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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the fiscal year ended June 30, 2003

OR

For the transition period from      to

Commission File Number 0-22025

AASTROM BIOSCIENCES, INC.

24 Frank Lloyd Wright Drive
P. O. Box 376
Ann Arbor, MI 48106
(Address of principal executive offices, including zip code)

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

Securities registered pursuant to Section 12(b) of the Act:
None

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

Common Stock, no par value

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No 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 o No x

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, 2002 was approximately $24 million. This computations 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, 2003, 71,244,315 shares of Common Stock, no par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

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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

ITEM 1. BUSINESS

     We are a late-stage development company that has strategically moved from a business model that was originally based on the Bone Marrow Transplantation market to a company focused on other human cell-based therapies. We have identified multiple paths to revenue based on our proprietary ex vivo (outside the body) cell production technology, including the near-term Cell Production Products operations, and an active Prescription Cell Product pipeline for stem cell tissue repair and regeneration, and cancer and infectious disease treatments.

     Our core technology is based on our proprietary AastromReplicell™ System, an integrated system of instrumentation and single-use consumable kits that implements our patented single-pass perfusion process in a fully automated closed-loop culturing system to optimize cell growth and viability. This system provides nutrients to cells by mimicking the natural cell-growth environment, and enabling cells to grow effectively while retaining high biological function, without various cloning approaches. Our programs currently use bone marrow, cord blood and blood cells as starting sources of cells. As such, federal support or other factors relating to embryonal stem cell research have no direct impact on our current product programs. In addition, this system provides Good Manufacturing Practices, GMP-compliant manufacturing and automated process control for the commercial-scale production of human cells. We do not believe that any other comparable system currently exists.

     Our Cell Production Products operation has created a path to near-term revenue. 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 are being sold to academic researchers and companies that are developing cancer vaccines. The recent commercialization of our automated cell production instruments and cell-specific production kits is expected to generate revenues although we are not yet able to project the market size and growth for these products.

     In addition, we are leveraging our ex vivo cell production technology for a growing Prescription Cell Product pipeline focused on two areas: Tissue Repair Cells (TRCs) for stem cell-derived tissue repair and regeneration, and Therapeutic Cells (TCs) for immune system-directed attacks on certain cancers and other infectious diseases.

     Using the AastromReplicell™ System with its patented single-pass perfusion, TRCs are grown from a small sample of a patient’s bone marrow and, once administered back to the patient, are intended to generate normal tissue. The primary TRC product being evaluated is our OCG-I cells for bone grafting (fusions, fractures or dental defects). We are currently preparing for OCG-I clinical trials in both the United States and Europe. We also have in development OC-I cells for osteoporosis, and SC-I cells for autologous bone marrow transplants in lymphoma patients. The SC-I product has been CE-Marked in Europe and is currently being evaluated by a limited number of centers in Europe. In the United States, the SC-I therapy reached Phase III trials, although we halted these trials due to a shift in medical practice that reduced patient need and availability. We also believe that the stem cell components of our TRCs may be useful for other medical indications, including the regeneration of cardiac and vascular tissues. Our CB-I clinical trials have been closed out. We have no plans to continue this product development of our CB-I kits at this time, unless entirely funded by grants, due to the limited size of the potential market.

     We are developing TC products using human cells to cause the patient’s immune system to attack certain cancers and other infectious diseases. Blood-derived dendritic cells, which are the body’s crucial mobilizers of the immune T-cells response, are cultured in the AastromReplicell™ System to produce our proprietary Dendricell™. After being exposed to a particular biological signal, or antigen, the Dendricell™ may act to trigger a cell-mediated immune response in a patient against the cancer cells or viral pathogens. The first Dendricell™ clinical trials are planned at Stanford

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University for a multiple myeloma cancer vaccine and at Duke University for a colorectal cancer vaccine. In addition, we are in the pre-clinical stage for a T-cell therapeutic targeting the Epstein-Barr Virus.

     In addition to our consumable DC-I, DCV-I and DCV-II cell product kits, we have begun marketing our automated cell production instruments in Europe and the United States for research use. Through Zellera AG, our wholly owned subsidiary located in Berlin, Germany, we are actively coordinating country-specific sub-distributorships and service networks in Europe.

     We are led by a seasoned management team, which is advised by a Technology Review Board comprised of well-respected senior medical, financial and marketing executives with extensive knowledge of our technology and industry. Management is leading a transition from our genesis as a medical device manufacturer to a contributor and developer in the broader and more potentially lucrative therapeutic sector.

Cell Therapy

     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, and more recently has expanded to include specialized procedures including hematopoietic stem cell transplants obtained from the marrow or from the blood stream after stem cell mobilization. Recent pre-clinical and clinical observations appear to extend the potential use of bone marrow-derived stem cells to regenerate multiple tissues including heart, lung, liver, bone, cartilage, nerve and blood vessels.

     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. Most recently, researchers are developing emerging cell therapies utilizing bone marrow-derived stem cells that may restore various tissues of the body including bone, cartilage, spinal cord, heart muscle, liver, blood vessels and beta-cells of the pancreas. While these forms of cell therapy are emerging as potential new treatment options for several diseases, 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. The AastromReplicell™ System is being developed to fill this need.

Tissue Repair Cells

     Bone marrow stem and stromal cells (sometimes also referred to as mesenchymal stromal cells) contribute to the repair of various solid tissues including bone marrow, connective tissues such as bone and cartilage, and other tissues including the heart. These cells are present in Aastrom’s TRCs. Diseases that could be treated with bone marrow-derived stem cells include bone fractures, osteoporosis, congestive heart failure, myocardial infarct, liver damage, diabetes, peripheral vascular insufficiency and spinal cord damage. Thus, cell based therapy could provide therapeutic intervention for millions of patients annually.

     Currently, there are unmet medical needs in the areas of bone grafting, osteoarthritis and osteoporosis that could be addressed by a cell therapy approach. In bone grafting, there is an unmet need for an effective bone substitute that does not require the invasive and highly morbid autograft procedure for harvesting the patient’s own bone. Aastrom’s TRCs could meet this need by providing a large number of bone forming cells to produce a response that is similar to autograft but without the invasive and morbid collection procedure. In osteoarthritis, the Aastrom cell therapy approach has the potential to be a means of repairing cartilage and delaying the need for joint replacement. In the osteoporosis market, there is a need for more regenerative/disease modifying therapies that is partially being met by emerging anabolic treatments. However, the requirements for daily oral medicines or needle injection for administration makes these emerging treatments highly inconvenient. For patients with severe osteoporosis, an Aastrom approach using a systemic infusion of expanded cells may have the potential to help rebuild bone while requiring fewer courses of therapy.

     Aastrom is in the late stages of initiating clinical trials with our bone marrow-derived stem cells (TRCs) to regenerate bone for the treatment of serious fractures. The Aastrom approach of expanding a small amount of marrow collected by needle aspiration could eliminate the requirement to collect large amounts of bone from patients, a procedure known as iliac crest bone harvest. Although highly effective, bone harvesting involves invasive surgical collection of tissues from the patient’s hip, often causing long term pain. Additionally, some patients, especially elderly patients, are unable to donate adequate amounts of harvested bone. The Aastrom approach would eliminate bone harvest morbidity and facilitate

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a more rapid patient recovery. If successful in the treatment of bone fractures, the use of bone marrow stem cells could be extended to the treatment of other orthopedic conditions such as spinal disk surgery requiring bone fusion.

     Recently, bone marrow-derived cells have been demonstrated to be able to form other unrelated tissues of the body such as muscle, nerve, brain, heart and liver. When studied in small animal models, marrow cells injected directly into the heart or mobilized into the blood stream have shown significant improvement in heart function after a myocardial infarct allowing more mice to survive. In these studies, marrow cells differentiated into cells of the damaged heart such as muscle and blood vessel. The potential implications of these observations are enormous, raising the possibility of organ regeneration from adult-derived stem cells avoiding the many issues of embryonal stem cells. Such observations will require demonstration in large animal models and eventually, in human trials. In human clinical trials, bone marrow cells have regenerated blood vessels to treat patients with peripheral vascular insufficiency. This indication occurs in up to 15% of adults and development of an effective treatment could improve the quality of life for patients by allowing ambulation without the pain of vascular insufficiency known as claudication, and by avoiding the extreme need for amputation in end-stage patients.

     The expansion of Aastrom’s Tissue Repair Cell program, as mentioned above, is based on the progress of Aastrom’s lead SC-I bone marrow stem cell product. Aastrom’s ex vivo-produced SC-I bone marrow stem cell product has demonstrated clinical success for hematopoietic and bone engraftment in humans. Aastrom’s SC-I cells have also been able to regenerate bone when given intravenously and will be studied to treat fractures by installation directly into the fracture site. The SC-I cell mixture is comprised of expanded bone marrow, including both hematopoietic, endothelial and mesenchymal stem cells, and is intended for the restoration of normal blood and immune system function in patients that have undergone aggressive chemotherapy or radiation treatment. The SC-I cell mixture is intended to provide either an alternative method of obtaining cells used in stem cell transplantation, or to augment cells obtained through a peripheral blood stem cell (“PBSC”) collection in situations where it is difficult to obtain the desired quantity of PBSCs.

     Once collected, the stem cell mixture is infused intravenously and the stem and stromal accessory cells migrate into the bone cavity where they engraft to form new marrow tissue. The hematopoietic progenitor cell components of the cell mixture provide early restoration of circulating white blood cells and platelets. The replenished bone marrow will normally provide long-term hematopoietic function, but complete restoration of bone marrow may, in some cases, take months following myeloablative cancer therapy. When the patient’s hematopoietic system contains malignant cells, such as in the case of leukemia, stem cells from a suitable donor are generally required in order to avoid reintroducing the disease during cell infusion if stem cells for the transplant had been collected from the patient. Such donor-derived transplants are termed “allogeneic” transplants. Procedures using cells derived from the patient are termed “autologous” transplants.

     In July 2002, Aastrom’s SC-I autologous bone marrow stem cells produced using the AastromReplicell™ System, were granted orphan product status by the U.S. Food and Drug Administration. Aastrom’s therapeutic ex vivo-produced bone marrow stem cells received the orphan product designation for use in cancer patients requiring a stem cell transplant following high-dose chemotherapy, but who are unable to provide sufficient numbers of blood stem cells for adequate treatment using current transplant methods. This orphan product classification is awarded to select approaches that offer potential therapeutic value in the treatment of rare disease and conditions.

Therapeutic Cells for Immunotherapy

     Therapeutic Cells for Immunotherapy involves using cells of the immune system to eradicate a disease target. A number of research institutions and other companies are investigating T-lymphocytes (T-cells) and dendritic cells for this purpose. We anticipate that many of these procedures will require ex vivo cell production and manipulation, and present a significant market opportunity for our products and technologies.

     Dendritic cells are blood system-derived cells that play an important role in the function of the immune system by presenting antigen to the immune system to trigger an immune response. Dendritic cells, when exposed to cancer cells or other pathogens, can serve as “educator” cells to activate other cells of the immune system. Researchers believe that cultured dendritic cells could augment the natural ability of a patient to present tumor antigens or antigens from infectious agents to the immune system and aid in the generation of a cytotoxic T-cell response to the offending agent.

     Clinical trials are currently underway at leading cancer centers to demonstrate the effectiveness of this new therapeutic approach in multiple cancer types. Common to these new therapeutic approaches is the requirement to culture and activate the dendritic cells outside of the patient (ex vivo). In these initial trials, production of the dendritic cells is

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performed using manual research laboratory equipment, open culture processes and specialized personnel. In order for these procedures to receive regulatory approval to be used in standard medical practice, we believe that they must be standardized and implemented through user-friendly, sterilely-closed, automated and process-controlled products. The AastromReplicell™ System is designed to address this key need by enabling automated therapeutic dendritic cell production through a standardized product format.

     T-lymphocytes, a class of white blood cells, play an important role in the human immune system and are responsible as the effector cell of the immune response in a broad spectrum of cancers and infectious diseases. Therapeutic procedures using cytotoxic T-lymphocytes (CTLs) involve collecting T-lymphocytes from a patient and culturing them in an environment resulting in significantly increased numbers of T-cells including those with specificity for a particular disease target. Another approach is to generate only antigen-specific CTLs ex vivo by stimulating their growth with antigen-specific dendritic cells or other antigen-specific presenting cells. Clinical trials have demonstrated that both kinds of T-cell therapy can be very effective to treat cancer and viral infections. Other companies and institutions have initiated clinical trials to demonstrate CTL effectiveness. The ex vivo production of these cells under conditions for use in medical treatment represents a critical step in the advancement of this therapy and the AastromReplicell™ System in being developed to support this application.

     We have developed our Dendricell™ products to provide a base dendritic cell for certain of these emerging immunotherapies. Following CE Mark approval, we are selling the Dendricell™ products in Europe. In the U.S., we intend to sell the Dendricell™ products for clinical research use, and we are evaluating plans to develop our own proprietary cancer vaccines, subject to additional funding or strategic partnerships

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 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 therapy 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.

Aastrom’s Single-Pass Perfusion for Human Cell Growth

     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. 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

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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 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.

The AastromReplicell™ System

     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 other cell types. The AastromReplicell™ System is comprised of several components, including single-use therapy kits such as the OCG-I, SC-I, OC-I, DC-I, DCV-I and DCV-II Therapy kits, and microprocessor-controlled instruments. The single-use therapy kits include an AastromReplicell™ System Cell Cassette cartridge which contains our proprietary cell culture chamber, supply and waste reservoirs and harvest bag and 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 medical or laboratory technician and can implement clinical-scale cell production at the patient care site. The endpoint of the AastromReplicell™ System process is a blood-bag containing cell product. The control and documentation features of the AastromReplicell™ System have been designed to meet GMP requirements for the therapeutic production of cells. The product configuration of the AastromReplicell™ System consists of an instrumentation platform that can be integrated within the hospital or other centralized facility operating a variety of single-use therapy kits that are specific to the desired medical application. The System can be scaled-up producing simultaneously multiple independent cell batches and is suitable for installation in a regional or de-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 product design of the AastromReplicell™ System will allow us to develop additional cell therapy kits to provide a commercialization pathway for a number of emerging cell therapies being developed by other researchers.

Potential Advantages of AastromReplicell™ System

     The AastromReplicell™ System is designed to enable a cost-efficient and minimally invasive alternative, or supplement, to existing procedures, which could offer numerous advantages for both patients and medical staff:

     The AastromReplicell™ System can generate larger quantities of cells from a small starting sample. Alternative procedures to obtain the large quantity of stem cells necessary for transplantation require a patient to endure up to multiple hours of procedure time or up to approximately 100 invasive needle sticks to obtain the necessary quantity of stem cells required for the transplant. The AastromReplicell™ System offers an alternative that requires less than two hours of procedure time and significantly fewer needle sticks.

     Pre-clinical tests have demonstrated tumor cell purging of certain cancer cells in the AastromReplicell™ System expansion process. Cancer patients with tumor metastases, in which the cancer has spread to the blood and bone marrow, have not traditionally been candidates for autologous stem cell transplants because such transplants might reintroduce cancer cells into the patient. Moreover, patients may have undetected tumor cells present in their marrow or PBSC transplant, which could re-establish cancer in the patient following transplant. Our initial pre-clinical results, as well as studies conducted by third-party investigators, have shown that some primary human tumor cells die or do not grow during hematopoietic cell culture. The smaller volume of starting cells used for the AastromReplicell™ System compared with bone marrow harvest or PBSC transplants may provide approximately 10 to 70 fold less tumor cells in a transplant.

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     Further, in an evaluation of 14 tumor-contaminated bone marrow samples that were expanded with the AastromReplicell™ System process, the presence of breast cancer cells in each sample was either substantially reduced or was no longer detectable. Tumor cells that were detectable after expansion in the AastromReplicell™ System showed a significant reduction in clonogenicity (the ability to replicate). We believe that this combination of passive depletion during culture with the lower starting volume of tumor cells may result in a tumor-free or tumor-reduced cell product for transplant. The clinical benefit of such tumor depletion, if any, will vary depending upon the type of cancer and state of disease.

     Supplemental therapy with AastromReplicell™ System produced cells. Collection of cells for transplant is a variable procedure requiring longer collection procedures for some patients compared to others. The AastromReplicell™ System offers a means to augment current collection techniques, thereby reducing variability and the overall collection burden for the patient and care provider. For some patients, these standard collection techniques are unable to collect enough cells for a therapeutic dose and the AastromReplicell™ System offers a means to obtain the required cell volumes to permit continuation of treatment.

     The AastromReplicell™ System automates the process of growing human cells and is designed to be used directly in a hospital setting. Growing human cells has largely been a research laboratory process, requiring substantial time and technical expertise. The AastromReplicell™ System is designed to provide sterilely-closed, automated cell production capabilities directly at the patient care site in compliance with regulatory standards, providing process reliability and reducing the need for highly skilled operators.

Product Development

     The AastromReplicell™ System is an automated clinical system designed to produce therapeutic cells for the treatment of a broad range of diseases, including cancer, infectious diseases and the restoration of solid tissues.

     The AastromReplicell™ System is designed as a family of products consisting of an instrumentation platform that operates single-use, patient-specific therapy kits. Each therapy kit, which is specific to the desired cell or tissue type, is operated by the AastromReplicell™ System instrument platform, which automates the otherwise complex cell production processes. This instrument platform allows for on-site cell manufacturing that is compliant with GMPs. The process instructions contained within each therapy kit, and where applicable, the reagents, growth medium and cytokines, are specific for the production of each cell type. This product design feature provides for a variety of therapy kits to be integrated into the AastromReplicell™ System product line.

Prescription Cell Products

     Our initial development efforts had been 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 in this market has led to the discontinuance of further product development in this area. Our current product development efforts are focused on the development of bone marrow stem cells for use in orthopedic indications (OCG-I product for bone grafting and OC-I product for osteoporosis) and the development of bone marrow stem cells for use in vascular system regeneration (VC-I product). 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 in current development for OCG-I to demonstrate bone formation in patients with large bone fractures. Opportunities for the utility of bone marrow stem cells in cardiac repair are being evaluated. 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.

Cell Production Products

     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 cells, keratinocytes and neuronal cells. For example, Aastrom recently 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

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specialized, environmentally controlled facilities; (v) providing greater accessibility of these procedures to care providers and patients; and, (vi) in certain cases, 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. These business opportunities are dependent upon successful development and regulatory approval of these novel cell therapies. These novel therapies may not be successfully developed by other companies or approved by applicable regulatory authorities, and our processes or product candidates may not be able to be successfully applied in such therapies. In addition, we may be required to obtain license rights to such technologies in order to develop or modify existing or future products for use in such therapies. We may not be able to obtain such licenses and such licenses, if available, may not be obtained on commercially reasonable terms. See “Clinical Development” and “Business Risks.”

     Research and development expenses for the fiscal years ended June 30, 2001, 2002 and 2003 were $4,983,000, $5,428,000 and $5,647,000, respectively.

Clinical Development

     The clinical trial direction of our studies has been influenced by observations limiting the scope of hematopoietic stem cell transplantation and by observations that our bone marrow cell products may be suitable as an adjunct to substantial market opportunities in bone and blood vessel regeneration.

Planned Activities

     In reviewing the pre-clinical and clinical data for our bone marrow cell products in various Aastrom supported trials, we have noted a substantial increase in the mesenchymal stromal cell content. Mesenchymal stromal cells are integral for bone marrow to generate non-hematopoietic tissues such as bone and cartilage. Our bone marrow cell product had been given to one patient, on a compassionate basis, with a congenital genetic defect (hypophosphatasia) which results in a lethal condition of abnormal bone and cartilage formation. This compassionate use treatment, now published in the Journal of Bone and Mineral Research, resulted in sustained bone formation in the child that has continued after expanded cell infusion. Subsequently, we have demonstrated in the laboratory that our expanded bone marrow cell product is capable of forming bone. Based on these pre-clinical and clinical observations, we are now preparing to initiate clinical trials for bone regeneration in patients with severe fractures who require the addition of bone forming cells to their fracture site. The results of the fracture studies may allow our bone marrow cell product (termed “OCG-I”) to also be used as an adjunct to spinal fusion surgery after appropriate clinical trials and review by the FDA. The market value of these two orthopedic procedures is substantially greater in comparison to the static and rather limited hematopoietic stem cell market. We are also planning to evaluate OCG-I cells to augment dental bone engraftment treatment as a method to improve the well-being of patients.

     Our bone marrow cell product has also been demonstrated in the laboratory to contain a substantial number of cells capable of both forming and stimulating blood vessel growth. We are considering concepts of studying expanded bone marrow cells for the treatment of peripheral vascular disease based on clinical observations of efficacy using large volumes of unexpanded bone marrow cells.

     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.”

Previous Activities

     The AastromReplicell™ System and certain cell products produced using this system have been evaluated in multi-site clinical trials in the U.S. under Investigational Device Exemption (IDE) and Investigational New Drug (IND) from the FDA. The initial goals of our clinical trial program were to obtain a Pre-Market Approval (PMA) in the U.S., necessary to market the AastromReplicell™ System for autologous hematopoietic stem cell support after high-dose cytotoxic therapy for the treatment of patients with carcinoma of the breast or lymphoma, and to support European marketing activities.

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     Recent discussions with the FDA have indicated that the cell products will now require a Biologics License Application (BLA) for product registration, which was not originally expected or planned.

     We have conducted clinical trials in the U.S. evaluating bone marrow cells produced in the AastromReplicell™ System from a small starting amount of the patient’s own bone marrow. Results from initial studies demonstrated the ability of the AastromReplicell™ System to safely and reliably produce stem and progenitor 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.

     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. This procedure appears to improve the certainty of hematopoietic engraftment by providing a more reliable means of cell collection and blood count recovery.

     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:

	1)		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.
	2)		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.
	3)		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.
	4)		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.

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 significantly affect the rate of hematopoietic recovery. We had extended these trials into a comparative adult trial with concurrent controls. Recently, the clinical enthusiasm for the use of CB for the treatment of adults has diminished with the identification of increased morbidity and mortality when compared to pediatric patients receiving CB transplantation. The increased morbidity was due to delayed hematopoietic and immunological recovery. The waning enthusiasm for CB transplants for adults has caused Aastrom to halt its CB comparative trial due to the very diminished market opportunity. Our research has identified alternative approaches with our technology using stromal cells for ex-vivo production of CB cells. We may later pursue a clinical evaluation of one or more of these approaches.

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. During the formation of this alliance, MTF purchased, for cash consideration of $750,000, 1,759,112 shares of our

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common stock pursuant to a private placement. During the formation of this alliance, MTF purchased, for cash consideration of $750,000, 1,759,112 shares of our common stock pursuant to a private placement which required subsequent registration. We have no information as to if, or when, MTF would sell its shares.

     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 matrices and our Tissue Repair Cells (TRCs). The companies will share in the development and clinical trial expense of these treatment approaches and products, and will adopt a coordinated promotion and marketing strategy for future products. In addition to the initial focus of allograft-based bone graft treatments employing combination products, the companies will explore new approaches for the regeneration of joint cartilage, as well as effective combinations of TRCs with MTF’s new ceramic technology.

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 AastromReplicellTM 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. The agreement provided for Immunex to receive up-front and renewal fees totaling $5,500,000. The amended agreement, allowed us to extend the term for successive two-year terms upon written notice and was subject to certain minimum purchase requirements. We have provided a notice extending the agreement through March 2003, and 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.

     In December 1996, we entered into a Collaborative Supply Agreement with Anchor Advanced Products, Inc., Mid-State Plastics Division (MSP), now a division company of Moll Industries. Under this agreement, MSP conducted both pre-production manufacturing development and now performs commercial manufacturing and assembly of the Cell Cassette component of the AastromReplicell™ System for us. Throughout the term of this agreement, we have agreed to treat MSP as our preferred supplier of Cell Cassettes, using MSP as our supplier of at least 60% of our requirements for Cell Cassettes. The term of the manufacturing agreement is seven years, expiring in December 2003. Moll, which had filed for bankruptcy in September 2002, has announced that effective June 5, 2003 its plan of reorganization was confirmed by the courts and that it officially emerged from bankruptcy with a plan that became effective June 24, 2003. We are currently negotiating a new agreement with Moll. We retain all proprietary rights to our intellectual property that is utilized by MSP 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 to one other issued U.S. patent. These patents present claims to: (i) certain methods for ex vivo stem cell division as well as ex vivo human hematopoietic stem cell stable genetic transformation and expanding and harvesting a human hematopoietic stem cell pool; (ii) certain apparatus for cell culturing, including a bioreactor suitable for culturing human stem cells or human hematopoietic cells; (iii) certain methods of infecting or transfecting target cells with vectors; and (iv) a cell composition containing human stem cells or progenitor cells, or genetically modified stem cells, when such cells are produced in an ex vivo medium exchange culture. Certain patent equivalents to the U.S. patents have also been issued in other jurisdictions including Australia and Canada and under the European Patent Convention. These patents are due to expire beginning in

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2006. In addition, we and our exclusive licensors have filed applications for patents in the United States and equivalent applications in certain other countries claiming other aspects of our products and processes, including a number of U.S. patent applications and corresponding applications in other countries related to various components of the AastromReplicell™ System.

     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 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 failure to either develop a commercially viable alternative or obtain such licenses could result in delays in marketing our proposed products or the inability to proceed with the development, manufacture or sale of products requiring such licenses, which could have a material adverse affect on our business, financial condition and results of operations. If we are required to defend ourselves against charges of patent infringement or to protect our proprietary rights against third parties, substantial costs will be incurred regardless of whether we are successful. Such proceedings are typically protracted with no certainty of success. An adverse outcome could subject us to significant liabilities to third parties and force us to curtail or cease our development and sale of our products and processes.

     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

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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.

Research and License Agreements

     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.

Regulatory Process in the United States

     Our products are potentially subject to regulation as medical products under the Federal Food, Drug and Cosmetic Act, and 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 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^TM 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 medical devices and 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.

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     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.

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Product Approval

     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.

     Some of our products may be classified as Class III medical devices. The FDA categorizes devices into three regulatory classifications subject to varying degrees of regulatory control. In general, Class I devices require compliance with labeling and record keeping regulations, Quality System Regulation (QSR), 510(k) pre-market notification, and are subject to other general controls. Class II devices may be subject to additional regulatory controls, including performance standards and other special controls, such as post-market surveillance. Class III devices, which are either invasive or life-sustaining products, or new products never before marketed (for example, non-“substantially equivalent” devices), require clinical testing to demonstrate safety and effectiveness and FDA approval of a PMA prior to marketing and distribution. The FDA also has the authority to require clinical testing of Class I and Class II devices.

     We, and any contract manufacturer, may be required to be registered as a medical device manufacturer with the FDA. These manufacturers will be inspected on a routine basis by the FDA for compliance with the FDA’s QSR regulations. These regulations would require that we, and any contract manufacturer, design, manufacture and service products and maintain documents in a prescribed manner with respect to manufacturing, testing, distribution, storage, design control and service activities. The Medical Device Reporting regulation requires that we provide information to the FDA on deaths or serious injuries alleged to be associated with the use of our devices, as well as product malfunctions that are likely to cause or contribute to death or serious injury if the malfunction were to recur. In addition, the FDA prohibits a company from promoting an approved device for unapproved applications and reviews company labeling for accuracy.

     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 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

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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. The BLA describes 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.

Regulatory Process in Europe

     The AastromReplicell™ 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 European Union (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.

     The MDD vest 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™ 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 European Union. 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.

Competition

     The biotechnology and medical device industries are characterized by rapidly evolving technology and intense competition. Our competitors include major pharmaceutical, medical device, medical products, chemical and specialized biotechnology companies, many of which have financial, technical and marketing resources significantly greater than ours. In addition, many biotechnology companies have formed collaborations with large, established companies to support research, development and commercialization of products that may be competitive with ours. Academic institutions, governmental agencies and other public and private research organizations are also conducting research activities and seeking patent protection and may commercialize products on their own or through joint ventures. We are aware of certain other products manufactured or under development by competitors that are used for the prevention or treatment of certain diseases and health conditions that we have targeted for product development. There can be no assurance that

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developments by others will not render our product candidates or technologies obsolete or noncompetitive, that we will be able to keep pace with new technological developments or that our product candidates will be able to supplant established products and methodologies in the therapeutic areas that are targeted by us. The foregoing factors could have a material adverse affect on our business, financial condition and results of operations.

     Our products under development are expected to address a broad range of existing and new markets. We believe that our stem cell therapy products will, in large part, face competition by existing procedures rather than novel new products. Further, in instances that do not require our patented processes for growing cells, we will face competition for our products from existing manual cell culture techniques, which techniques may be viewed by potential customers as more cost effective than our process. Our competition will be determined in part by the potential indications for which our products are developed and ultimately approved by regulatory authorities. In addition, the first product to reach the market in a therapeutic or preventive area is often at a significant competitive advantage relative to later entrants to the market. Accordingly, the relative speed with which we, or our potential corporate partners, can develop products, complete the clinical trials and approval processes and supply commercial quantities of the products to the market are expected to be important competitive factors. Our competitive position will also depend on our ability to attract and retain qualified scientific and other personnel, develop effective proprietary products, develop and implement production and marketing plans, obtain and maintain patent protection and secure adequate capital resources. We expect our products, if approved for sale, to compete primarily on the basis of product efficacy, safety, patient convenience, reliability, value and patent position.

     Aastrom competes in several key business segments. Within each business segment, we believe there are multiple competitors including the following competitors: (i) Tissue Repair Cell: Genzyme Corporation, Osiris Therapeutics, Inc. , Isolagen, Isotis and Johnson & Johnson are active in the market, (ii) Dendritic Cells: Dendreon Corporation, Genzyme Corporation, Immuno-Designed Molecules (vaccine market only), and (iii) Cell Production Products: Baxter Oncology, Miltenyi Biotec, Inc., and Nalge Nunc International.

Employees

     As of August 13, 2003, we employed approximately 44 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 13, 2003, are as follows:

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     R.     Douglas Armstrong, Ph.D. joined Aastrom in June 1991 as a Director, and as its President and Chief Executive Officer. In 1999, Dr. Armstrong was elected as Chairman of Aastrom’s Board of Directors. From 1987 to 1991, Dr. Armstrong served in different capacities, including Executive Vice President and Trustee of the La Jolla Cancer Research Foundation (LJCRF), now named the Burnham Institute, a 250-employee scientific research institute located in San Diego, California. Dr. Armstrong received a Bachelor of Arts degree in Chemistry from the University of Richmond, and a Doctorate in Pharmacology and Toxicology from the Medical College of Virginia. Dr. Armstrong has held various faculty and staff positions at Yale University, University of California, San Francisco, LJCRF and University of Michigan. In addition, he was a participant in the formation of Telios Pharmaceuticals, Inc., has served on the boards of both biotechnology companies and a venture capital fund, and currently serves as Chairman of the Board for the Center for Cell Therapy.

     Robert J. Bard, J.D., R.A.C. joined Aastrom in October 2002 as Vice President Regulatory Affairs & Quality Systems with over 29 years of extensive domestic and international regulatory experience in the pharmaceutical, medical device and biotechnology sector. Prior to joining Aastrom, Mr. Bard served in several senior management capacities for a number of other companies in the medical industry, including: Gliatech, Inc., McKinley Medical, LLLP, I-Flow Corp., IVAC Corp. and Ultra Medical Devices, Inc., where he was responsible for regulatory compliance, quality assurance and manufacturing operations for biotech pharmaceuticals and medical devices. Mr. Bard earned a law degree from the American College of Law, and has a B.S. in Microbiology, with a minor in Biological Chemistry, from the University of California-Los Angeles. In addition, he has studied Pharmaceutical Sciences at Idaho State University and Mechanical Engineering at California State University-Long Beach. Mr. Bard is a member of the California Bar. He completed his ISO 9001 Lead Assessor Training in 1995, is a certified member of the Regulatory Affairs Professional Society, and is an ASQ-certified Quality Engineer. Mr. Bard is also the author of numerous professional and scientific papers and articles.

     Brian S. Hampson joined Aastrom 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™ 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 a Bachelor of Science and Master of Engineering degrees in Electrical Engineering from Cornell University.

     Steven N. Wolff, M.D. joined Aastrom in April 2001 as Vice President Medical Research. Prior to joining Aastrom, Dr. Wolff held various distinguished positions at the Vanderbilt University School of Medicine, most recently as Professor of Medicine in the Division of Hematology/Oncology, and as Director of the Bone Marrow Transplant Program. In addition, Dr. Wolff has served on the National Marrow Donor Program Council from 1995 to 1997, as the Council’s President in 1997, and as the Chairman of the Finance Committee. Currently, Dr. Wolff participates as a Board Member for the Lance Armstrong Foundation, having served as Board President in 1998. Dr. Wolff holds an M.D. from the University of Illinois, with postgraduate training at Vanderbilt University School of Medicine and Washington University School of Medicine, and holds an undergraduate degree from Queens College. Dr. Wolff’s role with Aastrom changed effective August 31, 2003. At that time, Dr. Wolff relinquished his executive officer status as Vice President, and moved to a consulting role with the Company. In this capacity, Dr. Wolff will continue to provide Aastrom with leadership in the clinical trial and research areas. The new role will allow Dr. Wolff to resume his activity in academic medicine.

     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. 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.

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ITEM 2. PROPERTIES

     We lease approximately 23,000 square feet of office and research and development space in Ann Arbor, Michigan under a lease agreement expiring in December 2004. 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.

ITEM 3. LEGAL PROCEEDINGS

     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.

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

     None

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

     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 applicable Nasdaq Market:

Price Range of Common Stock

     As of August 31, 2003, there were approximately 542 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.

     In May 2003, we issued in two separate transactions a total of 1,759,112 share of our common stock to Musculoskeletal Transplant Foundation (MTF) for an aggregate of $750,000. These shares were sold in a private placement under the exemption from registration provided by Section 4(2) of the Securities Act.

     In September 2002 and February 2003, we agreed to issue warrants for public and investor relations services. Under the terms of these agreements one holder is entitled to purchase 600,000 shares of common stock at $0.75 per share through December 19, 2004, and the other holder is entitled to purchase 100,000 shares of common stock at $0.50 through February 4, 2004. In addition, we have agreed, subject to a placement agreement to issue a warrant to purchase 97,595 shares of common stock at $0.91 through June 6, 2005. A placement was completed in June 2003. These warrants are issued in private transactions to investors who a