood stream after stem cell mobilization. In hematopoietic procedures, stem cells are transplanted into patients to restore blood and immune system function that is damaged or destroyed by aggressive chemotherapy and/or radiation therapy used to treat the cancer. In immunologic cell therapy, T-cells and dendritic cells are administered to stimulate an immune response in patients with various forms of cancers and infectious diseases, such as viral infections. In recent years, pre-clinical and clinical observations appear to extend the potential use of bone marrow-derived stem cells to regenerate multiple tissues including bone, blood vessels, cartilage, cardiac tissue, and nerves.

      While these forms of cell therapy are emerging as potential new treatment options for several diseases and medical disorders, the success of cellular therapy is based, in part, on the need for care providers to be able to access therapeutic quantities of biologically active cells necessary for patient treatment, cost-effectively and in compliance with regulatory requirements. Our patented AastromReplicell® System and single-pass perfusion technology are intended to enable the manufacturing of patient specific cell products for clinical use.

      In the expanding field of cell therapy, we develop proprietary Prescription Cell Products (PCP) for the regenerative repair of damaged human tissues and other medical disorders, the first of which is now in the clinical stage. Our lead PCP products are Tissue Repair Cells (TRCs), which are a unique mixture of bone marrow-derived stem and progenitor cells, produced ex vivo. In previous multi-center clinical trials involving over 160 patients, our TRCs have been demonstrated to be safe and reliable, and to regenerate certain normal healthy human tissues.

      We have also developed our proprietary AastromReplicell System, which is a patented, integrated system of instrumentation and single-use consumable kits for the commercial production of human cells. The AastromReplicell System was developed to provide a manufacturing platform for our proprietary cell products, such as our TRCs. The AastromReplicell System technology has recently been expanded for the production of dendritic cells and dendritic cell vaccines, and is the basis of our Cell Production Products (CPP) business. The clinical use of dendritic cell vaccines is minimal at this time, and as such the market is only just developing. We are currently exploring the market for our CPP dendritic cell vaccine products in the European Union (EU) and in the United States by targeting academic and other third party therapeutic cell developers requiring automated cell production with GMP compliance.

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      Our commercial production pathway for our Prescription Cell Products is enabled through the AastromReplicell System platform. This proprietary and automated clinical cell production system combines patented GMP-compliant automated cell production with patented “single-pass perfusion.” Single-pass perfusion is our technology for growing large quantities of highly robust human cells outside the body. These cells include adult stem and progenitor cell mixtures — cells required for forming solid tissues such as bone, vascular tissue, cartilage, and blood and immune system cells.

      Stem cells are human cells that have the capability to form many or all of an individual’s tissues and organs. Our PCP cell therapy programs currently utilize bone marrow-derived stem cells, a class of adult stem cells that is found in every individual’s bone marrow. Access to adult stem cells is obtained through a recognized procedure, without controversy, and these cells have successfully grown to the increased number of cells required for certain clinical applications, using the patented technology embodied in the AastromReplicell System. Our programs have used bone marrow, cord blood and blood cells as starting sources of cells. As such, federal support or other factors relating to embryonic stem cell research have no direct impact on our current product programs.

      Our primary business model utilizes patented core technology and processes for the manufacturing and distribution of TRC cell products for use in multiple medical markets. Initially, we will pursue TRCs for the following two therapeutic areas:

	•	Local bone regeneration in fractures, spinal fusion and jaw bone reconstruction for dental implants
	•	Vascular (blood vessel) regeneration in limb ischemia resulting from diabetes and other diseases

      In the future, we may develop, and/or support third party development of TRC products for other areas such as cartilage regeneration and cardiac tissue regeneration.

      In the EU, our business and marketing activities are directed through Zellera AG, our wholly-owned subsidiary located in Berlin, Germany

Prescription Cell Products

      We are leveraging our ex vivo cell production technology for a growing Prescription Cell Product pipeline by focusing on our Tissue Repair Cells (TRCs) for stem cell-derived tissue repair and regeneration.

      The clinical trial direction of our development effort has been influenced by observations that our bone marrow cell products (TRCs) may be suitable as a treatment for bone and vascular regeneration, each of which may represent a substantial market opportunity. In reviewing the pre-clinical and clinical data for our bone marrow cell products in various Aastrom-supported trials and research, we have noted that the cells produced contain a substantial increase in the cell types that can generate connective tissues including bone and cartilage. In addition, our bone marrow cell product has been given to one patient, on a compassionate-use basis approved by the FDA, with a congenital genetic defect (hypophosphatasia) resulting in a lethal condition of abnormal bone and cartilage formation. The results of this compassionate-use treatment, now published in the Journal of Bone and Mineral Research, demonstrated bone formation in the child.

      Using the AastromReplicell System, TRCs are grown from a small sample of a patient’s bone marrow. Once administered back to the patient, the cells are intended to generate normal healthy tissues. The primary TRC application we are initially pursuing is bone grafting (large bone fractures, spine fusions or jaw bone reconstruction). In August 2003, the FDA approved our Investigational New Drug (IND) application to begin a multi-center Phase I/II clinical trial for bone grafting in severe leg fractures. Our bone grafting clinical trials have recently been initiated in the U.S. and EU for the treatment of tibial non-union fractures, and we expect to announce additional clinical sites for this application. The initiation of the EU clinical studies for jawbone reconstruction needed for dental implants are pending the finalization of applicable cell production licensing requirements. Once sufficient data is obtained to show the safety and bone-forming

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      Under normal circumstances, bone has the ability to maintain its integrity and repair itself when fractured or damaged, due to its capacity to regenerate. Bone grafting is the procedure of locally applying cells or other material to a bone site to either build or repair needed bone tissue when the clinical situation is such that the natural bone generation process is either too slow or unable to occur. Through scientific advances, it is now widely known that bone grafting can accelerate the regenerative process.

      There are different approaches to bone graft procedures, and each carries with it certain disadvantages. Traditionally, autograft material is surgically taken from the patient’s iliac crest (hip bone) and implanted where it is needed. Sometimes “extenders” are added to this material. There are a number of issues with this autograft procedure, including:

	•	Potential infection at the bone harvest site
	•	Very painful harvest procedure and painful after-effects at the collection site
	•	Chronic pain at the harvest site
	•	Limited supply of autograft material
	•	Additional time in surgery to collect the autograft material and additional time in the hospital to recover

      As a substitute to traditional autograft, allograft, synthetic, and osteoinductive (e.g. bone morphogenic proteins) materials have recently been introduced to address some of these market issues, and are now included in approximately 50% of bone graft procedures in the U.S. However, some of these substitute materials have not been able to produce the same level of clinical efficacy as traditional autograft (e.g. the tempo of formation and the quality of bone), and their use has some other limitations. Additionally, the matrix products (allograft and synthetics) are almost always combined with some biological material, either as an extender of autograft material, in combination with blood or plasma material, or with bone marrow (typically less than 100 ml).

      Our TRCs are being developed as an alternative to the autograft harvest process. First, a physician collects a small starting sample of a patient’s bone marrow with a needle aspiration in a simple outpatient procedure., Then our TRCs are produced in the AastromReplicell System in about 12 days. The TRCs, containing an expanded amount of bone-forming stem and progenitor cells, are mixed with a matrix (allograft or synthetic), and may provide a viable alternative to autograft without the painful after-effects. The total served market for such a product is believed to be more than 1 million procedures annually in the U.S., EU and Japan.

      Additionally, published results from other clinical studies have suggested that large volumes of a patient’s own bone marrow may be concentrated and injected into the vascular tissue area of patients with limb ischemia. Degenerated vascular tissue has a high occurrence in diabetic patients, and can result in immobility, severe ulcerations, and amputation. Bone marrow cells may rebuild this vascular tissue and offer therapeutic benefit; therefore, we are pursuing research to explore the capability of TRCs for vascular regeneration.

      We also believe that the stem and progenitor cell components of our TRCs may be useful for other medical indications, including the regeneration of cardiac tissue and cartilage.

Cell Production Products

      Our Cell Production Products (CPP) operation seeks to market and sell the AastromReplicell System and DC-I (dendritic cells for fusion and transfection), DCV-I (complex antigen-loaded dendritic cells) and DCV-II (peptide-loaded dendritic cells) cell production kits to academic researchers and companies that are developing dendritic cell-based cancer vaccines. We expect that the recent collaborations with users of these products may generate very modest amounts of revenues at irregular intervals, although we are not yet able to project the market size, potential revenues or revenue growth for these products. The EU has recently issued

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Aastrom’s Proprietary Core Technologies

      Our technology platform consists of two components: (i) proprietary processes, “single-pass perfusion”, and culture devices to enable certain types of stem cells and other types of human cells to be produced with superior biological capabilities as compared with standard cell culture approaches, and (ii) the AastromReplicell System, a clinical cell production platform that is designed to standardize and enable an effective GMP-compliant commercialization pathway for bringing therapeutic cell production to medical practice. The AastromReplicell System consists of an instrumentation platform, to be integrated within the hospital or other centralized facilities, that can operate a variety of single-use cell production kits that are specific to the desired medical application. Through this product configuration, we intend either to directly provide cells for therapeutic use, or to enable customers or potential collaborators with the capability to produce cells for therapeutic applications through sale of the AastromReplicell System product line and cell therapy products. This approach is intended to provide a product pathway for each cell therapy that is equivalent to a biological product including regulatory approval, reimbursement, marketing and pricing. We believe that the product design of the AastromReplicell System will allow us to develop additional cell therapy products to provide standardization for a number of emerging cell therapies being developed by other researchers.

      We have developed proprietary processes and patented technologies for ex vivo production of therapeutic stem and progenitor cells as well as other key cells found in human bone marrow. This proprietary process is called “single-pass perfusion” and provides a cell culture environment that attempts to mimic the biology and physiology of natural bone marrow outside of the body. This process enables the production of stem and early- and late-stage progenitor cells needed for an effective bone marrow stem cell therapy procedure. When this process is applied to other cell types, the resulting cell product appears to have enhanced biologic function as compared to cells produced through standard static culture processes. In pre-clinical studies performed at Aastrom, T-cells produced using our proprietary processes appear to have a significantly higher replicative capability. Further, dendritic cells produced using this process appear to have an enhanced ability to present antigen to the immune system. We believe that these benefits can improve the overall clinical effectiveness of these procedures.

      Growth factors can be added to stimulate specific cell lineages to grow cells, or to increase cell growth, to meet a particular therapeutic objective. We believe the stem cell growth process can best be completed with little or no additional stem cell selection or purification procedures. This stem cell replication process can also enable or augment the genetic modification of cells by providing the cell division step needed for new genes to integrate into the stem cell DNA. Other currently available cell culture methods tend to result in a loss of stem cells, either through death or through differentiation into mature cells. When compared with cells grown using standard cell culture techniques, the perfusion approach enables stem cells to grow, and improves the biological features of other types of human cells as well. We have exclusive rights to several issued U.S. patents that cover these processes and cell compositions.

      We have developed a proprietary cell culture chamber to implement our process technology. The culture chamber can produce cells on a clinical-scale and allows for recovery of the cells for therapeutic use. Our pre-clinical and clinical data indicate that our cell culture chamber may be used for growing various types of human therapeutic cells, such as stem cells, T-cells and dendritic cells used for immunotherapies, chondrocytes for cartilage replacement, and mesenchymal cells for bone and cartilage replacement. We hold exclusive rights to issued U.S. patents and additional applications for our cell culture chamber device technology.

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      The AastromReplicell System is our proprietary clinical-scale cell production platform to enable the large scale ex vivo production of a variety of therapeutic cells at healthcare facilities, independent laboratories, transplant centers, blood banks, and centralized cell production facilities. It has been designed to implement our stem cell growth process as well as processes for the production of certain other cell types. The AastromReplicell System is comprised of several components, including microprocessor-controlled instruments and single-use cell production kits such as the TRC-I (for the production of our TRC cell products), DC-I, DCV-I and DCV-II kits (for the production of cells used in our CPP operation for sale to third parties). The single-use cell production kits include an AastromReplicell System Cell Cassette cartridge containing our proprietary cell culture chamber, supply and waste reservoirs, and harvest bag along with process specific software which provides the cell production processing parameters to the AastromReplicell System instruments. The microprocessor-controlled instruments include the AastromReplicell System Incubator which controls the culture conditions for the production of cells within the Cell Cassette, and the AastromReplicell System Processor which automates the procedure sequences such as the inoculation of cells into, and harvesting of the cells from, the Cell Cassette. The AastromReplicell System Manager provides user interface software that monitors the cell production process in multiple Incubators, records relevant process variables and operator actions, and automatically generates cell production batch records.

      The AastromReplicell System is designed to be operated with minimal operator activity by a qualified cell production or cell processing technician to implement clinical-scale cell production. The endpoint of the AastromReplicell System process is a blood-bag containing the specific cell product. The control and documentation features of the AastromReplicell System have been designed to meet GMP requirements for the production of cells for clinical use. The System can be scaled-up producing simultaneous multiple independent cell batches and is suitable for installation in a regional or centralized cell production facility. This is intended to provide a product pathway for each cell therapy that is similar to a biological product including regulatory approval, reimbursement, marketing and pricing. We believe that the design of the AastromReplicell System may allow us to develop additional cell production kits to provide a commercialization pathway for a number of emerging cell therapies being developed by other researchers.

      The typical industry approach to growing human cells has largely used manual research laboratory methods, requiring substantial time and technical expertise. The AastromReplicell System is designed to provide closed-system, automated cell production capabilities in compliance with regulatory standards, with high process reliability and reduced requirements for specialized facilities and staffing.

Product Development

      Our initial development efforts were focused on the development of the SC-I kit for the production of bone marrow stem cells for use in bone marrow transplantation. A decreased market opportunity for the SC-I product led to the discontinuance of further product development in this area. Our current product development efforts are focused on the development of bone marrow-derived stem and progenitor cells — Tissue Repair Cells (TRCs) — for use in orthopedic indications (bone grafting, spine fusion and jaw bone reconstruction) and for use in vascular system regeneration. These cells and processes are very similar to those produced with the SC-I process which have been introduced into human patients in previous trials. (See “Clinical Development.”)Clinical trials are underway to demonstrate bone formation in patients with large bone fractures, and clinical protocols are in development for spine fusions and jaw bone reconstruction, and for treating limb ischemia resulting from peripheral vascular disease. All of these products use Aastrom’s proprietary process and device technologies. We believe that additional products may be developed for use in a variety of other emerging cell therapies.

      Our research programs are currently developing new variations of TRCs that are intended to improve either the functionality for certain clinical indications, improve storage and shelf life, or to decrease the cost of the manufacturing of the TRC products. Programs are also exploring the capability of TRCs to generate different types of human tissues, such as bone, vascular, cartilage and cardiac tissues.

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      The AastromReplicell System has the potential to supplant current manual cell culture methods to produce therapeutic quantities of cell types such as T-cells, dendritic cells, cell-based cancer vaccines, chondrocytes, mesenchymal stem cells, keratinocytes and neuronal cells. For example, Aastrom developed the DC-I, DCV-I, and DCV-II kits for dendritic cell production. Other than a limited application of chondrocyte therapy, novel cell therapies are still in early stages of development by third parties, and such other cell therapies may not be successfully developed. Potential advantages of the AastromReplicell System in these therapies may include: (i) reducing labor and capital costs; (ii) enhancing process reliability; (iii) automating quality assurance and process record keeping; (iv) reducing the need for specialized, environmentally controlled facilities; (v) providing greater accessibility of these procedures to care providers and patients; and, (vi) providing a more biologically active cell product.

      Modification of such processes and application of our products to the expansion of other cell types will require additional development of specialized cell culture capabilities that may need to be incorporated within our existing product platform. Such modifications may require us to raise substantial additional funds, or to seek additional collaborative partners, or both. We may not be able to successfully modify or develop existing or future products to enable such additional cell production processes. See “Clinical Development” and “Business Risks.”

      Research and development expenses for the fiscal years ended June 30, 2002, 2003 and 2004 were $5,428,000, $5,647,000 and $6,289,000, respectively.

Clinical Development

      Currently, our clinical trial direction is focused on the utilization of our TRCs in the areas of bone regeneration and vascular regeneration in limb ischemia resulting from diabetes and other diseases. Both of these therapeutic areas have substantial market opportunities. Our current studies were also influenced by the limited scope of hematopoietic stem cell transplantation.

      In reviewing the pre-clinical and clinical data for our TRCs a substantial increase in the mesenchymal or stromal stem and progenitor cell content was observed. Mesenchymal stromal cells are integral for bone marrow to generate non-hematopoietic tissues such as bone and cartilage. Our TRCs have been administered to one patient under a compassionate use request approved by the FDA, who had a congenital bone disease called hypophosphatasia, which results in a typically lethal condition of abnormal bone and cartilage formation. This compassionate use treatment, now published in the Journal of Bone and Mineral Research (April 2003, Vol. 18, page 264), resulted in long-term systemic bone formation in the child. Subsequently, we demonstrated in the laboratory, and in mice, that our TRC product is capable of forming bone lineage tissue.

      Based on these and other pre-clinical and clinical observations, we are currently enrolling patients in U.S. and EU clinical trials for bone regeneration in patients with severe limb fractures. The U.S. trial is being conducted under an FDA approved Investigational New Drug (IND) application, including up to three participating centers and as many as 20 patients. The EU trials are now underway at centers in Spain and Germany, under Ethical Committee approvals. We are developing a protocol and an IND submission for a clinical trial to evaluate TRCs in spine fusions. We expect to have clinical result data from the first five treatments in Spain during the quarter ended December 31, 2004. We are also planning to evaluate TRCs to augment jaw bone reconstruction as a method to improve the well-being of patients needing dental implants, and intend to initiate these studies and provide proof of concept during fiscal year 2005 in the EU.

      In addition to bone and hematopoietic tissues, TRCs have been demonstrated in the laboratory to contain the stem and progenitor cells capable of forming vascular tissue or blood vessel growth. Based on clinical observations of the efficacy obtained using large volumes of unexpanded bone marrow cells, we are developing clinical protocols that will evaluate our TRCs for the treatment of limb ischemia, such as occurs in diabetes and other peripheral vascular diseases.

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      The preliminary results of our pre-pivotal trials may not be indicative of results that will be obtained from subsequent patients in the trials or from more extensive trials. Further, our pre-pivotal or pivotal trials may not be successful, and we may not be able to obtain the required biologic license application (BLA) registration or required foreign regulatory approvals for the AastromReplicell System in a timely fashion, or at all. See “Business Risks.”

      The AastromReplicell System, and certain cell products produced using our system, have been evaluated in multi-site clinical trials in the U.S. under an Investigational Device Exemption (IDE) from the FDA.

      Results from these studies demonstrated the ability of the AastromReplicell System to safely and reliably produce stem and progenitor cells (called “SC-I cells”) that engraft and restore blood system function in breast cancer patients who had undergone very aggressive chemotherapy. Further, the small volume aspirate, along with a purging of contaminated tumor cells during the stem cell production, indicated a way to offer patients a transplant with a lower risk of receiving back tumor cells.

      Based on positive results from the feasibility stage trials, we had initiated a randomized Phase III U.S. clinical trial evaluating the SC-I cells produced with the AastromReplicell System to compliment traditional therapies by augmenting stem cells collected from a single Peripheral Blood Stem Cell (PBSC) apheresis procedure. The objectives of this study were to demonstrate that an optimal hematopoietic recovery could be achieved using the SC-I cells with a sub-optimal PBSC dose that otherwise would not provide this desired outcome.

      However, during the course of the Phase III clinical trial of the SC-I cells, medical developments occurred that have influenced our strategy. These developments included:

	•	The demonstration that high-dose cytotoxic therapy requiring stem cell support did not result in increased survival benefit for patients with carcinoma of the breast compared with standard, less toxic chemotherapy, thus eliminating this medical approach
	•	The demonstration that bone marrow stem cells collected from the PBSC after mobilization by cytokine(s) and/or chemotherapy resulted in more rapid hematopoietic engraftment compared to stem cells collected directly from the bone marrow
	•	The demonstration that only a fraction of patients would be unable to be successfully mobilized for the collection of PBSC using a combination of chemotherapy with augmented dose hematopoietic cytokines
	•	The demonstration that dose-dense chemotherapy followed by cytokine supported hematopoietic recovery may be an alternative to PBSC transplantation for patients with carcinoma of the breast
	•	A change in the policy of the FDA that the AastromReplicell System cell products will now require a Biologics License Application (BLA) for product registration, which was not originally expected or planned

The results of these medical market developments substantially reduced the ability to accrue patients in the Phase III trial we had started. Further, these observations indicated to us that the market value of the product studied by the current clinical hematopoietic studies was becoming markedly constrained and much reduced from estimates performed before trial initiation. Given the limited market opportunity, the newly added regulatory requirements, and our available resources, we are no longer pursuing that Phase III trial. With the greatly reduced market size for the SC-I cells, we successfully obtained Orphan Product Designation.

      We have also conducted clinical feasibility trials to evaluate umbilical cord blood (CB) cells produced in the AastromReplicell System to improve recoveries of pediatric and adult patients requiring donor-derived (or allogeneic) stem cell transplants. Results of the pediatric transplants indicated that AastromReplicell System-produced cells were safe and well tolerated by the patients. Results from our adult cord blood trial may suggest that the AastromReplicell System could increase the quantity of cord blood cells available but do not

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Strategic Relationships

      In June 2003, we announced a strategic alliance with the Musculoskeletal Transplant Foundation (MTF) to jointly develop and commercialize innovative treatments for the regeneration of tissues such as bone and cartilage. The collaboration aligns us with the leading provider of allograft, or donor-derived tissue, materials (matrices) with a focus on forming a coordinated business and clinical approach for new products and treatments needed in orthopedic medicine. Under the terms of the alliance, Aastrom and MTF will coordinate and fund the development of products that are based on combinations of MTF’s allograft matrices and our Tissue Repair Cells (TRCs). The companies will both contribute in certain development and clinical trial expenses of these treatment approaches and products, and intend to adopt a coordinated promotion and marketing strategy for future products.

Manufacturing

      We have established relationships with third party manufacturers that are FDA registered as suppliers of medical products to manufacture various components of the AastromReplicell System.

      In March 2003, we signed a three-year master supply agreement with Astro Instrumentation, L.L.C., to manufacture our products, component parts, subassemblies and associated spare parts, used in the instrumentation platform of our AastromReplicell System. We retain all proprietary rights to our intellectual property that is utilized by Astro pursuant to this agreement.

      In March 1996, we entered into a License and Supply Agreement with Immunex Corporation, now a wholly owned subsidiary of Amgen Corporation, for an initial five-year term to purchase and resell certain cytokines and ancillary materials for use in conjunction with the AastromReplicell System. Subsequently, this license agreement was extended through March 2003. We are currently negotiating a new agreement with Amgen. In the event that Amgen elects to cease to supply to us cytokines and ancillary materials or is prevented from supplying such materials to us, there is no assurance that we could successfully manufacture the compounds ourselves or identify others that could manufacture these compounds to acceptable quality standards and costs, if at all. However, we are currently conducting pre-clinical research to evaluate the elimination of these components.

      In February 2004, we entered into a five-year agreement continuing Moll Industries as our supplier of Cell Cassettes. Under this agreement, Moll will perform commercial manufacturing and assembly of our Cell Cassette, the main single-use component of the AastromReplicell System. We retain all proprietary rights to our intellectual property that is utilized by Moll pursuant to this agreement.

      There can be no assurance that we will be able to continue our present arrangements with our suppliers, supplement existing relationships or establish new relationships or that we will be able to identify and obtain the ancillary materials that are necessary to develop our product candidates in the future. Our dependence upon third parties for the supply and manufacture of such items could adversely affect our ability to develop and deliver commercially feasible products on a timely and competitive basis. See “Business Risks.”

Patents and Proprietary Rights

      Our success depends in part on our ability, and the ability of our licensors, to obtain patent protection for our products and processes. We have exclusive rights to over 25 issued U.S. patents, and non-exclusive rights

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      The validity and breadth of claims in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. No assurance can be given that any patents based on pending patent applications or any future patent applications by us, or our licensors, will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to us, that any of the patents that have been or may be issued to us or our licensors will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held or licensed by us. Furthermore, there can be no assurance that others have not developed or will not develop similar products, duplicate any of our products or design around any patents that have been or may be issued to us or our licensors. Since patent applications in the United States are maintained in secrecy until shortly before patents issue, we also cannot be certain that others did not first file applications for inventions covered by our, and our licensors’ pending patent applications, nor can we be certain that we will not infringe any patents that may be issued to others on such applications.

      We rely on certain licenses granted by the University of Michigan and others for certain patent rights. If we breach such agreements or otherwise fail to comply with such agreements, or if such agreements expire or are otherwise terminated, we may lose our rights in such patents, which would have a material adverse affect on our business, financial condition and results of operations. See “Research and License Agreements.”

      We also rely on trade secrets and unpatentable know-how that we seek to protect, in part, by confidentiality agreements. It is our policy to require our employees, consultants, contractors, manufacturers, outside scientific collaborators and sponsored researchers, board of directors, technical review board and other advisors to execute confidentiality agreements upon the commencement of employment or consulting relationships with us. These agreements provide that all confidential information developed or made known to the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties except in specific limited circumstances. We also require signed confidentiality or material transfer agreements from any company that is to receive our confidential information. In the case of employees, consultants and contractors, the agreements generally provide that all inventions conceived by the individual while rendering services to us shall be assigned to us as the exclusive property of Aastrom. There can be no assurance, however, that these agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets or unpatentable know-how will not otherwise become known or be independently developed by competitors.

      Our success will also depend in part on our ability to develop commercially viable products without infringing the proprietary rights of others. We have not conducted freedom of use patent searches and no assurance can be given that patents do not exist or could not be filed which would have an adverse affect on our ability to market our products or maintain our competitive position with respect to our products. If our technology components, devices, designs, products, processes or other subject matter are claimed under other existing United States or foreign patents or are otherwise protected by third party proprietary rights, we may be subject to infringement actions. In such event, we may challenge the validity of such patents or other proprietary rights or we may be required to obtain licenses from such companies in order to develop, manufacture or market our products. There can be no assurances that we would be able to obtain such licenses or that such licenses, if available, could be obtained on commercially reasonable terms. Furthermore, the

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      Certain of our, and our licensors’, research has been or is being funded in part by the Department of Commerce and by a Small Business Innovation Research Grant obtained from the Department of Health and Human Services. As a result of such funding, the U.S. Government has certain rights in the technology developed with the funding. These rights include a non-exclusive, paid-up, worldwide license under such inventions for any governmental purpose. In addition, the government has the right to require us to grant an exclusive license under any of such inventions to a third party if the government determines that: (i) adequate steps have not been taken to commercialize such inventions, (ii) such action is necessary to meet public health or safety needs, or (iii) such action is necessary to meet requirements for public use under federal regulations. Additionally, under the federal Bayh Dole Act, a party which acquires an exclusive license for an invention that was partially funded by a federal research grant is subject to the following government rights: (i) products using the invention which are sold in the United States are to be manufactured substantially in the United States, unless a waiver is obtained; (ii) the government may force the granting of a license to a third party who will make and sell the needed product if the licensee does not pursue reasonable commercialization of a needed product using the invention; and (iii) the U.S. Government may use the invention for its own needs.

      In March 1992, we entered into a License Agreement with the University of Michigan, as contemplated by a Research Agreement executed in August 1989 relating to the ex vivo production of human cells. Pursuant to this License Agreement, as amended: (i) we acquired exclusive worldwide license rights to the patents and know-how for the production of blood cells and bone marrow cells as described in the University of Michigan’s research project or which resulted from certain further research conducted through December 1994; and (ii) we are obligated to pay to the University of Michigan a royalty equal to 2% of the net sales of products which are covered by the University of Michigan’s patents. Unless it is terminated earlier at our option, or due to a material breach by us, the License Agreement will continue in affect until the latest expiration date of the patents to which the License Agreement applies.

      In December 2002, we entered into an agreement with Corning Incorporated that granted them an exclusive sublicense relating to our cell transfection technology for increased efficiency in loading genetic material into cells. We own the intellectual property rights to methods, compositions and devices that increase the frequency and efficiency of depositing particles into cells to modify their genetic code. Under terms of the agreement, Corning’s Life Sciences business will utilize our unique technology to enhance the development of their molecular and cell culture applications in areas that are not competitive to our core business interest. We retain exclusive rights to the applications of the technologies involving cells for therapeutic applications, and received an upfront payment in addition to future royalties from Corning.

Government Regulation

      Our research and development activities and the manufacturing and marketing of our products are subject to the laws and regulations of governmental authorities in the United States and other countries in which our products will be marketed. Specifically, in the United States, the FDA, among other activities, regulates new product approvals to establish safety and efficacy of these products. Governments in other countries have similar requirements for testing and marketing. In the United States, in addition to meeting FDA regulations, we are also subject to other federal laws, such as the Occupational Safety and Health Act and the Environmental Protection Act, as well as certain state laws.

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      Our products are subject to regulation as biological products under the Public Health Service Act. Different regulatory requirements may apply to our products depending on how they are categorized by the FDA under these laws. The FDA has indicated that it intends to regulate the cells produced in the AastromReplicell System as a licensed biologic through the Center for Biologics Evaluation and Research. However, there can be no assurance that the FDA will ultimately regulate the AastromReplicell System in this manner.

      As current regulations exist, the FDA will require regulatory approval for certain human cellular or tissue based products, including cells produced in the AastromReplicell System, through a biologic license application (BLA).

      The FDA has published regulations which require registration of certain facilities, which may include our customers, and is in the process of publishing regulations for the manufacture or manipulation of human cellular or tissue based products which may impact our customers. We believe that the fixed validated process in a sterile disposable provided by our products will assist our customers in meeting these requirements, but the regulations may change prior to final release.

      Approval of new biological products is a lengthy procedure leading from development of a new product through pre-clinical and clinical testing. This process takes a number of years and the expenditure of significant resources. There can be no assurance that Aastrom’s product candidates will ultimately receive regulatory approval.

      Regardless of how our product candidates are regulated, the Federal Food, Drug, and Cosmetic Act and other Federal statutes and regulations govern or influence the research, testing, manufacture, safety, labeling, storage, record-keeping, approval, distribution, use, reporting, advertising and promotion of such products. Noncompliance with applicable requirements can result in civil penalties, recall, injunction or seizure of products, refusal of the government to approve or clear product approval applications or to allow us to enter into government supply contracts, withdrawal of previously approved applications and criminal prosecution.

      In order to obtain FDA approval of a new medical product, sponsors must generally submit proof of safety and efficacy. In some cases, such proof entails extensive pre-clinical and clinical laboratory tests. The testing, preparation of necessary applications and processing of those applications by the FDA is expensive and may take several years to complete. There can be no assurance that the FDA will act favorably or in a timely manner in reviewing submitted applications, and we may encounter significant difficulties or costs in our efforts to obtain FDA approvals, in turn, which could delay or preclude us from marketing any products we may develop. The FDA may also require post-marketing testing and surveillance of approved products, or place other conditions on the approvals. These requirements could cause it to be more difficult or expensive to sell the products, and could therefore restrict the commercial applications of such products. Product approvals may be withdrawn if compliance with applicable regulations are not maintained or if problems occur following initial marketing. For patented technologies, delays imposed by the governmental approval process may materially reduce the period during which we will have the exclusive right to exploit such technologies.

      If human clinical trials of a proposed medical product are required, the manufacturer or distributor of the product will have to file an Investigational Device Exemption (IDE) or Investigational New Drug (IND) submission with the FDA prior to commencing human clinical trials. The submission must be supported by data, typically including the results of pre-clinical and laboratory testing. Following submission of the IDE or IND, the FDA has 30 days to review the application and raise safety and other clinical trial issues. If we are not notified of objections within that period, clinical trials may be initiated, and human clinical trials may commence at a specified number of investigational sites with the number of patients approved by the FDA. We have submitted several IDEs and INDs for the AastromReplicell System, and have conducted clinical studies under these IDEs and INDs.

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      We believe that the cells produced in the AastromReplicell System will be regulated by the FDA as a licensed biologic, although there can be no assurance that the FDA will not choose to regulate this product in a different manner. The FDA categorizes human cell or tissue based products as either minimally manipulated or more than minimally manipulated, and has proposed that more than minimally manipulated products be regulated through a “tiered approach intended to regulate human cellular and tissue based products only to the extent necessary to protect public health.” For products which may be regulated as biologics, the FDA requires: (i) pre-clinical laboratory and animal testing; (ii) submission to the FDA of an IND or IDE application which must be effective prior to the initiation of human clinical studies; (iii) adequate and well-controlled clinical trials to establish the safety and efficacy of the product for its intended use; (iv) submission to the FDA of a biologic license application (BLA); and (v) review and approval of the BLA as well as inspections of the manufacturing facility by the FDA prior to commercial marketing of the product.

      Pre-clinical testing covers laboratory evaluation of product chemistry and formulation as well as animal studies to assess the safety and efficacy of the product. The results of these tests are submitted to the FDA as part of the IND. Following the submission of an IND, the FDA has 30 days to review the application and raise safety and other clinical trial issues. If we are not notified of objections within that 30-day period, clinical trials may be initiated. Clinical trials are typically conducted in three sequential phases. Phase I represents the initial administration of the drug or biologic to a small group of humans, either healthy volunteers or patients, to test for safety and other relevant factors. Phase II involves studies in a small number of patients to assess the efficacy of the product, to ascertain dose tolerance and the optimal dose range and to gather additional data relating to safety and potential adverse affects. Once an investigational drug is found to have some efficacy and an acceptable safety profile in the targeted patient population, multi-center Phase III studies are initiated to establish safety and efficacy in an expanded patient population and multiple clinical study sites. The FDA reviews both the clinical plans and the results of the trials and may request us to discontinue the trials at any time if there are significant safety issues.

      The results of the pre-clinical tests and clinical trials are submitted to the FDA in the form of a BLA for marketing approval. The testing and approval process is likely to require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis, if at all. Additional animal studies or clinical trials may be requested during the FDA review period that may delay marketing approval. After FDA approval for the initial indications, further clinical trials may be necessary to gain approval for the use of the product for additional indications. The FDA requires that adverse affects be reported to the FDA and may also require post-marketing testing to monitor for adverse affects, which can involve significant expense.

      Under current requirements, facilities manufacturing biological products must be licensed. To accomplish this, a BLA must be filed with the FDA. In addition to the pre-clinical and clinical tests, the BLA includes a description of the facilities, equipment and personnel involved in the manufacturing process. An establishment license is granted on the basis of inspections of the applicant’s facilities in which the primary focus is on compliance with GMPs and the ability to consistently manufacture the product in the facility in accordance with the BLA. If the FDA finds the inspection unsatisfactory, it may decline to approve the BLA, resulting in a delay in production of products.

      As part of the approval process for human biological products, each manufacturing facility must be registered and inspected by the FDA prior to marketing approval. In addition, state agency inspections and approvals may also be required for a biological product to be shipped out of state.

      The AastromReplicell System instruments and disposables are currently being regulated in Europe as a Class I Sterile, Class IIb or Class III medical device, under the authority of the Medical Device Directive (MDD) implemented by EU member countries. These classifications apply to medical laboratory equipment and supplies including, among other products, many devices that are used for the collection and processing of blood for patient therapy. Certain ancillary products (e.g., biological reagents) used as part of the AastromReplicell System are treated as Class III medical devices.

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      The MDD vests the authority to permit affixing of the CE Mark with various Notified Bodies. These are private and state organizations which operate under license from the Competent Authority of the member states within the EU to certify that appropriate quality assurance standards and compliance procedures are followed by developers and manufacturers of medical device products or, alternatively, that a manufactured medical product meets a more limited set of requirements. Notified Bodies are also given the responsibility for determination of the appropriate standards to apply to a medical product. Receipt of permission to affix the CE Mark enables a company to sell a medical device in all EU member countries. Other registration requirements may also need to be satisfied in certain countries.

      We have received permission from our Notified Body (The British Standards Institute) to affix the CE Mark to the AastromReplicell System instrumentation and components for the SC-I kit, CB-I kit, DC-I kit, DCV-I kit and DCV-II kit. This has allowed us to market these products in the EU. There can be no assurance that the AastromReplicell System will continue to be regulated under its current status, any change in which would affect our ability to sell the product and adversely affect our business, financial condition and results of operations.

      New directives (laws) have recently become effective in the EU that may affect the manufacturing of cell products and clinical trials. These changes have delayed or in some cases temporarily halted dendritic cell clinical trials in the EU, which has reduced the number of customer opportunities and affected our progress in our Cell Production Products business. The recent changes to the European Union Medicinal Products Prime Directive shifted patient-derived cells to the medicinal products category. These new laws may delay some of our current planned clinical trials in the EU.

Competitive Environment

      The biotechnology and medical device industries are characterized by rapidly evolving technology and intense competition. Aastrom’s competitors include major multinational medical device companies, pharmaceutical companies, specialty biotechnology companies and chemical and medical products companies operating in the fields of tissue engineering, tissue regeneration, orthopedics and in a small number of instances, cell-based therapies. Many of these companies are well-established and possess technical, research and development, financial, and sales and marketing resources significantly greater than Aastrom. In addition, many smaller biotech and specialty medical products companies have formed strategic collaborations, partnerships and other types of joint ventures with larger, well established industry competitors that afford these companies potential research and development and commercialization advantages in product areas currently being pursued by Aastrom. Academic institutions, governmental agencies and other public and private research organizations are also conducting and financing research activities which may produce products directly competitive to those being commercialized by Aastrom. Moreover, many of these competitors may be able to obtain patent protection, obtain FDA and other regulatory approvals and begin commercial sales of their products before Aastrom.

      Aastrom’s potential commercial products address a broad range of existing and emerging markets, in which cell-based therapy is a new and as of yet, unproven, commercial strategy. In a large part, Aastrom faces primary competition from existing devices and products. Some of Aastrom’s competitors in orthopedic device and tissue engineered orthopedic applications have longer operating histories and substantially greater resources. These include Stryker Corp., Medtronic, Wright Medical, Smith & Nephew, Biomet, Osteotech, J&J/ DePuy, Zimmer and Synthes/ Mathys Medical. Other well-established competitors, such as CONMED, Arthrex and Implex Corporation compete in orthopedics with a variety of other tissue substitution products. A number of other companies have developed tissue-derived products for these markets, including Regeneration Technologies, Allosource, Lifecell Corporation, NovaBone, IsoTis Orthobiologics, Co.don and OrthoVita.

      In the general area of cell-based therapies, including orthopedics and other tissue regeneration applications, Aastrom competes with a variety of companies, most of whom are specialty medical products or biotechnology companies. Some of these, such as Genzyme Corporation and Fidia SA are well-established and have substantial technical and financial resources compared to Aastrom. However, as cell-based products are only just emerging as viable medical therapies, many of Aastrom’s direct competitors are smaller

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      Domestic product sales and rentals for the fiscal years ended June 30, 2002, 2003 and 2004 were $0, $0 and $10,000, respectively. Foreign product sales and rentals for the fiscal years ended June 30, 2002, 2003 and 2004 were $80,000, $314,000 and $39,000, respectively.

General

      We cannot project when we will generate positive cash flows from our consolidated operations. In the next several years, we expect that our revenue sources will consist of modest sales at irregular intervals from our CPP business to academic and commercial research centers, grant revenue, research funding and licensing fees from potential future corporate collaborators, and potentially the sale of TRCs in certain non-U.S. countries. To date, we have financed our operations primarily through public and private sales of our equity securities. As a development-stage company, we have never been profitable and do not anticipate having net income unless and until significant product sales commence. Achieving this objective will require significant additional funding. Our ability to achieve profitability on a sustained basis, if at all, or to obtain the required funding to achieve our operating objectives, or complete additional corporate partnering transactions is subject to a number of risks and uncertainties. Please see the section entitled “Business Risks”.

Employees

      As of August 31, 2004, we employed approximately 50 individuals on a full time equivalent basis. A significant number of our management and professional employees have had prior experience with pharmaceutical, biotechnology or medical product companies. None of our employees are covered by collective bargaining agreements, and management considers relations with our employees to be good.

Executive Officers of Aastrom

      Our executive officers, and their respective ages as of August 31, 2004, are as follows:

      R. Douglas Armstrong, Ph.D. joined Aastrom in June 1991 as its President and Chief Executive Officer, and as a Director. In 1999, Dr. Armstrong was elected Chairman of Aastrom’s Board of Directors. In July 2004, the duties and responsibilities of President were transferred to the Company’s new Chief Operating Officer, allowing Dr. Armstrong, as CEO, to increase focus on strategic activities and issues, investor relations, the Board of Directors, and Aastrom’s European subsidiary, Zellera AG, for which he is also Chairman of the Supervisory Board. From 1987 to 1991, Dr. Armstrong served as Executive Vice President and Trustee at the La Jolla Cancer Research Foundation (LJCRF), now named the Burnham Institute, a scientific research institute located in San Diego, CA. Prior to joining the Burnham Institute, Dr. Armstrong held various faculty and staff positions at the Yale University School of Medicine, University of California, San Francisco, LJCRF and the University of Michigan. Dr. Armstrong received a Bachelor’s of Arts degree in Chemistry from the University of Richmond in Richmond, VA, and completed his Doctorate in Pharmacology and Toxicology from the Medical College of Virginia. Additionally, Dr. Armstrong was a participant in the formation of Telios Pharmaceuticals, Inc., has served on the boards of both biotechnology and venture capital organizations, and currently serves as the Chairman of the Board for the Center for Cell Therapy.

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      James A. Cour joined Aastrom in July 2004 as its President and Chief Operating Officer. Prior to joining Aastrom Mr. Cour held executive level management positions with several companies, including Baxter International, Windsor VanGelder Limited and Cytomedix. Mr. Cour brings to Aastrom over twenty years of business success and accomplishments, ranging from strong expertise in operations and business development to strategic planning and international business. His broad range of experiences includes the management of major multinational healthcare operations, as well as a biotech/medical device company. Mr. Cour is skilled in the areas of medical products, biologic pharmaceuticals, business development, strategic alliances, analysis of new technologies and licensing. Mr. Cour received a Bachelor of Business Administration, with honors, from the University of Notre Dame, and an MBA from the University of Chicago, with concentrations in Marketing and International Business, with a specialization in Finance. He was also licensed as a Certified Public Accountant.

      Brian S. Hampson joined the Company in July 1993 as Director, Product Engineering and became Vice President Product Development in June 2000. He has been a principal leader in the development and engineering of the AastromReplicell Cell Production System. Previously, Mr. Hampson served as Manager, In Vitro Systems at Charles River Laboratories and held other positions after joining that company in January 1986. While at Charles River, he managed a number of programs to develop and commercialize novel bioreactor systems to support large-scale cell culture and biomolecule production. Prior to that, Mr. Hampson held several engineering positions at Corning Incorporated from September 1979 to January 1986, including assignments with KC Biological, a wholly owned subsidiary of Corning at the time. Mr. Hampson received his Bachelor of Science and Master of Engineering degrees in Electrical Engineering from Cornell University.

      Alan M. Wright joined Aastrom in September 2000 as a member of the Board of Directors until August 2002 when he joined the Company’s management team as Senior Vice President Administrative and Financial Operations and Chief Financial Officer. From 1991 to 2002, Mr. Wright held several executive positions at CMS Energy and its principal subsidiary, Consumers Energy, most recently as its Executive Vice President, Chief Financial Officer and Chief Administrative Officer, where he was responsible for raising $17 billion in capital during his tenure. Prior to joining CMS Energy, Mr. Wright held various financial management positions at Entergy Corporation, including Vice President of Finance. He served on the Finance Committee and the Finance and Regulation Executive Advisory Committee of the Edison Electric Institute (EEI), the Conference Board Council of CFOs, the Committee on Corporate Reporting of the Financial Executives Institute, and on Jenkins’ Special Committee to the Financial Accounting Standards Board. Mr. Wright earned a Bachelor of Science degree in Economics from Cornell University under a General Motors national scholarship. He has also completed Stanford University’s Executive Program, the EEI Executive Leadership Program and post-graduate studies in Accounting at the University of West Florida. In addition, Mr. Wright serves on the Board of Directors of Ensure Technologies, a privately held company.

Available Information

      Additional information about Aastrom is contained at our website, www.aastrom.com. Information on our website is not incorporated by reference into this report.

      We lease approximately 23,700 square feet of office and research and development space in Ann Arbor, Michigan under a lease agreement expiring in December 2004. We are currently negotiating an extension to our current lease and expect to complete this negotiation prior to its expiration. We believe that our facilities are adequate for our current needs. Additional facilities may be required to support expansion for research and development abilities or to assume manufacturing operations that are currently fulfilled through contract manufacturing relationships. We also lease office space in Berlin, Germany for our European Operations, Zellera AG.

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      We are not currently party to any material legal proceedings, although from time to time we may become involved in disputes in connection with the operation of our business.

      None

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PART II

      Beginning on February 4, 1997 our common stock was quoted on the Nasdaq National Market under the symbol “ASTM”. Since June 11, 2002, our common stock has been quoted on the Nasdaq SmallCap Market under the symbol “ASTM”. The following table sets forth the high and low closing prices per share of common stock as reported on the Nasdaq SmallCap Market:

Price Range of Common Stock

      As of August 31, 2004, there were approximately 594 holders of record of the common stock. We have never paid any cash dividends on our common stock and we do not anticipate paying such cash dividends in the foreseeable future. We currently anticipate that we will retain all future earnings, if any, for use in the development of our business.

      The following table sets forth information as of June 30, 2004 with respect to compensation plans (including individual compensation arrangements) under which equity securities are authorized for issuances:

(1)	Includes shares issuable under the 2001 Stock Option Plan and the 1996 Employee Stock Purchase Plan.

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      The statement of operations data for the years ended June 30, 2002, 2003 and 2004 and for the period from March 24, 1989 (Inception) to June 30, 2004 and the balance sheet data at June 30, 2003 and 2004, are derived from, and are qualified by reference to, the audited consolidated financial statements included in this report on Form 10-K and should be read in conjunction with those financial statements and notes thereto. The statement of operations data for the years ended June 30, 2000 and 2001, and the balance sheet data at June 30, 2000, 2001 and 2002, are derived from audited consolidated financial statements not included herein. The data set forth below are qualified by reference to, and should be read in conjunction with, the consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

(1)	Cost of product sales and rentals for the year ended June 30, 2000 includes an inventory write off of $1,027,000 and for the years ended June 30, 2002, June 30, 2003 and June 30, 2004 includes a charge of $202,000, $748,000 and $253,000 for obsolete and excess inventory, respectively.

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Overview

      We are a late-stage development company focused on the development of processes and products for the ex vivo production and sale of human cell products for use in cell therapy and regenerative medicine. Our pre-clinical and clinical product development programs utilize adult bone marrow stem and progenitor cells for forming solid tissues such as bone, vascular tissue, cartilage, and blood and immune system cells. We currently operate our business in one reportable segment — research and product development, conducted both on our own behalf and in connection with various collaborative research and development agreements with others, involving the development and sale of processes and products for the ex vivo production of human cells for use in cell therapy.

      While cell therapies are emerging as potential new treatment options for several diseases and medical disorders, the success of cellular therapy is based, in part, on the need for care providers to be able to access therapeutic quantities of biologically active cells necessary for patient treatment, cost-effectively and in compliance with regulatory requirements. Our patented AastromReplicell System and single-pass perfusion technology are intended to enable the manufacturing of patient specific cell products for clinical use.

      In the expanding field of cell therapy, we develop proprietary Prescription Cell Products (PCP) for the regenerative repair of damaged human tissues and other medical disorders, the first of which is now in the clinical stage. Our lead PCP products are Tissue Repair Cells (TRCs), which are a unique mixture of bone marrow-derived stem and progenitor cells, produced ex vivo. In previous multi-center clinical trials involving over 160 patients, our TRCs have been demonstrated to be safe and reliable, and to regenerate certain normal healthy human tissues.

      We have also developed our proprietary AastromReplicell System, which is a patented, integrated system of instrumentation and single-use consumable kits for the commercial production of human cells. The AastromReplicell System was developed to provide a manufacturing platform for our proprietary cell products, such as our TRCs. The AastromReplicell System technology has recently been expanded for the production of dendritic cells and dendritic cell vaccines, and is the basis of our Cell Production Products (CPP) business. The clinical use of dendritic cell vaccines is minimal at this time, and as such the market is only just developing. We are currently exploring the market for our CPP dendritic cell vaccine products in the EU and in the United States by targeting academic and other third party therapeutic cell developers requiring automated cell production with GMP compliance.

      Our commercial production pathway for our Prescription Cell Products is enabled through the AastromReplicell System platform. This proprietary and automated clinical cell production system combines patented GMP-compliant automated cell production with patented “single-pass perfusion.” Single-pass perfusion is our technology for growing large quantities of highly robust human cells outside the body. These cells include adult stem and progenitor cell mixtures — cells required for forming solid tissues such as bone, vascular tissue, cartilage, and immune system cells.

      Our primary business model utilizes a core infrastructure for the manufacturing and distribution of TRC cell products for use in multiple medical markets. Initially, we will pursue TRCs for the following two therapeutic areas:

	•	Local bone regeneration in fractures, spinal fusion and jaw bone reconstruction, and
	•	Vascular (blood vessel) regeneration in limb ischemia resulting from diabetes and other diseases.

      In the future, we may develop, and/or support the development by third parties, TRC products for other areas such as cartilage regeneration and cardiac tissue regeneration.

      In the EU, our business and marketing activities are directed through Zellera AG, our wholly-owned subsidiary located in Berlin, Germany.

      Since our inception, we have been in the development stage and engaged in research and product development, conducted principally on our own behalf, but also in connection with various collaborative

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Critical Accounting Policies

      There are several accounting policies that we believe are significant to the presentation of our consolidated financial statements. Note 1 to our consolidated financial statements “Overview and Summary of Significant Accounting Policies” summarizes each of our significant accounting policies. The most significant accounting policies include those related to inventory, revenue recognition and accounts receivable.

      Revenue recognition. We generate revenue from grants and research agreements, collaborative agreements, product sales and rentals and licensing arrangements. Revenue from grants and research agreements is recognized on a cost reimbursement basis consistent with the performance requirements of the related agreements. Revenue from collaborative agreements is recognized when the scientific or clinical results stipulated in the agreement have been met and there are no other ongoing obligations on our part. We recognize revenue from product sales when title to the product transfers and there are no remaining obligations that will affect the customer’s final acceptance of the sale. If there are remaining obligations, including training and installation (which we believe to be significant), we recognize revenue upon completion of these obligations. We recognize revenue from licensing fees under licensing agreements when there are no future performance obligations remaining with respect to such fees. Payments received before all obligations are fulfilled are classified as deferred revenue.

      Accounts receivable. We make estimates evaluating collectibility of accounts receivable. We continuously monitor collections and payments from our customers and maintain an allowance for estimated credit losses based on any specific customer collection issues we have identified. While such credit issues have not been significant, there is no assurance that we will continue to experience the same credit losses in the future. As of June 30, 2004, our allowance for doubtful accounts was $7,000.

      Inventory. We value our inventory that consists primarily of finished components of our lead product, the AastromReplicell System and our disposable cell production cassettes, at the lower of cost (specific identification using first in, first out) or market. We regularly review inventory quantities on hand and record a provision to write down obsolete and excess inventory to its estimated net realizable value. Based on the aging of inventory at each period end, we utilize a systematic approach to determine our reserve for obsolete and excess inventory. Under this systematic approach, AastromReplicell System inventory that is less than twelve months old, based on the receipt date, will be carried at full value. Inventory quantities in excess of twelve months old are reserved over a six-month period, until the items are either sold or fully reserved. We review cell production cassette inventory relative to its age and our expected sales and, where quantities exceed expected sales utilization, we reduce the recorded value of cell cassette inventory. We feel this approach is appropriate given our limited product sales history and the risk associated with our ability to recover the

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      The summary of significant accounting policies should be read in conjunction with our consolidated financial statements and related notes and this discussion of our results of operations.

Results of Operations

      Total revenues were $1,302,000 in 2004, $844,000 in 2003, and $877,000 in 2002 Grant revenues increased to $1,178,000 in 2004 from $520,000 in 2003 and from $797,000 in 2002. Grant revenues in 2004 have increased from prior years as a result of increased activity on the collaborative grant with the Defense Advanced Research Projects Agency (DARPA) and additional grant awards from the National Institutes of Health. Grant revenues accounted for 90% of total

      Total costs and expenses were $11,959,000 in 2004, $10,557,000 in 2003 and $9,158,000 in 2002. The increase in costs and expenses is primarily the result of increased selling, general and administrative expenses to $5,390,000 in 2004 from $4,017,000 in 2003 and $3,528,000 in 2002, reflecting the continued expansion of marketing activities in the EU to further our commercialization efforts and additional capital raising costs not related to specific transactions. Selling, general and administrative expenses for the fiscal year ended June 30, 2004 also includes a non-cash charge of $53,000 relating to certain warrants issued in August 2003 for public and investor relations services and a $372,000 non-cash charge related to an employee performance-based stock option that vested in September 2003. Research and development expenses increased to $6,289,000 in 2004 from $5,647,000 in 2003 and $5,428,000 in 2002, reflecting increased research and product development activities in the area of tissue regeneration and our on-going and planned bone grafting clinical trials in the United States and the EU. Research and development expenses in 2004 include $256,000 of cell cassettes allocated for use in clinical trials, research and product development studies. Cost of product sales and rentals were $27,000 in 2004, $145,000 in 2003 and none in 2002. This decrease is due to the decline in the volume of product sales. The non-cash provision for obsolete and excess AastromReplicell System inventory was $253,000 in 2004, $748,000 in 2003 and $202,000 in 2002. The decrease in 2004 is the result of the carrying value of our AastromReplicell System inventory that was written down to zero by September 30, 2003.

      Interest income was $169,000 in 2004, $134,000 in 2003 and $342,000 in 2002. The fluctuations in interest income are due primarily to corresponding changes in the levels of cash, cash equivalents and short-term investments and decreasing yields from our investments during the periods.

      Our net loss was $10,488,000, or $.14 per common share in 2004, $9,579,000, or $.19 per common share in 2003, and $7,939,000, or $.19 per common share in 2002. These increases in net loss are primarily the result of increased costs and expenses as the result of expanded research and marketing activities and, for the purposes of computing per share amounts, were offset by an increase in the weighted average number of common shares outstanding resulting from additional equity financings. We expect to report additional significant net losses until such time as more substantial product sales commence.

      We have not generated any net taxable income since our inception and therefore have not paid any federal income taxes since inception. We issued shares of common stock in prior years, which resulted in multiple ownership changes under taxation rules (Section 382 of the Internal Revenue Code). Consequently, pursuant to these taxation rules, the utilization of net operating loss and tax credit carryforwards will be

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Liquidity and Capital Resources

      We have financed our operations since inception primarily through public and private sales of our equity securities, which, from inception through June 30, 2003, have totaled approximately $131 million and, to a lesser degree, through grant funding, payments received under research agreements and collaborations, interest earned on cash, cash equivalents, and short-term investments, and funding under equipment leasing agreements. These financing sources have generally allowed us to maintain adequate levels of cash and other liquid investments.

      Our combined cash, cash equivalents and short-term investments totaled $16,926,000 at June 30, 2004, an increase of $6,414,000 from June 30, 2003. During the year ended June 30, 2004, we raised net proceeds of $16,096,000 through the sale of our equity securities. The primary uses of cash, cash equivalents and short-term investments during the year ended June 30, 2004 included $9,525,000 to finance our operations and working capital requirements, and $157,000 in capital equipment additions.

      Our combined cash, cash equivalents and short-term investments totaled $10,512,000 at June 30, 2003, an increase of $907,000 from June 30, 2002. During the year ended June 30, 2003, we raised net proceeds of $10,016,000 through the sale of our equity securities. The primary uses of cash, cash equivalents and short-term investments during the year ended June 30, 2003 included $8,990,000 to finance our operations and working capital requirements, and $119,000 in capital equipment additions.

      We expect that our capital expenditures for the fiscal year ended June 30, 2005 will be $145,000, in total. The primary use of these expenditures will be for cell production equipment.

      Our future cash requirements will depend on many factors, including continued scientific progress in our research and development programs, the scope and results of 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 for at least the next several years due to the expected spending for research and development programs and the cost of commercializing our product candidates. We intend to seek additional funding through research and development agreements or grants, distribution and marketing agreements and through public or private financing transactions. Successful future operations are subject to several technical and business risks, including our continued ability to obtain future funding, satisfactory product development, obtaining regulatory approval and market acceptance for our products. We expect that our available cash and expected interest income will be sufficient to finance currently planned activities at least through the end of fiscal year 2005 (ending June 30, 2005). These estimates are based on certain assumptions which could be negatively impacted by the matters discussed under this heading and under the caption “Business Risks”, included herein. In order to grow and expand our business, and to introduce our product candidates into the marketplace, we will need to raise additional funds. We will also need additional funds or a collaborative partner, or both, to finance the research and development activities of our product candidates for the expansion of additional cell types. We expect that our primary sources of capital for the foreseeable future will be through collaborative arrangements and through the public or private sale of our debt or equity securities. 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, continued stock market listing and economic conditions affecting the public markets generally or some portion or all of the technology sector. If our common stock is delisted from The Nasdaq SmallCap Market, the liquidity of our common stock could be impaired, and prices for the shares of our common stock could be lower than might otherwise prevail.

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      On July 28, 2004, we received a letter from the Nasdaq Stock Market indicating that for 30 consecutive trading days the bid price for our common stock had closed below the $1.00 minimum continued listing requirement established by Nasdaq Marketplace Rule 4310(c)(4). Pursuant to applicable Nasdaq rules, we have been provided a grace period until January 24, 2005, to regain compliance by having our stock price close at $1.00 or more for a minimum of 10 consecutive business days. Under the current Nasdaq rules, if the stock price does not satisfy the minimum bid price requirement by January 24, 2005, we may also be granted at least one additional 180 day grace period to regain compliance if we meet the required initial listing criteria. Our most material initial listing requirement is the minimum shareholders’ equity balance of $5,000,000. As of June 30, 2004, out shareholders’ equity balance was $17,608,000.

      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” and “Notes to Consolidated Financial Statements” included herein.

Long-Term Contractual Obligations and Commitments

      The following table sets forth Aastrom’s contractual obligation along with cash payments due each period.

New Accounting Standards

      In December 2003, the FASB issued a revision of FIN 46 (FIN 46R), which clarified certain complexities of FIN 46 and generally requires the adoption of all special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after December 15, 2003 and to all non special-purpose entities that qualify as variable interest entities no later than the end of the first reporting period ending after March 15, 2004. At June 30, 2004, Aastrom did not have any entities that require disclosure or new consolidation as a result of adopting the provisions of FIN 46R.

      As of June 30, 2004, our cash and cash equivalents included money market securities. Due to the short duration of our investment portfolio, an immediate 10% change in interest rates would not have a material effect on the fair market value of our portfolio, therefore, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio.

      Our sales to customers in foreign countries are denominated in U.S. dollars. Accordingly, we are not directly exposed to market risks from currency exchange rate fluctuations. We believe that the interest rate risk related to our accounts receivable is not significant. We manage the risk associated with these accounts through periodic reviews of the carrying value for non-collectibility and establishment of appropriate allowances in connection with our internal controls and policies. We do not enter into hedging transactions and do not purchase derivative instruments.

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BUSINESS RISKS

      Our business is subject to a number of uncertainties, including those discussed below.

Our past losses and expected future losses cast doubt on our ability to operate profitably.

      We were incorporated in 1989 and have experienced substantial operating losses since inception. As of June 30, 2004, we have incurred cumulative net losses totaling approximately $114 million. These losses have resulted principally from costs incurred in the research and development of our cell culture technologies and the AastromReplicell System, general and administrative expenses, and the prosecution of patent applications. We expect to incur significant operating losses until product sales increase, primarily owing to our research and development programs, including pre-clinical studies and clinical trials, and the establishment of marketing and distribution capabilities necessary to support commercialization efforts for our products. We cannot predict with any certainty the amount of future losses. Our ability to achieve profitability will depend, among other things, on successfully completing the development of our product candidates, obtaining regulatory approvals, establishing manufacturing, sales and marketing arrangements with third parties, and raising sufficient funds to finance our activities. We may not be able to achieve or sustain profitability.

Failure to obtain and maintain required regulatory approvals would severely limit our ability to sell our products.

      We must obtain the approval of the FDA before commercial sales of our cell product candidates may commence in the United States, which we believe will ultimately be the largest market for our products. We may also be required to obtain additional approvals from foreign regulatory authorities to continue or increase our sales activities of cells and equipment in those jurisdictions. If we cannot demonstrate the safety, reliability and efficacy of our product candidates, or of the cells produced in such products, we may not be able to obtain required regulatory approvals. If we cannot demonstrate the safety or efficacy of our technologies and product candidates, including long-term sustained engraftment, or if one or more patients die or suffer severe complications, the FDA or other regulatory authorities could delay or withhold regulatory approval of our product candidates.

      Finally, even if we obtain regulatory approval of a product, that approval may be subject to limitations on the indicated uses for which it may be marketed. Even after granting regulatory approval, the FDA and regulatory agencies in other countries continue to review and inspect marketed products, manufacturers and manufacturing facilities, which may create additional regulatory burdens. Later discovery of previously unknown problems with a product, manufacturer or facility may result in restrictions on the product or manufacturer, including a withdrawal of the product from the market. Further, regulatory agencies may establish additional regulations that could prevent or delay regulatory approval of our products.

Any changes in the governmental regulatory classifications of our products could prevent, limit or delay our ability to market or develop our products.

      The FDA establishes regulatory requirements based on the classification of a product. Although the AastromReplicell System is considered to be unregulated manufacturing equipment in the U.S., the FDA may reconsider this and classify the System as a Class III medical device, or the FDA may ultimately choose to regulate the AastromReplicell System under another category. Because our product development programs are designed to satisfy the standards applicable to medical devices and biological licensure for our cellular products, any change in the regulatory classification or designation would affect our ability to obtain FDA approval of our products. The AastromReplicell System is used to produce different cell mixtures, and each of these cell mixtures will, under current regulations be regulated as biologic products, which require a biologic license application (BLA).

      New directives (laws) have recently become effective in the EU that may affect the manufacturing of cell products and clinical trials. These changes have delayed or in some cases temporarily halted dendritic cell clinical trials in the EU, which has reduced the number of customer opportunities and affected our progress in our Cell Production Products business. The recent changes to the European Union Medicinal Products Prime

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Our inability to complete our product development activities successfully would severely limit our ability to operate or finance operations.

      Commercialization in the United States of our cell product candidates will require substantial clinical trials. We may not be able to successfully complete development of our product candidates, or successfully market our technologies or product candidates. We, and any of our potential collaborators, may encounter problems and delays relating to research and development, regulatory approval and intellectual property rights of our technologies and product candidates. Our research and development programs may not be successful, and our cell culture technologies and product candidates may not facilitate the production of cells outside the human body with the expected result. Our technologies and product candidates may not prove to be safe and efficacious in clinical trials, and we may not obtain the requisite regulatory approvals for our technologies or product candidates and the cells produced in such products. If any of these events occur, we may not have adequate resources to continue operations for the period required to resolve the issue delaying commercialization and we may not be able to raise capital to finance our continued operation during the period required for resolution of that issue.

We may not be able to raise the required capital to conduct our operations and develop our products.

      We will require substantial capital resources in order to conduct our operations and develop our products. In October 1999, we were forced to reduce operations based on our declining level of capital resources and our limited financing alternatives available at that time. The previous reduction in our operating activities has delayed our product development programs. We expect that our available cash and financing will be sufficient to fund currently planned activities through our 2005 fiscal year (ending June 30, 2005). However, in order to grow and expand our business, and to introduce our new product candidates into the marketplace, we will need to raise additional funds. We will also need additional funds or a collaborative partner, or both, to finance the research and development activities of our product candidates for the expansion of additional cell types. Accordingly, we are continuing to pursue additional sources of financing.

      Our future capital requirements will depend upon many factors, including:

	•	continued scientific progress in our research and development programs;
	•	costs and timing of conducting clinical trials and seeking regulatory approvals;
	•	competing technological and market developments;
	•	our ability to establish additional collaborative relationships; and
	•	the effect of commercialization activities and facility expansions if and as required.

      Because of our long-term funding requirements, we are likely to access the public or private equity markets if and whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Further, we may enter into financing transactions at prices, which are at a substantial discount to market. This additional funding may not be available to us on reasonable terms, or at all. If adequate funds are not available in the future, we may be required to further delay or terminate research and development programs, curtail capital expenditures, and reduce business development and other operating activities.

The issuance of additional common stock for funding has the potential for substantial dilution.

      As noted above, we will need additional equity funding to provide us with the capital to reach our objectives. At current market prices, such an equity issuance would cause a substantially larger number of shares to be outstanding and would dilute the ownership interest of existing stockholders.

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Our stock price has been volatile and future sales of substantial numbers of our shares could have an adverse affect on the market price of our shares.

      The market price of shares of our common stock has been volatile, ranging in closing price between $0.79 and $1.83 during the twelve month period ended June 30, 2004. The price of our common stock may continue to fluctuate in response to a number of events and factors, such as:

	•	clinical trial results;
	•	the amount of our cash resources and our ability to obtain additional funding;
	•	announcements of research activities, business developments, technological innovations or new products by us or our competitors;
	•	entering into or terminating strategic relationships;
	•	changes in government regulation;
	•	disputes concerning patents or proprietary rights;
	•	changes in our revenues or expense levels;
	•	public concern regarding the safety, efficacy or other aspects of the products or methodologies we are developing;
	•	reports by securities analysts; and
	•	status of the investment markets.

      Any of these events may cause the price of our shares to fall, which may adversely affect our business and financing opportunities. In addition, the stock market in general and the market prices for biotechnology companies in particular have experienced significant volatility that often has been unrelated to the operating performance or financial conditions of such companies. These broad market and industry fluctuations may adversely affect the trading price of our stock, regardless of our operating performance or prospects.

Our stock may be delisted from Nasdaq, which could affect its market price and liquidity.

      We are required to meet certain financial tests (including a minimum bid price for our common stock of $1.00) to maintain the listing of our common stock on the Nasdaq Stock Market. Our common stock may be recommended for delisting (subject to any appeal we would file) if we do not maintain compliance with the Nasdaq requirements within specified periods and subject to permitted extensions. If our common stock were delisted, it could be more difficult to buy or sell our common stock and to obtain accurate quotations, and the price of our stock could suffer a material decline. Delisting would also impair our ability to raise capital.

      On July 28, 2004, we received a letter from the Nasdaq Stock Market indicating that for 30 consecutive trading days the bid price for our common stock had closed below the $1.00 minimum continued listing requirement established by Nasdaq Marketplace Rule 4310(c)(4). Pursuant to applicable Nasdaq rules, we have been provided a grace period until January 24, 2005, to regain compliance by having our stock price close at $1.00 or more for a minimum of 10 consecutive business days. Under the current Nasdaq rules, if the stock price does not satisfy the minimum bid price requirement by January 24, 2005, we may also be granted at least one additional 180 day grace period to regain compliance if we meet the required initial listing criteria. Our most material initial listing requirement is the minimum shareholders’ equity balance of $5,000,000. As of June 30, 2004, out shareholders’ equity balance was $17,608,000.

We must successfully complete our clinical trials to be able to market certain of our products.

      To be able to market Prescription Cell Products in the United States, we must demonstrate, through extensive preclinical studies and clinical trials, the safety and efficacy of our processes and product candidates, for application in the treatment of humans. If our clinical trials are not successful, our products may not be marketable.

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      Our ability to complete our clinical trials in a timely manner depends on many factors, including the rate of patient enrollment. Patient enrollment can vary with the size of the patient population, the proximity of suitable patients to clinical sites, perceptions of the utility of cell therapy for the treatment of certain diseases and the eligibility criteria for the study. We have experienced delays in patient accrual in our previous and current clinical trials. If we experience future delays in patient accrual, we could experience increased costs and delays associated with clinical trials, which would impair our product development programs and our ability to market our products. Furthermore, the FDA monitors the progress of clinical trials and it may suspend or terminate clinical trials at any time due to patient safety or other considerations.

Even if we obtain regulatory approvals to sell our products, lack of commercial acceptance could impair our business.

      We are seeking to obtain regulatory approval to market stem cell tissue repair and regeneration treatments, and cancer and infectious disease treatments. Even if we obtain all required regulatory approvals, we cannot be certain that our products and processes will be adopted at a level that would allow us to operate profitably. Our tissue repair products will face competition from existing, and/or potential other new treatments in the future which could limit revenue potential. It may be necessary to increase the yield and/or cell type purity, for certain of our AastromReplicell System cell processes to gain commercial acceptance. Our technologies or product candidates may not be employed in all potential applications being investigated, and any reduction in applications would limit the market acceptance of our technologies and product candidates and our potential revenues.

The market for our products will be heavily dependent on third party reimbursement policies.

      Our ability to successfully commercialize our product candidates will depend on the extent to which government healthcare programs, such as Medicare and Medicaid, as well as private health insurers, health maintenance organizations and other third party payors will pay for our products and related treatments. Reimbursement by third party payors depends on a number of factors, including the payor’s determination that use of the product is safe and effective, not experimental or investigational, medically necessary, appropriate for the specific patient and cost-effective. Reimbursement in the United States or foreign countries may not be available or maintained for any of our product candidates. If we do not obtain approvals for adequate third party reimbursements, we may not be able to establish or maintain price levels sufficient to realize an appropriate return on our investment in product development. Any limits on reimbursement available from third party payors may reduce the demand for, or negatively affect the price of, our products. For example, in the past, published studies have suggested that stem cell transplantation for breast cancer, that constituted a significant portion of the overall stem cell therapy market, at the time, may have limited clinical benefit. The lack of reimbursement for these procedures by insurance payors would negatively affect the marketability of our products.

Failure of third parties to manufacture component parts or provide limited source supplies, or imposition of additional regulation, would impair our new product development and our sales activities.

      We rely solely on third parties such as Astro, Moll, Cambrex and Amgen to manufacture our product candidates, component parts and growth factors and other materials used in the cell expansion process. We would not be able to obtain alternate sources of supply for many of these items on a short-term basis. If any of our key manufacturers or suppliers fail to perform their respective obligations or if our supply of growth factors, components or other materials is limited or interrupted, we would not be able to conduct clinical trials or market our product candidates on a timely and cost-competitive basis, if at all.

      Finally, we may not be able to continue our present arrangements with our suppliers, supplement existing relationships, establish new relationships or be able to identify and obtain the ancillary materials that are necessary to develop our product candidates in the future. Our dependence upon third parties for the supply and manufacture of these items could adversely affect our ability to develop and deliver commercially feasible products on a timely and competitive basis.

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Use of animal-derived materials could harm our product development and commercialization efforts.

      Some of the compounds we use in our current bone marrow or cord blood cell expansion processes involve the use of animal-derived products. Suppliers or regulatory authorities may limit or restrict the availability of such compounds for clinical and commercial use. Any restrictions on these compounds would impose a potential competitive disadvantage for our products. Regulatory authorities in the EU are reviewing the safety issues related to the use of animal derived materials which we currently use in our production process. It is unknown at this time what actions, if any, the authority may take as to animal derived materials specific to medicinal products distributed in the EU. Our inability to develop or obtain alternative compounds would harm our product development and commercialization efforts.

Given our limited internal sales and marketing capabilities, we need to develop increased internal capability or collaborative relationships to sell, market and distribute our products.

      While we have commenced marketing on a limited basis of the AastromReplicell System and SC-I, DC-I, DCV-I and DCV-II cell production kits in the EU and domestically for research and industrial use, we have only limited internal sales, marketing and distribution capabilities. We intend to get assistance to market our products through collaborative relationships with companies with established sales, marketing and distribution capabilities. While we have entered into such arrangements with respect to Switzerland, Turkey and Italy, we will need to establish additional relationships to be able to achieve the market coverage we desire. Our inability to develop and maintain those relationships would limit our ability to market, sell and distribute our products. Our inability to enter into successful, long-term relationships could require us to develop alternate arrangements at a time when we need sales, marketing or distribution capabilities to meet existing demand.

If we do not keep pace with our competitors and with technological and market changes, our products may become obsolete and our business may suffer.

      The market for our products is very competitive, is subject to rapid technological changes and varies for different candidates and processes that directly compete with our products. Our competitors may have developed, or could in the future develop, new technologies that compete with our products or even render our products obsolete. As an example, in the past, published studies have suggested that hematopoietic stem cell therapy use for bone marrow transplantation, following marrow ablation due to chemo-therapy, may have limited clinical benefit in the treatment of breast cancer, which was a significant portion of the overall hematopoietic stem cell transplant market. This resulted in a substantial decline in the market for the AastromReplicell System with our SC-I kit.

      Our products are designed to improve and automate the processes for producing cells used in therapeutic procedures. Even if we are able to demonstrate improved or equivalent results, the cost or process of treatment and other factors may cause researchers and practitioners to not use our products and we will suffer a competitive disadvantage. As a result, we may be unable to recover the net book value of our inventory. Finally, to the extent that others develop new technologies that address the targeted application for our products, our business will suffer.

If we cannot attract and retain key personnel, then our business will suffer.

      Our success depends in large part upon our ability to attract and retain highly qualified scientific and management personnel. We face competition for such personnel from other companies, research and academic institutions and other entities. Further, in an effort to conserve financial resources, we have implemented reductions in our work force on two separate occasions. As a result of these and other factors, we may not be successful in hiring or retaining key personnel. The Company has a key man life insurance policy for R. Douglas Armstrong, Chief Executive Officer and Chairman of Aastrom. Our inability to replace any other lost key employee could harm our operations.

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If our patents and proprietary rights do not provide substantial protection, then our business and competitive position will suffer.

      Our success depends in large part on our ability to develop or license and protect proprietary products and technologies. However, patents may not be granted on any of our pending or future patent applications. Also, the scope of any of our issued patents may not be sufficiently broad to offer meaningful protection. In addition, our issued patents or patents licensed to us could be successfully challenged, invalidated or circumvented so that our patent rights would not create an effective competitive barrier. Furthermore, we rely on three exclusive, world-wide licenses relating to the production of human cells granted to us by the University of Michigan for certain of our patent rights. If we materially breach such agreements or otherwise fail to materially comply with such agreements, or if such agreements expire or are otherwise terminated by us, we may lose our rights under the patents held by the University of Michigan. At the latest, these licenses will terminate when the patent underlying the license expires. The first of these underlying patents will expire on March 21, 2012. We also rely on trade secrets and unpatentable know-how that we seek to protect, in part, by confidentiality agreements with our employees, consultants, suppliers and licensees. These agreements may be breached, and we might not have adequate remedies for any breach. If this were to occur, our business and competitive position would suffer.

Intellectual property litigation could harm our business.

      Our success will also depend in part on our ability to develop commercially viable products without infringing the proprietary rights of others. Although we have not been subject to any filed infringement claims, other patents could exist or could be filed which would prohibit or limit our ability to market our products or maintain our competitive position. In the event of an intellectual property dispute, we may be forced to litigate. Intellectual property litigation would divert management’s attention from developing our products and would force us to incur substantial costs regardless of whether we are successful. An adverse outcome could subject us to significant liabilities to third parties, and force us to curtail or cease the development and sale of our products and processes.

The government maintains certain rights in technology that we develop using government grant money and we may lose the revenues from such technology if we do not commercialize and utilize the technology pursuant to established government guidelines.

      Certain of our and our licensors’ research have been or are being funded in part by government grants. As a result of such funding, the U.S. Government has certain rights in the technology developed with the grant. These rights include a non-exclusive, paid-up, world-wide license to use the technology for any governmental purpose. In addition, the government has the right to require us to grant an exclusive license to use the developed technology to a third party if the government determines that:

	•	we have not taken adequate steps to commercialize such technology;
	•	such action is necessary to meet public health or safety needs; or
	•	such action is necessary to meet requirements for public use under federal regulations.

      In these instances, we would not receive revenues on the products we developed. Additionally, technology that was partially funded by a federal research grant is subject to the following government rights:

	•	products using the technology which are sold in the United States are to be manufactured substantially in the United States, unless a waiver is obtained;
	•	the government may force the granting of a license to a third party who will make and sell the needed product if we do not pursue reasonable commercialization of a needed product using the technology; and
	•	the U.S. Government may use the technology for its own needs.

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      If we fail to meet these guidelines, we would lose our exclusive rights to these products and we would lose potential revenue derived from the sale of these products.

Potential product liability claims could affect our earnings and financial condition.

      We face an inherent business risk of exposure to product liability claims in the event that the use of the AastromReplicell System during research and development efforts, including clinical trials, or after commercialization results in adverse affects. As a result, we may incur significant product liability exposure, which could exceed existing insurance coverage. We may not be able to maintain adequate levels of insurance at reasonable cost and/ or reasonable terms. Excessive insurance costs or uninsured claims would increase our operating loss and affect our financial condition.

Our corporate documents and Michigan law contain provisions that may make it more difficult for us to be acquired.

      Our Board of Directors has the authority, without shareholder approval, to issue additional shares of preferred stock and to fix the rights, preferences, privileges and restrictions of these shares without any further vote or action by our shareholders. This authority, together with certain provisions of our charter documents, may have the affect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire control of our company. This affect could occur even if our shareholders consider the change in control to be in their best interest.

Forward-Looking Statements

      This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. These forward-looking statements include statements regarding:

	•	potential strategic collaborations with others;
	•	future capital needs;
	•	product development and marketing plan;
	•	clinical trial plans and anticipated results;
	•	anticipation of future losses;
	•	replacement of manufacturing sources;
	•	commercialization plans; and
	•	revenue expectations and operating results.

      These statements are subject to risks and uncertainties, including those set forth in this Business Risks section, and actual results could differ materially from those expressed or implied in these statements. All forward-looking statements included in this registration statement are made as of the date hereof. We assume no obligation to update any such forward-looking statement or reason why actual results might differ.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

      In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Aastrom Biosciences, Inc. and its subsidiaries (a development stage company) at June 30, 2003 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2004, and for the period from March 24, 1989 (Inception) to June 30, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

	PRICEWATERHOUSECOOPERS LLP

Minneapolis, MN

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AASTROM BIOSCIENCES, INC.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements

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AASTROM BIOSCIENCES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements.

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AASTROM BIOSCIENCES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY